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?