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Suresh Krishnamurthy

There is huge potential for expansion in the broking business.

INVESTMENT in the book-built initial public offer of India Infoline can be considered at Rs 80, the upper end of the price band. The offer (though open till April 25) is already over-subscribed at the upper end of the price band. At Rs 80, the stock is stiffly valued. Equity broking and financial services business are only now starting to grow in India.

The potential for early entrants with a nationwide presence such as India Infoline is substantial. The market is also large enough to accommodate quite a few players. Important, there is considerable scope for participants not affiliated to any banking company, such as Indiabulls and India Infoline, to carve a niche for themselves. From that perspective, the ruling valuation can be considered attractive.

The risks involved can be quite high. The stock cannot be considered the best exposure to the equity broking business. The threat from competition is intense.

There are also other concerns over the quality of financial performance in the first nine months, loss of market share in online trading, volatility in commodity broking and pending registration of the company's subsidiary by the RBI.

In addition, the valuation captured in the India Infoline offer price does not allow scope for substantial re-rating in the near-term as happened in the case of Indiabulls.

Investors need to be patient to hold for a longer-term, raising the risks involved in the investment.

The firm

India Infoline derives its revenues from several sources — equity and futures broking, depository services, mutual fund and insurance broking, commodity derivatives broking and content generation in the form of equity research. The company has also firmed up plans to enter portfolio management. On obtaining approval from the RBI for commencing operations as a non-banking finance company, India Infoline also plans to expand its margin funding business.

Equity broking, however, continues to account for a major portion of the company's revenues and profits. About three-fourth of the consolidated profits can be attributed to equity broking.

Given the expected growth in broking volumes over the next few year, equity broking and margin funding will continue to remain the principal revenue streams for the company.

The other revenue streams, if they grow in line with their potential, could lend stability to the firm's earnings growth.

The concerns

The quality of the profits generated in the nine months ended December 2004 should concern investors. During this period, amounts stated as receivable from sundry debtors went up by about Rs 50 crore compared to the value at end-March 2004.

It is possible that the entire increase is due to margin funding. The offer document, however, does not provide clarity. Also, it does not give a break-up in income due to equity broking and margin funding. This is a let down from an investor's perspective. Hopefully, when another subsidiary starts the business of margin funding, there will be more clarity on the income derived from these two revenue streams. The drop in the market share of India Infoline in the online trading business should be of even more concern. The company enjoyed online trading volumes in the cash market of about 18 per cent at end-March 2004. The share rose to 22 per cent in the subsequent months but has since dropped to 19 per cent.

The decline in market share is even more precipitous in the futures and options segment. Here, the market share has dropped from 18 per cent at end-March 2004 to 13 per cent at end-December 2004. Trading volumes in the nascent commodity derivatives have plunged too.

The only consolation is that offline broking volumes in the NSE's cash market have been on the rise. Thus, the overall market share of India Infoline in the NSE's cash market has improved steadily over the months. Still, given the larger growth of online trading volumes in India, the decline in market-share is disappointing.

This also places a question mark over the company's ability to sustain market share gains, which is essential to shielding the company's profitability from the vagaries of the stock market trends. Such expectations are also built into the offer price.

The value

At Rs 80, the stock trades at 27 times its profits for the nine months ended December 2004. In contrast, the stock of Indiabulls trades at a multiple of 43 times its profits for the nine months ended December 2004.

Indiabulls subsequently declared its profits for the quarter ended March 2005 and it is expected that the profit growth of India Infoline would not be substantially lower that that of Indiabulls.

The valuation, which shows a discount to that of Indiabulls, however, appears justified and is not necessarily a sign that the stock is undervalued at that price. Strong growth over the next few years in trading volumes could generate reasonable capital appreciation for investors.

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