When Prem Watsa first bought a stake in IIFL in FY11, revenue from its broking business made up the bulk of the company’s revenue. However, today, a little over 70% of IIFL’s revenue comes from its non-banking finance business. Watsa has now announced an open offer for a bigger share of IIFL’s ownership pie. For an additional 26% stake in IIFL, Watsa is willing to pay ₹1,621 crore or ₹195 a share, thus valuing the firm at ₹6,234 crore. Assuming the offer is successful, Watsa’s stake in IIFL would rise to 34.7% from 9%.
Watsa has established himself as an astute investor with a proven track record but what explains his investment interest in IIFL? According to an industry observer who did not wish to be named, IIFL is a good consolidated play on the brokerage, wealth management and lending businesses.
In other words, a sound multi-product company that might interest investors. Nirmal Jain, founder and chairman, IIFL Group, says diversification has helped the group weather difficult economic situations with the brokerage business today (FY15) contributing around 12% revenue against 66% a decade back.
“Firms that already had capital market services in their portfolio have diversified and now offer a wider variety of financial services, giving them an edge over pure-play non-banking financial companies (NBFCs),” says R Venkataraman, co-promoter and managing director, IIFL Holdings.
IIFL Holdings’ business today encompasses brokerage, investment banking, wealth management, distribution of financial products and the NBFC. The last business accounts for 72% of the overall revenue. Meanwhile, the wealth management business contributes 10% to the top-line. In FY15, IIFL reported a profit of ₹724 crore on a turnover of ₹3,666 crore.
While IIFL’s earnings from its brokerage income have declined 45% since FY10, its earnings from its financing income has gained 358% in the same period. Analysts believe that IIFL Holdings is a strong capital market play supplemented by an NBFC business that gives stability to its business model. With the brokerage business having taken a backseat in IIFL’s plans, Venkataraman adds that wealth management and NBFC are going to be the key focus areas for the group, going ahead.
Changing tack
Today, IIFL’s non-banking finance arm IIFL Finance offers loans against property, gold loans and loans against shares. Wealth management, Venkataraman believes, is still a nascent industry in India. “There is a huge amount of wealth generation that is going to happen. And if we have a bullish market, more wealth will be created,” he adds.
IIFL Wealth was established in 2008 and its assets under management have grown 44% annually to around ₹80,000 crore. In FY15, the wealth management business’ profit was more than ₹100 crore — up 118% on a Y-o-Y basis. “IIFL Wealth has focused on long-term relationships and invested time on understanding each client’s needs rather than just prescribing them wealth solutions,” says Venkataraman. But how does IIFL intend to compete with foreign banks that are offering similar services in the wealth management space?
“Our team has a deep understanding of Indian HNIs and entrepreneurs. We understand the Indian way of relationship management and wealth preservation,” he adds. On the profitability of the business, Venkataraman says it is difficult to pinpoint the margins in this space. But what is clear is that relying purely on the stock market for survival is passé.
With seven years (FY08-FY15) of declining cash and retail volumes still fresh in mind (retail volumes as a proportion of total cash volumes declined from 55% in FY08 to 50% in FY15), market players feel that the diversification model is the way ahead for the industry.
Motilal Oswal, chairman and managing director at Motilal Oswal Financial Services, says there will be a natural shift of niche broking players towards related capital-market products. “These players will need to provide solutions to clients rather than just offering equity broking to survive.”
Look who's changing on the street
Brokerage firms now have a diversified revenue profile
FY15 was the first fiscal for Motilal Oswal Financial Services’ housing finance venture Aspire Home Finance. For now, a major part of its top-line (61%) still comes from broking and related activities.
Investors, however, see a huge potential in the diversifying story that is playing out in the broking space. ICICI Prudential AMC’s fund manager Vinay Sharma, whose fund holds an over 11% stake in Motilal Oswal, feels diversifying into the NBFC space would have a multiplier effect on the earnings of traditional brokerages. Angel Broking, which has a strong presence in retail broking, also plans to launch a housing finance company.
“We could leverage our existing retail clientele to offer this service. We are looking at the model followed by new-age HFCs, which make their money by giving low-ticket-size loans to people whom banks typically don’t entertain,” says Vinay Agrawal, CEO at Angel Broking. However, they would need to raise funds for the housing finance
company. “We will come out with an IPO eventually but for the HFC plan, we are also exploring the PE funding route,” he adds.
One of the reasons why brokers sense a big opportunity in the lending business is because PSU banks continue to struggle amid structural and macroeconomic challenges. Over the past two or three years, there has been a huge shift in credit market share towards private banks and well-run NBFCs. PSU banks have not done that well due to capital constraints and asset quality issues. Some private equity investors are excited about what they have seen in private banks and private NBFCs over the past seven to eight years. They believe this story will continue for the next seven to eight years as well. So, this is one tailwind that brokerages want to ride on.
“They feel that they can garner market share from PSU banks for a long time to come,” Sharma adds. While the HFC business is already quite competitive, with banks, HDFC and standalone HFCs fighting it out, Agrawal says Angel Broking
will focus on small entrepreneurs who don’t get access to housing finance due to lack of a fixed income or salary. He adds that the broking house already has a large team on the ground, which could be leveraged for the HFC business to source loans.
Private equity player IFC already owns 18% stake in Angel Broking, which it had bought for ₹152 crore. Centrum Capital is another capital market firm that is looking to further diversify its structure through the NBFC route. The firm is already into a wide range of businesses, right from travel, hotel bookings, money changing and visas to investment banking and broking. And it is now thinking about diversifying its lending business, which is currently focused on capital market activities such as lending against shares and margin funding.
“We are looking to enter the business of SME lending and giving out loans against property. We may possibly even enter the housing finance market later,” says Sandeep Nayak, ED and CEO at Centrum Broking. According to sources, an ex-Citi banker is likely to head the NBFC. The firm is also looking to venture into foreign exchange, wealth management and equity broking in west Asia.
Geojit BNP Paribas whose Geojit Credit was ensnared in the NSEL crisis plans to revive it’s NBFC business. “We already have an NBFC which is currently not doing much business. Geojit Credit was engaged in commodity lending which got stuck in the NSEL issue. We are contemplating new business plans for our NBFC. That is definitely on the cards. We may resume our commodity lending business, but primarily we would be looking at other avenues in the NBFC space,” says Satish Menon, executive director at Geojit BNP Paribas.
The brokerage house is also looking to diversify its revenue mix through the mutual fund distribution business. At present, brokerage contributes 70% of the Kerala-based company’s operating revenue.
“Our focus is to grow the mutual fund business at a much higher rate than the equity business. It is a derisking strategy, as we understand that new people will enter the market through the mutual fund route. We will be launching a financial planning module as well, which will integrate with the mutual fund business,” says Menon.
High costs and limited scalability are reasons why established players are looking for other pastures beyond broking. “Broking is a limited-scale market. If someone wants to grow, you need to bring in additional funds. Within this limited scale, you get a 4-5% market share. After that, you need fund-based activities to grow further,” says Vikas Khemani, president and CEO, Edelweiss Securities. He adds that the operating costs in the retail segment are relatively higher and profitability is low. “Thus far, retail participation has largely been through the mutual fund route rather than through direct exposure,” he says.
Silver lining
“Broking is a capital-intensive business and is not everyone’s cup of tea. Many broking firms are operating proprietary desks rather than gaining from any real brokerage,” mentions Oswal. ICICI Prudential’s Sharma feels that the fledgling discount broking business poses another risk to traditional brokerages.
However, with retail investors showing signs of renewed interest, established players don’t want to miss out on the high-yielding segment. Angel Broking remains bullish on the segment and is looking to scale up through the inorganic route. For the company, 90% of its revenue still comes from the broking business. According to media reports, Angel Broking was earlier interested in Sharekhan, which was recently acquired by BNP Paribas. Menon says that Geojit BNP Paribas could also take the inorganic route if there is an interesting opportunity. “We would be interested in strengthening our brokerage business beyond south.” For the company, Kerala, Tamil Nadu, Karnataka and Andhra Pradesh are currently the major markets.
In a limbo
Cash volume growth has not really recovered over the past eight years
However, players like MOFSL continue to be bullish on equities. Retail cash volumes were up 73% in FY15 on a Y-o-Y basis, mentions Motilal Oswal in the company’s annual report. “With fading return in physical assets (gold and real estate) and equity markets rallying 24% in FY15, retail participation in equities increased significantly in FY15. We believe that more retail savings could move away from physical assets to financial savings such as equities going forward,” states an Ambit Capital report.
Going ahead, experts believe consolidation is going to be a natural process as it is going to be difficult for smaller players to survive given the high costs involved in operating a brokerage business. “Smaller brokers are going to lose their market share. The kind of investment you need to make in technology and the high compliance costs would make it difficult for small brokers to survive,” adds Menon.
Although the past has not been encouraging, Venkataraman of IIFL Holdings maintains that the future of the broking industry looks better. “We are at the beginning of an upcycle. Volumes have also come back in the market. Our house view is that the economy will slowly but surely start doing better. We have seen the worst of the slowdown. Interest rates will also come off over the next 12-18 months and the economy will see a broad-based recovery because of government spending. That should set the ground for the bull market to recommence.”
Meanwhile, it’s not just Watsa who is interested in the likes of IIFL Holdings — other investors are also looking to catch the bus, as capital market players look to enter the lending business. “The market is hot and attractive now. We are getting proposals from private equity players and are currently evaluating them,” says Nayak of Centrum. Private equity player Everstone already owns 15% in parent Centrum Capital.
Sharma, however, feels that the NBFC business may not be as easy to handle for new entrants. “The difference between these two businesses is that in brokerage, you always take a little credit risk, whereas when you diversify into an NBFC business, you need to be very careful about what kind of credit risks you are taking.”
For instance, PSU banks are now suffering for the mistakes they made in 2009-2010. “Do you have good risk management practices? What segments are you choosing? Have you seen cycles or at least studied cycles for those segments? Because some of these segments that NBFCs cater to are very cyclical in nature and if you are not aware of the cycles, you could get into credit issues. If you make one mistake, you have to suffer for the next two to three years,” cautions Sharma. Despite the risks involved, the next few years look good for diversified capital market firms. “Financial services, wealth management and stock broking are businesses where things have consolidated a fair bit and look promising,” Nayak adds.That being the case, investors like Watsa have truly made smart bets.
