Shares of the Nairobi Securities Exchange (NSE) that are on sale across East Africa are expected to appreciate by at least a fifth in the medium term.

According to equity experts, future performance is dependent on global investor perception of the Kenya economy and execution of planned products.

Investor notes by four investment banks, which own a combined 16.3 per cent of the bourse and Crested Stocks and Securities of Uganda said separately the stock could rise up to 48 per cent if NSE succeeds in rolling out new products to attract more investors.

Afrika Investment Bank (AIB), Faida Investment Bank (FIB), Sterling Capital and Old Mutual said the likely upgrade of Kenya from a frontier to an emerging market status would boost the stock’s performance.

The Capital Markets Authority has warned investors to be cautious about projections by analysts who already own a stake in the bourse, because this presents a potential source of conflict in their valuation.

In research reports to investors, the analysts say the stock, which is on sale, has an upside valuation of between 20 per cent and 48 per cent based on the initial public offering price of Ksh9.5 ($0.0 per share ($0.106).

“Our investment case is informed by a projected steady growth in revenues of 15.2 per cent up to 2017 driven by increased transaction levies and listing fees, interest income and alternate revenue channels,” analysts at Old Mutual say in their report released on August 6.

NSE is selling 66 million shares hoping to raise Ksh627 million ($7.01 million) for financing new trading infrastructure to increase efficiency and launch new products.

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Sterling, AIB, Old Mutual and FIB have a 4.08 per cent stake of 5.25 million shares each in the NSE. They are among the 22 trading partners who hold an equal stake in the bourse but they are expected to reduce their joint interest to below 40 per cent in three years.

The Treasury and the Investor Compensation Fund Board hold an equal stake of 5.1 per cent of 6,562,500 shares each in the Exchange.

FIB has given the stock a target price of Ksh14.13 ($0.16), representing a 48.8 per cent upside potential from the offer price. Old Mutual’s price target of Ksh13.14 ($0.147), represents a 38.3 per cent upside potential from the offer price. Sterling Capital on the other hand has a target price of Ksh11.4, 20 ($0.161) upside while AIB’s targets price is at Ksh11.875 ($0.132), an upwards of 25 per cent valuation.

The analysts have defended their valuations, saying they are based on initiatives in the pipeline that present major opportunities for growth.

In the 2013 financial year, the NSE made Ksh262 million ($2.93 million) in profit after tax. Sterling Capital estimates profit after tax will stand at Ksh284.9 million ($3.19 million) in 2015.

According to Crested Stocks and Securities analysts, the future performance of the NSE is subject to Kenya’s classification as a frontier market, which has a higher investment risk than emerging or developed markets.

NSE’s chief executive officer Peter Mwangi said in an earlier interview that the exchange was in discussions with indices like the FTSE and MSCI to upgrade the market from frontier to emerging markets status by the end of 2016.

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Investing in a frontier market can be challenging due to lower market capitalisation and lack of adequate liquidity.

“In addition to this, there is also a risk of single country exposure, politics in Kenya and macroeconomic indicators including inflation, interest rates, exchange rates, money supply, trade deficits and budget deficits. There is also an operations risk such as regulatory environment, financial and investment risk,” Crested Stocks and Securities analysts say in their assessment of the NSE IPO.

The IPO needs to sell at least 68.8 per cent of the shares to be deemed successful, allowing it to list on the Main Investment Segment (Maims). The offer closes on Tuesday, August 12.

“One of the major concerns mainly for our Ugandan investors is the foreign exchange risk from investing in a foreign country. Dividends, if any, will also be paid in a foreign currency,” analysts at Crested Stocks said.

The NSE plans to inject the IPO funds into new trading infrastructure to increase efficiency and launch new products. This is aimed at increasing market turnover. The bourse also plans to introduce new products in the market to capture the needs of diverse clients, increase liquidity levels and widen its revenue basket.

New products

The products scheduled for introduction include the Exchange Traded Fund, which operates like unit trusts, Real Estate Investment Trusts, the Derivatives Exchange and Asset Backed Securities.

It also plans to engage county governments to encourage them to float municipal bonds in the market for purposes of raising development capital and encouraging more corporate to list bonds on NSE.

The bourse is also contemplating establishing exchanges in Somalia, Southern Sudan, Democratic Republic of Congo and Burundi to diversify away from Kenya, where more exchanges are likely to be licensed in future.

Plans are underway to lobby for the development of a regulation to guide the listing as Shariah compliant bonds, otherwise known as sukuks.

Currently, a big proportion of the NSE’s income is dependent on Kenya through new listings fees, a fixed commission of 0.24 per cent on every equity executed transaction, initial listing fees, application and additional listing fees, rental income and data vending.

“Growth in the coming years is expected from the transaction levy… As the market performance increases the equity turnover increases. We, however, note limitations such as alternative capital raising platforms which also affects the numbers of IPO’s in the coming years,” said Parshv Shah, an analyst at AIB.