ILFS Investment Manager- Free Lottery?

Background: 

ILFS Investment Managers Ltd (IIML), is one of India's premier & probably one of the oldest PE funds. It manages various schemes/funds which invest in Real Estate, Infrastructure & other similar sectors.

Business Model: As IIML is a PE Fund, its basic function is to raise funds under various schemes and then invest the same in opportunities available in Indian space. 
The invested amount also known as the Earning AUM is what it earns fee income on . 

The income on this AUM has 2 components

1. Annual Management Fees: This is around 1.75-2 % charged annually, and is taken every year till the tenor of each scheme. This is the predictable revenue stream for IIML.
2. Carry Income: Each scheme has a defined hurdle rate ( around 11-13%). This is the bare minimum rate the fund will try to return, although this is not an obligation. If the fund is able to generate returns above the hurdle rate, IIML gets a certain percentage of the additional return generated ( 20-30%). These are accrued to IIML usually after the scheme ends and money is returned to investors in scheme.

From the above income, majority expenses are in form of salaries and overheads. The profit margins are around 33% and IIML distributes around 70% of these earnings in form of dividends. 

Present Situation:

The AUM of IIML is primarily invested in real estate and infra. Both these sectors have been in doldrums for last 3-4 years. This has led to the following for company

1. Negligible or no growth in AUM of IIML- Company has been trying to raise funds for last 2 years now, but might be able to raise just USD 100 mio by FY13. Management con-call says that outlook for raising funds remains bleak. Also, IIML will start having large exits of funds starting FY14-15 and thus AUM will further dip. No new funds and foreseeable exits, will lead to IIML having falling Earnings going forward
2. Negligible carry income- Since, real estate and infra have not performed there has been no carry income for the company. This has led to no kicks in earning of the company.

What is the bet now?

As discussed the revenue stream of IIML has 2 components, fixed income through annual fees and variable income through carry.  Let us assume the worst case scenario in which  IIML is niether able to raise fresh funds nor gets any carry income. 

Even in such a scenario IIML will earn the fixed annual fees. By understanding when do these schemes end we can predict the fixed revenue which will accrue to IIML over next 5 years or so and thus do an estimation of the earnings of the company. 

If the above exercise gives me a value which is higher than the market cap of company less cash, then we are entering a well run business with fixed revenues at a price lower than its liquidation value. This also exposes us to some other events like improvement in economic scenario leading to growth in AUM and subsequent increase in carry income. Also, by entering at this value my downside is protected since IIML pays out almost majority profits in form of dividend.

Estimation of Value:

I took the following assumptions ( based on historical data of company)  while try to find the value of company

1. Cost of capital= 10%
2. Fee income= 1.75%
3. PAT margin= 33% ( Historically it hovers in this range only)
4. USD/INR rate= 50

Schemes of IIML:
  

Fund	USD Mn	INR Crs	Start Date	Maturity
Growth Funds
Leverage India	153	765	2004	2013
Tara India fund	225	1125	2007	2017
Auto Ancillary	15	75	1998	-
South Asian Regional	25	125	1995	-
Total	418	2090
Infra Funds
AIG Indian Sectoral	91	455	1996	-
SCI Asia Growth	658	3290	2008	2016
India Project Dev	16	80	2000	-
Pan Asia Dev. Fund	45	225	2006	2013
Total	810	4050
Real Estate Funds
ILFS Realty-1	525	2625	2006	2014
ILFS Realty-2*	895	2237.5	2007	2015
Yatra & SIREF	430	2150	2007/09	2016
ILFS Milestone	229	1145	2007	2015
	2079	8157.5
Total	3307	14297.5

 * This is a 50:50 JV, hence I have considered only 50% of total AUM

Basis the above table, the earnings can be projected as given in table below:

Fig. in Crs	FY12	FY 13	FY14	FY15	FY16	FY17
Opening AUM		14297.5	13807.50	11182.50	7800.00	2360.00
Loss in AUM		490*	2625	3382.5	5440	1125.00
Closing AUM	14297.5	13807.50	11182.50	7800.00	2360.00	1235.00
Income
Fee @ 1.75%		241.63	195.69	136.50	41.30	21.61
Other income		13.53	10.96	7.64	2.31	1.21
Total		255.16	206.65	144.14	43.61	22.82
PAT@ 33%		84.20	68.20	47.57	14.39	7.53

* As per latest managment con-call IIML has already raised USD 66Mio and will be able to raise around USD 100 Mio by end FY13. This increase has been accounted for here


Since, we have estimated the earnings in case the fund is liquidated, we can do PV of these earnings to determine the worst case value of the company.

 

Cost of Capital	10%
		PV
1	84.20	84.20
2	68.20	56.36
3	47.57	35.74
4	14.39	9.83
5	7.53	4.68
Total		190.81

  This gives me a worst case value of Rs. 191 Crs. If I add cash of 100 Crs the value of the company is around Rs. 290 Crs. Thus any case IIML is not able to raise any further funds or does not get any carry income it can be approximately valued at around Rs. 290-300 Crs

Conclusion:

The present market cap is around Rs. 490-500 Crs as compared to liquidation value of around Rs. 290 Crs. 

For me it is not a free lottery yet, but i would be watching this idea very closely. Any, indication/ confirmation of IIML being able to raise funds, would lead me to revisit the above numbers.

Resources:
Link for XL sheet used is here
Company presentation is here 

Regards,
Saurabh
PS- Not invested
 

Weekend Learning

Last weekend I had a chance to meet some fantastic investors (Gaurav , Ayush , Neeraj, Ashish, Puneet, Suhail) and also got a mail from a friend of friend who attended Valuex (An investor conference in Mumbai held last Saturday). Basis these interactions i have tried to capture the learning i had and highlighted one's which I personally find of key importance

Investment Philosophy:

1. In India Statistical Bargains remain cheap for a very long time, due to limited catalysts. These catalysts such as form of investor activism, minority stockholders doing some corporate action etc are usually inactive. Statistical Bargains originated in US, where there are means to induce these catalysts. Also, lack of growth in US companies has led to investments moving to these ideas.
2. India, we all agree is a growing economy, and hence the best bets are the ones which have a growth component attached. Buy stocks at reasonable valuation( Margin of Safety) which show signs of growth and then ride the growth. Also, in such stocks be mentally prepared for horizon of 3-5 years and also ups and downs in between. If one is able to ride the growth they can be the big winners.
3. Their are 3 segments to broadly classify businesses B2C , B2B & B2G (Business to Government)  and clearly B2G is most frowned upon
4. People are scared of investing in illiquid stocks because they are scared of working hard --> Stocks are usually illiquid because they have not yet been discovered. Infosys used to trade less than 1,000 shares / day in 1994.
5. In an Indian context Price is what you pay, Value is what the promoter allows you to make. Cash, real estate, assets should be taken with a grain of salt as most likely a promoter will not allow you to realize its value.

Investment Methodology:

1. Promoter integrity is the top thing too look. Indian promoters find ways to take out money and hence it is key to be associated with right kind of people. Meeting distributors, creditors, end-users is one way to see how involved the management is in the business. Attending AGM's is another way to get a feeler on the company and also to understand the outlook and future plans of promoters.
2. RoE is the holy grail. If RoE is less than cost of capital creating sustainable wealth is almost impossible. 
3. Also evaluate company on asset turnover and margins. These are the 2 levers which company has to increase RoE
4. Double Counting creates bubbles: During periods of boom margins are the highest to which we apply high valuation multiples. Margins are mean reverting, thereby in your analysis it is important to adjust for this factor
5. Don't mix your investment themes. Example, Special Situations with bargains or with long term ideas.
6. Even if stock is up 100% from your purchase,but if you find growth story intact and valuations cheap keep adding.  Its all about buying well, rather than selling well.
7. Have an exclusion list. If any company falls in that sector/ concept don't waste time. For example, most of us agreed that B2G is an example of ideas to avoid.
8. Dumbest thing to do is forecast. Be comfortable with the idea that you don't know the future. It is very difficult to comes to term with this.
9. In bear markets don't use relative valuations but use your judgement on absolute valuations. In bull-markets use relative valuations to make selling decisions.

Psychological Biases and other thoughts

1. Use Anchoring bias as a tool to take decisions. If you find a stock good, buy it then you will be anchored to that price rather than waiting for price to come down.
2. Assuming that all stocks which you have will be a 10 bagger is living in fool's paradise, but if your process is right you will get once in a while a large bagger. 
3. Make sure your investment process does not change in good or bad periods. Good performance makes one complacent while bad performance makes one defensive
4. Differentiate between Hold-to-Maturity and Revert to Mean Ideas in your portfolio:

   Hold-To-Maturity: Great businesses which are compounding machines that have been bought at reasonable valuations. These are long-term investment ideas. 

   
   

   Revert to Mean: OK businesses at beaten down valuations because of poor performance where performance can bounce back in the foreseeable future. 

5. Markets are not efficient but they reflect current investor psychology. 
6. How do you determine in an investment decision whether you suffer from overconfidence or are just an independent thinker. Every business has certain milestones, when those milestones are not being hit by the business you must reconsider your investment 
7. Use simple scenario analysis to avoid investment pitfalls. For e.g. to Justify 2000 valuations for IT they would have to go at 75%-100% in the foreseeable future. If they did this for over 10 years, they would have become 40% of India's GDP. Even if they did manage to do this the Rs would have to go down to Rs 25 whereby margins for these companies were not sustainable. 
8. Read, read and read more. Few books recommended
1. Finding the next Starbucks
2. The Warren Buffet Way
3. Commentary of international value funds

And finally, we did discuss some stock ideas like Suprajit, GRP,Atul Auto, Magma Fincorp, Ashiana Housing, Ashok leyland, Clariant, BASF etc.

Hopefully we all will benefit from these thoughts, and incorporate the same while evaluating an idea.

cheers,

saurabh

PS- Don't consider all of us bores. We did discuss things beyond stocks and investing :)

A Tale of 2 Situations

Once there was an investor,  who one fine day entered the holy gates of big bad city called Stock Markets.  To help me in this city he found there were various types of people. The most talked ones were the high priests who sat in high temples of finance, and eulogised about everything and anything. Then there were a lot of traders, merchants who helped him in navigating the city on weekly, daily and hourly basis and finally there were the outcasts, who said generally spoke less and did all contrary things.
After meeting all of them and getting fairly acquainted with the city our hero decided to venture where few went, to the den of alchemists who made money without taking risk. They did this by finding special situations which nobody would see.

There he met a gatekeeper who gave him 2 tests and said that he had to go through to them to meet the alchemists.

Gatekeeper: Company Name: IGL Ltd
The price of the company was going all over the place (some times variation is as high as 30-40% in a day) as the company was engaged in a legal battle with a government body on pricing of gas prices. The ruling for the case is coming on 10th August and CMP is 250 . What will you do?
Hero: Interesting since company can either win or lose the case I will do the following:

• Buy a put option of August Expiry with strike price of Rs.220. The present price of such an option is Rs. 0.78 and lot size is 1000 my cost will be Rs.780
• Buy a call option of August Expiry with strike price of Rs. 270. The present price of such an option is Rs. 2.79 and lot size is 1000 my cost will be Rs. 2790

So by paying total of Rs.3570 i have given a wager on both positive and negative decision for company. If ruling goes against, stock price falls by around 20%  and i make a killing on my put option. Similarly, if it is in favour i make a killing on call option.

Gatekeeper:  Good. Now let me take you to the courtroom and you can see how things pan out. 

In the courtroom, as our hero waits anxiously proceedings begin and end in 5 minutes. The ruling is neither positive or negative but has been deferred till November 31st. 

Hero: Horror! Horror! this cant happen to me. I never thought of this scenario and now i will lose a fair bit of my wager as a lot of people would have bet on either side and now they will sell.
Gatekeeper: Aye Aye Sir! You will lose money but more importantly learn these 2 lessons

• A special situation is really "special" only if the outcome is known. Else, it has speculation involved in it.
• Always do a probabilistic analysis of all scenarios. For example, in this test all 3 scenarios of favorable, unfavorable and status quo were equally probable. 

Now let bygone be bygone, let me give you another test:

Gatekeeper : Company Name: Muthoot Finance Ltd- The company has a zero coupon bond maturing on 11th Oct 2012. The maturity value of this bond is Rs.1132. Suppose today is 7th Sept 2012 and value is Rs.1115. What will you do?

Hero: Aha! this is a simple one. As in previous test i know the outcome and also there is only 1 scenario of company paying me back. Although another scenario could be of company defaulting on its bond, but past track records and recent performance of company tell me that this is has a negligible chance. So, I will buy this bond at Rs.1115 and then on maturity i will get Rs. 1132. If i use the XIRR function my return is around 16.5% p.a, which is far higher than bond investments.

Gatekeeper: My friend you take things too simplistically. Did you consider the brokerage and tax? Suppose your brokerage is 0.3%, then your purchase price becomes Rs. 1118.3 and returns lessens to around 13%. Add short term taxation to it and returns further fall to around 9.1%.  Does it look that exciting now?

Hero: Hmm...no it surely dose not, but i never thought that these things impact returns.

Gatekeeper: As i said there are no mistakes only lessons. The lessons here is that Returns in special situations are moderate, so always consider transaction costs and tax and then take a decision.

That is it from me for now.

Hero: So now can i go in? 

Gatekeeper: Of course you can. The fact that you have taken tests is good enough. Now proceed to the real alchemists who reside here and here.

Regards,
Saurabh
PS- The protagonist was yours truly, and gatekeeper in one case was Kiran.

The Growth Conundrum

As a long term investor, one should be concerned with two things while buying a stock,

• Quality of the Business
• Price at which one buys the stock

Courtesy of internet, screens, forums, list of bloggers on this blog the the chances of you coming across good businesses and stock ideas is pretty high (serendipity). So without much effort the first point is taken care of.

It is on the second point that divergence appear amongst investors, and it appears more so in case when we are talking of stocks on high growth path.

For last few days I have been struggling to solve this problem of "what price to pay for growth" until i bumped onto one of the blogs of Aswath Damodaran ( If anyone wants to learn valuation, please go through his lectures. They are free and brilliant). The link to these blogs are here and here

Based on the blog I ran the test on 5 companies, who meet probably all criteria of a quality business. These were: Amara Raja, Astral Poly, Atul Auto, GRP and Kaveri Seeds.

Before, jumping to conclusions of the test let me first share the methodology here.

Step: 1 : Find out the enterprise value of the stock ( Mcap+Debt- Cash)
Step: 2:  If we assume that company doesn't do any growth going forward then it can pay the entire income out to stockholders as dividends and as interest to lenders.In this case, operating income from the most recent period will be cash flow each year in perpetuity. The value of these cash flows can be computed by discounting back at a cost of capital to yield a value for assets in place.By doing this we know what is the value of assets which company holds now.
Step 3: This involves calculating the value of assets which are required for growth. To calculate this we would need the following inputs

• Expected growth rate: I have assumed 25% for all the 5 companies
• Expected Return on Capital: I have taken average last 5 years as an indicator for this.
• Length of Growth: I have assumed 5 years,since all of them operate and have strengths to deliver growth for long periods.
• Reinvestment Rate: For a company to grow it needs to reinvest money it earns into business which can be calculated as Reinvestment Rate= Expected growth rate/RoC

Once we have this data in place we simply to a DCF for 5 years, with operating income of each year being reduced by the reinvestment amount required.

Step 4: The difference between EV(Step 1) and Value of Assets( Step 2) gives us the price which we are paying for growth.
Step 5: Comparing price found in step 4 with value of assets for growth( Step 3) will give us an indication whether this stock is overpriced/cheap/fairly valued.

The results of my analysis courtesy Prof. Damodaran are given below. Also attached is the link for excel sheet with all calculations. It is a modified version of what Prof. has shared on his blog. 
 

Inputs	Amara Raja	Astral	Atul Auto	GRP	Kaveri
Growth Rate	25.00%	25.00%	25.00%	25.00%	25.00%
RoC ( Avg. 5 years)	31.00%	21.80%	30.00%*	29.40%	20.00%
Growth Period	5	5	5	5	5
Cost of Capital	15.00%	15.00%	15.00%	15.00%	15.00%
Stock Price	239	310	114	1603	1073.00
Outputs ( In Crs)
Enterprise Value	3918	727	121	269	1361
Value of Assets in Place	1442	322	107	159	427
Value of Assets for Growth	1107	149	80	116	159
Price Paid for Growth	2476	405	13	111	934
Price Paid/Value	2.24	2.71	0.17	0.96	5.89

* For Atul Auto RoC is average of last 3 years.

The link for the excel sheet is here. One can modify all the input parameters into the sheet to see at what price/growth rate/RoC does a stock become overvalued or cheap.




Has this solved my conundrum? Yes, but i have fallen into another conundrum of a few biases :(. More on that later

Till then Happy "growth" Investing.

Regards,
Saurabh
PS- Invested in Atul Auto, GRP & Kaveri Seeds, although all are very small positions as of now.

JB Chemicals: Cash is King

In a rising market such as what we are witnessing today, it becomes increasingly difficult to find good stocks which are cheaply available. 

For me one of the resorts in such a run up is to find statistical graham style cash/debt- capacity bargains (Explained brilliantly by Kiran here: Debt Capacity Bargain) and one of the stocks which has popped up is JB Chemicals (JBC). 

Business of JBC:  JBC was founded by Mr. J.B.Mody and is one of the oldest branded generic drug manufacturers in India. Some of its well known brands are metrogyl, rantac, nicardia etc. JBC also does contract manufacturing with specialty in lozenges and supplies them to various geographies.

Like a typical branded generic play JBC is a good but not great business. The same can be concluded if we look at its RoE & RoC figures, which are in range of 16 to 18% consistently.

The company becomes interesting when we consider that they have recently sold off their OTC business of Russian & Other CIS countries. Sales from this division were around Rs.200 Crs and PAT of around and company received Rs.1200 Crs for the same out of which Rs. 320 Crs was paid as dividend.

At present cash position of the company is as follows:

Cash & Investments= 560 Crs

Less Debt               = 80 Crs 

Balance                 = 480 Crs

Present market cap of the company is around Rs.637 Crs, which means we are getting the whole business for around Rs. 157 Crs or around Rs. 18.

Excluding the CIS business JBC had sales of around Rs.635 Crs in FY 12 and if we assume a nominal growth of 10% & lower end PAT margin of 10%, we get EPS of around 7.5 which means we are effectively buying the company at P/E of 2x, which is much lower than P/E assigned to other comparative companies.

So, it is clearly established that on a valuation front the company looks deep into cheap territory. 

However, there are certain pitfalls one needs to check to ensure that such ideas don't become value trap. Let’s have a look at them

A) Is the management efficient in capital allocation or will they blow away the cash they have got :

Few indicators for this are

• RoE & RoC
• Sales to Free cash flow
• Past usage of cash
• Dividend Payout ratio

1) RoE & RoC- Both look decent but not great which can be expected from a branded generic drugs manufacturer.

	FY12	FY11	FY10	FY09	FY08
RoE	67	16.5	16.5	14.79	11.15
RoC	8.33	17.62	16.59	18.03	10.11

2) Sales to Free Cash Flow- This looks healthy. Any company able to convert around more than 10% of its sales to cash is doing good business. I have not taken this for FY 12 as they comprise of income due to asset sale.

In crs	FY12	FY11	FY10	FY09	FY08
Operating cash	879	133	109	98	38
CAPEX	80	33	12	15	28
FCF	799	100	97	83	10
Sales	797	854	716	670	558
FCF/Sales	-	11.71%	13.55%	12.39%	1.79%

3) Past Usage of Cash: If the company has been generating cash as indicated above it is important to look has the company blown away cash in the past. This can be checked by looking at Dividend Payout ratios, whether they have done unrelated diversification or any special payouts to promoters etc. The same can be checked by again looking at cash flow statements to see if there are lots of investments and if yes where are they going. Similarly is money being constantly used for large CAPEX’s etc can be seen from the cash flow statement.

If we look at AR’s of last 5 years, Dividend Payout Ratio is has been consistently in range of around 13-15% for which is an ok indicator.

The company also doesn’t seem to be very aggressive in CAPEX, or forming subsidiaries or investing in JV’s.

This gives comfort that they will probably not blow away cash in random unrelated things.

B) Integrity of management/Aggressive Accounting- Company is in business for 50 years and there are no as such litigation's/problems evident. Also, spoke too few people in industry who have say management is honest though not the most efficient.

To check for aggressive accounting we looked at cash from operations and PAT for last 5 years. Most of the times there is not much divergence here, which indicates fair accounting by company.

In Crs	FY12	FY11	FY10	FY09	FY08
PAT	677	139	118	25	45
Net Cash flow from operations	879	133	109	98	38

C) Indication of management on future business plans- As per AR of FY12, company has indicated that they want to focus only on pharma segment with more focus on domestic business. They are not is a hurry to use the cash till they get the right opportunities. They are specifically looking to increase product penetration and also get approvals for few other geographies.

Conclusion: JBC looks like a decent bet to me for medium to short term, wherin I expect the valuation gap to close. Although, one needs to keep a track on how does the company plan to utilize the cash? Another point to be noted is that when one looks at cash/debt capacity bargains it is better to have multiple bets.

Regards,

Saurabh

PS- Have initiated a starter position. Also as stated earlier I am invested in other cash/debt bargains like Mazda ltd and Piramal Enterprises ltd