Royal Mail shares were not sold too cheaply

Suddenly everyone’s an expert on the stock market. Apparently, it was obvious that Royal Mail shares were too cheap at the IPO price of 330p, and Vince Cable has now called in Lord Myners to review the whole affair.

Some examples:

  • The other day, a politician (who shall remain nameless) offered up the nugget of wisdom that the low price had “cost” the taxpayer hundreds of millions of pounds.
  • A newspaper article said the government had lost out on £750 million (equivalent to 34,000 NHS nurses apparently) by not pricing the IPO at 455p, the price of the shares at the end of their first day of trading.

Okay, so the share price went up by 38% on the first day of trading; that does look suspicious. But is it really evidence of an excessively low price?

I don’t think it is.

330p to 615p in 3 months, it must have been a fix

By mid-January, the 330p IPO price was looking even more ridiculously cheap. The shares had climbed to 615p and looked odds-on to double in price within the first six months.

Surely the IPO price must have been too low if it almost doubled in a few short weeks?

If only it were that simple.

615p to 470p in 6 months, perhaps valuing companies isn’t as easy as everyone thinks

That 615p price lasted for just a fleeting moment. Today the shares are trading at about 470p, down almost 24% in six months.

So if 330p is obviously too low and now 615p seems to be obviously too high, what price should the IPO have been?

Valuing Royal Mail using its expected dividend yield

Unlike those who think it’s all so obvious, I don’t think there’s a clear answer, but I’ll take a stab at it anyway using the trusty old dividend yield as a starting point.

The full-year dividend is generally expected to be around 21p so the IPO price of 330p put the dividend yield at 6.4%. For context, the FTSE 100 yield was 3.5%.

To price Royal Mail shares in line with the market yield the IPO price would have been 600p.

Clearly, that’s a lot higher than 330p. But generally, IPOs are launched with a 10% or so discount relative to a reasonable estimate of the expected market price.

This helps to ensure a “smooth getaway” for the IPO and in this case, it would have put the IPO price at 540p and the yield at 3.9%.

That all seems very sensible but Royal Mail had just been through a restructuring, it didn’t exactly have a strong record of profitability and it had workforce relation issues. And as an IPO there was less transparency in its results compared to listed companies, so valuing it in line with the market would have actually over-valued it.

To price in that uncertainty a discount should be applied, but what discount?

In other words, are there any other companies out there that are broadly comparable in terms of size, potential and uncertainty, so that we can look at their valuation multiples and dividend yields and apply them to Royal Mail?

If Royal Mail was Tesco, 330p wouldn’t be cheap at all

I’ll use Tesco as the comparison company because it’s another large, well-known company surrounded by a fair degree of uncertainty.  If you don’t like Tesco feel free to use any company you like.

Tesco currently has a dividend yield of 5.3%, well above the market average because investors are afraid of the impact of Lidl and Aldi on the established supermarket leaders.

Let’s assume that a 5.3% yield is reasonable for a well-established company that is under pressure; one where the dividend isn’t expected to be cut, but where there are problems to be resolved.

If Royal Mail had been launched with a dividend yield equal to Tesco’s at 5.3% then its IPO price would have been 396p. That’s less than the 455p it closed at on the first day and just 20% higher than the actual IPO price.

But don’t forget that a 10% discount is required for a smooth IPO. Apply that and we’d end up with an IPO price of 357p, just 8% above the actual IPO price.

Of course, that’s an incredibly simplistic valuation, but I think it’s probably as robust as anything the investment banks came up with, and it shows that 330p wasn’t necessarily all that cheap; certainly not cheap enough to require a review by Lord Myners.

Instead what we have with the Royal Mail IPO “crisis” is a lot of political mileage being made out of something that, once you look into it, is almost completely un-noteworthy.

Disclosure: I own shares in Tesco and Tesco is a holding in the UKVI model portfolio.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

10 thoughts on “Royal Mail shares were not sold too cheaply”

  1. Great article.

    It shows that with some pretty basic analysis, assumptions and common sense you can make some pretty fundamental conclusions about the value of a company.

    I’d love to ask some of the politicians/journalists that have been vocal on this issue to provide some basic rationale (like yours above) about why they were cheap and what a fair price would have been. I suspect most would struggle to provide anything coherent in their answers!

    1. Hi UTMT, exactly.

      When I bought UK Mail a few years ago it had an 8% yield. Too cheap? Yes, and the share price doubled. Then I bought Aviva with a 7% yield. Too cheap? No, the dividend was cut (although eventually after a couple of years things worked out okay).

      If this stuff was easy we’d all be Warren Buffett. What annoys me most is people (politicians) who know zero about investing making comments about valuations.

  2. H John

    The fuss about this annoys me too. I have some ‘socialist’ friends and they seem to be experts without ever having owning any shares.

    Waren buffet suggests that floatations are generally not a good to buy a share , its better to wait until the share is not wanted.

    Its very hard to value any company particularly when it has a weak business franchise. Its a low tech company with lots of long term obligations and low barriers to entry and other potential problems. The rules for its existance are changing all the time….

    Its a shame that the floatation generated the publicity that it did but I bet the government are glad to have sold it. The sad story may not be over.


    1. Hi Ken, as always we’ll have to wait a few years and then we can see if the valuation was reasonable, but at the time of the IPO hindsight wasn’t an option.

      Perhaps the “last mile” of delivery will be opened out to companies like G4S and Serco, if it hasn’t already, and then who knows how Royal Mail will compete in the 21st century as a standalone company.

  3. John

    For me Royal Mail was cheap all day long. There were no buts that I will make money.

    Unusual for me, this time I asked my clients to subscribe, this is how confident I was. For me the Government was given away free money.

    I read the prospectus but did not do too much research . All I did was to compare the info from the prospectus with Deutche Post available financial information. In 20 minutes I was sure that there is something very cheap on offer and not looked back.

    1. Hi Eugen, that’s an interesting insight and I suppose it depends on how you define “cheap”. If everybody thinks something is cheap then they all pile in and buy it, pushing the price up and validating the idea that it was previously (and obviously) “cheap”.

      It’s like the stock market in the late 90’s. By 1996 everyone thought that stocks were going to go to the moon because of the internet, and so stocks were “cheap” in 1996. By 2000 the UK market had more or less doubled in four years and so they were right. Relative to 2000 stocks were “cheap” in 1996.

      But of course the FTSE 100 was back to its 1996 level in 2003 (7 years of zero capital gains) and again in 2009 (13 years of zero capital gain), so perhaps stocks weren’t quite so cheap in 1996.

      If you can time the market then perhaps Royal Mail was cheap at its IPO, but personally I will hold off judgement for five or ten years.

  4. John

    It was cheap compared with Deutsche Post, I already explained that, it was 60% cheaper than the DP share price on a lots of financial measures.

    The truth is that everyone piled up and tried to buy some Royal Mail stock, so I was not alone thinking it was cheap.

    I had experience with privatisations in my country and understood Governments usually sell cheap. Here in UK it was the same when Margaret Thatchers privatised lots of companies.

    When ‘free money’ comes around I am always there. It is something I won’t miss.

    Now I am out and not interested what lies in for Royal Mail future. Private management should do well, they only need to keep the advantage they have. It should not be hard.

  5. Hi John

    I have started to wonder at what price would this be attractive to me and I am arriving at sort of 2.50 to 2.80 , certainly less than 3.00. Will it get there within a year or so ???



    1. Hi Ken, unfortunately unless you have a crystal ball that’s just not answerable! Until the company gets a couple of years under its belt, along with full year dividends and reported earnings, it’s impossible to say much about it. Personally I don’t touch anything that hasn’t been listed for 10 years so it will be a long time before I’ll be looking to invest.

      Still, it’s now lower than it was at the end of day one, and having been over 600p it’s clear that nobody really knows what it’s worth yet.

  6. Hi John

    You are right nobody yet knows what it is worth and its only going to be years of results that give us an idea of that. Particularly as I am sure that its structure / liabilities / assets have been prepared for floatation in a way that is not usual with a commercial company. For me this just has all the ingredients of volatility , its hardly like a specialist company making hydraulic valves or aerospace parts. Low barrier to entry , regulation , unions , pensions , politics. There are going to be some interesting and attractive times ahead. Time will tell.


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