Should you invest in LIC IPO? Is it Good or Bad for Your Portfolio?

LIC IPO- A Crowd Puller

LIC’S IPO is one of the crowd pullers of the current Indian Stock Market. LIC was formed in the year 1956 by merging & nationalizing 245 private insurance companies in India. LIC works with 2048 computerized branch offices, 8 zonal offices, and 113 divisional offices. LIC also has a network of 1,537,064 individual agents, 342 corporate agents, 114 brokers, 109 referral agents, and 42 banks for soliciting life insurance businesses.

LIC is the world’s largest in terms of domestic market share with more than 64.1% of total Gross Written Premium (GWP) as of 2020. Until 2000, it was the only Life Insurance Company in India.

The Saudi Arabian Oil Co (Aramco) brought in the world’s biggest Initial Public Offering (IPO) in 2019.

The Saudi government raised $25.6 billion by diluting just a 1.5 % stake, valuing the company at $1.7 trillion.

Now let’s talk about LIC IPO.

LIC IPO was deferred because of the market volatility as a result of the geopolitical situation.

The Indian government had planned to divest 5 % equity for Rs 65,000 crore ($8.7 billion) in the insurance behemoth Life Insurance Corporation (LIC). But recently they revised the plan to raise Rs.21,000 crore which is a 3.5% stake.

The LIC IPO will open on 2nd May for Qualified Institutional Buyers and on 4th May for subscriptions and close on 9th May.

You can bid for shares in a lot size of 15 shares and in multiples thereof.

No green shoe option will be available in the LIC IPO. (Green shoe means the right to sell more shares than initially planned.

If you bid successfully, you will get the shares allotted on 12th May. If you are unsuccessful in bidding, you will get the refund the next day (13th May). Shares will be credited to the Demat account by 16th May and the stock is expected to list on 17th May.

• 50% – Qualified Institutional Buyers (QIBS)
• 15% – Non-institutional Buyers
• 35% – Retail Individual Investors (RIIS)

LIC will be the largest IPO in India in spite of the reduced size.

Now, let’s analyze and review the LIC IPO, including its valuation and pricing. Should you invest in this LIC IPO? Will it give you a profit or loss for you? Let’s figure it out.

Table of Content

I.)Valuation of LIC’S IPO

• Embedded Value
• What’s the Reason for a massive leap in EV?

II.)Pricing – Can Investors Expect Profit from LIC IPO?
III.)Retail Individual Investor Standpoint for LIC IPO
IV.)Step Back From The Carnage In Dalal Street
V.)LIC IPO: Good or Bad for Your Portfolio?
VI.)A Replacement For LIC IPO?

Valuation of LIC’S IPO

As an investor, we will analyze financial metrics like PE RATIO, EPS & ROE before investing in that company. This is not the case for valuing Life Insurance Companies. The value of a life insurance company is evaluated by future profits that the existing business can generate.

This value is taken from the Embedded Value (EV) that represents the sum of the present value of all future profits from the current business and shareholders’ net worth.

Embedded Value

The Embedded value is a recognized method for the measurement of the value of life insurance companies. This is calculated by adding the net asset value (nav) of the firm’s capital and surplus to the present value of future profits of a firm. In simple words, it is the value that someone is ready to pay to buy the company as a whole or the value that is required to start a similar company.

As of 31 March 2021, the EV of LIC was Rs. 95,605 crores. But, according to The Draft Red Herring Prospectus (DRHP) filed on 13 February 2022, it is reported as Rs. 5.4 lakh crore., so the LIC IPO is valued at 1.1 times its Embedded value.

What’s the Reason for a massive leap in EV?

LIC would invest the collected premium & hold the profits arising out of these investments in a single fund called Life Fund. This is shared between the policyholders (in the form of bonuses) and shareholders (which is the government, in the form of dividends) in the ratio of 95: 5.

An amendment was made last year in sec 24 of the Lic Act. As per this Amendment, the surplus in the participatory fund would be shared between policyholders and shareholders in the ratio of 90: 10. On the other hand, the surplus in the non-participatory fund will be fully available for distribution to the shareholders. That’s the reason for the 5-time leap. Usually, IPO is priced at 2.5-3 times the embedded value.

Pricing – Can Investors Expect Profit from the LIC IPO? 

LIC fixed Rs 10 as a face value for each. Policyholders and employees of the country’s largest insurer will get a discount over the floor price. The discount for the policyholders is Rs.60 per share and for employees and retail investors Rs.45 Per share.

• The LIC IPO’s price band is Rs.902 to Rs.949 per equity share.
• If we take the last 3 years’ weighted average Earnings Per Share of Rs.4.7 and the upper price band of Rs.949, P/E is 202x.
• In the same way, if we consider FY2021 Earnings Per Share of Rs.4.7 and the upper price band of Rs.949, P/E is 202x.
• If we consider 6 months Earnings Per Share and annualize it, the P/E is 200x
• This means the company is asking IPO price of Rs 949 in a P/E ratio of 200x to 212x.

According to the Draft Red Herring Prospectus, peers like HDFC life is trading at P/E 94x (Highest) and SBI Life at P/E 81.4x (lowest), and the industry average at 85x. Hence LIC IPO is highly-priced.

One out of every three stock debutants on Dalal street in the year 2021 is listed below its issue price. Zomato, one 97 communications (Paytm), sapphire foods to name a few. Issue pricing will be key, especially given the past experience with public issues of general insurance companies —new India assurance co ltd and general insurance corporation of India Ltd. 

New India assurance shares which were offered in the range of Rs. 770- Rs. 800, are now quoted at Rs. 126.85. While the price of general insurance corporation shares has fallen from Rs 912 to Rs 125.50. Even though both the companies issued one bonus share for every share held, this would still mean a loss for the IPO investors.

Retail Individual Investor Standpoint for LIC IPO

Here, it is classified further into 3 portions viz., 

• Policyholder Reservation Portion, 
• Employee Reservation Portion, and
• Retail Portion. 

According to the Draft Prospectus, the total value of allocation to an eligible policyholder should not exceed ₹2 lakh after discount. The NRI category is not eligible under the ‘Policyholder Reservation Portion’. Therefore, the NRIs holding LIC policy will have to apply under the retail category. 

Lock-in period: There is no lock-in period and if the policyholders want to, they can sell the equity shares immediately on listing.

Insurance is not an easy part for investors to find out. The financial statements are full of jargon.  they don’t resemble the financials of any other sector. Metrics like new business adjusted profit, embedded value, etc. are alien to most retail investors.

There is tremendous exuberance coming from individuals living in remote districts of the country. Due to the efforts of those LIC agents, it seems like an army of retail investors is sitting on the sidelines, just waiting to pour their money. LIC products have been more of push products by a strong agency force, and have been able to sell policies that are more costly compared to other life insurance players.

Step Back From the Carnage in Dalal Street

Investors need not rush in to buy. Recent years have been tough for LIC. Though it is the market leader, its share is declining. As per the CRISL report, LIC the market share has been steadily declining–down from 100% in the pre-2000 era to 71.8% in 2016 and further down to 64.1% in 2020. 

 SBI Life, which is the second-largest in the country, was only 5% in 2016 and 8% in 2020. The company needs to reinvent policy products to be competitive.

The Prospects Of Indian Insurance Companies are extremely bright. But the low level of transparency in the reported profits of these entities makes it difficult to find an insurance stock to create wealth in the long run.

 LIC IPO: Good or Bad for Your Portfolio?

The current IPO is just 3.5% of the stake. The central government will hold at least 75% in LIC for the first five years post the IPO and then hold at least 51% at all times after five years of the listing.

LIC had good revenue growth and margin growth in the past 3.5 years. But the LIC IPO’s price is on the higher side. You could consider if it was priced less.

If you are considering to invest in the LIC IPO, then invest only for a medium to long term and not for listing gains. As LIC IPO is highly priced, you may or may not get the listing gains.

Even if you are investing for medium to longterm, as LIC IPO is overpriced, have surplus money to average out in case of subsequent fall in price.

A Replacement for LIC IPO?  

The IPO craze has changed the primary market into a lottery, especially for retail investors. 

Investors with a decent understanding of equity markets and their risk, with moderate risk tolerance, can consider investing in diversified mutual funds. Diversification in equity mutual funds comes with market capitalization and investing across sectors. The main aim of diversification is to protect portfolio returns from extreme market conditions. 

In the bullish phase,  small-cap funds will perform well. While in falling markets, the large caps will act as a cushion to the mutual fund portfolio returns.

Diversified mutual funds help in achieving  long-term financial goals like retirement, child’s education and marriage, etc. Investors who stay invested in these funds for the long term will benefit from the compounding effect of returns—hence helping in meeting the long-term financial needs of an investor. Investors can invest in diversified equity funds through the SIP and Lump Sum Route.
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