Are we on a different Planet?

A

I was recently analyzing the asset management industry and started looking at HDFC asset management and other companies in the space. As I always do, I started comparing with other asset management companies around the globe. The valuation gap has blown my mind. I often wonder what Indian investors are smoking to be so optimistic.

The opportunity size is large and all kinds of nice things can happen, but this gap is not so big that valuations of Indian firms should be 5X of a similar firm.

Let me give you one such example – KKR & Co. This is a global private equity firm which has expanded into other aspects of Alternative asset management. The company has been investing in real estate, private credit, public markets and other hedge funds. The company has around 210 Billion in AUM and is valued at around 24 Bn or 11% of AUM

In contrast, HDFC AMC manages around 51.7 Bn and is valued at 11 Bn or 21% of AUM. So 2X the valuation on the face of it. Just hold that point for now.

The first reaction of most Indian investors would be to say that India has a long runway, HDFC is a strong brand, we will soon be a 100 Gazillion economy yada yada yada. The problem is that once the stock price rises, people come up with stories to justify it.

I am not denying that HDFC is a storied name and has good growth opportunities. However that does not mean you can justify any valuation. Let’s look at some facts

  • HDFC AUM has grown by around 21% CAGR over the last 5 years. KKR has grown its AUM at around 14% CAGR in the last 5 years. Just as HDFC has growth opportunities in India, KKR is growing globally and in multiple product categories such as Hedge funds, credit and other forms of alternative investments
  • I will argue that every dollar of AUM for KKR is much more valuable than that of HDFC. HDFC AUM is into Equity and credit mutual funds. HDFC AMC revenue was approximately 0.6% of AUM. Let’s bump it up to 1% to be generous.
  • In comparison, KKR invests in private equity, hedge funds and other alternative investments. If you have studied this sector, you would know that fees for such vehicles is higher than vanilla mutual funds. KKR earns a management fees of 1-2% and accrues a percentage of profits above a threshold, also called as carry. KKR earned around 1.8% of AUM as income in 2018 and for reasons I don’t have space to explain, it was much lower than what the company will earn in steady state. It will be safe to assume that KKR will earn around 2.5% of AUM as topline income as some of its newer funds mature
  • ROE is not important as asset management is an asset lite business and does not need capital for operations

From an AUM perspective, KKR may be growing slower than HDFC, but has better economics than the latter.

Wait, there’s more

Now let me share something which will make you think really hard

KKR invests its own capital (shareholder capital) in its private equity and other such funds. These funds have earned 15% CAGR (in dollar terms) over the last 20+ years. If you follow the global markets, you will know that is a great return. In other words, an investor in KKR is buying an AMC (like HDFC AMC), but also investing in the underlying Private equity and other funds.

KKR has around 18.22 dollars/ share (or 15 Bn) invested in such funds. This is the book value of the firm. If we exclude this number for a like to like comparison with HDFC AMC, the company is valued at 4.4% of AUM. This is for a firm growing its AUM by 13% where the topline is suppressed due to newer funds which are under-earning compared to the older funds.

In effect HDFC AMC is valued at 5X KKR for now. Also keep in mind, that there is pricing pressure on mutual funds globally (their fees are reducing) whereas alternative investments face no such pressure.

Think twice

Is the growth profile and runway for HDFC so much more than KKR? Does being India focused provide HDFC more stability than KKR? Btw, KKR is also invested in India via some of its PE and other strategies. HDFC can expand into alternative investments and grow that business, but that is nowhere on the horizon.

As I am not invested in HDFC AMC, the downside for me from being wrong is low. However investors in the company needs to think long and hard on what is so special about the company that it should be valued at such a premium.

Is it the whole brand name and quality narrative of 2019? (similar to the small and midcap narrative of 2017). What is so special about quality in India v/s all the other countries?

Are we on a different planet?

9 comments

  • thanks RC . History & present had proved that we r on different planet.cause if we give ” Neharuyin Vichardhara” 50-60 yrs to lead the country as of TINA FACTOR . INDIA DOES NOT PRODUCE GOOD CORPORATE Governance companies is the problem . your analysis on valuation is great .so there will be always BUBBLE LIKE situation in all sector .

  • Though, I agree with this article findings, generally, real estate, and private equity are not liquid assets and need to be discounted more than equity and credit.

  • That may be the case with the book value part of it, but these asset classes also have much higher fees for the asset management company. Finally they are not liquid, but within a corporate structure they make sense. a 5-9 year horizon works well if the returns are high. when a company builds a plant which has 20 year life, we dont discount that ?

  • Hi, Just a quick question. When KKR does non AMC business like private equity etc, they do run a risk of getting into losses if their investment turns sour. Isn’t that right? If so, wouldn’t that have an impact on the valuation as risks are more in such cases as compared to an AMC business where if any losses in MF returns is not impacting the AMC?

  • Great point. Narrative often follows the price action. What a wise man does in the beginning a fool does it in the end. I still remember 5-6 years ago, when people used to start investing in stock markets for the very first time, most of them used to chase cheap stocks (pricing wise). However, now most of the beginners i come across are chasing super quality companies like Asian Paints, Hdfc Amc and Hul. Something seems to be broken and the moment it corrects itself. Many people would start saying “Mene bola tha”. This is classic Greshams Law in action. When poor and undemanding investors come in the market, the expected returns drastically reduce.

  • Good one! Btw another view point .. KKR can undercut HDFC AMC and still make good return for its shareholders. I had same theory against micro finance companies. If margins and growth is great, why wouldn’t a bit player like HDFC Bank enter that sector.
    btw HDFC LIfe and SBI Life similar story!

  • Read your article about HDFC AMC.

    When you compare with global peers you should also think the growth or wealth creation done by global players in 1980’s and 1990’s.Now only the AMC business in western countries became saturated.
    India’s Negative and Positive is it’s population.That makes global players to expand business to India and FPI invest in India Too.
    In every Bull Market we find new sectors that lead the bull and after the bull in that sector only the leader will compound rest of the life.
    In india the asset management business will have long run than in western countries due to future oppertunity.Market discounts that oppertunity and 10 percentage 130 crore population is huge to explore when we compare with developed countries.
    As you said it’s an asset light model, it can be a cash cow too.
    If General Insurance business created wealth for warrent buffet….In india,i believe ,AMC business will be fastest wealth creator than general insurance as it’s asset light business model in a 130 crore populated country.huge oppertunity.
    After 20 to 30 years our AMC business may get saturated like western peers but who needs 20 years?.We should ride along with buzzing sectors in every Bull Market.

    Indian Market will give new new oppertunities every time.Use it Wisely and Create Wealth.

  • My Simple Doubt…

    If Royal Enfield’s Sales Created Wealth for Eicher Motors Shareholders…

    If Jockeys Sales Created Wealth for Page Industries Shareholders…

    and If you believe … Mutual Fund Industry will grow in coming Years….IN INDIA.

    Why Can’t we bet on Asset Management Company-HDFC AMC?.

    Aditya

By Rohit Chauhan

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