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IL&FS Investment Managers (IIML) - A Perfect Dhandho Investment with Low Risk & High Reward

Content Index

• IL&FS Investment Managers – Investment Snapshot :- Slide #3 • Industry Opportunity – An Overview:- Slide #5 • IL&FS Investment Managers – Business Overview :- Slide #10 • Investment Rationale :- Slide #17 • IL&FS Investment Managers – Financials:- Slide #26 • Concerns & Reasoning :- Slide #28 • Conclusion :- Slide #31

“ Specialists in discovering Multibagger stocks “

IL&FS Investment Managers – Investment Snapshot (as on October 30, 2012)

Recommendation :- BUY

Maximum Portfolio Allocation :- 7-8 %

Investment Phases & Buying Strategy

1st Phase (Now) of Accumulation :- 40% 2nd Phase (July -2013) of Accumulation :- 60%

Current Accumulation Range :- 23-26 Rs

The 2nd Phase of buying can happen after 6 months, when there would be more clarity of future Fund Raising – even if it means a Higher Buying price as it would clear a lot of uncertainties and Position this stock as a Core Portfolio Pick.

Core Investment Thesis :

An Unique Business Model (Only Listed Pure Asset Management) which has the Potential to deliver Strong Return for Shareholders by focussing on a Strong Structural Growth Opportunity. This Company like CRISIL is one of the few Financial stocks which doesn’t require Capital for Growth and has a High Dividend Payout. Valuations are attractive enough to limit the Downside, while positive Improvements can help earn Multibagger Returns.

Current Market Price – Rs. 25.3 Current Dividend Yield – 5.85% Bloomberg / Reuters Code –ILFS IN/ ILFS.BO BSE / NSE Code – 511208 / IVC Market Cap (INR BN / USD Mn) – 5.32 / 98.5 [1 USD – Rs. 54] Total Equity Shares [Mn]– 210 Face Value – Rs. 2 52 Week High / Low – Rs. 32 / Rs. 23 Promoter’s Holding – 50.32 % Institutional Holding – 4.88 %


Key Investment Highlights 1) A One-of a kind Unique Company in the New Generation Private Equity Industry with has Huge Growth Potential.

2) Company is a Leader in the Private Equity with Strong and Durable Competitive advantages to sustain it going forward, especially in the Infra and Real Estate sector where it has good Moats.

3) The Business doesn't require any Capital for growth which can be seen from the abnormally High Dividend Payout ratio of > 80% in the Standalone entity. This ensures consistently High Dividend and Return on Invested Capital.

4) Business Model of the company makes sure that Share Holder's are rewarded heavily and this can be seen from one of the Best Return on Equity (ROE's) of >50% consistently. These returns can in fact inch Higher with increased AUM.

5) This stock is a high Dividend play and would give Stability and Cash Flows for your Portfolio with its Dividend Yield of > 5.5% at current market prices. Moreover, High Dividend Yield will allow Investors to continue Holding onto the stock.

6) The Management which is Top-Notch in both Competence and Integrity in an Industry where the stability of the Core team along with their Network and Skills is the Differentiating factor.

7) Company is promoted by one of India's Top Business Houses (IL&FS Group) which is known for its high Quality Corporate Governance practices and Share-Holder friendly actions. Group has a good working relationship with Govt.

8) IIML Stock which has created a good history of Huge Shareholder Value creation, which can be seen from the following facts. (By Investing 1 Rupee in the stock in 2002, you would have received over 10 Rs as dividend by now and also the current Share value would be over 33 Rupees.)

9) Stock has two Key triggers in the form of New Fund Raises and Carry Profit which is not being discounted by markets and the stock has the potential to generate very strong returns over the next 3 years for Investors.

10) In spite of all these positives, share is available at attractive valuations. It is available at a Price to Earnings (P/E) of < 8 and Price to Book (P/B) multiple of < 2. In fact the company is quoting at a 50% discount (~ 4X AUM) to its Global Peers which have a much lower Growth potential.


Industry Opportunity & Potential - An Overview


Private Equity Industry

• Globally Private Equity Industry has shown good growth over the past 2 decades providing the much needed Risk Capital to Private Enterprises and has helped scale several Businesses.

• Good Fund Managers have been able to scale up their Business successfully and now there are a Handful of Private Equity investors who have a Portfolio size of > 100 Billion $’s.

• Globally different models of Private Equity has evolved over the period including Leveraged Buyout’s (LBO’s), Control Investing, PIPE Investments, Venture Capital, Roll-Ups etc. Most of Indian Private Equity managers work on simple PE Model.


Successful Private Equity Requirements


Fund Raising Deal Sourcing Deal Making Portfolio Value- Add Exit

• Successfully managing a Private Equity Asset Management involves Fund Raising, Deal Sourcing, Deal Making, Portfolio Value Add and a good Exit. Strengths on each of these areas is of prime importance for being a successful Private Equity Asset manager.

• The Business as such may not have direct Moats – but there are several Indirect Competitive Advantages like Track Record, Exit Record, Sector Specialization etc. All these would help a successful Private Equity Investor to become even more successful. Here clearly, Success breeds Success in this Industry.

Indian Private Equity Opportunity


• Indian Private Equity industry has grown with the Indian growth story with the boom years of 2003-08 attracting huge amounts of Global Capital into India.

• India still has a lot of potential considering its Fast Growth requiring Huge Foreign Capital and the Scale of Opportunity. Penetration of PE Investment as % of GDP can improve from the current levels.

• Over the past 15 Months, the India growth story has lost some of its sheen due to Macro Economic problems (Twin Deficits) and Political instability. The Tax uncertainty which arose out of GAAR also made most Global Investors nervous on India. While a few of these issues have been sorted out, still the levels of Optimism is far from the 2008 levels.

Sectoral PE Funding Opportunity

• The Biggest requirements for Capital will come from Capital Intensive sectors like Infrastructure and Real Estate across the country. • As can be seen from the images, the requirements for Equity Capital in Infrastructure space would be huge going forward and there is a definite need for Private Equity Investors in this space. • Infrastructure and Real Estate together contribute to over 60% of total disbursements in the Private Equity Industry and they target for an IRR upwards of 18% which will help them earn good Net returns for Investors. “ Specialists in discovering Multibagger stocks “

IL&FS Investment Managers – Business Overview


IIML – Business Model • IIML has a very strong Business Model where it earns a recurring and stable revenue of 1-2% of AUM as Management Fee.

• There is also a volatile and unpredictable Revenue stream in the Form of carry profits, but it can generate Bulk profits with Good Performance of its Invested Funds.

• There is no Investment Risk as such, as these Investments do not reside in the Balance Sheet and there will be no Write-Off or decrease in Value.

• Also the High Share of Carry Profits to Management which is inline with Industry standards helps IIML to retain talent. Average Hurdle Rates range around 11%.


IIML Fund History

• IIML is one of the pioneers of Indian Private Equity Industry with its Fund Management business started as early as 1995.

• IIML as a company has seen more than 2 Economic cycles and hence has the experience of surviving through the tough times unlike the New PE firms.

• IIML has pioneered in Raising several New fund formats like Real Estate, Infrastructure, PIPE, Auto Fund etc.

• IIML has a strong Collaboration with specialized Investors like Milestone, Stand Chartered etc which shows the Growth intentions of IIML.

• IIML has been on the road to raise 3 New Funds, most of which are expected to reach First Close by March of 2013. “ Specialists in discovering Multibagger stocks “

Current Fund Raising -Tara IV Growth Fund - PIPE Fund - Middle East Infra Fund

IIML – Overall Snap Shot


• IIML is India’s Largest Private Equity Manager with AUM of over 3.2 Billion S’s. Out of which around 2.4 Billion $’s fall under Earning AUM slot.

• IIML has consistently grown its AUM from 0.3 Billion 6 years back. The rapid rise is what contributed to strong Profit Growth.

• IIML had also gone in for Inorganic Growth through acquisition of Saffron Asset Advisors at around 8.5% its AUM, which helped it to acquire Yatra Capital which is an Open Ended Real Estate Private equity platform.

Growth Private Equity


• Growth Private Equity is the foremost vertical in which IIML has first started PE operations.

• It has a very strong track record in Growth Private Equity which can be seen from the 4 Fund raises which is has done in this Sector with successful divestment of 2 Funds.

• IIML has expertise across Sectors in Growth Private Equity with its Portfolio across different sectors of the Economy. • Growth Private Equity has become highly crowded with several new PE Investors sprouting in this segment. But still Growth PE gives the best Fund Management Fee in the form of 2% of AUM. • Also considering higher IRR of these funds, the Carry Profits are good for Investors. • With the economy growing across sectors, there would be several opportunities for deploying Growth Capital in several private companies in these sectors.

Infrastructure Private Equity

• Infrastructure Funds are usually much large compared to Growth Private Equity, but have lower Fund Management Fees.

• IIML with its Parentage has a strong presence in the Infrastructure PE segment and will continue to dominate this space. • Infrastructure in itself encompasses a whole range of Sub-Sectors which can be seen from the Investment Break up.


Real Estate Private Equity


• IIML has a strong Profile in Real Estate with several successful investments across the sector. Its portfolio is also well diversified across Geographies, minimizing the Risk of the Portfolio.

• IIML also has its own proprietary Real Estate arm QVC which undertakes real estate projects by leveraging the parent’s contacts and Knowledge in this space.

• Indian Real Estate continues to be very buoyant and IIML would be able to generate decent returns on its portfolio. It also structures Investments in different ways like Fixed Return, Lease Rent Models etc. With its strong expertise in this sector – IIML will continue to be one of the leaders in this segment helping Investors earn a decent return on their capital.

• IIML is the first company in India to raise a Pure Real Estate focused fund.

• It also has a Open End Platform in the form of Yatra and a collaborated Real Estate fund with Milestone Advisors whose entire focus is Indian Real Estate Market.

• IIML has several exit routes in its Real Estate funds and companies has a very diverse Portfolio across sub-segments

Investment Rationale


Key Highlights

IIML’s Business Model makes sure that it has a Predictable Revenue Stream in the form of

Management Fees + an Upside for Good work in the form of Carry Profits which provides the

right Incentives for Long Term Share Holder Value Creation.

Great Business Model

The Opportunity for Private Equity Capital into a developing country like India is huge and considering

the Moats of IIML, it would be the best way to play the growth of PE

Industry in India - especially in Infrastructure and Real Estate.

Huge Growth Opportunity

IIML has strong Record across all stages of Fund Management from Fund Raising,

Selecting Investments, Nurturing them to Exiting out. Also IIML is one of the few Investment Management companies in India which has seen two Full economic

cycles and has delivered strong returns to all stake-holders.

Strong Track Record

We believe the Markets are not factoring two potential upsides to the stock in the

Form of New Fund Raises once the overall environment improves + Potential

Carry Profit. If these materialize the profit from the stock would be tremendous for Share-holders.

Potential Upsides

IIML is available at attractive valuations which factors in several risks. Under-Valuation can be seen,

1.) MCAP/ AUM = 0.4X 2.) Price/ Earnings = 7X 3.) Dividend Yield = 5.85% 4.) Price/ Book Value = 2.27X

Healthy Valuations

IIML


Strong Competitive Advantages


• IIML has strong Invisible Moats in the business which will help it to maintain its dominance in the Indian Private Equity space. Company’s moats extends to all processes of a Fund Management company which is from Fund Raising, Deal Sourcing, Portfolio Management to Exits.

Fund Raising Capabilities


• IIML has well established relationships with several Institutional Investors built over the past many years. Company continues to strengthen its Fund Raising abilities by partnering with various Institutions and also expanding its Geographical reach. In fact, IIML has been working on establishing Offices across the Globe to raise Funds from Local Investors like in Middle East where it is starting a new Infrastructure Fund. Considering IIML’s track record, Parentage and Management – it will continue to have an edge over other Asset Managers to raise funds during tough phases as it did during 2008 & 2009.

IIML – Strong Parentage helps Deal Sourcing • IL&FS (Infrastructure Leasing & Financial Services) is one of India’s largest conglomerates with annual revenues in excess of 2 Billion $’s.

• IL&FS is promoted by several reputed Institutions and is a Board run company. The group has very good relationship with the Government which has been established in several instances.

• The Group is especially strong in Infrastructure where it currently is involved in over 30 Billion $ worth of projects which is next only to L&T.

• This Strong parentage helps in better Deal Sourcing, Value Addition etc in the Infrastructure space which is a huge positive for IIML.

• IL&FS group’s backing also helps the Investee companies in several ways, helping IIML to land on several sweet deals and generate strong returns.


Successful Investments


Infrastructure PE

Real Estate PE

Growth PE

Good Track Record


• IIML’s fund performance impacts its Future Fund raises and also in the amount of Carry Profit generated. The usual Hurdle rate is around 11% and the recent funds are pegged to Dollar Returns.

• On a base of 2 Billion $’s any outperformance over its hurdle rate will throw huge amounts of Cash for shareholders in the form of Carry profits. While the dollar appreciation would have hit the Investment portfolio of IIML, any shift in the same would provide good benefits on overall IRR.

• IIML has a strong Track record of earning good returns for its Limited Partners over all its Funds. Its also is comfortable in several Exit Formats which can be seen from the exits which it has been able to get even in the tough Market conditions of 2011 & 2012.

Healthy Financials


• IIML has been able to grow its profits over 10X in the last 10 years. The good thing has been the consistently high Dividend Payout Ratio along with Operating profit Margins > 50% sustainably. It can be clearly seen that the growth of IIML doesn’t require any additional capital helping Investors to fully profit from the growth of IIML’s business.

Attractive Valuations


• It can be clearly seen from the No's below that, Markets are pricing in the Worst Case scenario where there would be no significant Carry Profit and also the AUM will dip sharply over the next 3-4 Years

• We strongly believe that with these kind of Negatives priced in, the further downside is very negligible and can arise only from a complete Write-Down of India Growth story.

• On the Upsides, with the Environment changing IIML will be able to generate significant Carry Profits (even small Outperformance on AUM of 2 Billion $’s will give Huge Profits). Also future Fund raises can help the company to sustain and grow its AUM.

Present Market Capitalization = 532 Cr Current Enterprise Value of IIML = ~ 450 Cr Visible Management Fee Revenues = Till FY-16 Average Free Cash Flow (FCF)/ Year = ~ 65 Cr Conservative Estimates of Total FCF till FY-16 = ~ 260 Cr Present Value (PV) of FCF till FY-16 = ~ 220 Cr Decoding Current Market Valuation :

So, basically the PV of Terminal Value of IIML by Stock Market = ~ 230 Cr which is (450 of Current EV -220 of PV of FCF till FY-16) Hence the Terminal Value of the Business based on current Market Capitalization in FY-16 = 300-320 Cr Required FCF after FY-16 to hold on to the desired Terminal Valuation = ~ 30-40 Cr So, Average Asset under Management dip after FY-16 which the Market is pricing in = over 40% ( Since even 1.5 Bn $’s of Earning AUM can generate 30 Cr of FCF)

Financials


Earnings Projection

Financial Parameters (INR Cr) FY 11 FY 12 FY 13E FY 14E

Revenue 197.33 220.60 220 221

Operational Expenditure 34.7 44.88 44.4 48.4

Staff Costs 46.07 57.12 56.6 61.6

PBIDTA 116.56 118.61 119 110

Interest Charges 12.61 15.69 15.5 6

Depreciation 26 26.5 27 27

Other Income 11.18 12.5 14 14.4

Profit before Tax (PBT) 89.13 94.92 90.37 91.01

Tax Payable 20.11 21.39 20.37 20.51

Profit After Tax (PAT) 69.02 73.53 70 70.5

Diluted EPS 3.11 3.29 3.21 3.20

Cash Earnings per Share 4.5 4.6 4.5 4.5

Book Value per Share 8.62 11.2 11.3 11.4

• The Changes in the Topline for the next year would vary, if the Rupee is to move in either direction substantially. All estimates are slightly on the Conservative side. • Management has been able to control its expenses in line with Revenues, which has helped it to maintain its Margins consistently. • Cash Earnings per Share is a little higher considering the higher levels of Amortization owing to Saffron Buyout. • Company will be able to generate Free Cash Flows consistently over the next 4 Years in excess of 60 Cr Rs which will help it to reduce Debt and increase the Profitability slowly.

Specialists in discovering Multibagger stocks “

Concerns & Reasoning


1.) Low Volume Stock :

IIML Stock has very low Volumes which is a Risk for Liquidity of any Portfolio. But considering the fact that it’s a Long term bet, Investors can both accumulate and exit out of the stock in phases.

2.) Macro Economic Issues + Political Uncertainty :

At the end of the day, growth story of IIML is nothing but the increasing Capital Requirements for the Infra & Real Estate Industry based on India’s development. Hence any issues with respect to India’s Macro Economic variables will affect IIML – especially Rupee Movement. On the converse, wit India’s growth IIML will be able to capitalize on the Increased Global Investors appetite for investing money in India.

3.) Investing Mistakes which can dent Further Fund Raises :

Though none of the Investments directly lay on IIML’s books directly, a bad decision will affect further Fund Raises. IIML’s investing failures in DB Realty & karturi Global has not been taken well by the Market. But we feel, in any portfolio there would be duds – but the Management's experience will enable better performance than most other Fund Managers.

4.) Not able to Deliver Sustainably High Returns + Exit Issues :

Exits in India have been one of the key issues for most PE Investors and IIML would also be affected to an extent by the subdued environment especially over the next 4 years when it needs to Exit profitably for receiving any Carry Profit.

5.) Increasing Competitive Intensity and High Cyclicality :

Private Equity as an Industry has seen immense competition in the Boom times & also has Cyclical characteristics. But buying the stock at the bottom of the cycle will enable good returns for Investors.

Conclusion


Price Chart

• IIML Stock has been in a consistent Correction phase since late 2010, from which the India Growth Story started receding amongst Global Investors.

• Stock has strong Support at 24 Rs, below which its Dividend Yield will start looking better than Fixed Income Products – hence capping off further decline to an extent.

• Promoters share has been consistent for the past many years as there has been no major dilutions except for regular ESOP’s. There has been several purchases over the past few months from Company Insiders which is a good Sign for improvement in the Stock.


Share Holding %

June 2012

Mar 2012

Dec 2011

Sept 2011

Promoters 50.32 50.44 50.44 50.44

FII 3.22 2.81 2.77 2.75

DII 1.66 1.71 1.90 1.94

Decent Correction in Share Price

Conclusion A Dhandho Investment Opportunity is one where an Investor can take an Out-Sized bet in a trade which has characteristics of Low Risk and High Return on probability basis. As we can see, IIML is one stock where there is a very low probability of the Investor losing his money – but if things work, the Investor has hit a Jackpot. Valuations is the one which is providing downside support to the stock while the Upside Potential comes from its Strong Business Model combined with durable Moats.

IIML is the only listed pure play Asset Management company in India. Actually speaking, the company like IIML does not have any need for listing as there is Zero Capital requirement for growth and the primary reason for its listing has been its history (It got listed in Late 90’s when it had other businesses). Company’s Management has in fact tried to de-list itself through Buy-Back two times in the past, but have been unsuccessful in it. Its business Model will continue to throw cash going forward as the company would not like to move into Proprietary Investment or LBO’s etc.

Even though the recent Economic Downturn might have a sentimental impact on the Global Fund flows, no one can remove the fact that India will continue to be one of the fastest growing economies in the world with huge capital requirements for Infrastructure, Power and other sectors of the Economy. This will present huge Opportunities for Private Equity Asset Managers and this is a strong structural trend and the scalability of the model is very high unlike its Peers.

Considering the High Dividend Yield the stock provides at the current valuations, any Investor can patiently wait for the positives to occur as he doesn’t have any significant Time loss. At around 6% Post Tax dividend yield, its almost equal to other Interest Instruments in the Market. In addition to this, we have chances of Improving Revenues from new Asset under Management (AUM) + Carry Profits (Existing Funds)+ P/E Expansion (Better Future Visibility) which will help the company to grow its profits and allows Investors to earn good Returns on their Money. Hence, IIML is a Perfect Dhandho Investment.


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