Credit Analysis and Research (CARE) Ratings is coming out with an Initial Public Offer, to garner up to Rs 540 crore, at Rs 700-750 a share. The entire IPO represents an offer for sale of 25 per cent stake held by a host of institutional investors such as IDBI Bank, Federal Bank, State Bank of India, IL&FS and Canara Bank, among others.
Although the company will not receive any issue proceeds, the offer represents only a partial exit by these institutional investors, most of which will continue to hold stake in the rating agency after the IPO. This instills confidence. More important, CARE’s performance has been good, with strong growth and high margins. While the high margins and return on equity might inch lower as the company gradually diversifies its concentrated portfolio (a large chunk of revenue comes from the high-margin rating business) and geographical presence, the growth rates should remain healthy. Also, the valuations are lower than its closest peer, Icra, which provides comfort on the potential risk in the rating business consequent to implementation of Reserve Bank (RBI) guidelines in 2014.
Trading margins for growth
CARE is India’s second largest rating company and enjoys much higher Ebitda (earnings before interest, taxes, depreciation and amortisation) margins as compared to peers such as CRISIL and Icra (its own is 70 per cent). The negligible contribution of the low-margin research business to revenue and lesser exposure to small and medium enterprises’ ratings are key drivers of these high margins. Notably, ratings form 87 per cent of CARE’s overall revenue, exposings the company to any slowing in the Indian debenture/bond markets.
|CARE: GROWING AHEAD OF PEERS|
|In Rs crore||CRISIL||CARE||ICRA|
|Y-o-Y change (%)||20.8||26.1||7.5|
|Ebitda margin (%)||32.5||75.3||36.4|
|Y-o-Y change (bps)||-145.0||-110.0||-160.0|
|Y-o-Y change (%)||6.7||31.6||2.4|
|CRISIL figures are trailing 12 months ending Sept 2012
CARE and ICRA figures are for FY12
All figures are consolidated Source: Company, research reports
|HIGH MARGINS UNSUSTAINABLE|
|In Rs crore||FY11||FY12||H1’FY13|
|Ebitda margin (%)||76.4||75.3||70.0|
|Profit after tax||87.9||115.7||50.0|
|Source: Company RHP|
Also, by RBI’s new norms, banks can adopt an internal ratings mechanism for their credit offerings by end-March 2014. Such bank loans/facilities form 21 per cent of CARE’s rating business revenue, which could be adversely impacted if banks go for internal ratings from April 2014. The management, though, believes not all banks will be able to make this transition, due to lack of the infrastructure required.
|Price (Rs/share)||700 -750|
|Size (Rs crore)||504-540|
However, the management expects its Ebitda margins to trend lower as it increases its international presence, as well as due to the scaling up of its research business. The company plans to grow its businesses, both geographically and into newer segments. It has also planned to monetise the research operations, entering into knowledge process outsourcing and training domains. The company is also looking at inorganic growth and acquired a Sri Lanka-based risk management company, Kalypto, in November 2011. CARE plans to bring Kalypto’s products into the Indian markets as well. In addition to existing operations in Nigeria, Maldives and Mexico, CARE plans to enter South Africa, Brazil, Malaysia and Portugal. While these plans augur well for growth, these might eat away at some of its Ebitda margins, at least in the interim.
Valuations & outlook
CARE’s revenues and net profit have grown at a compounded rate of 41 per cent and 44 per cent, respectively, over FY2008-12. Even for FY12, these grew 26 per cent and 31 per cent, respectively. At the upper price band of Rs 750 and assuming a bottom line growth of 25 per cent in FY13, the stock is priced at 15 times earnings, a good discount to its nearest peer. While the significantly larger peer, CRISIL, is trading at 31 times one-year forward estimated earnings, the multiple stands at 21 times for Icra, the third largest rating agency in the country. Even on a historical basis, at Rs 750 a share, CARE’s issue is priced at 18.5 times its FY12 earnings, while its closest peer, Icra, trades at 27 times.
While the changes in key regulations governing rating agencies remain a key risk, the rating company’s limited experience in international markets, with higher competition, are key challenges. But, most of this is already reflecting in the IPO valuations, pegged reasonably lower than its nearest peer.
“Historically, credit rating agencies have traded at 17-18 times one-year forward earnings. CARE’s valuations look sanguine in this context. Going forward, the multiple gap between CARE and Icra should come down,” believe analysts at Emkay Global.
On the whole, CARE enjoys a strong financial position, a well-established brand positioning and richly experienced management. The fast-growing and high cash-generating business, higher margin profile and reasonable valuations make this offer a good investment opportunity.