Primary Offer. IEX: Power at a price

The initial public offering (IPO) of 10-year-old Indian Energy Exchange Ltd (IEX) will open on October 9 in a price band between ₹1,645 and ₹1,650. The entire issue is an offer-for-sale with existing shareholders selling 60.65 lakh shares to raise ₹1,000 crore; no part of the IPO proceeds will go to the company.

The points in favour of the company are a robust exchange platform, its near-monopoly status in energy trading, decade-long experience and sound reputation. Its financials are also sound with steady growth in revenue and robust margins.

However, the company operates in an area where government policies and regulations can mar the business outlook significantly. Likely competition from a similar platform launched by the government is also a concern.

The asking price of the IPO also appears stiff when compared to the recent deal values in the company. Reliance Infrastructure, which had picked up 4.12 per cent stake in IEX when the exchange was formed, sold its stake in December last year; the transaction valued the company at ₹2,500 crore. At the IPO price, the company is valued at ₹5,000 crore. Nothing has changed in the last 10 months to justify doubling of the price.

The issue is priced at 44 times its 2016-17 earnings. This pricing seems influenced by the valuation multiples at which MCX and BSE are currently trading. Such comparison is, however, not right as the number of participants on IEX are just 5,900 compared to millions who trade on the other two exchanges. Two, speculation is not allowed on IEX; this restricts volume expansion.

Long-term investors can, therefore, avoid this issue and wait for a better price after listing. But given the frothy primary market conditions prevailing currently, listing gains cannot be ruled out.

IEX is the country’s largest energy exchange, leaving its immediate competitor, Power Exchange India, far behind. It was promoted by Jignesh Shah’s Financial Technologies (since renamed, 63 Moons Technologies) and PTC India Financial Services, neither of which hold any shares in the company now.

IEX’s customers are primarily electricity generators and buyers. Almost all of the trading volumes come from the short-term day ahead market (DAM), where sellers offer the electricity they intend to supply the following day in 15-minute blocks through the trading day. Some trading also takes place in the term ahead market (TAM), which are mostly bilateral contracts for selling specified quantum of electricity for specified time periods that could be up to 11 days. RECs (renewable energy certificates) and Escerts (Energy Savings Certificates) are also traded on the exchange though revenue from these products constitutes a minuscule part; Escerts trading, in fact, began only in September.

The entry barriers to this business are quite high, as there are restrictions in terms of limits on shareholding. Companies like NVVN, a subsidiary of NTPC, have baulked at the idea of entering this business. In its operations, IEX does not have many peers. Energy trading is still nascent in India and there is good long-term potential for energy exchanges.

IEX’s financials have also shown steady growth. Its revenue and profits have grown at a compounded annual growth rate of around 14.5 per cent between FY-13 and FY-17. The company’s operating profit margin was 74 per cent in FY-17 and net profit margin was 48 per cent. Growth and margins have been strong in the first quarter of FY-18 as well.

However, energy trading is a heavily-regulated business in India. Although envisaged in the Electricity Act, 2003, the concept of ‘open access’ or a free-market for electricity, has not quite taken off in India, mainly because State governments are not keen on it. Most of the electricity distribution companies (discoms) are State-government-owned and they frown at their customers, leaving them and buying energy from elsewhere. States have tended to dissuade open access by imposing heavy levies such as cross-subsidy charges and additional cross-subsidy charges, making free trade less attractive. Big States like Uttar Pradesh and Maharashtra are resisting energy procurers in their States from buying electricity over the exchanges. Other States might follow suit.

While it is evident that IEX is the dominant player with a 95 per cent share of the market, one development last year should concern its managers — something the prospectus dismisses with passing mention. Last April, the Centre launched an ‘e-bidding and e-reverse auction portal’ called DEEP, or Discovery of Efficient Electricity Price, meant for discoms to buy short-term power.

All State-owned discoms are mandated to buy short-term power on the portal. The Government has said that the scope of DEEP would be expanded to cover medium and long-term procurement of power too. By all accounts, DEEP is not as robust a platform as IEX. However, as it is backed by the government, it has the potential to offer stiff competition to IEX, stunting IEX’s ability to price its services.

Also, in India, derivatives on energy are not available. You might do forward trading, which means you have to actually supply or buy electricity on the specified date. As such, there is no scope for speculation in energy. The government’s intention is to protect end-consumers; therefore, giving permission for derivatives is unlikely. Even if derivatives are allowed, such products would be under the purview of SEBI and trading could be allowed on SEBI-regulated exchanges such as NSE, BSE or MCX.

There seems limited scope for improving participation dramatically with 50 distribution companies, over 400 electricity generators and over 3,900 open access consumers already registered for trading on the IEX. With the exchange mandated to enable energy trading, diversification would also be limited in the future.

Then there is also the question of jurisdiction for control over the exchange — the Central Electricity Regulatory Commission or the SEBI. The matter is still undecided. While this may not be a major risk factor, it is a blip of uncertainty on the radar.