The Hindu Business Line : IL&FS Investsmart: Invest at Rs 125

Mr A. R. Barwe (left), Independent Director, with Mr Hemang Raja, MD & CEO... Eyeing a larger share in capital market-related products and services. — Paul Noronha

INVESTMENTS in the initial public offering of IL&FS Investsmart at Rs 125 can be considered. The potential for growth in the financial services business is bright and an entrenched player such as IL&FS Investsmart can outperform the competition. The company's presence in a number of other segments such as merchant banking and debt broking is another positive factor. The entry of E*Trade, a large US-based firm that is a pioneer in the field of Internet-broking, into the firm as a strategic investor, also augurs well.

Negative factors galore

There are a number of negative factors though; the poor quality of disclosures being one. The offer document does not detail the trading volumes in its retail broking business over the years. There is not a word in the offer document about its derivatives broking business, the fastest growing trading segment in the capital markets. Has the company been losing market share?

Similarly, the company has not revealed the number of client relationships and assets under management in its portfolio management business. Even in the distribution business, the company says it mobilised Rs 14,164 crore in FY-05. Figures for the previous year and the break-up into equity and debt funds mobilised are not available.

Of far more concern to investors is that the company has still not started its Internet-broking business. Online trading volumes are increasing at a rapid pace. The company's technology infrastructure too may appear inferior to competition. The company has in the past paid fines to National Stock Exchange due to technical glitches, which the company claims have since been rectified.

If the offer is attractive despite these factors, it is because of the following factors:

Trading volumes in the capital market segment have stayed robust and the prospect for steady rise in volumes is bright.

Given the demographic structure of India, increasing distribution reach of intermediaries and the low participation of retail investors in the equity market, the prospects for sustaining a two-digit growth in volumes over a long period in excess of five years is bright.

Even in the first three months of FY-06, trading volumes in equities and derivatives at the National Stock Exchange NSE have risen by 8 per cent. Prospects for top brokers are superior as they grab market share from the smaller players.

The presence of IL&FS Investsmart in businesses with equally bright growth prospects, such as financial products distribution, merchant banking and debt broking and syndication, is a positive factor. These are low-margin businesses. Volume growth could, however, be impressive as the capital mobilisation plans of small- and medium-size businesses may increasingly get routed through the capital market.

IL&FS Investsmart is already a sizeable player in mutual fund distribution, initial public offer distribution and in merchant banking for small and medium-sized offers. These non-broking businesses are already critical for IL&FS; they contributed about half of the profit before tax of the company for FY-05.

The company is set to establish its online trading platform. According to the offer document, IL & FS Investsmart is negotiating with E*Trade to avail of its expertise in establishing this business. If Investsmart were to set up the business quickly, the entry into this fast-growing business segment would only boost growth.

Attractive valuation

On valuation parameters, the offer is attractive. With revenues of Rs 75 crore and profits of Rs 21.7 crore, India Infoline is now valued at Rs 375 crore at a price-to-earnings multiple of 17.5. In contrast, IL&FS Investsmart with sales of Rs 113.70 crore and profits of Rs 33.1 crore is seeking to be valued at Rs 550 crore at a PE multiple of 16.5. Geojit Financial Services is trading at a PE multiple of 13.5 times.

This valuation is attractive considering the multiple businesses in which IL & FS Investsmart operates. The return on net worth generated over the past two years, which is in excess of 30 per cent, is also impressive. Profit growth over the past two years has also been impressive. Thus, the PE multiple demanded appears reasonable.

The valuation, however, does not contain any discount for the poor disclosures and the consequent implications for quality of corporate governance.

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