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Royal Mail delivers profits

The government got the Royal Mail IPO price technically right - what wasn't taken into account was the impact of low interest rates on investor demand
October 16, 2013

The usual suspects - The Guardian, the Labour Party, the unions - were out this week condemning the government for allegedly underpricing the astonishingly successful Royal Mail (RMG) floatation. The eventual buy-in price of 330p a share was top of the advertised pricing range. In our view, the price was fair given the company's prospects and its stubbornly troublesome labour relations. With hindsight, the government could have charged more, but it seems obvious that the popularity of the IPO with retail investors reflects a fundamental truth about earning income at a time of low interest rates.

IC TIP: Hold at 474p

Retail investor demand for Royal Mail shares before the initial public offering (IPO) was reportedly higher than for the Lastminute.com IPO in 1998 at the height of the dot.com boom. Lastminute was certainly mis-priced - the company floated at 500p a share and finished below 80p when it was eventually de-listed in 2005. This isn't a portent for the Royal Mail as, in contrast to Lastminute in 1998, the company is actually profitable. The forecast dividend yield of around 6 per cent at the strike price explains a lot of the demand. Many small investors have been earning no more than 2 per cent a year on their cash savings and the opportunity to earn a relatively high yield was simply too tempting to pass over, which is a powerful reason why Royal Mail share certificates will be hitting the doormats of middle England over the next few days.

Institutions have also been busy topping up their initial allocations and the evidence is that many funds are having to shop on the open market to bring their portfolios into line with the Royal Mail's likely weighting in the FTSE 100. Panmure Gordon analyst Gert Zonneveld, who accurately forecast the current trading range, said that only 300 out of 800 funds that applied for shares received an allocation in the initial sale, meaning many managers have had to compete.