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.
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.
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.