IL&FS Investment managers (NSE code; IVC: Mcap 540 crs) is an AMC managing private equity funds in infrastructure and real estate. The source of income for the company is through asset management fees (currently earning weighted avg of 1.4%) and carry which company earns if the return on exit exceeds some pre-determined rate (generally 10-12%). But in carry, company share is only 30%, balanace distributed among management (carry not considered in current valuation). I came across this stock while reading interview of Sanjay Bakshi on Safalniveshek.com. Though Mr. Bakshi mentioned this stock in the sense at one point in the past it was trading below its liquidation value, I think even at current price of INR 26, this stock provides opportunity to benefit from positive black swan and one of those stocks which I think fall in the category aHeads I win and Tails I do not loose mucha. You can read about the company and its business model on page no. 40 of Mr. Bakshi interview here https://docs.google.com/open?id=0B8Mr8IuAEwz7WnlOTmxBWGtncjg and initiation report by Parag Parikh FAS here https://docs.google.com/open?id=0B8Mr8IuAEwz7TFpIQV84WXMzekU__
Reasons to buy:
1). Market is factoring a worst case scenario: Market factoring that AUM will fall drastically by 50% within four years (i.e earnings AUM will decline from USD2.5bn to USD 1.25bn by CY 2016) and then will grow at only 2-3% p.a. Going by the nature of income which is more like annuity, I have used discounting rate of 8% instead of my general 10%. Even If one wants to use 10% rate it will imply terminal growth rate of 5% pa in 2016, which is again not a very optimistic assumption. (Other assumptions cash profit margin of 45%, AUM fees of 1.4% and INR/USD rate of 45. And if USD/INR rate averaged 55 for next few years, this it should provide upside of another 10- 20% upside).
2). Attractive dividend yield of 5.5%: IL&FS is expected to generate INR 180 cr of free cash flow over next four years (on the back of existing earnings AUM of USD 2.4bn, so maintaining a dividend yield of 5-6% (current yield 5.7%) over next 3-4 years should not be a problem. As on Mar-12, company had net cash (inc current investments) of around 38crs. Dividend had grown at a CAGR of 40% during 2005-10 and during 2009-12 had grown modestly at 4% CAGR, inline with profit growth. So we can expect that in worst case scenario, dividend will atleast remain flat.
3). Insiders are buying: CEO had bought stake of 0.8% in the last two years. Ravi (membe of BOD) bought 0.8% stake in 2009 at P/ CEPS(price to cash EPS) of 9.6x. Other member of BOD together purchased about 1% stake in Q4 2009 when P/ CEPS was around 9x. (current P/CEPS is 5.5x)
Reasons not to buy:
No fresh fund raising for next 2-3 years: Between 2000-05, company raised only USD 153m. Infact company could not raise any funds during 2000-03. So there is possibility that for another 2-3 years company is not able to raise any funds in which case share price will remain range bound. The entire increase in AUM from 2005 onwards is because of drastic growth (or bubble) in real estate sector. Currently more than 60% of AUM is from real estate PE.
Costly acquisition IMHO, Saffron acquisition in Aug 2010 was one their big mistake (overpaid) and the benefits are yet to be realised. If they make any other acquisition like this, it will destroy the value. Price paid for saffron was too steep. USD 50m (INR 250 crores). At this price this deal was 25% of its then prevailing market cap, but as % of profits was hardly 10%.
Disc: Invested in stock, so opinion can be biased.
Other negatives (though not a big concern, but disclosing for completeness)
Majority of the income is received in USD. Any adverse exchange rate will impact the profitability adversely. Income is in USD and expenses are in INR (I have assumed INR/USD rate of 45)
Entirely dependent on international money flow. Domestic institution share is less than 2%.
Pressure on fixed mgt fee. In international markets, fixed fee is 1% for real and infra and in india its still at 1.4-1.5%, so expect pressure going forward.
ESOP are structured in a way which is max. beneficial to employees. Vesting period is one year and exercise period is 4 years. So even if, ESOPS are granted on MV basis, employees have free ride for four years.
Around 2% of shares are issued as equity options every year. 20% of current issued capital is because of options. But 70% of options were issued during boom period of 2005-08. Also after 2009, no funds were raised by the company.
6). INR 20 crores loan to Employee welfare trust for buying stocks, but for last one year there is steep decline in share prices.
- Almost INR 30 crores is given as loans and deposit to parent company.