Should you subscribe to IPO of Prudent Corporate Advisory?

India’s mutual fund (MF) penetration (assets under management (AUM) as percentage of GDP) is at 15 per cent - lower than the global average of 75 per cent and far behind developed as well as other emerging economies. This gives the industry with a roughly ₹37 lakh crore AUM as of now, a long runway for growth. Prudent Corporate Advisory Services (Prudent), deriving most of its revenues from MF distribution is looking to ride on this potential. The company is raising ₹538 crore through the IPO, which is entirely an offer for sale.

A revenue mix favouring higher yielding equity funds, well-diversified distributor (MFD) network and a technology-led distribution model are positives. However, Prudent operates in a competitive and fragmented business. Competition from direct plans and prolonged volatility in markets or corrections from hereon may also impact AUM /revenue growth. The valuation is a dampener too. At the IPO price band of ₹595- 630, the stock will trade at 32-34 times its annualised nine-month FY22 earnings. Adjusting the earnings for the acquisition of mutual fund business of Karvy (AUM of ₹8092 crore) in end-November 2021, the valuation comes to 30.5-32.5 times. While there are no like-to-like peers, Anand Rathi and ICICI Securities which are more diversified or larger, trade lower. Investors need not rush to invest in the issue now and can adopt a wait and watch approach.

Business model

Prudent manages total MF AUMs of ₹48411 crore as of December 2021. About 90 per cent of this come from the B2B segment, where the company provides all the back-end technology and infrastructure needed for MFDs. The front-end for the customers is through the Fundzbazar portal. The remaining 10 per cent AUMs come from the B2C segment, which caters mainly to HNIs, through a network of relationship managers. To expand its catchment of distributors in existing territories, to capture new territories as well as to cater to B2C customers, the company sets up physical presence through branches, which number 110 currently. Seventy per cent of the transactions happen online. Prudent shares about two-thirds of the commission it receives from AMCs to the channel, which according to the management, is in line with peers.

While MF distribution is its bread and butter forming 85 per cent of revenues, Prudent derives about half of the remaining 15 per cent of revenues from sale of insurance products which are more profitable than MF products and building this business is a focus area. Stock broking, PMS/AIF/ structured products, curated portfolios are also on its list, giving ample opportunities for cross-selling.

Advantages

Among mutual funds, equity-oriented funds have higher expense ratios as against debt/passive ones and this generates higher commissions. As of December 2021, equity AUMs constituted about 92 per cent of the total for Prudent, 42 per cent of the equity AUMs coming from SIPs. SIPs generally give visibility on trail commissions due to regular repeated nature of the investment over a period of time. Commissions as a percentage of average AUMs stand at 1.06 per cent for the company, while it is at 1.13 per cent for peer NJ India Invest.

Prudent also enjoys a well-diversified as well as a reasonable sticky MFD base. 18.4 percent of the ARNs (AMFI Registered Number) are empanelled with them and top 50 ARNs bringing in only 8 per cent of the AUM. 50 per cent of them have stayed with Prudent for over 5 years.

For MFDs, B-30 (beyond top 30) cities present good hunting grounds for AUMs considering that the commission structures are bit higher than T-30. B-30 AUMs are also more retail oriented, with a tilt towards equity funds and hence provides them with profitable growth opportunities. 16.6 per cent of Prudent’s AUM’s come from B 30 cities and it has 28 per cent of its distributors in these places. The company is looking to further the penetration here and has established 38 branches in B-30 centres over the last 3-4 years.

Concerns

Though Prudent is among the top ten players in terms of average AUMs (who together account for about 45-50 per cent market share), its market share is less than 2 per cent. The catching on of app-based investing most of which offer direct plans as well as increasing awareness of lower expense ratios of direct plans has been drawing investors towards it. This is a threat to the regular plans that MFDs offer.

Investing in passive funds has caught on too due to reasons such as certain categories of funds underperforming their benchmarks consistently, lack of room for innovation in actively managed funds due to SEBI’s strict categorisation rules. Also, rising interest in international investing for which ETFs / FoFs present a convenient route as well as the lower expense ratios of passive funds compared to active ones are factors. Passive AUM at ₹5.3 lakh crore now accounts for 14 per cent of total pie.

This trend may bring down yields for MFDs, which has already taken a hit from the ban on upfront commissions and the adoption of a full trail model as well as the rationalisation of TER ( total expense ratios) charged by MF houses from April 2019. For instance, for the year ended March 2020 in which this was implemented, commission and fee income from MFs for Prudent grew by just 0.06 per cent over the previous year, though a reduction in AUMs from the market correction in March 2020 may have also been another reason.

The Covid bull-run has seen total AUMs for the company move up by 60 per cent year-on-year in FY21 and another 56 per cent from there to ₹48411 crore in the April – Dec 2021 period. Operating leverage has helped margins move up from 19.8 per cent to 25.3 per cent in this period. Consequently, profits have doubled from 27.8 crore in FY21 to 57.6 crore in April – Dec 2021. 

If the current market volatility continues or leads to a prolonged correction, its impact on the topline and profitability needs to be monitored. CRISIL expects the mark to market gains in the equity category to moderate down to an average of 7-11 per cent in next five years post March 2021 and equity AUMs for the industry to grow at 9-11 per cent CAGR over March 2022 to March 2026.

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