The Hindu Business Line : Infrastructure Development Finance Company: Invest at Rs 34

INVESTMENTS can be considered in the initial public offer of Infrastructure Development Finance Company. Considering the growth prospects and the fundamental strengths of the company, the pricing is not demanding. If anything, it has left some money on the table that would get reflected in the form of gains on listing.

Strong credentials

IDFC is a non-banking finance company promoted by a number of Indian and international investors such as the SBI, IDBI, ICICI, the Asian Development Bank and IDFC. The Government of India would hold a 24 per cent stake in the company, post-offer. IDFC also enjoys the status of a public financial institution.

The management is in the hands of professionals with vast experience in infrastructure finance. IDFC hopes to emulate the role played by HDFC in housing finance. Like HDFC, IDFC too has been developing strong linkages with both government agencies and the private sector. Since its inception in 1997, it has played a major role in financing a number of private and public sector infrastructure projects.

In terms of business focus, IDFC is focussed on lending to three main areas — energy, telecommunication and transportation projects. Though debt is the predominant mode of financing, IDFC has invested in the equity of a number of firms. It has also floated a 100 per cent subsidiary — IDFC Asset Management Company — that manages for a fee a venture capital fund with a corpus of Rs 850 crore.

Highly competitive

The segment of infrastructure finance is intensely competitive with a number of large organisations such as the SBI, IDBI and ICICI willing to finance projects at attractive rates. Notwithstanding its status as an NBFC that bars access to low-cost short-term funds, IDFC can still effectively compete with banks. For the year ended March 2005, the cost of funds for IDFC was about 6.53 per cent.

This is significantly higher than that of competitors such as the SBI and ICICI which mobilised funds at about 5 per cent. IDFC's cost-to-income ratio of about 11 per cent, however, is substantially lower than that of either the SBI or ICICI, making it competitive. For the SBI and ICICI, the proportion of cost-to-income would be between 40 per cent and 60 per cent.

Besides, banks have to adhere to regulations mandating holding of low-yielding assets such as cash reserves and government securities. This regulation increases the effective cost of funds for banks vis-a-vis top-rated institutions such as IDFC which do not have to do so. The low incidence of bad loans, at less than 1 per cent, also keeps the company's cost of operations low.

Robust growth

IDFC's competitiveness is reflected in its business growth. Advances to the infrastructure sector have grown at an annual rate of 31 per cent per annum in the past four years. The competitive pressure has, however, been reflected in the form of steep fall in spreads in FY-05. Spreads — the difference between the rate at which funds are lent and borrowed — in infrastructure finance fell from 7.04 per cent to 4.52 per cent.

The decline in spreads is, however, not a significant negative factor. It is difficult to expect spreads of 7 per cent to sustain. Even the spread of 4.52 per cent appears to be on the high side and may well go down in the years ahead. Boost to profitability must come largely from an enhanced scale of operations. The scope for improvement in the scale of operations is vast. The debt-equity ratio of IDFC was about 3.3 at end-March 2005. It would be even lower if the capital infusion of Rs 400 crore, likely from this offer, is considered. Regulations, however, permit debt-equity ratio of about 10, indicating the potential for growth without further capital infusion. In addition, the low debt-equity ratio is the principal reason why the return on net worth of IDFC is only about 16 per cent even though it enjoys considerable tax benefits and high spreads in its business.

Attractive pricing

Adjusted for non-recurring profits, the earnings per share of IDFC works out to about 1.7 on the post-issue equity. The P-E multiple would, thus, work out to 20 based on an offer price of Rs 34. In terms of book value, the company's net worth works out to about Rs 2,500 crore, including the unrealised gains in its investment portfolio and the capital infusion through the offer. The price-to-book value would, thus, work out to about 1.5.

In terms of both parameters, the offer pricing is attractive for a number of reasons. First, the potential for growth is immense.

The size of infrastructure financing business is huge in India and IDFC's share is small. The scope for ramping up volumes is, thus, is quite high. Also, IDFC does not need significant capital infusion in the foreseeable future to accommodate business growth.

In addition, the potential for earning attractive spreads is strong. Now, at the turn of the interest rate cycle, IDFC enjoys spreads of 4.5 per cent. Its operational costs and tax incidence are quite low. The probability of earning a return on net worth of between 20 per cent and 25 per cent is, thus, high.

The downside, however, is that the risks are quite high. The focussed nature of operations makes IDFC vulnerable to project failures. At end-March, the energy sector accounted for 34 per cent of the total disbursements. The near-failure of development finance institutions such as IDBI, IFCI and ICICI in the past is an indication of the potential for downside for investors.

It may, however, be inappropriate to compare IDFC to the three institutions of a bygone era. IDFC promises to be more knowledge-driven and less prone to the excesses that characterised the 1990s.

On that premise, the pricing is attractive and an investment in the offer is justified. The offer opened on July 15 and closes on 22.

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