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.

Consumer stocks – are we reaching a bubble territory?

Broader market indices are not near their all time highs as yet. But a number of consumer stocks are quoting at all time high or near that. To illustrate the point, let us take a look at few of them below:

                                                                       

S.No.	Stock	CMP as on 22/07/2011	P/E ttm
1.	Jubilant Foodworks	869	78.16
2.	Gillette India	2,247	70.72
3.	Procter & Gamble Hygiene	1,973	50.99
4.	Nestle India	4,309	47.64
5.	Titan Industries	221	45.71
6.	Page Industries	2,291	43.66
7.	Zydus Wellness	648	42.01
8.	Dabur India	111	41.14
9.	Talwalkars Better Value Fitness	243	39.56
10.	Britannia Industries	480	39.48
11.	Asian Paints	3,110	38.45
12.	TTK Prestige	3,102	37.66

                                    Source: Money control

The questions that arise in the mind of an investor then are –

• Are these stocks reaching a bubble territory or do they still have more steam left?
• If you have missed the bus, will an entry now make money?
• When will the valuation cycle reverse for these & other consumer stocks, if at all?
• If invested, should one exit these stocks at present moment?

No easy answers there and nobody can guess the precise moves of Mr Market. On top of that, how stock price behaves in the short term is guided by so many factors – volumes, technicals, sectoral triggers, liquidity besides stock-specific fundamentals. You would notice that these stocks are not capex intensive, command high capital return ratios and generally debt-free or low debt companies.

Having said that, I would say high point of valuation in consumer stocks would be marked by the following factors:

1. Peaking interest rates: We are still some time away from the peak point in the interest rate cycle. RBI will continue the monetary tightening with at least a couple of interest rate hikes looming on the horizon. What remains to be, however, seen is whether the regulator goes ahead with straight hikes in the next few months or takes a pause in between or makes use of other monetary tools at their disposal.
2. Pick-up in investment demand: Linked to interest rate cycle is the investment demand and its drivers in the domestic economy. We hear that credit offtake by Corporate India has slackened and may take a few quarters before the trend comes back.
3. Next secular run in the market: You must be wondering why I have included this as a factor. Well, at the moment, it appears as if investors are chasing same few consumer stocks which are low on floating stock. But we can’t blame investors – they find safety in these domestic companies which are debt-free and FCF positive particularly when interest rates are high. Moreover, being domestic consumption themes, these are relatively insulated from global vagaries. This leads us to the next stage. So whenever we see the next secular run in the market, we’ll find liquidity chasing more number of large cap stocks; with the result that the scarcity premia for consumer stocks will ease out and their valuation likely to stabilize.
4. Growth in earnings: As above developments roll out in next few months, the consumer stocks will be watched by the marketmen for their earnings coming as anticipated or falling short of market expectation. It is possible that a few consumer stocks involving discretionary spends could face greater pressure on earnings growth and valuation multiples might be dented in such a scenario.
5. Brand power will stay: Most of them are strong brands, some with good MNC parentage which have traditionally traded at significant premium to the index and may therefore maintain their market position.

It will, therefore, be wrong to paint all of them with the same brush. Companies that have an established track record over last many decades are there to stay. For instance, Nestle India is going to complete 100 years in the country, that’s no small achievement. The company has excellent management, very high ROE, great brands, distribution network and backed by high quality business. Such a company will always trade at premium valuations. Can this multiple soften, well it can.

The bigger concern is for some of the less established consumer names (not necessarily from above list) where investors will do well to exercise caution and keep a tab on the earnings trajectory in the coming quarters.