IL&FS investment managers is a private equity/ fund management company promoted by ILFS (50.5% ownership). The company is in the business of raising funds from investors (institutional – both in India and abroad) in the form of individual fund offerings.
These funds have their individual mandates such private equity investments, infrastructure or real estate type investments. The company is responsible for investing the funds, managing the risks of individual investments and then finally working out exits from these investments. The company has been fairly successfull in managing the funds, generating 20%+ returns on most of the funds in the past for the fund investors.
The main source of revenue for the company is the fixed 2% management fee on these funds and an override on the returns over a threshold (a percentage of the gains made, above a threshold)
FinancialsThe company has delivered a 35% growth per annum over the last 8 years. The company earned around 225 Crs in 2012.
The company has grown the net profits at around 40% over the same period and made around 74 Crs in 2012. The main cost for the company is compensation for the employees and overhead expenses incurred on launching and operating the funds. The company has been able to maintain net margins in excess of 30% in the last 10 years.
Finally, the company has been able to maintain a high ROE of 30%+ and if one excludes the excess cash on the balance sheet, the ROE would be in excess of 50%.
PositivesThe business requires minimal incremental capital to grow. The main assets of the company are the brand, its relationships with clients and the skills/knowledge of its employees.
The company needs very little capital to grow (some extra office space and maybe a few computers) and hence the entire profit is truly free cash flow. The company has consistently maintained a high dividend payout ratio in the past (over 50%) and used the excess capital to acquire a new fund (saffron) in 2010.
The company has a long operating history in raising and investing funds in various opportunities in India with good results (returns in excess of 20%). As a result the company has a good reputation with current and potential investors which should help the company raise additional funds from the clients in the future.
RisksThe company operates in a very competitive environment with minimal entry barriers. The company now faces stiff competition from a large number of Indian and international competitors such as hedge funds and other private equity funds. This has resulted in higher competition for raising India specific funds and investing the same in attractive opportunities (businesses) in India. This could result in lower returns for the fund investors and hence lower income for the company in the future.
The slowdown in the investment cycle, recent actions by the government such as the GAAR fiasco and other global macro-economic factors have made it difficult for the company to raise new funds. In addition the exit timelines for the fund investments have increased due to weak stock markets, resulting in lower returns for the fund investors. All this has impacted the revenue of the company which depends on the volume of funds managed (AUM) and the carry (excess returns over a threshold). It is unlikely that the investment cycle will turn around quickly, due to which the company may face a longer period of low revenue growth or even de-growth over the next few quarters.
Management quality checklistManagement compensation: fairly high at 25% of revenue. However this kind of compensation is typical of the industry.
Capital allocation record: extremely good. The company has maintained a very high dividend payout ratio and has indicated that they will dividend out almost the entire profits to the shareholders.
Shareholder communication: Quite good. The company provides adequate details of the business in its annual reports and conducts quarterly conference calls to keep the shareholders updated on progress.
Accounting practice: conservative
Conflict of interest: none
ValuationThe company is currently selling at a PE of around 7 which is on the lower side of the past PE range of the company (6-23). A company earning an ROE of around 30% and with a 15%+ growth prospects can easily support a PE of 15 or more. The company thus appears undervalued by most objective measures.
ConclusionThe company has performed extremely well in the past and has rewarded the shareholders well. The period from 2003-2008 was a bull market for private equity and stock markets resulting in high returns for the company’s funds. This resulted in good profits and high growth for the company.
The markets have slowed down considerably since the 2008 financial crisis and the Indian government has made it worse in the last few years. As a result, the company has struggled to raise new funds which is needed to drive the topline and profits for the company. It is likely that the company will take a few more quarters before it can raise and deploy new funds and a result the topline and profits could stagnate for some time.
The long term prospects of the company are good, though it will take time for the company to start growing again. This would test the patience of most investors.
Disclosure: No position in the stock as of writing this post
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog