CAMS IPO: Should you invest or avoid?

Computer Age management Services Limited (CAMS) is the leader in the two-player MF Registrar and transfer agent (RTA) industry, with a 70% market share. It services 16 of the 41 AMCs and 4 out of the top 5 AMCs that account for a lion’s share of Indian mutual fund assets.

It is therefore small wonder that CAMS enjoys high profit margins, high return on equity, positive cash flows and has a generous dividend policy. As a quality proxy play to the mutual fund industry, can CAMS be part of your long-term portfolio at its offer price?

Here’s a review on the IPO of CAMS.  

CAMS IPO: About the offer

CAMS is a financial infrastructure and service provider to mutual funds and other financial service players. It is India’s largest RTA to the mutual fund industry and has been in the space for over two and a half decades. CAMS and KFin Technologies (earlier Karvy Fintech) service the entire mutual fund industry, barring a captive unit run by Franklin India.

The company is coming up with an IPO which is entirely an offer for sale. It will provide part exit to private equity investor Great Terrain (a Warburg Pincus affiliate) and full exit to NSE (as required by SEBI) who are present shareholders.

• At the issue price band of Rs 1229-1230, the issue size will be Rs 2240-2242 crore.
• The post issue market-cap at the upper end of the price band will be Rs 5997 crore.  
• The offer is open from September 21-23.

Great business

CAMS enjoys several advantages, seen from a business and financial perspective.

Significant moat: CAMS was among the early movers in the MF space and has relentlessly gained market share over the years, leaving little room for competitor KFin Technologies.

The moat that CAMS enjoys does not necessarily come from conventional sources such as brand or distribution clout. Rather, it arises from the complexity of operations it handles, as the end-to-end servicing partner connecting the AMC, distributors and investors. This ensures highly sticky clients (the AMCs). It is difficult for a new player even with enough capital and technology acumen to wean an AMC from such a long-standing service-relationship. An existing AMC client will have to incur significant costs and resources to migrate from this end-to-end service.

In fact, mutual funds who have attempted to run their captive operations have given up the practice as it is a lot more cost-efficient to outsource it to a player like CAMS who services multiple customers and benefits from scale economies.

High profit margins: B2B businesses are usually perceived as low-margin but CAMS breaks the mold with an EBITDA margin at an average 40% in the last 3 years and average ROE of 32%.

 This has been possible because CAMS’ revenue model is linked to the AUM of the fund houses it services. Th average AUMs serviced by CAMS grew at 21% CAGR over the past 3 years (data below) and is expected to grow at a healthy pace in the future (given low penetration of MFs in the country). It is noteworthy that CAMS’ service is highly technology-driven – so an increase in AUM does not necessarily increase cost proportionately up to a certain threshold. Revenues derived from AUM growth also mean limited incremental capital requirements to scale up. These are the primary reasons for the company to enjoy its high margin and return on equity.

The healthy profitability reflects in strong cash flows and a sound dividend policy. The company has in the past declared 150-200% dividends and has indicated a target payout of 65% in future.

Not an attractive offer price

At the higher end of the price band, CAMS’ price earnings ratio (PE) would be at 36.7 times its annualized per share earnings for FY-21 (based on June quarter EPS). We think the June quarter is largely reflective of what to expect in the upcoming quarters, given the significant outflows being witnessed in the mutual fund industry now. We think this pricing is expensive for the following reasons:

Industry valuation still evolving

Most of the IPO notes you’ve read would likely have compared CAMS’ PE with listed AMCs – Nippon Life India and HDFC AMC and depository player – CDSL. The point made is that CAMS’ asking valuation is in line with peers. However, we think that these ‘peers’ are not strictly comparable to CAMS and may themselves be expensively valued.  

• The graph above will tell you that the most highly valued of the lot – HDFC AMC – has seen a sharp de-rating in valuations this past year.
• Nippon Life AMC, despite being among the top 5 AMCs by AUM, has been struggling to re-rate for a while.
• Even CDSL, which has seen its valuations shoot up recently on the back of the demat boom and the margin requirement regulation by SEBI, has traded at a PE of 20-30 times much of the time post-listing. It is noteworthy that CDSL’s IPO was made at 19 times in June 2017.
• The data below will also tell you that the ROEs for all these players have moderated over time.

Traditionally, with a majority of AMCs yet to turn a profit, mutual fund players in India have been valued mainly on a percentage of AUM basis. For example, the Nippon Life stake in Reliance AMC in 2012, was at a whopping 6.8% of the AUM. Hold on. Well before that, Eton Capital acquired stake in the same AMC at 13% of AUM in the bull market bubble in December 2007.

It was usual to accord high PEs to players because it was widely believed that the MF business was in a very nascent stage in India with significant scope for scaling up of earnings. But as the industry matures and comes up against hurdles like the growth of passive funds and tighter SEBI regulations on fees, valuations appear to be readjusting to the new normal of more moderate growth and profitability.

Evaluating whether these companies are likely to grow at 35-40% annually (as suggested by their PEs) from here on – the answer is likely to be a No.  CRISIL estimates MF industry AUM growth over the next 5 years at 18% annually. When AMCs, which are far more scalable than RTAs, with limited to no incremental costs incurred on additional assets are witnessing a trend of de-rating, a service provider to such an industry should receive lower valuations too, in our view.

CAMS after all, is not a B2C company (the current market fancy) and derives very little of its moat from brand recall, unlike product manufacturers where lakhs of customers may flock to an AMC for a brand name or favoured fund manager.

Not a tech play

If not valued like AMCs, would CAMS deserve a high PE for being a high-end technology player? One of the key characteristics that mark a true tech play is the unlimited scalability that technology offers to a business.

In most of the highly valued tech plays of today, the marginal cost of servicing an additional customer is close to zero. As the customer base grows, revenues increase, and profit margins increase as well. New-age platform offerings like Netflix fall neatly into this category.

While B2B companies too may have such models can CAMS be viewed similarly? We don’t think so.

CAMS’ cost of servicing a new “customer”, say a new AMC is not small as it may have to hire people, establish processes and customize its offering to the new client. This is reflected in the huge manpower cost it incurs with its close to 4700 employees, front end and back end. That employee costs have hovered at 36-38% (and was at 43% in the June 2020 quarter) of revenue in the past three years, suggest that scaling for CAMS isn’t cost-free. Sure, CAMS is a technology-intensive company and this strengthens its moat and increases the efficiency of its operations, but it does not deliver the profound scaling advantages that true technology companies enjoy.

Pricing pressure to continue

The rapidly changing regulatory and product (passive products) landscape for MFs have implications for CAMS too. The graph below shows the decline in RTA fees for CAMS, in line with the change in expense ratios structures mandated by SEBI.

Both an increase in online transactions and cap on expense ratios have led to the decline. Both trends are likely to continue, putting pressure on AMCs to trim their costs, including RTA fees. The RTA charge is also the lowest for the fast-emerging class of ETFs (classified as             others). This space is likely to gain traction as more products emerge and a higher proportion of DIY investors move into MFs. To this extent, one cannot afford to pay steep valuations for CAMS for its pricing power or possible margin expansion. Although CAMS earns revenue as a percentage of AUM, it works on a slab basis.

Other segments unlikely to buttress valuations

We believe that CAMS is a proxy play for the mutual fund industry, with 85-90% of its revenue coming from this industry, and will remain so. We don’t think the company’s other business segments will support valuations, for the following reasons:

The other businesses of CAMS are either:

• Low margin, very high competition (plenty of online platforms) but with a high addressable market (e.g. myCAMs)
• High margin but small addressable market with less moat (e.g. AIF) or
• Low margin, very high competition, and high addressable market (e.g. ECS)

To this extent CAMS must toe the line of the MF industry on growth. The industry without any doubt boasts growth prospects – but not at the same rate at which it has grown historically. CAMS’ asking price also dampens the dividend yield (0.5% of higher price band for target payout of 65%) despite its liberal payout.

Summary

We view this as an IPO that is priced to give a good exit to existing stakeholders. The main ones among them (promoter entity Great Terrain) entered only in 2018 at Rs 682 and further added to holdings in 2019 at Rs 718.  This is a quality, well-governed company with a good dividend payout opportunity if your entry price is attractive. Add it to your watch list and catch it at a better valuation, of not over 25-30 times.

With inputs from Srikanth Meenakshi

(Please note that our IPO reviews do not consider any near-term listing gains).

More to read:

Our general views on IPOs

Offer document from CAMS