Investors can consider subscribing to the book-built public offer of ICRA Ltd at the cut-off price. The high-margin profile and scalability of ICRA's businesses make the stock an attractive investment option for those with a three-year perspective. The offer is being made in the price band of Rs 275-330, translating into a price-earnings multiple of 15-18 times the company's likely earnings for FY-07. As this is an offer for sale by two of ICRA's promoters, there will be negligible equity dilution, post-offer.
Positive triggers
Though the valuations are not cheap in the light of the company's historical financials and the stock's small-cap status, the opportunities for ramp-up in earnings from the ratings and knowledge businesses are huge, especially given the company's position as one of the two entrenched players in the domestic ratings business. The take-off in the corporate investment cycle and the potential for new business from a variety of issuers and debt instruments are some of the possible triggers to revenues and earnings from this level.
ICRA is one of the two entrenched players in the domestic ratings business, enjoying about a 28 per cent market share, based on a number of outstanding issues rated (399 out of 1,382). Given that the rating business is its key earnings driver, ICRA's financials bear a high degree of correlation with trends in domestic debt issuances. Sluggish revenue and earnings growth from FY-02 to FY-05 was followed by a significant improvement in both metrics over FY-06 and in the first nine months of FY07, as corporate fund-raising efforts took off after a moribund phase in the preceding years.
Rated corporate debt issuances in FY-06 increased 32 per cent increase over FY-05 while rated commercial paper issuances grew 47 per cent growth.
These trends have continued into the current fiscal, with the second half of this year seeing a significant increase in activity. This has reflected in a sharp expansion in revenues and profits from ICRA's ratings business in FY-06 and FY-07.
Ratings, the key driver
ICRA's consolidated operations generated net profits of Rs 13.5 crore on revenues of Rs 51.2 crore for the first nine months of FY-07, translating into an annualised EPS of Rs 18.1 on the post-offer equity base. The ratings business accounted for about 55 per cent of revenues, with businesses such as consulting (17 per cent), outsourcing (5 per cent) and information services (2 per cent) chipping in with the balance. The rating business, however, is the key profit driver.
The margin profile of ICRA's businesses is high, with EBIDTA margins consistently at 33-34 per cent. The ratings business has a healthy margin profile and has offset marginal or negative contributions from the other nascent businesses. The ratings business appears to offer scope for significant scalability, with low incremental costs, allowing further leeway for margin expansion. Personnel costs have been the key element of cost. Though ICRA's attrition levels have been high, it has managed to steadily augment its headcount from 239 employees to 407 over the past three years.
New opportunities
Going forward the prospects for the ratings business are predicated on a continued increase in domestic debt issuances by companies and the financial sector.
The activity in the corporate debt market appears set to remain brisk. The domestic capex cycle is likely to remain robust in the light of the emerging capacity constraints in manufacturing, ambitious expansion plans lined up in sectors such as commodities, automobiles and chemicals and continuing public investments in infrastructure.
Since about 97 per cent of the debt offers in India are rated and ratings are often driven by regulatory fiat, an increase in debt issue activity would directly translate into more business for the domestic rating agencies.
Over the medium term, new business opportunities for ICRA could also arise from rating requirements for bank loan exposures as they transition to Basel-II, a revival in securitised debt as banks face liquidity constraints, and greater depth in the debt markets arising from participation by insurers and local bodies. Other businesses such as consulting, outsourcing and information services also offer scaling up possibilities as ICRA can leverage on its existing knowledge base and skilled personnel to deliver these services.
With CRISIL being ICRA's only competitor in the listed space, the valuations for the company's stock are bound to be compared to the former. The CRISIL stock trades at a price-earnings multiple of about 24 times the current earnings, considering consolidated operations, and at about 38 times, based on the standalone operations. This valuation reflects CRISIL's larger revenue and earnings base, its higher growth trajectory arising from its research outsourcing operations and pedigree from the controlling stake held by S&Ps, apart from the company's sizeable investment book.
With a stronger focus on the ratings business and a smaller scale of operations, the ICRA stock is likely to be valued at a discount to CRISIL. However, evaluated for the domestic ratings business alone, ICRA's operations compare reasonably well with CRISIL's on market share, margin profile and return parameters.
With Moody's Investor Services emerging the sole promoter of ICRA after this offer, with a 28.5 per cent stake, the possibility of new business opportunities from an expanding relationship with Moody's, and a possible stake hike by the promoter at a later date, also remain possibilities.
The offer price may, thus, allow scope for reasonable appreciation in stock price, for investors with a three-year perspective.
Offer details: IFCI, the Specified Undertaking of the UTI and the SBI are jointly putting up their 25.81 lakh shares in ICRA Ltd for sale to public shareholders, through this offer for sale. The proceeds will thus go to the offerors.
The offer for sale is also being followed by a preferential allotment of 2.88 lakh shares to Moody's India and 9.06 lakh shares to ICRA's ESOS Welfare Trust at the offer price. ICRA's post-offer equity base will amount to Rs 10 crore.