CRISIL — Open Offer: Book profits

Crisil, a global analytical company providing ratings, research and advisory services, has always traded at a significant premium to its peers. However, the stock, at Rs 1,184, now trades at 32 times its calendar year 2013 earnings, much higher than peers and its own long-term average of 22 times.

A sharp rally over the last month was triggered by the open offer announced by Crisil’s promoter McGraw-Hill Asian Holdings, to acquire 22 per cent shares in the company, taking the total holding to 75 per cent. The stock re-rated significantly and is very close to the open offer price of Rs 1,210 now. This offers investors a good opportunity to exit the stock.

Crisil’s ratings and research segments are set to grow at a slower pace than in the past. Lower fees from smaller rating mandates also put pressure on profitability. For an expected earnings growth of 18-20 per cent for the next two years, current valuations are steep. While market preference for defensive stocks may see valuations hold in the short-term, over two-to-three years, the stock will correct to lower levels.

Selling in the market may be the more cost-effective option. Shares sold back to the promoter will attract short-term capital gains tax at the applicable slab rate and long-term capital gains tax at 10 per cent.

Set to slow

Crisil has transformed itself from a pioneer of credit ratings in the country, into an independent research house as well. This has given the company ample growth opportunities. Its revenues have grown at 22 per cent annually over the last three years. Momentum in revenue and healthy margins have aided a return on equity of 46 per cent for 2012. This has justified the premium valuation of the stock in the past.

Crisil’s business spans three segments — ratings, research and advisory services. Within ratings, the company services the entire range of debt instruments. Within the research segment, it caters to both domestic as well as global markets. In the Indian market, it is the largest independent research house.

Clients include 1,200 Indian and global companies, 90 per cent of India’s banks and the entire mutual fund industry, among others. The global research and analytics division counts 12 of the top 15 global investment banks among its clients. Crisil also provides offshore rating services to S&P under the Global Analytical Centre (GAC) segment.

Crisil’s business is now well-diversified. About 37 per cent of its total revenues are from the domestic market while 32 per cent and 24 per cent come from the US and the UK markets, respectively. The research segment has steadily increased its share in revenues from 40 per cent five years ago, to 54 per cent currently. The ratings business grew 22 per cent in 2012, driven by bank loan ratings (BLRs) and SME ratings, amidst muted bond issuances. With various small companies opting for ratings, BLRs will continue to see a healthy growth.

In the second quarter of 2013, there was notable recovery in bond issuances, on account of several new innovative instruments, including India’s first inflation-indexed bond and the first Tier-II capital issuance under the Basel-III regulations (both rated by Crisil). However, the sustainability of this recovery for the rest of the year will be doubtful.

The RBI’s recent measures to tighten liquidity and keep interest rates high, will impact bond issuances this year. Along with a sluggish domestic market, pressure on rating fees too, will be a factor, as it will hinge on the smaller mandates from bank loan and SME ratings. The low realisations in these sub-segments will put ressure on profitability. In the first half of 2013, the margins in this segment are down 270 basis points from last year.

‘Coalition’ impact

In the research business, uncertain global environment posed challenges for Crisil’s global research and analytics segment. Overall, the research segment grew 24 per cent in 2012, driven by its acquisition of the UK-based firm, Coalition, during the year. Crisil’s research business has been built through the inorganic route with the acquisition of Irevna in 2005 and Pipal Research in 2010.

In the second quarter of 2013, in spite of the challenging environment in the US and the UK, client additions and favourable currency movements saw a growth of 34 per cent over the previous year.

However, this was primarily boosted by consolidation of revenues from the acquisition of Coalition, which contributes 16 per cent of research revenues. In the second half of this year, the incremental contribution from Coalition will be lower as the business was acquired in the second half of 2012. Thus, the overall growth in the research segment will begin to moderate.

In the advisory business, which is 6 per cent of total revenues, the growth has remained muted. The slowdown in the Indian economy and, particularly, challenges in the energy sector have impacted business in this segment.

The offer

Crisil’s promoter Mc-Graw-Hill, with 53 per cent stake, is making an open offer for 22 per cent stake in the company. The open offer will be open from July 24 to August 6. The open offer price is Rs 1,210.

However, remember that all shares that are tendered through the offer may not be accepted. The current public shareholding in the company is 47 per cent.

Assuming that all public shares are tendered, only one in every two shares can be accepted. The acceptance ratio (number of shares accepted to those tendered) may change, depending on the actual number of shares tendered. Institutions that hold 26 per cent of shares may chose not to tender.

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