Reliance Nippon Life Asset Management: Sell in open offer

BL Research Bureau

Reliance Nippon Life Asset Management (RNAM) that had fallen out of favour with investors, has rallied over 45 per cent since February this year, post Nippon Life Insurance’s (JV partner) announcement of acquiring additional stake in the asset management company (AMC). Expectations of the deal happening at a much higher valuation than the market price of RNAM (in February), had buoyed the stock.

In May, Nippon Life signed an agreement with Reliance Capital to increase its stake in the AMC to 75 per cent at Rs 230 per share. As per SEBI takeover norms, Nippon Life has made an open offer to existing shareholders at Rs 230 per share (open until 5th August). The current stock price at Rs 227 is near about the open offer price, after the steep rally since February.

Reliance Capital which currently holds 32 per cent will completely exit the AMC, through sale to Nippon Life—the remaining stake through offer for sale to other financial investors. Nippon Life currently has 42.8 per cent stake in the AMC.

For investors in RNAM --up until the news of Nippon’s acquisition—the stock was under pressure, trading way below the IPO listing price of Rs 252 (listing in Nov 2017). Financial troubles of the Reliance ADAG group (Reliance Capital a part of it) had been a key overhang for the stock. Added to this, slowdown in flows leading to moderation in AUM growth and uncertainty over regulatory tweaks around fees and commission have also kept the stock under pressure.

At the open offer price of Rs230, RNAM trades at 7 per cent of AUM (As of June). This is near about the valuation sought at the time of the IPO. In comparison, its peer HDFC AMC trades at a steep premium of 12 per cent AUM. While there is a wide gap in valuations, significant re-rating in RNAM in the near term is unlikely. The stock was trading at 4-5 per cent of AUM through most of last year.

Hence while visible improvement in profitability and the exit of Reliance Capital augur well for the AMC in the long run, much of the positives appear priced in for now. Nippon Life acquiring a majority stake in the business will be beneficial over the long run, as it could leverage on its global tie-ups to attract flows from international investors. But in the near term, possible changes in management team (though the company states there will be no/minimal re-jig) and change in name (no Reliance brand name) can impact the stock. Until the dust settles, and significant synergies of Nippon’s strengths flow in, sharp re-rating is unlikely. Hence investors with a short term horizon can tender their shares in the open offer. Long term investors willing to wait out the transition, can hold on to part of their holdings in the AMC.

Profitability improves

RNAM is one of the largest AMCs in India. It manages a total consolidated AUM of around Rs 4.3 lakh crore as of June 2019. Aside from mutual funds, it also manages pension funds, offshore funds and managed accounts including portfolio management services and alternative investment funds (AIFs). The company’s mutual fund quarterly average AUM stood at around Rs 2.2 lakh crore as of June 2019.

RNAM’s large AUM base driving economies of scale, a well-diversified investor base and wide distribution network are key positives. A higher share of retail in its AUM (40 per cent vs industry 26 per cent) also bodes well as these flows are stickier in nature.

However, in the past year, growth in RNAM’s AUM has been muted. In the latest June quarter, total AUM shrunk by about 13 per cent YoY to Rs 2 lakh crore from Rs 2.3 lakh crore in the June quarter last year. Recent downgrades (including that of ADAG companies) and stress in the NBFC sector have impacted debt schemes of RNAM. Debt quarterly average AUM (including liquid funds) has fallen to Rs 1 lakh crore in the latest June quarter from about Rs 1.4 lakh crore last year. Debt constitutes 46 per cent of RNAM’s overall AUM from 58 per cent last year. Market share gains and pick up in AUM growth will be critical for significant re-rating of the stock.

However RNAM’s operational performance has improved over the past year. Several regulatory changes have had an impact on mutual funds’ earnings. A SEBI circular dated October 22, 2018, imposed a ban on payment of upfront commission and made it mandatory that all scheme related expenses be paid from the scheme only.

This resulted in fall in both revenues and expenses. So while revenues fell by about 18 per cent YoY in the June quarter, expenses also fell by about 32 per cent. This led to 9 per cent growth in core operating profit.

SEBI’s regulatory changes on the total expense ratio (TER) has also impacted AMCs from April 2019. SEBI, in its notification last year, revised TER limits sharply lower — in particular for large equity schemes. RNAM management has stated that it has passed on 80-90 percent of TER cut to distributors and hence the net impact on the profit will just be 2-3 bps.

While the improvement in profitability and exit of Reliance Capital are positives, much of this has already been priced in.

Valuation

The other listed player, HDFC AMC, is trading at a much higher premium. But it scores over RNAM on performance and profitability parameters. In the June quarter, HDFC AMC reported a healthy 18 per cent growth in AUM. It is now the largest actively managed equity mutual fund AUM, with market share of 16.2 per cent (June 2019). Core operating profit grew by a strong 44 per cent in the June quarter. HDFC AMC sports a strong return on equity of around 35 per cent (FY19), while RNAM’s return on equity stood at 19 per cent.

Exposure to ADAG Group

RNAM has extended inter-corporate deposits (ICDs) to companies belonging to the ADAG Group in the past. As of June 2019, the carrying value of these ICDs stood at Rs 399 crore. According to the notes to account, RNAM has not made any provision for this and in the event the underlying companies do not repay before the conclusion of deal (with Nippon) then the repayment of the ICD will be done through the proceeds of the sale of shares by Reliance Capital to Nippon Life.

At the scheme level also, RNAM has exposure to ADAG group companies (about Rs 1300 crore at face value). Investors will need to monitor the unwinding of these exposures in the coming months.

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