Religare : Subscribe to Edelweiss Capital IPO

Richly diversified business model; further fillip to growth from new forays

Investment rationale Well established financial services provider offering a gamut of products and services including investment banking, institutional broking, PE advisory services, asset management, insurance broking and wholesale financing.

Integrated services platform provides synergy in operations and allows the company to leverage client relationships across businesses to cross-sell products.

Recognised player in institutional broking (mainly in the F&O segment) and investment banking. Over 150 registered institutional broking clients as on September 2007 including domestic institutions and FIIs.

Phenomenal growth in revenues from existing and new businesses (128% CAGR over FY04-FY07) with consistently high margins. EBITDA margin typically ranges within 46-52% with a net margin of over 30%.

Aggressive managerial focus on expanding new high-margin business lines such as mutual funds, insurance broking and asset management.

Key concern Vulnerable to fluctuations in the equity market as a major chunk of revenues come from capital market related operations.

Valuation Adjusted PAT for the first five months of FY08 stood at Rs 809mn, translating to a fully diluted annualised EPS of Rs 26. Higher price band of Rs 825 represents a P/E multiple of 31.8x on FY08 post-diluted annualised earnings – a small premium to peers which we believe is justified. Subscribe.

Business overview Set up in 1996 as an investment banker, Edelweiss Capital (ECL) has gradually evolved into an integrated financial services provider, operating through two broad divisions – the agency business and the capital business. The company’s agency division comprises investment banking, institutional and private client broking, asset management, investment advisory and insurance broking services. The capital business consists of wholesale financing and treasury operations. ECL provides financial services across 43 locations in India with a focus on the institutional, corporate and high net worth individual (HNI) segments .

The company now aims to raise up to Rs 6.9bn via the issue of 8.4mn shares (face value of Rs 5 each) through the proposed IPO. It intends to utilise the proceeds for enhancing margin requirements with stock exchanges, funding expansion and infrastructure expenses, upgrading existing technology and prepaying loans.

Investment rationale Integrated financial services firm ECL has a wide breadth of financial services on offer spanning from investment banking, institutional equities, private client broking and wealth management to investment advisory, asset management, insurance broking and wholesale financing. The company’s product portfolio and clients are well segmented, increasing the predictability and visibility of income. Moreover, the integrated services platform provides considerable synergy in operations and allows the company to leverage relationships across businesses to provide multi-channel delivery systems. This also helps in cross-selling of products and retention of clients.

ECL’s business mix is well diversified with the agency and capital businesses contributing 58% and 42% respectively to overall revenues. The revenue share from both divisions is expected to more or less equalise, going ahead, due to the management’s emphasis on diversifying revenue streams to minimise risks from capital market fluctuations. Having honed expertise in its existing businesses, the company is also looking to explore new avenues to further broaden revenue streams.

Agency business performing well. So far, the agency business has been the primary revenue contributor, earning 58% of total revenues in FY07. Income from this segment consists of fees, brokerage and commission from transactions, advisory and brokerage operations. Equity broking and investment banking remain the biggest money spinners, though other businesses like insurance broking and investment advisory services are also growing robustly.

Led by a firm foothold in the institutional space Leading player in the institutional F&O and cash segments ECL primarily caters to institutional clients and has built a strong presence in the F&O (futures and options) and cash markets, which are a major source of its revenues. The company provides sale and trading services for equity derivative products to a large and diversified base of institutional investors, including domestic and foreign institutions (FIIs). At present, ECL has 150 institutional clients and is witnessing a strong uptick in volumes traded.

As the India growth story continues, not only has the number of institutional investors entering the market risen sharply, but assets under management of institutional funds have also swelled significantly. Further, SEBI’s recent guidelines on participatory notes have led to an increase in the number of registered FIIs. We believe ECL’s large market share in the F&O and cash segments together with its good rapport with institutional clients will enable it to garner huge trading volumes and thereby revenues from this expanding market opportunity.

New forays to expand fee income Apart from brokerage services, ECL is also amongst the leading players in investment banking and offers specialised advisory services on transactions, mergers and acquisitions (M&A), capital raising, real estate and infrastructure. The company has taken up several corporate assignments through its investment banking and advisory arms, generating substantial fee income. With the continued economic buoyancy, capital expenditure and M&A activity by corporates are expected to grow robustly, expanding the demand for advisory services.

Of late, the company has started new businesses like private equity (PE) advisory, asset management and portfolio management services (PMS) which will increase the proportion of fee-based income. Apart from mutual fund advisory services, ECL is planning to set up a public mutual fund in India, for which it has received clearance from SEBI. Its PMS business is also growing, with 95 clients and Rs 1.1bn in assets under management. We believe these new businesses offer huge revenue generation potential in the near term.

Treasury operations gaining scale Treasury operations are a part of ECL’s capital business accounting for over one-thirdof total revenues. The company follows a multi-strategy investment approach similar to banks to achieve maximum returns with minimum risk. A substantial portion of its treasury is invested in short-term low-risk categories to ensure liquidity for the business. ECL’s treasury team is backed by a team of qualified analysts and strong risk management systems. Going forward, treasury operations are expected to gain scale and account for a greater share of revenues.

Research-backed product offerings with efficient risk management ECL has dedicated research teams for institutional and HNI clients in the equity and derivatives segments. The company currently has 190 companies under coverage representing around 69% of the total market capitalisation on the BSE. ECL has 40 analysts in institutional research and a dedicated team of quantitative analysts for treasury operations. So far, the company has demonstrated the ability to identify early investment opportunities through intensive research which has benefited its clients.

In addition, ECL has built up strong and efficient risk management systems to support its broking, treasury and other operations. It has deployed resources in terms of technology, people and processes to evaluate and manage the market, credit and other risks across all offices from a centralised location.

Strong corporate and client relationships A very significant portion of ECL’s business comes from the institutional and corporate segments in the form of investment banking, investment advisory and insurance broking. By virtue of its extensive services portfolio, the company has been able to offer existing clients several additional services like fund raising, debt syndication and M&A advice, thereby cementing its relationship with them and providing opportunities to source further business in the long run.

Robust profitability and marginsOver FY04-FY07, revenue from operations has grown at a CAGR of over 128% whileprofits have logged a 140% CAGR. The EBITDA margin has remained within a rangeof 46-52% during this period with net margins growing at 30%-plus. This isexceptionally high as compared to peers (see table). ECL is also ahead of competitorsin terms of diversity of revenues, synergy in operations and strength of its business model.

Premium valuation to peers is justified; Subscribe As the table above shows, ECL would trade at a slight premium to its peers at the upper end of the price band. However, ECL’s premium to peers is justified on account of its consistently high margins, strong client base and presence in high-growth businesses like investment banking, institutional equities and PE advisory services. Further, the company’s superior brand recognition among corporates and institutions, high quality of research and consistent margin growth reflect greater revenue visibility.

Some of the newer business lines like insurance broking and fund advisory services are in a nascent phase, contributing only marginally to overall revenues. However, with the underlying business synergies and aggressive managerial focus, these new forays are likely to rapidly gather steam.

Adjusted net earnings for the first five months of FY08 stood at Rs 809mn which translates to a fully diluted annualised EPS of Rs 26. The higher price band of Rs 825 represents a P/E multiple of 31.8x on FY08 post-diluted annualised earnings. We recommend that investors Subscribe to the issue at the upper price band.

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.