Thanks .Very Helpful for the detailed explanation with proper data. You like guys made valuepick great. I will add this point in my investment checklist.
Agree. Cost/Tax to Edelweiss will depend upon at what price premium the ESOP has been offered. RSU could be at face value but ESOPs are not. Sometimes back Gruh has given ESOPs. I was wondering at the optimism of company because for months the stock price was below ~267, the esop exercise price. Now it is a different story.
@Gary24 - My point is simple. If you wanted your employees to own stock, purchase from the market and give them or advice them to purchase it from the market and pay them their full salary. That way the shareholders can value the stock more accurately and also be happy that their holding is not diluted year on year through ESOPs. Startups do it because they actually don’t have money to pay employees and dilution and ownership are necessary there. For mature companies, ESOPs are just accounting gimmicks to produce rosy P/Ls.
Well, Edelweiss is not into discovering new Global delivery model of financial services. At best it will have people who will do the job better than others which could be compensated by giving better compensation than the market. The ESOP trend has accelerated in FY18 compared with FY17 which tells you a story that even the company wants to encash jump in valuation. Moreover, if we do comparison with MOSL what is the ESOP they have given and the performance? Are they not largely comparable. IMO, we should avoid ownership bias.
Don’t you think that this ESOP valuation matter will be resolved with the implementation of IndAS.
Indian GAAP permits entities to account for Employee Stock Ownership Plans (ESOPs), either through the fair value method or the intrinsic value method though disclosure is required to be made of the impact on profit or loss of applying the fair value method. It is observed that most Indian entities prefer to adopt the intrinsic value method. The drawback of this method is that it does not factor in option and time value when determining compensation cost. Under Ind AS, the accounting for ESOPs will have to be remeasured using the fair value method. This may result in increased charges for ESOPs for many entities and will have a significant impact on key indicators such as earnings per share.
Also, Accounting for group ESOPs is now mandatory under IndAS.
interesting…how did you arrive at this figure of 270cr being cost of esops?
This is a very generic response to what clearly requires a much more nuanced analysis. To say that employee retention, employee alignment of interest and motivation is not atleast partially dependent on ESOPs in the case of Edelweiss in particular is clearly wrong. First of all a) Edelweiss is not like a mature cement company with fixed potential - its large but not mature and the potential to grow is unlimited, limited only by how its employees take the business forward - its growing by upwards of 25%+ for the past donkey years, b) there are many businesses within Edelweiss which are at very early stage in terms of where they can be in 10 years, c) In financial businesses, employees are almost everything - what differentiates a company trading at a P/B of 0.5 and P/B of 4 is largely employees and what they do with capital - so wealth creation is dependent on employees.
Finally yes, ESOPs in FY18 are huge and any analyst should adjust the same to calculate the actual profitability and give a valuation to the business accordinly but to say that the organization is wrong in giving large ESOPs in FY18 is not true and perhaps over generalized, myopic comment. In case of Edelweiss, it would be bad only if it has been giving too much ESOPs almost every year. For that you need to calculate average dilution for the past 5 years or so - just reading into one year data is small sample bias.
PS - In case of Edelweiss, whether or not you adjust the P&L for ESOPs, it will remain rosy
Disclosure - Invested long back and no positions currently.
Another good article reinforcing the belief that Edelweiss has got it right on ARC
Will the famous buyer of stressed assets, itself become a stressed asset? Warren Buffett has said that Turnarounds seldom turnaround and when a management with a reputation for brilliance, meets a business with poor economics, it is the reputation of the business which wins.The debt equity ratio is around 8 and interest coverage ratio is below 1.5 which is dangerous. ROE s and debt equity ratios are calculated on the entire business and not by keeping insurance business separate.
In that sense Edelweiss is risky. A perusal of Edelweiss annual report talks about a lot of Off balance sheet assets which is a jigsaw puzzle. Return on assets is a paltry 1.3 which makes it a low quality business. Pledging of promoters shares is another negative. Who can bet big with such odds?
Below report from Motilal Oswal on the poor economics of ARC business is informative
It will be good to update yourself with the latest numbers. Last qtr annualised RoA is 2% for consolidated and 2.6% for ex-insurance. RoE is 17% for consoldiated and 22.5% for ex-insurance. Thanks for the report! this one spooked many but turned out to be unecessarily pessimistic. Edel’s ARC will generate RoE of 20%+ and if they execute well could be a 25%+ RoE biz. I met one big investor last year who regretted selling Edel due to concerns expressed in this report. New IBC act and continuous amendments have made it a lucrative biz and that’s why everyone one wants to start an ARC.
Has anyone here done a research on the ARC business of Edelweiss? This article was a very helpful start but I have the following questions
What are the assets under each of the ARC funds (EARF-1 - Rs.90 Cr - 2010, EISAF-1 - Rs.500 Cr - 2012), EIASF-2 - Rs.2275 Cr- 2016)?
There are actually 30-35 companies that constitute 80 per cent of the capital deployed by Edelweiss. The big names are Essar Steel, Bharati Shipyard, Arshiya, Kairakal. What are the others and what type are each of these assets (distressed vs stressed, EBITDA positive?, turnaround?, debt vs equity etc.)
The article says “Shah is currently sitting over distressed assets under management of over Rs42,000 crore.” and also “India’s biggest distressed asset investor, Rashesh Shah of Edelweiss Group, has accumulated the largest pile of bad loans - over Rs 90,000 crore.”. Why is there a difference between the two numbers? Investor presentation puts the assets under ARC (Distressed Credit) as Rs.38,600 Cr. I do see under notes that this number is “Net of Edelweiss Contribution”. So is it safe to assume Edelweiss’ ARC assets are around 40k Crore?
I have personally seen the Vega City mall mentioned in the article rot for years due to distress and it was opened few months back. I had no idea Edelweiss was involved. This seems like an interesting business but everything will depend on type of assets in each pool since under 20% of “value-cases” will be contributing to over 80% of overall returns.
I see that managing an ARC is quite similar to running a VC fund. One deals with the birth of start-ups and another with terminally ill businesses and both will produce disproportionate results based on their small set of big winners while the rest will amount to near nothing.
Don’t think they provide details of each tranche of these funds except may be to actual investors of these funds. I don’t care as long as they get their fund management charges and upside performance fees.
Frankly, I don’t go into too much of details. We need to keep track of newsflow on this. I have mostly seen positive vibes so far which is due to their good sense of timing. They have acquired assets during the downturn and payback is coming when the macro is picking up.
The assets they acquire from banks need to be marked down by 40-50% and banks need to set aside provision before it could be sold to ARCs. So 90k cr assets would be worth 40-45k cr when it got sold to Edel ARC. Out of 100rs acquisition 15 rs need to be paid upfront in cash and rest in post dated receipts (SRs). Banks also partcipate in upside from over recovery i.e. more than what ARC paid. Now RBI has allowed listing of SR which takes away liquidity risk for Edel. Edel gets fund managenent fee as they own 80% ARC’s equity. This fund remains off balance sheet for Edel.
"This fund remains off balance sheet for Edelweiss"
In other words, profits are accounted in the books, while the assets remain out of it. So the real return on assets will be much worse. I reiterate my opinion that Edelweiss is a poor business.
What is the nature of these SRs? Are these a firm liability of the Edelweiss Fund where they have to pay the SRs on maturity irrespective of the recovery from the asset? Or are these payable only if Edelweiss gets money from the asset? In the second scenario, the value at risk is just 15% which Edelweiss has paid upfront. Whereas in the first scenario the Fund will have a much higher obligation.
Is this opinion based on merely the ARC business, or is it based on all the business verticals. If it is based on just the ARC business, then do realize that the entire Wealth & Asset Management vertical contributes a mere 10% to the Edelweiss PAT (FY17 figures). As ARC business is only a small portion of this vertical, it’s contribution to consolidated PAT is unlikely to be more than 5% or so.
The biggest contributor to the Consolidated PAT is their credit business that contributes 65% to PAT. The other contributors are Capital Markets (15%) and Treasury (10%). The above figures do not include their insurance business that is currently loss making and is likely to become profitable in a few years.
At a business level, Edelweiss holds only 60% stake in EARC (rest is held by minority partners such as CDPQ). Further, at a fund level, the stake of the EARC is only about 15% (rest is raised from external investors).
Hence, even though Asset Reconstruction is the most talked about business of Edelweiss currently, it’s contribution (positive or negative, if things go wrong) is expected to be negligible to Edelweiss consolidated profits.
However, if your opinion in the above comment is based on all the business verticals (and not just the ARC), please share the specific reasons for the same.
@Julian since when fund managers started keeping AUMs on their own balance sheet? They manage ARC fund like a distressed asset resolution fund with significant skin in the game by equity contrinbution.
@eamitmehta as far as I understand these SRs are non binding on Edel. It is payable after deducting expenses and other charges. We need to understand that ARCs are like sophisticated recovery agents so they share profit and loss with banks based on bilateral agreements and they can not give full guarantee of recovery. Their maximum loss is 15% of upfront payment if the recovery is zero in the worst case.
8 days back I had posted on why Edelweiss is a poor business. I am not stupid to classify a business as poor on the basis of one of its activities. One has to look at the business as a whole including the insurance business. The ratios have to be calculated for the whole year and one should not come to premature conclusions based on the performance in a quarter which was not audited.
Thanks Sumit. So, in essence, they pay 15% (that too is 40% to 60% of the loan value) and get the right to share the upside if the NPA is resolved. It’s like buying an option. No wonder they are expecting asymmetric results.
A few years ago we asked three questions to which we have not yet received an answer: “If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world should they go?” – Buffett; 1998 letter