Motilal Oswal Financial Services: Invest at cut-off

Investors can subscribe to the book-built initial public offering from Motilal Oswal Financial Services being made in the price band of Rs 725-825. The company offers a quality exposure to the domestic equity broking and financial services market, which has impressive growth potential.

The asking price for the offer also appears reasonable in the light of the company’s growth prospects and valuations enjoyed by peers such as India Infoline and Geojit Financial Services. At an offer price of Rs 825, the company would be valued at a price-earnings multiple of about 30 times the trailing and 26 times the forward earnings (on a fully diluted equity base). The company’s market capitalisation at this price would be about Rs 2,300 crore.

However, this stock is suitable only for investors with a high-risk appetite. With a high dependence on equity broking, Motilal Oswal’s earnings are inherently cyclical and pegged to the fortunes of the equity markets. Recent global developments may lead to a contraction in valuations for financial services players, which will have a bearing on the response to and post-listing performance of this IPO.
Operations

Motilal Oswal Financial Services (MOFS) is a NBFC, deriving its revenues mainly from four subsidiaries that offer stock broking (retail and institutional), commodity broking, venture capital and investment banking services. MOFS’ consolidated operations generated a net profit of Rs.69.5 crore on revenues of Rs.379 crore in 2006-07.

The equity broking business is currently the key revenue driver, accounting for 89 per cent of consolidated revenues. Contributions from the investment banking and venture capital arms, which commenced operations in 2006, are as yet marginal. Proceeds from this offer are to be used mainly to offer margin financing facilities to retail clients, augment working capital needs and purchase office space.
Prospects

Earnings prospects for the wealth management/equity broking business hinge mainly on the level of trading activity in the stock markets and MOFS’ ability to garner a larger share of transaction volumes amidst competitive pressures. Due to its early mover advantage in the traditional broking business, Motilal Oswal has managed strong growth rates in the wealth management business over the past four years.

While transaction volumes routed through the company in the equities (cash) market have grown at an annualised 93 per cent between FY-03 and FY-07, volumes in the derivatives segment have grown at 235 per cent per annum. Assets managed by its portfolio management services have expanded at an annualised 114 per cent over this period.

Given the very low retail participation in equities in the Indian context, there exists significant potential for expansion in the size of the broking and wealth management pie.

However, the relentless pressure on brokerage commissions due to entry of competitors with deep pockets (read private banks and foreign firms) and the growing popularity of online trading, are key challenges to be managed by traditional brokerages. Motilal Oswal has made a relatively late start in the online trading business (with its www.mybroker.com initiative) and, today, has a smaller online presence than some of its peers.

However, a healthy ramp up in clients over the past year and a recent strategic alliance with SBI to offer online trading services to the bank’s clients hold promise for an expansion in its online presence. An expansion in margin funding, financed by this offer, could generate additional revenue streams by way of interest receipts.

MOFS’ research strengths (a 34-member equity/commodity analyst team) and its extensive geographical reach covering 1200 locations in 377 cities, which enables it to tap into under-serviced markets, are key advantages over some of the company’s peers in the listed space.

The potential for expansion in MOFS’ earnings from its non-broking businesses is also substantial. The company’s large retail (2.43 lakh clients as of March) and institutional (251) client base offer considerable opportunities for cross-selling of products and services.

Businesses such as portfolio management and advisory services and distribution of third-party mutual funds/insurance are highly scalable and offer scope for substantial earnings growth at relatively small additional investments in infrastructure.

Offer details: Motilal Oswal Financial Services is offering 29.8 lakh shares (face value of Rs 5) at a price band of Rs 725-825. Citigroup Global Markets is the lead manager to the offer.