he other day, I was talking to a friend when the discussion steered towards the stock market and Initial Public Offerings. An IPO is when a company lists its stock on the stock exchange for the first time -- or goes public (in investment jargon).

My friend spoke about the way her investment in Indiabulls [Get Quote] had paid off. Indiabulls, an online trading portal and stock market information provider, came out with an Initial Public Offering in September 2004 at Rs 19 per share.

The issue was a stupendous success and those who invested in it still can't wipe the smile off their faces. Today, each share is worth more than Rs 100.

That brought her to the next question: Should she invest in the India Infoline [Get Quote] Limited IPO?

Let's see if we can answer her.

• How to invest in an IPO

Where does IIL's income come from?

Think India Infoline and immediately the Web site India Infoline comes to mind. It provides stock market information and advisories and research reports.

The bulk of the company's earnings -- around 60% -- comes from its online broking portal, 5paisa.

Other than its online presence, IIL also earns revenue from the offline distribution of mutual funds, life insurance products, government bonds and fixed deposits.

What kind of competition does IIL face?

Since the bulk of its profits come from online broking, let's look at that.  

IIL is certainly not the only company offering online equity (stock) trading.

A number of others players are jostling for attention: ICICI Direct, Kotak Street, India Bulls, HDFC Securities and Sharekhan to name a prominent few. 

Like IIL, these companies have also lined up a slew of initiatives to attract customers to their online trading platform.

Also, profits are completely dependent on current market conditions. When the market sentiment is good and investors are flocking in droves to the market, the brokerage IIL gets from trading will increase. So, in a bull run, you can expect the company to do well.

What if the market and, as a result, the brokerage revenue, slumps? Well, that will directly reflect in the company's profit line, which will dip.

The market for the retail distribution of financial products, online brokerage and offline distribution is extremely competitive. It is not going to be a cakewalk for IIL.

The growth of the online trading industry is also dependent on the penetration of computers into various towns and cities. And, of course, the simultaneous availability of Internet access.

• How you can get an online broker

Has IIL been making profits?

IIL has listed losses for four consecutive years -- from March 31, 2000, to March 31, 2003.

These loss figures read as Rs 4.5 crore (Rs 45.48 million), Rs 13.1 crore (Rs 131.08 million), Rs 5.8 crore (Rs 58.86 million) and Rs 4.7 crore (Rs 47.07 million) respectively.

But it turned the corner and made profits for the financial year ending March 31, 2004; IIL made a profit of Rs 7.4 crore (Rs 74.80 million).

Net profit for nine months ending December 31, 2004, stands at Rs 13.5 crore (Rs 135.43 million).

How is the IIL stock valued?

Let's see what the ratios throw up.

Earnings Per Share

EPS is arrived at by taking a company's net profit and dividing it by the total number of shares.

Based on the nine monthly profit figures, IIL's EPS translates to Rs 3.14.

EPS = Net profit (Rs 13.5 crore) / Total number of shares (4.3 crore) = 3.14.

Price Earnings ratio

The PE is the market price of the share (here, we take the issue price of Rs 80 at the upper end of the price band) divided by the EPS.

Therefore, PE = market price (Here we assume Rs 80 at the upper end of the band) / EPS (3.14) = 25.47.

A P/E ratio of 25.47 means the company earns Re 1 per share annually if the share price is Rs 25.47.

Generally, a lower PE ratio stock is much sought after, indicating there is room for growth.

Compared to Indiabull's current PE of 92, IIL's figure of 25.47 looks very cheap.

To understand ratios, read How to spot a good stock. 

Is the stock expensive?

Indiabull's IPO was priced at Rs 19 and IIL's IPO is priced at between Rs 70 and Rs 80. On the face of it, this is a huge difference. But of course, one must note that the face value of Indiabull's shares was Rs 2 and not Rs 10 as in the case of IIL.  

The India Bulls stock had an issue price (price at which you buy the shares during an IPO) of Rs 19 that rose to Rs 23.85 the first day it was listed (an increase of 25%).

Just remember it is not necessary for the IIL stock to behave in the same way, specially with the markets being so volatile. Buying IIL stock would be a good idea if you believe in the future prospects of the company and are willing to stay in for the long haul.

Why does it need the IPO money?

IIL wants to expand; it also wants to upgrade its technology.

Currently, the company has 73 offline branches across 36 towns and cities in India. It wants to open an additional 77 branches across 50 cities in India. This is a staggering 100% jump in its branch network!

Of the Rs 95 crore (Rs 950 million) it hopes to garner at this IPO, as much as Rs 63 crore (Rs 630 million) will be earmarked for branch expansion, upgrading technology platforms and for acquisition. That's right, they plan to acquire companies in the bargain, though they are tightlipped about the potential acquisition target/s.

How are the shares allotted?

Employees of the company: 8,78,138 shares

Qualified Institutional Buyers: 55,00,000 shares

Non-institutional investors: 27,50,000 shares

Retail investors: 27,50,000 shares

To understand the allotment process, read Want to bid for shares?

Meanwhile, IIL's promoters (and this seems to be a common practice nowadays) Jain and Venkataraman have been allotted 4,30,000 preferential shares at face value. This means they get it for Rs 10 each against the Rs 70-Rs 80 price band at which the share makes the IPO.

Before you jump to your feet, let me remind you this has been done to compensate the promoters for forgoing the 10% profit sharing agreement they had with IIL.

The logic: This 10% profit will now go to the shareholders instead of the promoters.

• Want to buy an IPO? Read this first

In a nutshell

Number of shares to be issued: 1,18,78,138

Face value: Rs 10

Issue price: Rs 70 -- Rs 80 price band

Issue dates: April 21 - April 27

DON'T MISS!
India Infoline sets IPO price at Rs 70-80

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