Edelweiss Financial Services

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526

Hi, Enterperise value of Advisory Business is roughly Rs 8,000 crore which would be future value in two years time subject to performance related milestones.

Kora Stake is between 15-17%.

Source - Concall and Today’s interview on CNBC TV 18.

Listing of Advisory Business is a significant development since it has realised fears of many investors that Edelweiss Financial Services would be structured as a Holding Company.

Minority shareholders in Edelweiss Financial Services would not be able to directly participate in dividends and voting decisions in the Advisory Business any more.

Disc - Invested since last 1 year - Sold around 1/3rd of Holding @ 201.

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527

Q1FY20 concall notes-
“One of the toughest phases in 30 years career. It is intense and painful but this sentiment will bottom out in H1 and turn up in H2.”

  • Bad Quarter - liquidity issue spready economy wide. Almost entire fall in profit was due to increase in borrowing costs. It used to be 100-125cr per Q and in Q1 it was 250cr. We think it will be same in Q2 and then come down.

    • Cost of credit in corporate credit book was high.

    • Of 162 projects, MMR and NCR are 2/3rd, 80% inventory is 1cr. All are under construction, RERA compliant, sales started in 80-85%. Real estate Pricing stabilizing. Problem is projects that are stuck due to execution or funding. No new significant project launches. Scale back of supply has started to happen. Demand supply should turn up next March.

    • Provisioning- 250cr in Q1, of which 200 is on wholesale. We have gone account by account. So 700-800cr credit cost for full year seems realistic.

  • H2 was ok but now we are seeing cash flow related stress in our asset quality. Collateral covers are still 1.8x loan book. We decided to proactively provide. Grappling with environment. This year will be year of consolidation/clean-up year for industry and we will see growth in Q1.

  • What are we doing in this env- Managing liquidity, reduced CP to almost zero, diversified borrowings of longer duration.

  • Raised equity in credit, $250mn from CDPQ. 1040cr came in May in NBFC. Will own 14-18% at the time of conversion in Credit business in ECL finance.

  • Raised equity in EGIA (ARC, Asset manag, Wealth management, Capital markets) $75mn from Kora management (leading tech oriented global financial services investor). Convertible structure. Expected mid point of conversion is 8000cr, which is 10PE of 2021. This business in this Q made 160cr pre minority PAT, 130cr post minority PAT. It is 500-550cr PAT business already, should be 800cr PAT business in next 2 years. Planning to raise more from others to raise total $200mn (1400cr) in 8-12 weeks. Edel will own 83% post equity conversion. We need this capital for ESOP/margin funding (huge opportunity, we have 70-75% market share), which sits in ECL finance right now.

  • Gearing come down from 5.2 to 3.7, will come down to 3.2-3.3, one of most conservative. This will bring down RoE but we will be ready to pick up post March 2020.

  • Insurance- DHFL, reliance capital etc bond investments on the books? "We are always hesitant to put individual accounts but it shows up in results. I am sure we will have some investments and whatever it is, we have provided for that. Numbers will not be large because we are small insurance company. 10-20-30 cr in insurance "

  • Stress level in stage 2……lot of movement from stage 1 to 2. Any major chances of SME slippages ? Across board going up. Buckets keep shifting specially on real estate side depending on cash flows. Our current stage 2 is same as a year ago. We are anticipating increased stress largely due to cash flows. We are stepping up our credit cost. This year we may have 700-800cr credit cost. Good news is that this has been going on for 3 Qs so there wont be too much worsening.

  • ARC Slowdown in resolutions- There is slowdown in NCLT resolutions which makes headlines. But many resolutions are happening outside NCLT, last week Alok industries got cleared. Last year 7kcr resolved and expect 12-13000cr recovery including Essar.

  • impact of regulations MF distribution-? Partial impact on wealth management but we are strong in bonds, alternates, structured funds. MF distribution is small so impact on Wealth management is minor.

  • Sharp decline in yield to AUA in wealth management. Couple of credit events caused lower activity across the board. Quarterly volitility. Its not structural but cyclical.

  • Partial Credit guarantee Scheme- We have SME and retail book of 14-15000cr. Will like to use this scheme to recirculate some of that because we have a strong origination engine and our capacity of origination is more than what we are originating, given the liquidity situation etc. We would release some capital and re-plow into originating more, that will become a model. during last 9 months we have not used asset sell downs in a big way. We have not done more than 500cr in last 8-9 months so Book is intact and available for securitization. We will securitize 2000cr and use that to scale up retail business.

  • Co-origination will be a great opportunity, which will be 80-20. Most NBFCs will structurally now become capital efficient rather than just grow books by 20-30-40%. You will have to increase the flow business, get more fee income and use things like co-origination so your RoA should go up but your gearing should come down to maintain same RoE. RoA increase to come from higher fee based or churn based activities and that is the new model that we think will come into play. Also seeing lot of co-origination opportunity on the wholesale side…lot of global players coming to us. Wholesale has good risk reward, gives 4-5% higher yield with 2-3% higher cost. Given current environment NBFCs should not do a lot of wholesale but co-origination will become capital efficient strategy to improve RoA without stretching balance sheet.

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528

The Coffee Day exposure and ever-greening of loans: Going back to my Edelweiss post where I had pointed out that Edelweiss had an exposure to Gonibedu coffee estate (belonging to Coffee Day group as pointed by @sachit ) and Edelweiss’s ever-greening of those loans, the ever greening was pretty obvious but bit I did not think that at that time that a 330 bps ever-greening of Coffee Day loan should have reflected poorly on Coffee Day too (from 9% to 12% should have reflected badly). What is also interesting is that Edelweiss said that this loan was stock in trade. Went through ECL’s balance sheet this year but don’t find NCD level details this time, could be anybody’s guess why?

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529

I think this was part of LAS operation and as far as I know this is a fantastic biz for Edel. Rashesh Shah has time and again said that it is a zero NPA biz and confirmed by Nitin Jain in this video. The current fund raise from Kora mgmt is to expand the same biz.

Regarding Coffee day, I think Edel won’t make any loss given the way they are monetizing the assets. I don’t know the details for sure but my understanding is that Edel has one of the best collateral management team mainly due to their ARC experience.

Disc: Remain invested

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530

I am not able to make sense of the numbers quoted by Rashesh Shah for the EGIA Business. As per the quarterly result presentation, they have made Rs.68 Cr. of profit. So how did this no. of Rs.160 Cr. come about??

Further they talk about Distress Credit as part of EGIA, but isn’t ARC part of Credit Business for which CPDQ had invested?

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531

Pls refer slide 14 of Investor presentation. EGIA Pre minority PAT is highlighted in red dotted box.
ARC - 98 Cr
Wealth & Asset Management - 54 Cr
Capital Markets - 14 cr
Total - 166 Cr

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532

I think they are running 2 distressed books one is pure ARC with their own funds and external loan facility and then they have a distress funding book in a Fund Structure.
Advisory Business with a book of ~2 Lakh Crore is being sold 4% AUA. With Kora investing as CCDs with 2 year conversion point. Stake sale is happening at a discount (but getting Private Equity money is what matters).

533

Sure, this is at a discount and the market is not wrong to take it negatively given the fact that it was the highest RoE biz segment. Two things to keep in mind that the investor is not sure about listing or exit timeline secondly there is a part of wealth Management that is cyclical e.g. LAS. We are surely looking at a bad cycle for the next 6 months and Edel might be worse off in the short term.

From Edel’s point of view they could protect their market leadership in a very profitable market segment by getting this money right now rather than later.

534

Yes. But overall if you consider the current conversion rate for both Credit & Advisory business. We are still getting Edelweiss at a 30% discount to its value.
Credit Business was valued at ~12k by CPDQ
Advisory Business is valued at ~9k by Kora
Insurance Business would be worth ~2k
so we are getting a ~22k business in 2 years for >14k market cap

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535

Yes, but holding company discount too.

536

Why holding company discount applied here?

537

it has 3 business verticals, with each of them having a partner (strategic or financial), plus each verticals independent capital structure, board of directors, etc. So, edelweiss is like a holding company of 3 different businesses (credit, advisory and insurance)

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538

Not entirely correct when subsidiaries are unlisted and the parent has full operational and management control. I think Edel will go for demerger like IIFL did recently which should create value eventually.

539

If Edel do a demerger I dont think most of the investor would like to be the part of their NBFC or loss making nascent Insurance when better quality INSURANCE with high franchise strength is available … Wealth Mgmt is their crown like IIFL and this exercise would be a puzzle for existing shareholders …

I don’t want to guess how the future unfolds as thats for everyone to predict / forecast but as of now if DHFL etc has shown cockroaches on Liability side then Edelweiss is the first to show cockroaches on Asset side …

Moreover Mr, Rashesh Shah in Q4 / Q3 concall clearly said that they are keeping enough liquidity and also one should expect a growth rate of 15-20% in FY20 but in just 3 months his tone became pretty defensive and all the way he was complaining of tighter liquidity and ECL.

They keep on diluting stake in subsidiary where opportunistic money is coming in… Its pretty simple to guess that for now BANKS / Bond market is not favoring Edelweiss.

lets see how things unfolds… Hope for the best !!!

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540

Last 8-10 days have been a tough and testing time for Edelweiss investors. Share price has fallen by more than 25% in a short span of time.

IMO, apart from the general market conditions, two specific news have put the stock further in red namely

  1. To sell a nearly 17% stake in Advisory business valuing this business at only 10-12 times 2 years forward PAT is indicative of how tough it is for the Company to raise finance and keep liquidity

  2. Listing of advisory business - Edelweiss Financial Services Limited will be a holding company reducing the market perception of EFSL to that of a Holding Company

The credit business too is finally showing slippages and management has guided for more credit costs in Q2.

Only silver lining has been management has been upfront and conservative in leverage in credit business and keeping sufficient liquidity. (Except for reversal of growth guidance by management which is also a function of market events not fully in managements control)

For instance management had guided that wholesale lending will be slowly moving off books to Funds, I have tried to corroborate with data

Q1%2020%20Loan%20Book%20movement

Clearly, Structured Credit has significantly reduced. Management in Q2 presentation has guided for another 3,000- 4,000 crore reduction in Wholesale book. If this is achieved with GNPA of less than 3% then it will be quite an achievement. It would mean developers are repaying from project cash flows as chances of refinancing look bleak - again this is dependent on markets.

It would also mean that overall wholesale book would be nearly half of Q2’19 levels - again quite an achievement if 50% of Risky book is recovered in ~ 18 months.

Another point is that as per management cost of borrowing has come down in last 6 months and spreads have been maintained.
Edel%20Spread%20QQ2'20

Im not sure of how cost of borrowing is calculated since cost of holding liquid treasury assets is booked under separate vertical viz - BMU

Next 6 months would be crucial for the credit business, and if the guidance is achieved, then there is a good chance of change in risk perception of loan book and consequent re-rating.

Also management should clarify on what would be the legal structure of the business post listing of Advisory business. If management cares about its long term perception and interest of minority shareholders of Edelweiss Financial Services - they should be given shares in the advisory business instead of shares being owned by the Holding Company. Such a clarification would again go a long way in dispelling fears and reversal of the de-rating of the stock.

Disc - after last post, sold another 1/3rd of holding in loss at ~ 122.

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541

This might be good for shareholders, but what about outstanding creditors of EFSL? Would they be ok with no recourse to other business segments like Advisory, in case of difficulties in the Credit business?

Disc: I hold Edelweiss NCDs

542

You must be holding NCDs issued by either ECL Finance or Edelweiss Housing Finance or any other NBFC company.
If you are holding NCDs of ECL Finance, there shouldnt be legal recourse to assets of advisory company since it is a separate legal entity.

543

This may be technically true (I am not at all an expert), but practically speaking, if ECL Finance or Edelweiss Housing Finance or Edelweiss Retail Finance faces repayment difficulties, I am sure they will borrow from or sell the Advisory business to make the repayments. However, if the businesses are separately listed (instead of being subsidiaries of the listed company), I don’t know how exactly things would work. As a NCD holder, I am much more comfortable with the current structure.
Maybe seniors on this forum can guide on this aspect.

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544

Wholesale book still is invested in Real Estate Projects. Money which has gone for land acquisition, inventory funding and this book has not reduced by much during the last 1 year. Which for me is the next red flag and needs to be monitored.
Structured Finance Book has gone towards construction of Residential Projects and Edelweiss has really brought down this book and would be further reducing it over the next 1 year.
Growth of Credit Business is seen in the Retail loan segment and co-origination deal with Bank of Baroda (BOB) should help going forward. I expect this business to become 70%+ of the credit book in next 2 years.
Distress Credit is an awesome place to be in India right now and Edelweiss has created the team and the structure for it. the numbers they are achieving is awesome 25%+ ROE and ROA of 4%. Market has taken a negative view on this business due to one big case which is dragging on (Essar Steel). but their are loads of deals which are happening in the market and IBC is acting as a catalyst to spur those and Edelweiss is latching on to those opportunity.
Net Net if they manage to keep the Gross NPA in control the Credit Book would become 70% Retail in the next 2 years which is as per the management guidance and not a bad thing. We already have a floor as CPDQ has valued the credit business at 12,000 Cr. (next 2 years).

Advisory Business Valuation - Mr.Rashesh Shah has created confusion by quoting PAT nos. which nobody can directly see in the books (due to co-mingling of distress credit books). I don’t think the pre-money valuation for Kora Management is bad as its been done at 4% of AUA of Rs.2,00,000 Crore (which is in line with whats the global norm for this business). They weren’t able to get a premium valuation due to market conditions but the deal has been done at fair valuation.

Insurance Business - I feel is non-core activity and the business would eventually be sold out to the partner at a good multiple and return to shareholders.

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545

A side plus for ARC business is that fees is back ended. To be realized with the debt resolution are completed.