Update - Hinduja Global Solutions Ltd

We discussed Hinduja Global Solutions Ltd (HGSL) here before the Annual Results for FY 2011 were declared. This is a follow-up post to update on the results for last 2 quarters and capture the business developments in the interregnum.

Consolidated Fin.	FY2010	FY2011	Q1-FY12	FY2012E
Revenue (Rs crore)	892.34	1073.24	278.40	1266.42
EBIDTA (Rs crore)	162.80	155.33	29.73	170.97
PAT (Rs crore)	130.11	107.32	20.29	113.97
EPS (Rs)	63.20	52.09	9.86	55.36
NPM (%)	14.58	9.99	7.28	9.00
ROE (%)	14.00	10.50		11.50
ROCE (%)	11.50	9.10		11.00

It is always a learning exercise to review what we had projected for full year FY11 and what the actual achievement is. Well, revenue is almost on the dot, Rs 1,073 crore against 1,076 crore projected by us for FY 2011. But, both EBIDTA and PAT have slipped due to higher staff costs and higher operating costs (on heads like rents, maintenance expenses, power, connectivity cost).

Unlike Balance sheets of many other companies that I see, finance costs in HGSL have in fact reduced from Rs 9.92 crore in FY10 to Rs 8.95 crore in FY11.

Revenue Mix

1.     By Geography – North America (38.22%), India Intl (19.59%), Manila (19.11%).

2.     By Client Concentration –Top 10 customer concentration has come down from 75% in FY 2010 to 62% in FY2011.

3.     By Business Verticals – Telecom & Technology (25.77%), Health Insurance & healthcare (25.73%), Consumer electronics, products & services (22.74%).

Highlights from Q1 FY2012 results:

1.     Implementation of wage hikes is the major reason for drop in EBIDTA margins.

2.     Cash per share Rs 239.22;

3.     EPS of Rs 9.86 (non-annualised);

4.     Consolidated EV/EBIDTA 0.9 times.

Recent Acquisitions:

HGSL has announced the following 2 acquisitions in the last 2 months:

1.     On-Line Support Inc (OLS), Canada at an enterprise value of C$74.85 million. OLS services customers across verticals such as media, telecom, technology and BFSI. It has over 1650 seats at 10 sites in Canada. In FY 2011, it had a turnover of C$63.4 million and currently has close to 1800 employees.

2.     HCCA Business Services (HCCA), service provider in Human Resource outsourcing, acquired from 3i Infotech Ltd. HCCA offers payroll, statutory compliance and employee lifecycle support to over 350 clients in India.

These 2 acquisitions are estimated to add annual revenues of USD 68 mn to HGSL, taking it to USD 320 mn as per company sources. Well, we have not factored the incremental revenues from these acquisitions in our estimates, so there can be some positive surprises.

Valuations:

Based on the review of results and looking at the pressure on margins that are visible clearly, we have scaled down the estimates for FY 2012E, without factoring the effect of acquisitions made by HGSL in recent past. But this company’s valuations offer so much margin of safety that it does not hurt to have underperformance from this stock in the short term. In the meantime, the dividend yield is a protective shield for the investors since dividend was maintained at Rs 20 for last year despite lower profitability.

At 8x FY12E earnings, we arrive at a price target of Rs 470 in next 12 months. From CMP of Rs 316, this means a healthy upside potential of 48%.

ILFS Investment Managers Ltd

At a time when retail investors are shying away from equity, and are all at sea as far as market volatility is concerned, I thought it will be good idea to discuss a stock related to equity investing itself.

Business & Operations:

1. Operating background

IL&FS Investment Managers Ltd (IIML) is the largest Private Equity Fund Manager in India with funds under management of the order of USD 3 bn. It is probably the only listed company which is a pure play on Private Equity (PE) space in India, covering the entire PE lifecycle right from raising funds, investing, managing, restructuring and going upto exits. There are other companies like ICICI and IDFC but they have a much larger lending business and not a pure play on PE business.

2. Parentage

IIML is a subsidiary of Infrastructure Leasing & Financial Services Ltd (IL&FS) which holds 51%. Latest shareholding pattern can be viewed here.

IIML manages funds on behalf of leading Indian and International institutions.

3. Revenue Model

I hope you are familiar with how AMCs in PE space work. Well, to keep it brief, there are 2 main revenue sources:

(i) Fund management fee – This is a fixed % fee that IIML earns on the AUM. Typically 1.5% to 2%. This fee is fixed for a fund and insensitive to market conditions. AUM has grown at an impressive CAGR of around 60% from 2006 to 2011, giving good revenue visibility on this component.

(ii) Carry profit share – This is a share in profit that IIML generates for its clients. Hurdle rate ranges in the region of 10-11% and carry is 20% of profit from investments at the time of fund exits. Shareholder share is typically 30% of the AMC share of carry. Realistically speaking, carry profits will begin accruing from FY13 and need not be factored in current year.

4. Business verticals

Over the years, IIML has managed funds investing across many business verticals:

(i)             Infrastructure

(ii)           Telecom & Technology

(iii)          Manufacturing

(iv)          Media & Consumer services

(v)           Retail

(vi)          Real Estate

5. Funds under deployment

(i)             Tara II – Fully deployed. It made 2 investments during Q1-FY2012.

(ii)           Real Estate II – Not yet fully invested, USD 150mio to invest.

(iii)          Infrastructure Fund - Not yet fully invested, USD 200mio to invest.

 Funds mentioned at (ii) & (iii) above are likely to be fully invested before end of this fiscal.

6. Exit experience

(i) Investment horizon is generally long term, say 3-5 years, and investment mostly in unlisted companies. Liquidity is mainly through IPO, Strategic sale, Buy-backs etc.

(ii) 3 funds are fully divested.

(iii) 51 investments are realized besides 21 partial exits/liquidity events.

(iv) Gross IRR of about 25%.

7. Notable Exits

Some of the prominent exits made by IIML over the years include Indraprastha Gas, Noida Tollbridge company, Hotel Leelaventure,Shoppers Stop, ABG Shipyard, Sasken Communications, IBN18 etc.

8. Fund raising

Following 4 funds are in the market:

(i)             Tara IV

(ii)            IL&FS Milestone Fund

(iii)           PIPE Fund

(iv)          Middle Eastern Fund

9. Strategic Initiatives

(i) During last year, IIML successfully completed merger with Saffron Asset Advisors which became effective since August 2010. The deal brought 2 new funds – Euronext-listed Yatra capital Ltd (Euro 220mn) and Saffron Real Estate Fund (USD 103mn).

(ii) The cost of acquisition was worked out at 8.75% of combined AUM that worked out at USD 35mn. To fund this merger, IIML raised debt of USD 20 mn at Libor related rates.

(iii) IIML opened an overseas office in Dubai to expand business presence in Middle Eastern region.

Management:

1. IIML has a well experienced management team with Mr SM Datta as the Chairman, Mr Shahzaad Dalal as Vice-Chairman and Dr Archana Hingorani as CEO & ED.

2. IIML employs 56 professionals handling different streams.

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Financial summary:                                                    

                                                                       

Particulars	FY2007	FY2008	FY2009	FY2010	FY2011
Total Income (Rs mn)	601	1,057	1,642	1,759	1,973
Total Cost (Rs mn)	221	592	796	856	1,090
PBT (Rs mn)	380	465	846	956	905
PAT (Rs mn)	178	319	623	741	693
Networth (Rs mn)	440	710	928	1,339	1,774
PAT Margin (%)	30	30	38	41	34
EPS (Rs)	1.50	1.60	3.10	3.60	3.40
Dividend (%) for FV 2	40	55	70	75	75
ROE (%)	43	58	79	66	44
ROCE (%)	61	81	84	64	34

Auditors: Deloitte Haskins & Sells

Investment Rationale: 

1. We like IIML for its excellent business model which is quite de-risked.

2.Management quality makes a lot of difference to this business and IIML team is well experienced across cycles and has been together for fairly long time. They have demonstrated good deal sourcing capabilities.

3. IIML has first mover advantage in many of the verticals and will be benefited when exits are made. Carry profits will be an icing on the cake.

Risks & Concerns:

1.Exposure to real estate is on the higher side and liquidity can be delayed in current concerns over real estate companies.

2. Exits through IPOs are dependent on the state of stock markets, and given their depressed condition, this window would be on hold for the present.

3. One of the directors has sold sizeable quantity of stock in the recent past which is available on disclosures on BSE/NSE.

4. Higher depreciation/amortization due to saffron merger costs.

Stock parameters:

CMP: Rs.27.95 (FV Rs. 2); Market Cap: Rs. 575 crore; 52-week high/low (NSE): Rs.57.85/ 27.75;  200 DMA: Rs.36.64

Valuation parameters:

PE: 8.7; P/BV: 3.1; Dividend yield: 5% (based on DPS of Rs 1.50 for FY11).

But these usual yardsticks do not fit well for valuation of an AMC. We compare MCap with AUM to get an idea of its fair multiple. Since this is a pure play on PE investing backed by high ROE and ROCE with significant growth in earning AUMs, we consider 7% as a fair multiple.

By that estimation, this stock has a decent upside and we assign a price target of Rs 44 in next 12 months.

Outlook:

IIML could give investors excellent appreciation in next 1-2 years. Presently it trades near its 52-week low and offers very good opportunity to accumulate.  In the meantime, enjoy the high dividend yield.