Why LIC listing challenge begins post IPO

Life Insurance Corporation, the bedrock for India's investment ecosystem and a brand with an unmatched following, is launching an initial public offering (IPO) soon. Market participants are labelling LIC IPO as "India's Aramco moment", comparing the scale and size of India's insurance giant with world's largest oil producing company Aramco, majorly owned by the Saudi Arabian government.

Like any commodity, equities in the capital market too work on demand- supply principle. If there is a scarcity of shares then the price of available pool of shares move up and reverse happens in case of abundance of shares.

Market participants believe that LIC is coming up with an IPO where the insurance giant will dilute only 5% equity for around ₹70,000-₹75,000 crore. After the IPO, it is believed, that LIC would fetch a market cap of around ₹14 lakh crore to ₹15 lakh crore.

LIC Listing Would Get Even More Interesting After The IPO

As per the Securities Contract (Regulations) Rules, LIC would need to dilute 25% equity within five years of listing. Roughly estimated, around ₹3.5 lakh crore worth of equity issuance should happen within five years. And that is how the LIC listing situation may get challenging for the government.

Does the Indian market have enough depth to absorb such large equity issuance?

Let us examine the texture and size of the Indian equity market.

For starters, asset under management (AUM) of domestic equity oriented mutual funds stand a tad over ₹13 lakh crore. As per SEBI guideline, no scheme can have more than 10% investment in a single company.

In an extremely unrealistically optimistic scenario, if all domestic mutual fund houses decide to take full 10% exposure in LIC, even then, they would invest only up to ₹1.3 lakh crore, still leaving about ₹2.2 lakh crore worth of equity untouched. Realistically, much more of that ₹2.2 lakh crore worth of LIC's equity absorption would become the onus of market participants like FIIs, HNIs, family offices and retail investors.

No FII To The Rescue

Foreign institutional investors are persistently selling Indian equities for the past few months. As per NSDL website, up to February 9, FIIs have sold equities worth ₹41,000 crore. The heavy selling in the first 40 days of the year indicate FIIs are not in a mood to remain invested in the overvalued Indian market.

For the record, Indian markets are currently trading at a heavy premium to emerging markets. MSCI India's one-year forward PE is currently at 24x versus 13x for MSCI Emerging Markets, implying a premium of 88%. This premium is on the higher side versus the historical average of 46%, says Amish Shah, head of India Research, Bank of America Securities.

Harendra Kumar, managing director at Elara Securities India, says FIIs are logically looking to take back some of the profits as India is now relatively expensive in relation to other emerging markets.

Reflecting the selling trend, FIIs ownership has dipped 50 basis points in December 2021 to 19.9% of NSE 500 companies. Between 2015 and 2021, FIIs ownership has hovered between 21% and 23%, informs Amish Shah.

What FIIs expect from LIC?

The US 10-year yield is above 2%. The Federal Reserve is on the path of raising interest rates. India's 10-year benchmark yield is around 6.75%. LIC being part of a sovereign is expected to give a return over and above what sovereign bond is yielding.

Accounting for currency hedging cost and impact cost, FIIs are looking for around 7% to 8% post tax return in dollar terms from LIC, says a market veteran on the condition of anonymity. As per the Greed and Fear report by Jefferies, rupee depreciated by around 1.7% against dollar in 2021. Such depreciation would also challenge any optimistic expectations return from LIC.

How much return LIC may garner in the first year of its listing would decide its subsequent dilution, he adds. Long term money committed by foreign pension and sovereign funds could only be possible if LIC management could chart a path to show how the company would provide 9%-10% returns to these funds.

This leads to the conundrum of 20% equity dilution by LIC while retaining the attractiveness of its shares, in the five years following the IPO.

What government did to make way for LIC IPO

The Government of India amended Securities Contracts (Regulations) Rules (SCRR), 1957 through a notification on June 19, 2021. The amended rule states- "at least such percentage of each class or kind of equity shares or debentures convertible into equity shares issued by the company equivalent to the value of five thousand crore rupees and at least five per cent of each such class or kind of equity shares or debenture convertible into equity shares issued by the company, if the post issue capital of the company calculated at offer price is above Rs one lakh crore rupees; Provided that the company referred to in this sub-clause (iv) shall increase its public shareholding to at least ten per cent within a period of 2 years and at least twenty-five per cent, within a period of five years, from the date of listing of the securities, in the manner specified by SEBI."

This move, many believe, was to make LIC IPO sweeter because it would have had to dilute 10% stake prior to the amendment. By tweaking the rules, the government paved the way for LIC to launch an IPO by diluting just 5% stake as it is a given fact that LIC market cap would exceed ₹1 lakh crore post issue.

The timeline for stake dilution has also been extended as per the new rules. However, LIC would still have to dilute 25% stake within 5 years of its IPO. And that is no mean feat, given the shallowness of the Indian market.

If the market forces are not conducive, what may LIC do to avoid diluting 25% stake?

It seems that the government, does have a trump-card up its sleeves, in the form of Section 19A Clause (6) of the Securities Contract (Regulations) Rule 1956 - the central government may, in the public interest, exempt any listed public sector company from any or all of the provisions of this rule.

Whether this clause is put to use by the government to save LIC from losing its sheen in the stock market is a question that only the future may answer.