CAMS - Indirect Bet on Financialization?

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I have read the Offer Document of CAMS and wonder if it is worthy of Investment as it focusses on Mutual Fund and Insurance Industries.

What I have put here is entirely from of Draft red Herring Prospectus as I am not capable enough of my own research. This is just an effort to get views from seniors to see if CAMS could be a long-term Investment candidate.

Computer Age Management Services ( CAMS) is a technology-driven financial infrastructure and services provider to mutual funds and other financial institutions with over two decades of experience.

It is India’s largest registrar and transfer agent of mutual funds with an aggregate market share of 69.4%. Over the last five years, they have grown their market share from 60.5% to 67.6% during March 2015 to March 2019.

Mutual fund clients include four of the five largest mutual funds as well as nine of the 15 largest mutual funds.

The growth in the AUM of mutual fund clients is important as substantial portion of revenues based on Average AUM. Also, they get more fees from equity mutual funds as compared to other categories of mutual funds. The AUM of equity mutual funds serviced by CAMS grew from Rs. 2,180 billion to Rs. 6,701 at a CAGR of 30% from March 2015 to September 2019.

Mutual Fund Industry Overview:
The AUM has risen at a CAGR of 17.4% from Rs. 1.1 trillion as on March 31, 2000 to Rs. 23.8 trillion as on March 31, 2019. Mutual fund AUM as a percentage of GDP rose from 4.3% in financial year 2002 to 12.5% in financial year 2019.

The AUM of equity-oriented funds grew at a CAGR of 39% from Rs. 2.1 trillion in financial year 2014 to Rs. 10.7 trillion for the financial year 2019, whereas the debt segment grew at a CAGR of 9% during the same period.

Individual investors (retail and high networth individuals) AUM outpaces institutional segment. Individual Investors Invest more in equity schemes (68%) vs institutional (14%).

SIP contributions have seen strong growth. Between April 2016 and March 2019, the monthly amount invested through SIPs has risen from approximately Rs. 31 billion to Rs. 80.5 billion or over 150% in absolute terms. Number of SIP Accounts grown 24% to 26.2 million in financial year 2019 from 21.1 million in financial year 2018.

According to CRISIL, the mutual fund industry’s AUM is projected to grow from Rs. 23.8 trillion as of March 31, 2019 to Rs. 54 trillion by financial year 2024, which represents a CAGR of 17% to 19% of which Equity AUM expected to grow 21-23% CAGR.

As on March 2019: HDFC Mutual fund is the largest AMC in terms of its AUMs (14%) followed by ICICI Pru (13.1%) - SBI (11.6%) - Aditya Birla Sun Life (10.1%) - Nippon India (9.6%) - UTI (6.5%) - Kotak Mahindra (6.1%) - Franklin Templeton (4.9%) - Axis(3.7%) and DSP Mutual Fund (3.2%). Top five AMCs have 58.4% Market Share.

There are 3 Mutual Fund Registrar and Transfer Agents Viz. CAMS | Kfin technologies | Franklin Templeton Asset Management.

Among the top five AMCs, HDFC Mutual Fund, ICICI Prudential Mutual Fund, SBI Mutual Fund and Aditya Birla Sun Life Mutual Fund are serviced by CAMS and Nippon India Mutual Fund is serviced by Kfin.

As of November 2019, CAMS serviced Rs. 18.7 trillion of average AUM which constituted approximately 69% of the total mutual fund industry AUM.

CAMS has the highest revenue in the industry and also witnessed the highest revenue growth in the past three years with a CAGR of 20.4% in between financial years 2016 and 2019. For the financial year 2019, CAMS revenue from operations has grown by 8.1% and its EBITDA margins and RoE are better than its competitors. CAMS is the most productive MF RTA with its AUM per branch being the highest in industry.

Apart from Mutual Fund Houses, CAMS provides services to Insurance Companies with its division CAMS Insurance Repository Services. Insurance repositories act as a single stop shop for policy servicing for e-insurance policies.

Currently, there are four Insurance Repositories. Out of 1247475 E-policies - Market share of:
NSDL Database Management 45%
CAMS Insurance Repository 39%
KARVY Insurance Repository 11%
Central Insurance Repository 6%
(As on September 2019)

Other than above CAMS has:
Electronic payment collections services business.
KYC registration agency business
Software solutions business where it develops software for in-house mutual funds services business and for other mutual fund companies.

I did not read much into other business as Almost 87% of the revenue comes from mutual funds services business.

PROMOTERS:
Great Terrain is the Promoter of CAMS based out of Mauritius.
Great Terrain held 100% by Harmony River Investment Ltd, Mauritius.
Harmony River Investment Ltd is directly owned by certain private equity funds managed by Warburg Pincus LLC, New York.

This promoter of promoter of promoter type holding - could it be a problem in future (Thinking of GMM Pfaudler!)

I am surprised to know that CAMS Identifies - HDFC, HDFC Bank, Acsys, NSE, NSE DAL, NSECL and NSEIL as the group companies :slight_smile:

Financials:
Not much data available as it’s a new listing:
As on March 31, 2019 they generated a revenue of 694 Cr - Operating profit of 201 Cr @ 29% margin and PAT of 131 Cr.

Interesting that CAMS gives out Dividend payout @ 65% which they intend to continue.

Risk Factors:
Almost 87% of revenue generated from mutual funds services business. Decline AUM of Funds could adversely impact revenue and profits.
Client concentration risk as TOP 5 client contribute 65% of revenue.
Regulatory Action Risk.

With my limited knowledge, I may not be able to answer any queries other than just hitting LIKE button :slight_smile:

Disclosure - I have taken a tracking position - looking forward to inputs from ValuePick’rs to add more.
Thanks.

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Thanks for starting the thread. I got 1 lot in the IPO and haven’t booked the profit. I think it is fairly priced currently. It is ~40 PE. But considering the growth prospects, and the mega-trend of financialization in India, this can be a good buy…

Key thing I would like to understand is how easy / difficult is it for mutual funds to shift from CAMS to other service providers. Is there some kind of strong lock-in?
Secondly, is there any threat from Paytm, Groww, Kuvera etc.? If there is, I would stay away as CAMS will not be able to compete with these companies

Someone knowledgeable with the business intricacies please help with above questions / and any other moat you think exists.

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If my understanding is correct, A Mutual Fund House concentrates on launching New products - Marketing and sales - and Investing the money received.

Once an application received/Account opened, The Registrar & Transfer Agent like CAMS takes over. Right from Application / Transaction Processing - KYC compliance - opening account - distribution of Units is done by CAMS. Then for distributors of the Fund, Maintenance of Broker / Sub-broker / Advisor Master details. Maintenance of Fee/brokerage/commission payable to brokers or distributors done by CAMS.

They take care of Addressing Investor query and grievance. Call Centre Management. Distribution of dividend etc and finally redemption.

In a nutshell, they are involved throughout the life cycle of an account - from the stage of account creation to processing transactions and redemption of the amount invested.

CAMS has in-house technology development for all this. They have pan-India physical network comprising 278 service centers spread over 25 states and five union territories. They work as an intermediary between Fund House, Distributor and Investor.

It is challenging for a Fund House to replicate all this in-house. Also, moving to a competitor is time consuming and disruptive. According to the CRISIL Report, the amount of time to be invested in migration, a high risk of business disruption, data loss, as well as customer and regulatory issues make it a bigger task to switch to a competitor.

There is no such thing as lock-in period as such. The average term of the relationship with ten largest mutual fund clients is 18 years and over a five year period, they lost only one client as a result of the merger of such fund with another fund that was serviced by a competitor.

As for the threat from Paytm etc, I am not sure if they can develop such a large Infrastructure, Software technology, and domain expertise which CAMS has developed over 2 decades.

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From the perspective of what service CAMS provide, paytm ,kuvera, groww & others aren’t into it, what they do is aggregate all MF’s & provides the customer a platform to trade in MF’s. From their marketing perspective too its seems they are focussing only on the customers, so it seems more of a brokerage play than anything else!
Or from a futuristic point, trying to create a monopoly & then charge the issuer for bringing in the customers!

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I have a question here on understanding this category of businesses which are proxy to something else like say CAMS, CDSL or even exchanges…how does one rate CAMS as compared to say a CDSL. One is proxy to mutual funds, other is to investing…which one has superior metrics here and exactly what do we compare? What is most significant in such companies to compare…is it the entry barriers or technological expertise or something else?
Does CAMS revenue depend only on AUM or also on number of customers a MF company has? CDSL revenues depend on customer base as well… although depository charges for individual customers would depend on their portfolio value? Thoughts welcome!

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I have a question. Isn’t this a technology enabled specialized BPO for MF industry. I find this no different than a BPO company doing claims processing an insurance company.If that be the case the case, should this be trading at a value it is trading now.

Add to that, they is no regulatory binding for MF to go to CAMS. I assume that for stocks SEBI mandates demat with depositories NSDL-CSDL.

MF can choose to do what CAMS is doing inhouse. When industries grows more service providers may come in.

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That’s a very good question. I think the valuation may depend on what actually drives the revenues of CAMS. Is it linked to AUM and number or customers it processes for a MF company or transaction based or something else, along with their pricing power. MF can squeeze margins of distributors in case of expense ratio reduction…can they do same for CAMS…is the expense on CAMS for a MF company significant or doesn’t matter to pinch them much? I think such details are important to know to dig further…

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Registrar and Transfer Agents (RTAs) are institutions formed to register and maintain detailed records of investor’s transaction on behalf of Mutual Fund Houses and for their convenience.

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CAMS Investor Presentation Q2fy21 Highlights:

Avg AUM at 19.4 Trillion that’s up 8.6% Y-o-Y and up 11.3% Q-o-Q. Market Share at 70%.

Op-Revenue 171.14 Crore that declined from 173.83 Crore Y-o-Y but increased 15.1% from 148.63 Crore Q-o-Q.

The AUM Growth driven by Non-Equity Assets (Debt and Liquid Funds which Have lesser margin) Revenue affected because of Outflows in Equity Assets (Now 34% Vs 37%).

PBT 66.1 Cr Vs 59 Cr up 12%. In Q1 PBT was 52 Cr.
PAT 49 Cr Vs 42.6 Cr Y-o-Y. In Q1 PAT was 39.8 Cr.

Op-Profit Margin 39.7%. PBT Margin 37.5% and PAT margin 27.8%. EPS for Q2 is 10.03.
Dividend Proposed at Rs. 6.75/Share.

Some other developments apart from Financials:
Franklin Templeton AMC appoints CAMS as their RTA.

UPI AutoPay enabled for SIPs through CAMSPay – first in the industry.
Aadhaar based eKYC ready to be launched.
myCAMS transaction volume up 34% Q-o-Q.

Disclosure: Invested.

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In my opinion CAMS is suitable investment option for long term investors as penetration of mutual fund is nascent in India. The stock has very long runway for growth and appreciate, with very good and professional management

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The attached report by HDFC Securities gives a good insight on the company.
CAMS_Initiating Coverage_HDFC Securities_Nov 2020.pdf (1.5 MB)

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That’s excellent operating profit margin, maybe next only to likes of an AMC…point is when they report such margins, will AMCs not try to squeeze it whenever they have pressure on them to maintain theirs? Who would hold upper hand whenever margins need a squeezing…AMC or CAMS?

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image

RTA Fees is on a decline over the years , but that should be get compensated with the increase in AUM of AMCs .

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Apart from Mutual Funds there are other business: Insurance Repository, Electronic payment collection, KYC registration etc services. Right now they are in Nascent stage contributing less than 15% to revenues. Going ahead, few years down the line, these may be additional revenue stream.

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Looks like a business with predictable revenue growth probability of 15%, but aren’t AMCs a better bet?

I like the 65% dividend distribution policy, what would be the approximate annual yield at current price?

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Thesis written as of 18th November, 2020

The write up focusses more on the qualitative views; for all the factual and supporting data can be found in the company RHP and investor presentations.

What does CAMS do?

CAMS (Computer Age Management Services) helps Indian mutual funds manage everything that is not core to running a mutual fund business. They key core functions of a mutual fund business in India are 1) researching securities and taking portfolio management decisions 2) launching new schemes to raise fresh assets for investors 3) marketing and communicating the brand identity and customer proposition. Leaving these aside, there are a string of non-core but operationally important activities such as 1) investor KYC, onboarding 2) two-way payment collections and processing between the fund and its investors across SIPs, new purchases, redemptions, NAV calculation, dividends etc. 3) generating and distributing investment statements for investors 4) tracking and calculating distributor commissions.

These are but a few examples and there are several other ancillary activities which CAMS undertakes on behalf of mutual funds. To give a very simple analogy, think of CAMS as the arteries which help circulate blood into and out of the heart. While the heart (the MF) is the most important organ, arteries are nothing less than an inseparable extension of it.

In technical language, CAMS is called an RTA (Registrar and transfer agent) and it is by far the largest in India with a 70%+ share. The market is a duopoly with K-Fintech (formerly Karvy) taking most of the remaining share. Although I would argue that CAMS is operating like a monopolist now as they have made steady share gains over the last 5-10 years and those continue even now. CAMS is the RTA for 4 out of the top 5 and 9 out of the top 15 MFs in India. The MF industry itself has been getting consolidated with the top 5/10 taking an increasing share of AUM from the 40+ total mutual funds that operate in India.

Business model – how does CAMS make money? Key revenue and cost drivers

CAMS charges a few basis points as fees on the total AUM serviced for their MF clients. This few basis points of fees translates into a sizeable revenue size for CAMS. For example, in FY20, CAMS reported a revenue of ~Rs7bn by servicing a total AUM of Rs18trillion. This works out to be ~4bps as fees.

Bulk of the revenue for CAMS comes from this model which is linked to AUM serviced (70%+ in my est.) and another 10-15% comes from charges basis transactions (paper based etc.). Another 10-12% revenue comes from newly incubated businesses such as similar services being offered to insurance companies and AIFs being set up in India. However, all said and done, they key business model remains being the operational arterial platform for mutual funds and charging them basis total AUM serviced. Typically, a mutual fund works with a singular RTA, services offered by an RTA are a complete package and not on a piecemeal basis. CAMS charges higher fees on equity AUM versus debt AUM possibly due to the higher complexity and transaction/ operational intensity of equity operations.

The cost structure for CAMS is similar to an IT services company. Staff costs is about 40% of sales as lot of people need to employed in technology related operations besides staffing for various support roles. Other opex is 20% of sales leaving CAMS with ~40% EBITDA margin (2x of IT services).

CAMS is clearly as asset light business with reasonable operating leverage given its largely fixed cost structure. To run its operations, CAMS needs office premises to staff its people, computers and servers and there are related software costs. CAMS also need to support its physical 270+ branch network to interact with investors on behalf of their AMC clients. All this translates into an EBITDA margin of 40% and an ex cash ROCE of 50%+ (Isn’t that better than most consumer businesses?).

CAMS is in some sense like a platform business and thus profitability can be non-linear as CAMS scales up further. CAMS cost of software and supporting services (increasingly automated and digital in nature) do not rise proportionally with rising AUMs they service. This is another feature of CAMS which makes it business superior to IT services which remains a linear business – revenue accretion is still linked to headcount or man hours billed. For those doubting this, please check the US$EBIT/employee for top IT companies over the last 10 years and you will see a flattish trajectory. I do not intend to belittle the IT services model but making the point that CAMS not only operates at higher margins but has a much higher non-linearity embedded into its business model.

Competitive advantages of the CAMS business model

  • Proprietary technology and know-how: CAMS has over the last two decades developed and evolved its systems bottom up. CAMS technology platforms and process architecture has evolved with the mutual fund industry. This is not something a new player can go and buy off the shelf. That CAMS systems have been superior is proven by their share gains over the years. The work done by CAMS cannot be easily done in-house by mutual funds either. For the MFs have not invested in such support software and processes. Even if they can do it inhouse, there is no incentive to do so themselves as CAMS is able to do it in the most efficient way given their scale and experience. Franklin MF who was doing it in-house until recently has also contracted CAMS to do it for them. This will move another 3% AUM share to CAMS taking total share to 73%.
  • Switching costs: Over the years, mutual funds have come to heavily depend on CAMS for their dealings with investors, distributors, payment processing, KYC and other compliance related tasks. CAMS has not disappointed and relationship with its top 10 MF clients has averaged almost two decades. That said, even if a client decides to switch to another RTA (not there are many options), there are very high switching costs as the entire backbone of the operations is so intertwined with the RTA. There is a risk of many things going wrong from cyber security, poor customer experience, loss of data etc. while moving between RTAs. Unlike IT services, where the customer typically works with 4-5 vendors on different projects, CAMS is the sole RTA offering end to end services to its clients. That only escalates potential switching costs. Customer stickiness is thus expected to be very high in this business.
  • Economies of scale making it a low-cost leader: CAMS rising market share and best in class operational systems has made it the most efficient RTA. This is now a virtuous circle – as CAMS gets larger versus the number 2 player, its unit costs keep reducing enabling it to offer the best priced services and yet remain very profitable.
  • Does CAMS have pricing power? CAMS pricing structure is tiered which means that fees drop as AUMs serviced scale up. This is why CAMS revenue growth can trail AUM growth for AMCs over the longer term. However, remember that CAMS has high operating leverage which means that even as % fees drop, absolute higher incremental sales flow through the bottom line better due to operating leverage. Essentially, this means that earnings growth and ROCEs for CAMS can actually inch up even as % fees charged on AUM trails down. One needs to be cognizant that with CAMS now being the sole efficient and dominant RTA, CAMS interests are well aligned with their MF client’s interests. A healthy CAMS will make sure systems are tight and ever improving which benefits the entire ecosystem. Lastly, one has to also realise that CAMS fees of 5bps is a very small fraction of the total expense ratios of mutual funds. So as long as CAMS is doing a good job, they are the last ones MFs will come after to squeeze out some pennies. The simple analogy I can give here is of Fevicol – if you want to cut your interior decoration budget, you would not think of replacing Fevicol with a cheaper adhesive. Simply because, Fevicol does a good job and constitutes a very small cost of the overall furniture making cost. There is obviously a risk that if SEBI caps or keeps cutting down expense ratios, CAMS will also be expected to oblige. But this is a risk even to the AMCs themselves.
  • Risk of customer high concentration? While the customer concentration risk is in this business, it is more than compensated by the fact that switching costs are very high.
  • Comparison with AMCs: I prefer playing CAMS over the AMCs as CAMS will win business irrespective of which AMCs retain or lose their market shares over the medium term. AMCs though consolidating have plenty of competition going within themselves while the industry structure of RTAs is much better. While AMCs can grow faster than CAMS in revenues, the longevity of dominance is harder to predict versus that for CAMS. (Some also call this the length of the competitive advantage period.)

Scalability – long runway for growth

The mutual fund AUM in India should compound in mid-teens over the next 15-20 years. This will be partly a function of price growth (the Sensex has a CAGR of ~15% since 1980) and an influx of new investors who shift their savings from FDs, real estate, gold, insurance into MF products. Given the tiered fee structure, CAMS revenue growth could be in low teens. There is an upside if CAMS can scale up its other new businesses (insurance etc) over time but we will leave that for now. Thus a 12-13% revenue CAGR over the next decade is easily conceivable for CAMS. Earnings growth can be higher due to the reasons we have argued above. Growth certainly won’t be linear as revenues are linked to underlying AUM and as we know markets can be volatile and may have a few bad years followed by a few good years; this is something which will affect AMC stocks as well.

Valuing CAMS

At about 30x FY22 earnings, CAMS seems reasonably priced to me. This is a business with very high barriers to entry and strong competitive advantages and a large growth runway. The business chugs out cash like anything I have ever seen due its negative working capital cycle. Its FCF/Sales ratio trends at ~25% amongst the highest you will find even across sectors such as consumer, IT or pharma. This combined with a strong pedigreed track record and ownership (HDFC twins and Warburg Pincus) makes me comfortable at current valuations when taking a longer-term view of the business. I have also done detailed DCF analysis but not sharing the same here.

Miscellaneous

Readings – there is a nicely written book on the history of CAMS by Sriram V which I would recommend for anyone wanting to understand CAMS better.

It can be found for free at: https://new.camsonline.com/assets/image/about/pdf/CAMS_An_Eye_for_Detail.pdf

Disclaimer: Biased and invested. So do your own work before investing.

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Just one point here, where do these figures of FCF/Sales ratio and margins stand when you compare them to say an AMC or a Life Insurance business?
Consumer, IT and Pharma are not closest of sectors (Risk factors and growth triggers are very different and hence valuations not comparable to a company which does outsourcing work of AMC etc.)…AMC and maybe Life Insurance are somewhat closer sectors, if at all.

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HDFC Securities initiates coverage on CAMS

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AMC should be similar though I have not crunched specific numbers here.

Dont agree with you on not comparing it with other businesses. While obviously every sector and every business is different, every business and every stock ultimately competes for every dollar allocated in the capital markets. As a fund manager you are spoilt for choice in terms of where to allocate your capital.

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You compared valuation and ratios of CAMS with that of other sectors like IT, consumer and Pharma. Each sector is valued differently for valid reasons so such comparison may not give answer we looking for. You are most welcome not to agree and have different opinion. I would compare CAMS with a business somewhat closer in risks and growth etc, if at all I compare it with other sectors. Maybe AMC and Life Insurance would be a good start. Thanks

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