Crisil’s foothold in CARE sparks fears of a forced entry
If you had Rs435 crore and had to choose between a 3.1% stake in Crisil Ltd and an 8.8% stake in Credit Analysis and Research Ltd (CARE Ratings), what would you choose? Here’s a tip from Crisil: go for the stake in CARE Ratings. After all, it did exactly that instead of using excess cash to buy back its own shares.
Prime facie, it looks like a sensible move. Crisil shares trade at a ridiculous valuation of over 43 times one-year forward earnings; while the CARE Ratings stake was bought at around 30.5 times earnings. But that’s too simplistic. Analysts at IIFL Institutional Equities have a target multiple of 30 times one-year forward earnings for Crisil and only 20 times for CARE Ratings, citing the latter’s high exposure to bank loan ratings, which it says will grow slower than bond ratings. With both firms trading far above reasonable valuations, it may have been best for Crisil to return cash in the form of a dividend.
From the looks of it, it’s unlikely Crisil’s management looked at valuations while deciding on the deal. In fact, a senior employee at CARE Ratings points out that it’s not every other day that a company makes an investment of Rs435 crore in a rival. “Who knows what’s in store?” he adds. Even though Crisil has said it’s merely a financial investment, some analysts view this as the first move before taking control.
What makes the deal look like a takeover bid is the fact that CARE Ratings, the third largest rating agency, does not have a promoter. The largest single investor is Life Insurance Corporation of India, whose shareholding is 9.8% in the company. Foreign investors collectively own about 38% while mutual funds together hold 18%. With the 9% stake giving a firm foothold, Crisil could gradually consolidate it into a sizeable stake, and perhaps even take control, goes the argument.
Another way to look at the deal is that it’ll help Crisil shore up its exposure to the ratings business. The share of ratings business in Crisil’s total revenue has been falling and is now about 30%, while for CARE Ratings, revenues primarily come from its ratings business. Both agencies provide rating and research services.
In a note after quarterly results of the rating agencies, analysts at IIFL noted that Crisil has become more of a knowledge process outsourcing/analytics services provider rather than a rating agency with research contributing 70% to earnings before interest tax, depreciation and amortization. With global investment banks facing cost pressure, Crisil’s research revenue is likely to grow at under 15% and therefore valuations are near peak, said the note.
In contrast, CARE Ratings’ revenues are mainly from the ratings business, of which a large portion is from bank loan ratings. For the quarter ended March, Crisil reported a 4% growth in its ratings revenues. CARE Ratings reported significantly lower ratings revenue growth of 1.5%.
Also, not to forget that Crisil has paid a high premium to acquire the shares. The acquisition price of Rs1,659.79 apiece is a 16% premium to Wednesday’s close.
It is not new for a leader of a marketplace to scout for small acquisitions or exposures to increase market share further especially in times of slow growth. But paying a steep price in the name of investment is unusual. Crisil in its official release said that it does not get a board membership nor will it interfere with the management of CARE Ratings and the stake purchase should be construed as only financial in nature. Nevertheless, the move has raised many eyebrows.
An employee at CARE Ratings said that there has been no communication from Crisil about the deal and misgivings are in the air already. But analysts at IIFL note that in the case of a merger, the total market share would be 60% and this could invite the ire of the regulator.