Mumbai: Avendus Capital Pvt Ltd is seeking a deep valuation cut in the mutual fund business of IDFC Ltd, which is up for sale, three people aware of the development said.

Avendus is prepared for a valuation of less than 2,000 crore, against IDFC’s expectations of 3,500-4,000 crore for the unit, the people mentioned above said on condition of anonymity. The asset management unit’s falling profits, narrow product offering and the end of IDFC’s marketing support post-sale have prompted Avendus to demand a lower valuation, these people said.

“There has been a delay in closure of the deal because of the mismatch in valuation expectations. Avendus has re-looked at the profitability and growth potential and is now willing to offer a valuation closer to 2,000 crore," one of the three people mentioned above said.

The impact of the recent rules issued by the mutual funds regulator, Securities and Exchange Board of India (Sebi), capping total expense ratio of mutual fund schemes have also been factored in, this person said.

In September 2018, Sebi had capped the expense ratio for open-ended equity schemes on the basis of their size. The larger the assets under management (AUM), the lower the expense ratio. As on 30 September 2018, the AUM of IDFC Asset Management Company stood at 69,483 crore, up 4.7% from 66,361 crore a year ago.

“In the absence of the banking channel that IDFC Bank offers, it will be a challenge for Avendus to grow the business. It is still going to be an expensive acquisition even at 2,000 crore. Avendus, however, is pressing ahead to achieve deal closure," another of the three people mentioned above said.

Besides AUM, the profitability of the business is also a major factor to value a mutual fund business, said this person.

The net profit of the asset management business as on 31 March 2018 stood at 54 crore, down from 97 crore a year ago, according to IDFC’s annual report.

The third person, however, said that IDFC has already started reaching out to other parties, as the Avendus offer does not meet its expectations.

The spokespersons of both Avendus and IDFC refused to comment.

“Avendus has been running one of the largest hedge funds in the country and is keen on deepening its presence in the asset management business. IDFC will offer it a ready-made platform," the second person said.

IDFC Ltd has identified mutual funds as non-core to its strategy as it is now zeroing in on building its banking operations with a strong focus on retail clientele, shedding its previous image of an infrastructure financier. The company is also looking to divest its alternate asset management business.

The standard practice of valuing asset management companies is to base it on the amount of money managed in equity portfolios (as equity schemes earn much higher commissions). The higher the proportion of equity funds, the higher the percentage of AUM applicable to derive the value of the asset management company. As of September, IDFC’s asset management unit had around 31% of its assets in equity schemes. It also had around 19% of its assets in liquid schemes.

The net profit of the asset management unit as on 31 March was 54 crore, down from 97 crore a year ago