UMEME IPO: Thinking aloud & The HERD

Finally the UMEME IPO is on and below we basically think aloud on some of the main issues, as a retail investors, we are considering so as to make an informed decision on whether to or not to participate in this IPO.

IPO Vitals
Company: UMEME Limited 
Country: Uganda
Sector: Energy, Distribution
Opening date: 15th October 2012
Price per share: 275/=
Shares on offer: 622,378,000
Grant Shares: 13,500,000
Incentive Shares: 18,048,400 (To be issued from Umeme Holdings Ltd)
Expected proceeds from IPO: 171,153,950,000/=
Cost of offer: 20/= per share
Transaction Advisor: Stanbic Bank Uganda Limited
Lead Broker: African Alliance Uganda Limited
Offering Shareholder: Actis, a British private equity firm
Closing time and date: 5p.m Uganda time on the 7th November 2012
Prospectus: 298 pages document
Allocation announcement: 14th November 2012
Listing date: 30th November 2012


Offer for Sale-Offer for subscription: What is the difference?
On offer for sale there are 350,000,000 (out of 1,338,300,000) shares issued and fully paid up by the listing shareholder, the offer for subscription is from the unissued share capital amounting to 272,378,000. Both of these offers are from the Authorised share capital of 1,800,000,000 shares. Well offer for sale shares existed before the IPO and the subscription ones did not- they were apportioned for this IPO and will have a share dilution effect of around 20% of the paid up share capital. Investors in such a scenario going forward should be keen on indicators like Earnings per Share (from where dividends per share are derived) as such corporate action is reflected therein considering that the impact of this 20% dilution will only arrive, so to speak, in the company books after the IPO, below we tackle the likely impact of this in the offer price discussion.


  275/=: offer price is it too high/low or what?

Share prices being high/low are not about the numerical ‘bigness’ of the figure it is about the value from the price or utility in economic terms. It simply means how much capital accumulation value or dividends it actually pays and in the world of the stock market equities it’s about the earnings per share (hinged on capital appreciation/depreciation). Notably dividend per share which is the portion paid out to shareholders from earnings per share.

Earnings per share is the half component for price valuation, the other being the actual price set  per share in this very UMEME instance for 2011 we compute:

Earnings per share= Net profit/number of share = 23,011,000,000/= /1,338,400,005 shares = 17/=
This therefore means that each UMEME share earned 17/= a share at the end of 2011 Offer subscription effect, on assumption the IPO is fully subscribed with *Crested Stocks and Securities Kampala UMEME Initiation of coverage report date 1st October 2012’s profit forecast
Earnings per share= Net profit/number of share = 36,215,041,000/= /1,624,278,005 shares = 22/=
This therefore means that each UMEME share might earn 22/= a share at the end of 2012 (compared to 27/= without subscription dilution), never the less a remarkable earning improvement.
On 275/= IPO price valuation
P/E or Price Earnings ratio: The lower the P/E the better the bargain
End of 2011 P/E= Price/Earnings per share = 275/17 = 16
End of 2012 P/E= Price/Earnings per share = 275/*22 = 12.5
To demystify the P/E ‘thing’ it basically comes down to how many years will it take an investor to recoup his/her today price in terms of earning, like for Kampala’s developed Real Estate deals the P/E is between 8 and 10- it takes 8 to 10 years once one buys a property to get back their initial investment money through rent.
For the purpose for this analysis we shall take the end of 2012 forecast of 12.5 as the PE considering the year is closing and relate it with the Kenya Power and Lighting Company (KPLC) listed on the Nairobi Stock Market: KPLC 17th October standing share price- 18.5 Kshs
                                              KPLC                                                   UMEME
Share Price                            18.5 Kshs (555 Ushs)                            275 Ushs
Market Cap                            35b Kshs (1,050b Ushs)                     447b Ushs
EPS                                       2.33 Kshs (69.9 Ushs)                             22 Ushs
Dividend                                  0.2 Kshs (6 Ushs)                                        -
P/E                                           7.7                                                          12.5
1 Kshs = 30 Ushs
Industry PE-12.9
Sector PE- 14.27 (Source: Reuters 2012)
Star Traders’ take: FLAT PRICED
The UMEME’s IPO price is at the brink of the industry’s Price Earnings valuation threshold therefore has no DISCOUNT; price discount is standard practice for any Initial Public Offering. We suspect that the subscription shares wiped out a would be discount, however it is important that would be investors know that the P/E determines only today’s price based on historical information and that UMEME as a distribution monopoly could easily double her net profits with the coming of the Karuma 600Mw dam earliest 6 years from today. Many times a numerically high price is confused for expensive, but is about affordability in terms of the difference between retail and wholesale trade.

Offer Allocation
International Pool- 46% (78.7b Ushs) constitutes foreign institutional investors’ or THE HERD! Domestic Pool constituting of: Employees & Directors 9% (15.4b Ushs), Retail East Africans 20% (34.2b Ushs) and Qualified Institutional Investors’ which are the East Africa NSSFs25% (42.7b Ushs) Below we have analysed this skewed allotment towards the International pool, who through book building actually determined the 275/= price for the IPO, Why skewed: the difference in cost or acquisition of investment capital or savings between the domestic and international pools in regards to macro economic factors like inflation coupled with the leverage to the International pool
Star Traders’ take: TOO MUCH INTERNATIONAL CLOUT AND FREEBIES
UMEME’s allotment is tailor made for the Institutional investors’, however this could have been the most sensible course of action considering UMEME’s perception real or imaginary amongst the Ugandan Public. No doubt the grant share to her 1,300 employees is to ensure fulfillment of the 1,000 minimum shareholders requirement for listing on Uganda’s only Stock Market. The illusionary freebies shares, in grants and bonus, worth 8.6b Ushs coupled with the non cash paying International pool and Qualified Institutional Investors could spark off a post IPO speculation run, after all above 50% of IPO does not involve cash ‘I got free shares and hey I only provided a bank guarantee to secure my allotment’ This allotment policy of almost nothing for something could lead to persistent oversupply of shares post IPO just like it happened at the Safaricom counter in 2008 the irony being that since listing in 2008 Safaricom has never made a loss as a business entity but even four years on it continues to trade below its IPO price of 5 Kshs.


Dividends and Utility companies Vis a Vis UMEME
Utility companies’ business models are high initial investment and thereafter a stable period of constant dividend, UMEME as a distribution player in the Power utility arrangement in Uganda, is very much in the initial investment period for sometime considering a 9% country population power usage penetration coupled with stable power demand of 12% per annum going forward. They say they need to roll-out prepaid metering which could cost them about $300m. Further investment required to expand the distribution network and refurbishing old lines like the $3m to be used for the Northern Line to Gulu serving areas like Lira, Apac and Masindi.

Reading the prospectus UMEME promises a 50% net profit pay out as dividend, this in business sense is unrealistic and downright careless, why would one secure credit to grow instead of cheap retained earnings- we bet Actis the current controlling shareholders now and even after IPO understands this very well and she goes on to indirectly but clearly explain the possibility of recalling this promise amongst Risk factors section 14 of the prospectus notably on page 133 “The Company may not be able to fulfill its dividends policy in future” You know why else would half the proceeds of this IPO go to clearing the shareholders loan, it’s to reduce risk of the controlling shareholder and besides like still under risk of offer Actis points out the risk of her being in control of management on page 132 and for me this points to the fact that Actis will have her cake and eat it; reduce her risk while not paying dividend but in the midst earn dividends through other avenues like management fees (page 196) and a possibly through preference shares which is an agreeable form of a shareholders loan.
Star Traders’ take: FORGET DIVIDEND, just salesman talk
UMEME is rightly supposed to grow and that calls for cash, cheap cash so forget dividend- for the other shareholders of course. In this regard investment in this IPO has got to be over the long term, we expect dividend payments could be massive from 2022 through the concession negotiations period and either at closure or renewal in 2025; this investment is a capital gains one, at its stage of development of putting down infrastructure (needing cheap finances to deliver on this) it would be naïve to expect and even demand for dividends.


Directors: Roles and Interests 
The major or ultimate shareholder who has the absolute hand in Director appointment and approval basically controls all affairs of a company, therefore Directors only secure interests of their appointing/disappointing authority in our case for UMEME it is Actis. We commend Actis for a well thought out and assembled six man Board and below we give a brief on their: individual clout, interests and roles: Chairman Bitature- He is the young energetic guy on board with versatile political connections in the country and also being the major shareholder in the Tororo based 48MW thermal plant Electro-Maxx which guarantees his genuine interest in the sector therefore making him part of the intertwined power supply chain. Mr Mulwana- At Star Traders’ Mzee Mulwana plays the role of what we call the ‘Phone Call Director’ these are individuals have been around seen all and now in advanced ages with real clout cultivated over time, they play no technical Board role but come in handy in times of serious external policy decision direction or access to the people/politicians in control of the fate of such policy decisions; For UMEME his role is about the concession: secure terms fair to the company and probably its renewal. Why Phone call Director? Because it literally takes one phone call from such Directors to access real power, to calm any situation, in a country like Uganda. Stuart David- This is the man from Actis, when you read the detailed Board section it is not hard to discover that he is the brain engine behind UMEME, as the representative of the Ultimate shareholder he holds more power in the Board room regarding the technical side of the business no wonder he sits on all of UMEME‘s Five Board Committees. Directors: Chapman, Maamar,Ian- these are purely technical input Directors with Chapman as Managing Director, Maamar with excellent independent understanding of the Power sector in Africa and Ian as Chair Audit committee.
Star Traders’ take: WELL ALIGNED BOARD
UMEME’s Board is a practically excellent Board, the only concern is that Actis has got absolute power over it and it will remain like this going forward, they will have the leeway to mostly influence the Actis interests even if they are detrimental to the other shareholders just like it is explained under the risk of shareholding. We would not change this Board composition though. Note that the Directors together with the employees are entitled to incentive shares of 10% limited with in their 9% pool, for other UMEME customers this is capped at 100,000 shares, watch especially Mr Bitature holding after IPO.


The HERD
The Bank of Uganda Governor on TV always threatens to burn their fingers this is usually when the Bank’s interventions are not delivering on say curbing inflation and stabilizing the economy. Who are they? SPECULATORS, International speculators trading in the debt side of the Securities Market Similarly Equity Speculation is rife during IPOs and when The HERD is given opportunity they pounce. The HERD is a group of international investors who are transactional in nature, sharp and have extensive knowledge, experience and financial muscle to execute small and big opportunities alike, they operate on small margins and could typically be termed as roaming capitalists. Every Herd needs a Herdsman to deliver them, for this IPO the Herdsman is one Mr Patrick Mweheire the visible in-charge of the Transaction Advisor /Book Runner Stanbic Bank Uganda Limited (Patrick is immediate past CEO of Renaissance Capital a Russian Private Equity firm he was based in Nairobi and under his stewardship RenCap tremendously grew handling deals outside Kenya in Rwanda, Burundi and DRC, we at Star Traders’ opine that he is a very talented regional Ugandan of the same kind as Chris Mwebesa the former Ugandan CEO of the Nairobi stock market ). To give a deeper understanding of The Herdsman motivation refer to page 253; All this works in a highly beneficial environment, the Herdsman secures a bigger portion for The HERD which on top of transaction fees secures that part of selling commission in a nutshell of the 20/= per share expense on this whole IPO The Herdsman will be entitled to close to 30% or 6/= per 275/=. Through Book building The HERD set the price for this IPO, it has been apportioned 46% of the IPO under the International pool arrangement and from press reports this is already oversubscribed; but HOLD- The HERD is highly leveraged in that they only provide Bank guarantees and will only pay on confirmation of shares they are allocated, this is where the speculation catch is- too much leverage creates an unfair trading field for trading stocks that is selling without putting down real money.

Star Traders’ take: 

INTERNATIONAL POOL- 46% of the IPO to Foreign (outside East Africa) Investors

The Qualified Institutional investors (East Africa’s NSSFs’) also enjoy this Bank guarantee investment leverage accorded to The HERD. For us this is the biggest risk of investing in this IPO- doing so alongside a class of highly leveraged and better positioned investors in an IPO literally made for them- from price determination by the book building exercise with participation exclusive to the foreign investors, to allocation of almost 50% of the IPO shares on offer. One of the upside of The HERD is that they move markets, when given less IPO allocation than they want they create demand with the opposite of when given huge IPO allocation they unload.

Just like the migration beasts in the wild, the herd’s stampede leaves no grass in its trail, for the UMEME IPO we believe this is a trail made for the HERD.

The 10% share bonus (limited to 100,000 shares for the Uganda UMEME consumers investing) just does not add up to the head start given to The HERD, coupled with the employees and directors grant shares this leads to a possibility of quickly unloading these gift shares worsening the whole supply stampede.

History never repeats itself, Stupid! It is the behaviors that lead to a similar historic event.

Cross listing by Introduction
From experience of cross listed firms from Nairobi on the Uganda Securities Exchange it is more of a Public Relations tool for these companies especially when they have a national operating business like Kenya Airways, Kenya Commercial Bank basically to give a presence, the fact is that some of these cross listing on the Uganda Stock Market have traded 0 shares in the last 12 months. Cross listing by introduction means that UMEME will want a presence without putting down shares for sale in Nairobi, who wants that especially considering that this if approved could be the very first cross listing for the Nairobi based Stock Exchange a 50 years plus market, national pride could be at play, It will be easier though if UMEME’s IPO is to attract a significant number of individual especially retail Kenyan shareholders’ to make their argument in Nairobi
Star Traders’ take: INCONSEQUENTIAL BUT WORTH PIONEERING
You know some years back there was talk of cross listing Stanbic Bank Uganda (Kenyan sister company is listed as cfc Stanbic), has not resurfaced again and considering the zero turnover impact of cross listed stock in Uganda we view this as inconsequential reason being that buying cross listed shares also entails factoring in foreign exchange rates at the time of trade; maybe East Africa could consider a similar currency for all her Stock Markets like in the Franco-phone West Africa. Also note that earlier UMEME information was that the IPO was to be dual both in Uganda and Kenya.


20% Retail East Africans and partly 25% Qualified Institutional Investors
For us this allocation is all about the concession bait, ‘We have Ugandans as part of shareholding, do you want them to lose their value holding’ this could be a catchy phrase during the concession renegotiation; very thoughtful though on the part of Actis.
Star Traders’ take: We would do the same in similar position.


Star Traders’ Last word on UMEME IPO: 
The IPO is flat priced, with the biggest risk being The HERD. Post IPO UMEME’s AGM could turn into Customer Complaints avenue; one of the adverts for this very IPO running goes like “I am Charles Chapman CEO UMEME buy shares and put me and my management to task we shall be happy to respond, and ends with slogan Power to the Consumer” UMEME is a structural monopoly true but it also single sources its power from UETCL; therefore for a monopoly dealing with another monopoly, those benefits of the monopoly are greatly diminished, and who says that monopolies are sure money makers, just check with the Rift Valley Railways in possession of the Kenya-Uganda Railways concession. 
We get a feeling of de ja vu especially regarding the striking behaviour similarities with the 2008 Safaricom IPO. Opportunity cost, UMEME’s 12.5 price earnings ratio currently is only better than Uganda Clays Limited (52) and close to the New Vision Limited (11.9) with all other PEs below 10. 
It is also double the Kenya Power and Lighting Company its equivalent in neighbouring Kenya’s valuation As Star Traders’ we are not taking part in this UMEME IPO, but we shall definitely consider the post-UMEME IPO in the secondary market. 
Our prediction is that UMEME could trade between 250/= and 350/= within the first twelve months of listing. 

Just thinking Aloud 
                                                              Star Traders’
                                                    www.eatrader.blogspot.com
                                                                Entebbe, Uganda.

 Pre-blog post comment: 

  WJA-Kireka 
 Well written yet somewhat confusing
 you speak highly of the board, and recognize its self and selfish interests 
you clearly point out that the sale is weighted to favor offshore investors, who are looking for modest returns 
You see it as a valuable long term investment but advise against IPO in favor of the later secondary market. 
 from your analysis, I would take a small IPO position, with reserve capital for the secondary market and average in over time for your 2025 projection