Wednesday, August 03, 2005

When the promoter goes to jail, the projections go out of the window

In June 2005, Provogue came out with an IPO priced at Rs 150 per share. The IPO was subscribed 67 times (social proof, deprival super-reaction) the number of shares offered. The stock opened for trading at Rs 250 and closed at Rs 205 on 2 August.

At Rs 205, the company's market cap comes to Rs 331 cr. Add debt of Rs 33 cr. and the enterprise value comes to Rs 364 cr. Is this valuation justified by the current fundamentals (the future will be hazy now, isnt it?)?

For FY 2004-05, the company reported revenues of Rs 115 cr., EBITDA of Rs 14 cr., and PAT of Rs 7.2 cr. So, the current enterprise value of Rs 364 cr. is 3.2 times revenues and 26 times EBITDA. The P/E comes to 46 times. Nifty's P/E is 14.58 times.

Sadly, the stock is not traded on futures and options. Sigh...

One interesting aspect of the IPO is the innovative application of Mr. Munger's "backward thinking" wherein the seller of shares approaches the intermediaries and tells them "I want Rs xyz per share, for selling z% of my company and now its up to you to justify this valuation by making projections about the future of my company." And so, given the nature of competition in the intermediateries market, there are strong incentives to apply backward thinking by taking the price being asked as correct, and working backward to figure out what the future of the company should be (on paper, of course), to justify that price.

When the promoter goes to jail, the projections go out of the window. Remember MS Shoes' Pavan Sachdeva and Mesco's Rita Singh? Where are their companies?

How can it be otherwise?

After all, pavlovian association works both ways. Fardeen Khan, who endorses the company's brand, and popular retail chains like Shoppers' Stop, Westside, Pyramyd, Pantaloon, and Lifestyle who sell Provogue apparel, will be doing some very serious thinking.

It will be interesting to watch what the insiders do with their stock.

Social Proof
Deprival Super Reaction
Pavlovian Association

Mental Trick:
Backward Thinking