Is the NSE IPO a Bargain?

The long-awaited Nairobi Securities Exchange IPO is finally here. The Kenyan stock market is offering the public a 34% stake in the business to raise cash for expansion and to reduce mortgage debt.

The IPO price has been set at Kshs9.50 per share. Is this a bargain opportunity for Kenya investors? Let’s take a quick look at the prospectus to find out.

The long-awaited Nairobi Securities Exchange IPO is finally here.

A 34% stake in the business is now on offer to the public as the Kenyan stock market looks to raise cash for expansion and to reduce mortgage debt.

The IPO price has been set at Kshs9.50 per share.

Is this a bargain opportunity for Kenya investors?

Let’s take a quick look at the prospectus to find out.

How Does the NSE Make Money?

We’ll start by gaining an understanding of how exactly the NSE makes money. Page 84 of the IPO prospectus breaks it down nicely.

NSE IPO operating income

The table in the middle of the page shows that transaction levies are the NSE’s primary source of operating income. In 2013, these levies amounted to more than Kshs405 million.

Transaction levies are fees charged on share trades. Currently, this levy is fixed at a rate of 0.24% of total trade value.

So, if you bought 10,000 shillings worth of Safaricom shares, the NSE would collect 12 shillings from you plus another 12 shillings from the seller for a total of 24 shillings.

Kshs10,000.00 x 0.0024 = Kshs24.00

Thus, the NSE makes money from each shilling’s worth of shares traded.

In the same table, we also see that the NSE collects annual listing fees. These are fees charged to each company that lists its shares for trade on the market.

Note that this income has been relatively stagnant over the past five years. This is because only a few new companies have joined the exchange during this time frame and some others have exited for one reason or another.

Page 85 of the prospectus shows some other sources of income. These range from interest on investments to rental income.

How Much Money Does the NSE Make?

Now that we have a bit of an idea how the NSE makes money, let’s try to figure out how much it earned from recurring sources in 2013. We want to derive a baseline earnings figure – one that we can be confident that the NSE will collect year after year even if the business stops growing.

The income statement on page 80 of the prospectus indicates that the NSE earned Kshs379,341,000 before taxes in 2013.

NSE IPO pre-tax income

We need to adjust this figure to account for income and expenses that aren’t likely to occur again next year.

Further up the income statement, we see that the NSE reported Kshs115,574,000 from the recovery of doubtful debts in 2013. That’s great for the NSE, but it’s probably not going to happen again next year. So, let’s subtract it from pre-tax earnings. We’re left with adjusted pre-tax earnings of Kshs263,767,000.

Kshs379,341,000 – Kshs115,574,000 = Kshs263,767,000

Now, let’s go back to page 85 to see if any of the income reported there looks like it’s unlikely to be repeated.

The only doubtful income stream I see is the “Market Access Fee” of Kshs40,000,000. It suddenly appeared in 2013, and I don’t know what it is. To be safe, let’s subtract it from our total.

After removing the market access fee, we’re left with adjusted pre-tax earnings of Kshs223,767,000.

Now, we must account for taxes. Kenya’s corporate tax rate presently stands at 30%. After applying this to the pre-tax amount, we are left with net income of Kshs156,637,000.

Kshs223,767,000 x 70% = Kshs156,636,900

How much is this per share?

The prospectus tells us on page 19 that the NSE’s total share count will be 194,625,000 at the conclusion of the IPO, assuming that the offer is fully subscribed.

Divide our adjusted net income by this figure, and we’re left with earnings per share of Ksh0.80.

Kshs156,637,000 / 194,625,000 = Ksh0.80

This EPS is the amount of income we can reasonably assume the NSE will collect year after year even if its growth stagnates.

So, on a normalized basis, the NSE IPO is set at a Price/Earnings ratio of 11.8.

Kshs9.50 / Ksh0.80 = 11.8

How Fast Will the NSE Grow?

This is where things get tricky.

We want to make a good guess as to how quickly the NSE will grow its earnings in order to determine whether Kshs9.50 is a fair share price.

If the NSE’s earnings stagnate right now, we’d receive an adjusted earnings yield of 8.4%.

Ksh0.80 / Kshs9.50 = 0.084

That’s not great – especially when Kenyan bond yields are hovering around 11%.

So, we’ll need the NSE to grow earnings to make the IPO worthwhile.

Over the past four years, the NSE grew its adjusted earnings at a yearly pace of 113%. That’s an exceptionally rapid rate, and it’s not likely to be sustainable much longer.

What might be a more reasonable expectation of earnings growth over the next five years?

One way to moderate our forecast is to consider growth in operating income instead of net income. Operating income tends to be less volatile than net income, and, therefore less likely to be skewed by abnormal events.

If we return to the income statement on page 80, we can see that operating income rose from Kshs164,387,000 in 2009 to Kshs488,766,000 in 2013.

Plug these figures into this calculator, and we find that the NSE’s operating income rose at a rate of 31.31% over the past four years.

Is this a sustainable earnings growth rate over the next five years? It may be considering that trade volumes are reportedly up 37% through the first half of 2014.

But let’s be extra conservative and assume that a reasonable earnings growth rate over the next five years is the nice round figure of 20%.

Is the NSE IPO a Bargain?

If the NSE’s adjusted earnings per share grew at an average rate of 20% over the next five years, they would equal Kshs1.99 in July 2019.

Ksh0.80 x 1.20 ^ 5 = Kshs1.99

Let’s conservatively assume that the market will value the shares at a P/E ratio of 10 at that time. This seems reasonable considering the NSE’s growth rate and the fact that shares of the Johannesburg Stock Exchange presently trade at a P/E of 16.

A P/E ratio of 10 gives the shares a value of Ksh19.90 in 2019.

Kshs1.99 x 10 = Kshs19.90

So that means they will have more than doubled in value from their Kshs9.50 IPO price. Not bad!

Plus, we mustn’t forget dividends!

According to page 19 of the prospectus, the NSE paid out a dividend of Kshs49,000,000 in 2013. This is equivalent to Ksh0.25 per share after the IPO is complete.

If we conservatively assume that the IPO will pay a dividend of Ksh0.25 per year for the next five years, holders of the stock will collect total dividends of Kshs1.25.

Now, let’s put it all together.

If NSE shares are priced at Kshs19.90 in 2019, and the company pays out a total of Kshs1.25 in dividends over the next five years, then investors will reap a total return of 122.6% – an annualized return of 17.4%.

(Kshs19.90 + Kshs1.25) / Kshs9.50 = 122.6%

122.6 ^ 1/5 – 1 = 17.4%

Is 17.4% a decent annual return? I believe it is, and, therefore I think the NSE IPO is one that Kenya investors can feel good about.

What Do You Think?

Now, it’s your turn. Have I been too optimistic or pessimistic in my assumptions? Are there other factors to consider when investing in IPOs? Let’s hear your thoughts in the comments.

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45 thoughts on “Is the NSE IPO a Bargain?”

  1. Well written post Ryan. While I may know the answer. Can you tell the readers why you would have chosen to use JSE as the comparable in your analysis given the differences in daily volumes?

    Thanks,

    Justin Mahwikizi

    1. Thanks, Justin. The JSE is the only other African stock exchange with publicly traded shares. It’s much larger and more liquid than the NSE, but its earnings multiple is a helpful reference point when forecasting the low end of NSE’s valuation range.

  2. Great Analysis – you could make the case that your analysis is to pessimistic – an exit P/E of 10 seems low, particularly conditional on the market growing fast for 10 years. The trouble as always is finding a way to make this bet… Most people don’t have an account on the NSE on which to trade…

    1. Much appreciated, Zachary. I try to err on the conservative side when forecasting because earnings misses are a major bummer. If the valuation looks good with a big margin of safety built in, then I’m happy to buy and hold through rough patches.

      Very good point about access to the NSE. Imara now offers a pan-African trading platform for individual investors. Well worth checking out if you’d like to do much investing on the continent.

  3. Thanks for good analysis, my only worry is that you have not factored in of the future value of the investors money and the inflation rate compared to that small margin of rate return.

    Secondly, the NSE wants to offset its mortgage debt and not forgetting that NSE is less risk and volatile hence return could be slow since there are less factors which could trigger an impact to its trading performance unlike the blue chip companies.

    1. Good point. Kenya’s inflation rate is between 7-8%. A 17% rate of return, which is based on conservative growth and valuation assumptions, outpaces that.

      Time will tell whether the assumptions are conservative enough, but the beauty of owning a small stock exchange like the NSE is that its fortunes are tied to the fortunes of the blue chips that are listed on it.

  4. Ryan, thanks for the eye opening analysis for lay investors some of us are. It is candid and to the point. However I would love to read a reply to Justin’s question above.

  5. You are spot on on the importance of transaction levies on the NSE IPO. NSE Kenya charges a transaction levy of 0.12% of the value of equity securities traded and 0.0035% of the value of fixed income securities traded. (page 101, note 25(c).
    You did not mention the new listings coming up that will bump up the sustainable earnings level. There are a no of SMEs lined up for listing, there are a no of institutions that are preparing for REITS, and there are a no of institutions lined up for fixed securities offerings. These new listings are likely to result in a one-off jump in operating income.

    Given the low levels of leverage, new investments to support the increased volumes are likely to result in sustainable higher levels on revenues. I dare say your 17% annualised return is quite conservative, the real figure has to be much higher.

    1. Thanks, Ruskin. You may be right that the forecast is too conservative. I prefer to err on the side of caution.

      FWIW, I’ve just been informed by an official at the NSE that the “market access fee” was not a one-off event. Thus, at the very least, the 2013 base earnings figure should be revised upwards by Kshs28,000,000.

      1. Hi Ryan,
        Great Analysis!!
        I however beg to differ on the Market Access fee. I have interacted with the NSE, the brokers & CMA and the market access fee is really the one-off fee that any entity would pay to become a trading participant with all the trading rights a broker has at the NSE. Before, this wasnt possible as one had to buy a “seat” to become a broker and part owner of the NSE. With demutualization, a market participant (read broker/investment bank etc), doesnt need to buy an equal ownership stake anymore so all they need is a one off fee to sign them up. They are not required to pay any recurrent annual fees as each trade that comes through that broker generates revenue thats shared among several entities including itself and the NSE.
        That said, yes, its not a one-off event in the sense that more participants will want to join the list of the current trading houses at a future date but that revenue isnt periodic and predictable. Hence, me thinks your conservative approach is pretty good.

          1. Many thanks for this additional background, MK. It’s helped me get a handle on the market access fee. It will be interesting to see how many new brokers join the party.

  6. The shares on offer are too little, no point of risking to give NSE cash for long and benefit only by getting 500 share only.

    1. This is an excellent point, Josiah, and one that I should have addressed in the article.

      The NSE IPO is likely to be oversubscribed — meaning investors will apply for more shares than are actually on offer. As Josiah points out, if this happens, each IPO participant will probably be awarded nothing but the minimum subscription amount — 500 shares. 500 shares at Ksh9.50 each is just Ksh4750 (roughly $50.00). That’s not very much. Plus, if you applied for more than the minimum amount of shares, you may have to wait some weeks for the difference to be refunded to you.

      With that said, investors may better off applying for no more than 500 shares and/or waiting for the shares to begin trading on the secondary market.

  7. Good work!

    You could also consider:

    – what the upcoming new issuance on the NSE might be by comparing the market cap to GDP ratio of Kenya with that of other countries. The new issuance will influence listing fees as well as well as transaction levies.

    -what the development historic transaction volume on the NSE was relative to the market cap of the stock exchange itself. This velocity figure gives you some hint about what is achievable in the longer run when compared to other exchanges.

    Who will be in the placement consortium?

    1. Great ideas for refining the model, Joerg. Thanks!

      Market cap to GDP was 36.7% for Kenya in 2012. This is higher than Nigeria’s at 12.7%, but much lower than South Africa’s at 160.1%. (The Johannesburg Stock Exchange is home to a number of very large multinationals.)

      Lead Transaction Advisers for the NSE IPO are Standard Investment Bank, Dyer and Blair, and Renaissance Capital Kenya. Lead sponsoring brokers are African Alliance Kenya, Faida Investment Bank, Genghis Capital, NIC Securities, and Kingdom Securities.

  8. Thanks Ryan. It is always helpful to declare or confirm existence of any conflict of interest.
    Personally, I think analysis looks ok. However, assumptions are just that. If we take into account experiences with past IPOs (logistical and otherwise) it may be prudent to actually wait and buy after the price as stabilised at where true value is. It is certainly true that price always follows value.

    1. Thanks. You raise an important point, MuhuriG.

      Let me be clear that I have no beneficial interest in NSE shares, and I don’t intend to participate in the IPO.

      Your advice is well taken, especially in light of the minimum allocation in case of over-subscription. One may be better off waiting for it to hit the trading floor if there still appears to be value.

  9. Hi Ryan,

    Thanks for your usual keen eye to African long term investment opportunities. I have two questions;

    1. How can i buy shares of the NSE? Which platform or brokers can be reached?
    2. I was curious about your response/ opinion about the current IPO in Tanzania, Swala Oil & Gas selling at 500 Tz shillings.

    If reference is needed please check http://www.swala-energy.co.tz

    Thank you in advance.

    Michael

    1. Thanks, Michael. You might find the following article helpful as an introduction to how to buy shares on the NSE:

      https://www.investinginafrica.net/2011/08/how-to-invest-in-kenyan-stocks/

      I believe SBG Securities and Dyer and Blair both offer online NSE share trading platforms.

      Apologies for not getting back to you on the Swala Gas IPO in Tanzania. I typically avoid natural resource stocks as I haven’t found an easy way for me to analyze them.

  10. Hi Ryan,
    PER of 10 for such quality stock would be good in Occident. But such domestic interest rate seems to be an handicap because domestic investors would prefer bonds.
    By the way, i think it’s better to wait a pull back in order to invest just because it’s possible to pay lesson the future.
    What’ your reaction about this ?
    Best,
    Hervé

  11. Hi Ryan,

    Thanks for the great succinct analysis of the IPO. Im a young graduate looking to improve my financial literacy and I am very interested in stock markets in Africa. You make it look so simple on how you extracted information from the prospectus, i know theirs no size fits all approach in valuation but could you suggest an approach or maybe some material i can read to help build some knowledge around this.

    Kind Regards

  12. Ryan I think your analysis is fine.Being conservative in valuation is what makes a security attractive, since it means the it can withstand some downside price risk. What of using the dividend discount model to take into account time value for money. Over to you Ryan

  13. thanks Ryan, though i am a green horn in matters securities, i am contented with your conservative analysis so that you dont over excite a potential green horn like me. Tell me, is your conservative figure the worst case scenario? I bought the safaricom shares when they were offered first time, but soon therefter the value dropped drastically to my disapointment and got stuck down there for quite some time. Do you see this for NSE IPO?

  14. good analysis Ryan.
    kind also do analysis for other seconday market stocks in the kenya.
    we really appreciate your advise.

  15. I would love to see your brilliant and indepth analysis of other available investment options for NSE.
    Can NSE now venture in Real Estate for example. How would that maximize returns and cope of business.
    Thank you.

  16. Hi, when is the right time to sell/buy shares in nse…. please advice on how to know when to buy or sell shares in nse so as to make good returns.

  17. Thanks, my friend. Have u factored in the referendum and the 2017 election effects in your prediction? Now that the IPO was over 600% subscribed where should I invest the refund?

    1. You’re welcome, Bedan. Thanks for the questions.

      I didn’t consider any specific political impacts, but I tried to use a very conservative growth forecast. While, there’s always the possibility of things going very, very wrong, I think investors can be reasonably confident of the growth projection.

      I’m not revealing any of my specific Kenyan stock picks at the moment, but a general guideline to follow is to invest in 1) a consistently profitable company that 2) consistently pays a dividend, 3) operates in an industry that you understand, and 4) trades at a price/earnings and price/book ratio lower than the majority of its peers.

  18. This is the best analysis I have see so far considering NSE has just trading with a high of 18.00 and a low of 15.00. Now at this price of 18.00 will it go any higher?

  19. Hi Ryan, im from Tanzania, this was a well written analysis. Stuff of legends my friend, more so that the stock is trading at Kshs 20.25 today.
    In my country, our stock exchange is also looking to List, its called DSE (Dar es salaam stock exchange). your article has provided an eye opening experience. Thank you so much. If you can visit the dse website and maybe write an article on it it too, it would help the citizens in my country to invest well.

    Thank you Ryan,
    You’re a legend in my books

    1. Thank you, Michael. Your comment made my day!

      I’m quite bullish on Tanzania and follow the DSE closely, but I confess I don’t know the status of the demutualization process. Let me know if there’s a prospectus available, and I’ll have a look at it!

      1. No prospectus yet. but you try to see if you can evaluate TOL a gas company. From your Analysis i have made an calculator on excel that dishes predictive figure of future returns, dividends and price of stock in the next five years.
        i can send it to you for a send opinion.

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