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Brokerages' High Valuation Expectations Put Off Buyers: E&Y's Suneja

13 March, 2012

While the economic meltdown of 2008 has hit all industries, it is the financial services space that has been shot in the arm. Some of the high-cost and low-return fragmented businesses like mutual funds will see consolidation while some high-growth sectors like the NBFC (non-banking finance company) is seeing traction from private equity investors, Rajeev Suneja, Partner (transaction advisory services), Ernst and Young India, said in an exclusive Q&A. Also on Monday, Suneja’s firm advised $50 million of investment by private equity firm Warburg Pincus and IFC in Jaipur-based NBFC AU Financiers.

Excerpts from the interview:

Mutual funds have failed to perform in India. Do you see some desperate sell-outs happening? What are the M&A opportunities you see in this segment?

In the asset management business, there have been a lot of activities and in the past, we saw some of the global, as well as domestic players, exiting. At the same time, there is a lot of interest from many global fund houses to enter India. We saw Natixis Global Asset Management tying up with IDFC in 2010 and that kind of interest still continues. At the same time, as the industry is too fragmented, consolidation seems imminent. With some of the big foreign players waiting to enter the relatively untapped Indian market, I see a lot of strategic sales, M&A and joint ventures happening in this sector.

The non-banking finance companies have already gone through a lot of pain. While capital remains a constraint, where do you see the funding coming from?

Fundraising activities will continue to happen in the NBFC space as money is the raw material for these financial institutions.

Some of the foreign banks, especially European banks, are reducing their exposure to India due to capital pressure on their balance sheets. And some of the foreign banks, which were earlier exploring the opportunities to enter the country, have also deferred their plans due to global reasons. However, we do not believe it poses any problem for the sector as such as the contribution of these banks in the credit space is very small. Also, some of these players were active in retail space and their market share can be easily taken by the existing NBFCs.

On the credit side, while there has been some slowdown in credit growth, considering the global situation, it is still a very good growth rate. With the exit of some foreign and domestic players, there is enough room for existing NBFCs to expand and grow. In case the existing regulations regarding NBFCs get changed in the form they are being deliberated, it may impact some of the NBFCs more than the others in the short run. Most of the retail NBFCs work in underpenetrated space where banks find it difficult to lend and we believe they will continue to grow. It’s not very easy for new players to replicate the model of existing NBFCs.

So are people chasing listed firms like we saw in the case of Magma Fincorp? Or unlisted NBFCs still continue to be attractive?

There is still a lot of interest in the unlisted NBFCs. Selectively though, there is interest for investment in listed firms if they are available at a huge discount to the intrinsic value like in the case of Magma.

Within NBFCs, a lot of firms are entering into the gold finance space. With the RBI removing the priority sector tag from it, their funding requirements have gone up. Do you see some investment opportunities there?

Until a few years ago, gold finance industry was being dominated by a few large players. But the recent entry of multiple players has increased the risk of the sub-segment. The gold finance sector requires specialised manpower and high growth rate, and the entry of new players is chasing the existing trained employees; it is putting stress in the situation and also increasing the cost of operations. Further, the change in the regulation PSL has increased the cost of borrowing. Despite the odds, the sector still remains very healthy. The biggest risk that this segment poses is that the credit may not be for productive purposes and, therefore, the over-reliance on collateral may not be seen in a positive light.  Having said that, the interest from the PE community still remains very high for gold finance companies.

How do you see M&A playing out in the brokerage industry?

The M&A opportunities in broking industry are not too many. While to some extent, people have been consolidating within firms by cutting jobs and reducing costs, consolidation in the sector remains a challenge. As most of these firms are single personality and relationships-driven, merging into another firm remains an inherent challenge. Also, with no turnaround in sight in the near future for the industry, the private equity interest remains low. There are opportunities in a brokerage-driven financial services group which is diversifying. But for pure brokerages, with high valuation expectations, strategic buyers are not ready to pay and that is why transactions are not happening.

Which are the other sectors within the financial services space that offer M&A and investment opportunities?

To my mind, insurance is one such sector. With the recent regulatory changes affecting profitability of the companies, there are a lot of existing promoters who want to exit. There could be some amount of traction there for replacement of existing partners. While there are quite a few Indian partners who want to exit, at the same time, there are still a lot of business houses and groups, both domestic and global, who want to enter the Indian market. We hope to see new JVs and some distribution alliances, and some smaller players getting consolidated with the larger ones.


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Brokerages' High Valuation Expectations Put Off Buyers: E&Y's Suneja

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