After plummeting below its IPO listing price last year and falling out of investors’ radar post SEBI’s regulatory changes, the stock of Reliance Nippon Life Asset Management, is back in the limelight. The stock skyrocketed 30 per cent over the past two days, after Reliance Capital invited JV partner Nippon Life Insurance to acquire its 42.88 per cent stake in Reliance Nippon Life AMC. The reason? Expectations of the deal happening at a much higher valuation than the current market price of Reliance AMC, as the JV partner is set to acquire controlling stake in the AMC.
While the stock of Reliance AMC may continue to rally on these expectations, investors need to be cautious and not buy into the rally aggressively. Muted performance in the nine months ended December 2018, regulatory changes impacting revenue and profitability, as well as volatile market conditions could continue to weigh on the earnings of the AMC in the near term.
The recent optimism in the stock has mainly been triggered by the expectation that Nippon Life would pay a premium price for acquiring controlling stake in one of the largest AMCs in India. By that count, Reliance AMC’s large AUM base driving economies of scale, a well-diversified investor base with growing share of retail investors, and wide distribution network are key positives, no doubt.
But in the past one year, multiple headwinds have plagued the stock.
For one, slowdown in flows and a lacklustre capital market have played spoilsport for AMCs.
Two, mutual funds mainly generate revenue from fees that they charge as a percentage of the AUM, known as management fees. These fees depend on a number of factors, such as the total value of AUM, regulatory limits and the composition of AUM. Regulatory tweaks such as tightening of fees and commission, further cap on expenses, etc., impact revenues and hence, profitability.
The SEBI circular dated October 22, 2018, imposed a ban on payment of upfront commission and made it mandatory for all scheme-related expenses to be paid from the scheme only.
These changes resulted in not only fall in revenues (and expenses), but also impacted the profitability. Reliance AMC’s operating profit fell 7.7 per cent y-o-y in the December quarter. Overall profit after tax fell by around 15 per cent in Q3 and 2 per cent for the nine-month period ended December 2018.
Reliance AMC’s quarterly average AUM has also fallen over the past year by about 3 per cent.
More pain
SEBI’s regulatory changes on the total expense ratio are also set to impact revenue and profitability of AMCs from April 2019. Mutual funds charge investors for managing their schemes.
This charge is called the total expense ratio (TER). The maximum TER that a fund can charge its investors is prescribed by SEBI.
SEBI, in its notification last year, revised these limits sharply lower — hence, for large equity schemes there could be a 25-70 bps reduction in expense ratio. This can impact revenue and profit of large AMCs, such as Reliance and HDFC AMC, though the extent of pain needs to be seen.
Valuation game
At the time of listing, the asking price valued the business of Reliance AMC at around ₹15,420 crore, about 7 per cent of its AUM then. Before the news of the stake sale broke out two days ago, Reliance AMC was trading 38 per cent below its listing price of ₹252, at about 4 per cent of its December 2018 AUM, a steep discount to the AMC’s IPO valuation.
After the 30 per cent rally, the valuation has moved up to 5 per cent of AUM, still lower than the IPO valuation.
In 2015, Nippon Life had increased its stake in the AMC to 49 per cent from 35 per cent, at a price that valued the business at about 5.6 per cent of its AUM then.
Hence, this has kindled hopes of Nippon Life acquiring stake in Reliance AMC at a higher premium to the market price. But given the underlying pressure on the AMC’s profitability, investors need to be vary of speculative buying in the stock.
Valuations of peers
The other listed player, HDFC AMC, is trading at a much higher premium of 8.5 per cent of AUM. But it has been consistently among the top two players in terms of AUM in the last few years. Also, HDFC AMC’s net profit as a per cent of AAAUM (annual average AUM) is higher than the others at — 0.26 per cent in FY18, compared to Reliance AMC’s 0.21 per cent and ICICI Pru AMC’s 0.22 per cent.
In the nine-month period ended December 2018, while HDFC AMC’s operating expenses as a per cent of AAUM was 0.29 per cent, for Reliance AMC it was about 0.32 per cent. HDFC AMC’s lower expenses structure can help it tide over the pressure on profitability, sustaining its premium valuation.