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Stake sale boost: R-Cap banks on profitable growth

Picking different strategies for different business is the name of the game at Reliance Capital

Niladri Bhattacharya & Manojit Saha  |  Mumbai 

The general perception regarding an Anil Ambani-controlled company is one that’s leveraged to the hilt. And was no exception.

However, things have changed. From a debt load of Rs 21,000 crore as little as six months ago, the company is now set to pare it to Rs 16,500 crore for starters. The loan book of the asset company is about Rs 15,000 crore, so essential net debt is in the region of Rs 1,500 crore which is a big step up for company.

The turnaround was possible because of two successful deals, which just shows that when it comes to valuations, Jr Ambani’s men can get them at huge premiums. First, was able to raise Rs 3,000 crore by selling 26 per cent of its stake in the company. When the deal was struck in March last year, the Japanese insurer valued the company at around Rs 12,000 crore, close to R Cap’s market cap at that time, which was Rs 14,000 crore. This, at a time when business growth of the insurance sector is coming down every month. Now, the insurance deal will be soon followed by selling stake in the asset management company. That leaves behind general insurance which the company hopes to turn around in the next financial year before divesting.

So, clearly things are happening at Reliance Capital, and the message from the younger Ambani scion is loud and clear: Unlock value and promote self-sustainable and profitable growth. Buoyed by the success of two deals with Japanese insurer Nippon Life, R-Cap is finally looking to reach the next level. Perhaps due to this new-found confidence, the group is not worried about the immediate headwinds such as high-interest rates, losses from general insurance, low yielding equity investments and weak commercial profitability.

No longer the financial services arm of the Anil Dhirubhai Ambani Group (ADAG), has been willing, so far, to tap into “legacy” investments for infusing capital—however, it would prefer a self sustaining model. “Over the years, the proprietary investment book has been pruned down to fund the investments in the company. Whenever we needed capital we booked profits by sale of investments to fund the growth. From 2008, the main objective is to make each line of business profitable so that they can fund themselves,” said Sam Ghosh, CEO

The street has also shown confidence in the company. Reliance Capital’s stock has jumped 85 per cent from January 1st, a huge improvement over 2011 when it was one of the worst performing scrips—down 63 per cent for the year and underperforming the bankex by 35 per cent and the Sensex by 40 per cent. “has fundamentally strong and undervalued businesses in and asset management. We expected value to be unlocked in these businesses and the company has already done so at substantially higher prices than our valuations. These deals have further strengthened our conviction in the considerable potential of the franchise,” said report by Espirito Santo Securities.

With enough capital to fund its growth over the next two years, the company is eyeing a return on equity of around 18 to 20 per cent in each of its five lines of business, namely asset management, life insurance, general insurance, broking and commercial Here’s an analysis of some of the issues that R-Cap will have to deal with going ahead:

Debt
Despite performing relatively well in the space and also among the group companies, R-Cap has always been perceived as a high debt company. However, isn’t perturbed and thinks it is perfectly manageable. Of the total debt of Rs 21,000 crore, the company has already knocked off Rs 2,700 crore by using the sale proceeds from the deal. Considering Rs 15,000 crore as the commercial loan book size, is left with a debt of Rs 3,300 crore. “So right now our debt is around Rs 3,300 crore and with Rs 1,450 crore to be pumped in (from AMC stake deal), the effected debt will be reduced to Rs 1,500 crore which is quite manageable,” Ghosh explained. Taking into account a net worth of roughly Rs 7,900 crore, it gives a reasonable comfort. “Our debt equity ratio will come down below 2 per cent to 1.8 after the AMC deal is closed. Considering that we can leverage up tp 5 to 6 times of the net worth, we are placed comfortably when it comes to debt,” he added.

Insurance business
Though business has witnessed a slowdown in sales largely due to the regulatory changes over the last 18 months, it has yielded profits. After roping in into the mix, R-Cap is now eyeing a bank partner to shore up its distribution network. The main focus is to remain among the top 4 companies in terms of new business income. The company is looking to have a bancassurance tie-up and are open to dilute a small stake as well in the company. “We are in talks with some banks, but the main issue lies in the premiums which are being sought by the banks,” Ghosh added.

However, the main concern in this vertical remains the general insurance business which has been in the red mainly due to the third party motor pool provisioning. However, with the Insurance Regulatory and Development Authority (Irda) dismantling the existing pool which would allow insurers to underwrite third party motor insurance policies at their own rates, with unwanted policies moved to a decline pool, R-Cap is eyeing a break-even by March 2013. Subsequently, it plans to rope in a partner and unlock its value, in the same way it did with the business.

“This is the only business which is not making any profits. Our general insurance business will break-even by the end of March 2013. We would like to make it more stable before bringing in a partner,” Ghosh said. “To get a good valuation, we are talking about a return of asset of 10 to 12 per cent,” he added.

Low returns from the commercial business
One of the main reasons behind drop in profits during the October-December period, apart from the loss in general insurance business, was the high interest costs. Profitability was impacted because of high rates and fixed costs. “The rate cycle has peaked and from here on the rates will only come down. This means our margins will only improve going forward,” Ghosh said.

Currently the RoE in the commercial business is at around 10 to 12 per cent and the company is looking to increase it to 16-18 per cent over the next one year. “We would continue to grow the loan book by 20 to 22 per cent by servicing the SME clients. This is the only segment where our focus is non-retail,” he added.

What is interesting is that the company is not following a fit-for-all strategy for all the lines of business and instead is picking horses for the courses. If the AMC and insurance business is about volume and retail focus, the financing business is aimed at niche customers for high value loans, where margin is the objective.

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