RBS

Hot on the heels of the Alibaba floatation, the largest International Public Offering (IPO) in history, the British Bank (RBS) Royal Bank of Scotland has priced the sale of a stake in US banking arm Citizens Financial Group. But unlike Alibaba's floatation the RBS's IPO price is on the lower end of its initial expected range. This has raised eyebrows amongst some analysts who are now wandering when the Banking group will eventually breakaway from British government ownership.

While RBS's public offering was expected to be priced between a price range of 23 USD and 25 USD per share. However, a set IPO price of 21 USD per share was instead chosen ,which is expected to raise 3.5 billion USD for the British bank. At the 21 USD mark, the value of RBS's total holdings would be around over 12 billion USD.

(2.1 billion pounds sterling ). 140 million shares, 25% of the US firm's common stock will be made available to the public. The underwriters could boost this amount by 21 million in a 30-day over-allotment option.

But why has RBS's floatation price been scaled down by almost 20 percent from its top range price?

Bearing in mind that the equity market is hovering arround record highs, the flurry of IPOs that have come on the market in the past year were mainly priced at the upper end of the companies expectations. So companies were able to raise better than expected levels of funds becuase the bullish stockmarket ensured good investor demand for IPOs.

A 21 USD floatation price with a 140 million share offering means that RBS is going to raise 560 million dollars less, a little over half a billion dollars, compare to its top range price of 25 USD.

Interactive Investor's head of investment, Rebecca O'Keeffe, believes that the lower IPO price of 21 USD is due to fears about the offer being overpriced relative to potential earnings. In other words, the future business prospects of US banking arm Citizens Financial Group may look less jammy than anticipated.

"This is disappointing for RBS and its investors and calls into question the timing of when, or even if, RBS will ever be able to untether itself from government ownership," she said.

However, not all analysts took a negative view. For example, Investec was "pleasantly surprised" with the initial pricing range, but added that market timing and reported investor resistance had led to a downward drag on the sale price.

Building RBS's bank balance, following the 2008 financial crisis, is no longer seen as the main priority of the bank. Banking analysts are more concerned now about the weaker than expected outlook and the impact this might have on the bank's earnings.

"We reiterate our view that capital repair should no longer be seen as a material challenge for RBS. Our primary concerns relate to a weak outlook for earnings and returns; we continue to forecast a modest loss in both the second half of 2014 and full-year 2015," said analyst Ian Gordon.

For the full year, Gordon believes that RBS will bring in pre-tax profit of 2.9 billion pounds sterling. At that pre tax estimated profit forecast it would give RBS earnings per share of 11.6p. Investec has a “hold” recommendation on the stock with a price target of 355p.

Other schools of thought on RBS are slightly more bearish believing that the current market prices for the stock is overvalued. This assumption is based on the fundamental analysis that the stock price is trading over and above the company's tangible Net Asset Value.

Tangible Net Asset Value t(NAV) is a measure of the physical worth of a company, which does not include any value derived from intangible assets such as copyrights, patents and intellectual property. Tangible net worth is calculated by taking a firm's total assets and subtracting the value of all liabilities and intangible assets.

RBS is currently trading on 1.0 times its tangible net asset value, which indicates that it may be overpriced. Investec don't think that RBS will deliver a Return on Tangible Equity RotE greater than the Cost of equity CoE before 2018/19. So for this reason they don't think it is cheap. “We see considerably better value in Barclays (BARC), Standard Chartered (STAN), Lloyds (LLOY), TSB (TSB) and HSBC (HSBA),” said banking analyst Ian Gordon.

The Return on Tangible Equity measures the rate of return on the tangible common equity. It is calculated by dividing net earnings tangible common shareholders’ equity. Tangible common shareholders’ equity equals total shareholders’ equity less , preferred stock, good will and identifiable intangible assets.

The Cost of equity is the return that stockholders’ require for a company. The traditional formula for cost of equity (COE) is the dividend capitalization model. Dividends per share (next year) divided by the Current Market Value of the Stock plus Growth Rate of Dividends. 

A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership.

RBS will remain the main shareholder in the 13th largest retail bank in the US, holding 75 percent of its common stock excluding the extra share option. RBS will be prohibited from trading this stake in any part for 180 days.