Tuesday, April 29, 2014

IL&FS Investment managers - No sales pipeline for a while

IL&FS is a infrastructure financing company setup by public sector banks. IL&FS Investment managers (IIML) is its private equity arm. I found out about it because Parag Parikh's fund (PPFAS) owns this stock and therefore it should be taken very seriously. Fundamentally the investment management business is great for value investing as it needs a brand and little capital to expand. Its downside is too much dependence on individual personalities if the company is not very large in terms of headcount - IIML has a headcount of just 58 people. Lack of fundraising has lead to reducing income and this trend is currently continuing. I am still not clear about what the carry is but online 3rd party articles say that only 30% of the carry goes to the shareholders and 70% goes to the management. This type of structure scares me as the business may be skewed too much in favor of the management.

1. How big is the moat?

Grade C moat
  • This is a business where one would expect a big moat but their fundraising seems to be weak. Bain claims that 8 Bil USD was raised in India in 2013 and IIML just got soft commitments of around 50 mil but no real capital
  • The carry split of 70% to management really dilutes the moat and as we will find in the pricing section the carry adds little to our fair value pricing
  • The survival of the business model depends on their returns in the private equity space. The private equity space in India is very risky as the market is immature and many a management has seen private equity type investing for the first time - leading to many slips between the cup and the lip

2. What are the risks?

  • IIML is not able to raise any more funds - under this circumstance the company's profits will keep falling until the revenue equals the cost of employees at which point they might start laying of employees

3. Financials

  • Dividend % of earnings is high with around 50% of earnings paid out as dividiends
  • As many of the funds are lying in foreign exchange overseas and the fees are paid in foreign exchange this company's earnings are like a net exporter - weaker rupee is good for its short term earnings. Although it is important to note that a weaker rupee probably will reduce returns to limited partners (LPs) in the funds which in turn will make it harder for IIML to raise new funds
  • Average compensation per head is 26L/year and has gone up by a CAGR of 10.5% which is good compensation control
  • I am going skip over the other financials

4. Soft factors

  • Insiders have net sold .36% of the company since the start of 2014
    • Most of that selling has been done by Mr. Shahzaad Dalal (Vice Chariman of the board) - he has sold 0.48% of the company
    • Mr. SM Datta, Mr. Saha and Mr. Bansi Mehta have been net buyers in 2014 of 0.12% of the company
  • IL&FS parent company (the promoter) continues to own over 50% of the equity

5. Pricing

  • As per my calculations the company is probably trading at somewhere around 1.9 times book value. I say book value because my confidence on the earnings is low. I would call this a value stock only if it traded at a discount to book value.
  • P/E of 4x quarter Dec 2013 earnings is 7.8 which is high for a company with no sales pipeline for the last few years.
  • The carry from the return on the funds can be estimated but my confidence around the timing is low. Use a back of the envelope calculation on a portfolio of 1.79 Bil with a hurdle rate of 11% and a return of 14% with average investment life to be 7 years the carry would be 920 Crores of which only 275 would go to shareholders. 1 quarter of salaries is 15 Crores. Thus I find that a few years of delay would reduce the carry by almost 100% in the absence of new funds being raised.
    • I have taken 15% as the return because I think the 24% gross IRR across the exited items is not going to repeat across the portfolio as:
      • The exits are probably the investments that worked out. The ones remaining may not be as good
      • The real estate market is subdued and 62 of the 161 investments are in real estate
  • The only reason I see why PPFAS currently owns the stock is to avoid short term capital gains at this point. Maybe I am missing something.