For all who are planning to invest in IPO's, there are a number of things to consider.
First and foremost, words from Warren Buffett on IPO's
Warren Buffett recommends avoiding IPOs, for the following reason: "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer(investors)."
We truly buy that theory and we are generally leery about investing in IPO's. Despite that I decided to look carefully at the CARE IPO.
The big disclaimer here is that we have no clue whether the stock price will go up or go down when the IPO is completed. We are value investors who try to buy great businesses at good prices. The reason we looked at CARE was because we like the business model a lot. It is a simple business model with a lot of promise.
Before that, we have to disclose that ICRA has been an important position for us close to a year. We bought ICRA during the lows in Dec 2011 at an average cost of INR 800. After researching the CARE IPO and re-reading the CRISIL and ICRA reports, we exited the ICRA position as well at INR 1353 with a neat 75% gain in less than 11 months.
The CARE IPO has been positioned very attractively at 20-22 times earnings. (EPS was around 17.50 for the first half of the year) ICRA is trading at 23 times earnings and CRISIL at 37 times earnings.
The CARE financial details are as below (from http://www.chittorgarh.com/ipo/care_ipo/358/)
About 0.7 crore shares will go public in this IPO with about 2.8 crores shares outstanding (25% of the company will be sold to the public)
The price for the CARE IPO is very attractive. Having held ICRA before, we are very much attracted to the business model. Barriers to entry are huge with government limited competition and very good pricing power in the market. It was actually the pricing power that led us to take the position in ICRA before.
When we were reading the prospectus, something caught our eye. We pay special attention to the risks section.
On page 16 of the prospectus (http://www.sebi.gov.in/cms/sebi_data/attachdocs/1317804515879.pdf)
If the banks whose clients avail credit rating services under the Basel II framework migrate to the
And on page 103,
Government Policies and Regulations
We are regulated by the SEBI CRA Regulations and are subject to detailed supervision and regulation by SEBI. In accordance with such regulations applicable to us, we require regulatory approvals, sanctions, licenses, registrations and permissions for operating our business, including our credit rating license. Our credit rating license expires on November 4, 2011 and we have applied to SEBI for grant of certificate of permanent registration, which is pending approval. We are also required to disclose key operational data and subject our operations to audits as per such regulations. See the section “Regulations and Policies” and “Government and Other Approvals” on pages 103 and 190 of this Draft Red Herring Prospectus. The laws and regulations applicable to us could change in the future, which could lead to higher compliance costs, reduce business opportunities or otherwise affect our business and results of operations.In addition, our business is driven, in part, by bank loan and facility ratings that we provide under the Basel II
framework. RBI has, pursuant to a circular dated August 10, 2011 (the “Circular”), issued draft guidelines for computing the credit risk capital charge under the “internal rating based” approach (“IRB Approach”). As per the timeframe specified for implementation of the IRB Approach as set out in the Circular, while banks would be permitted to apply to RBI from April 1, 2012 to migrate to the IRB approach, the RBI may, subject to an 18 month detailed analysis of the applicant bank, commence granting approvals by March 31, 2014. The IRB Approach will
allow the banks to use their own internal estimates for some or all of the credit risk components in determining the capital requirement for a given credit exposure. For further details, see the section “Regulations and Policies” on page 103 of this Draft Red Herring Prospectus. To the extent that banks whose clients avail debt rating services from us apply for and receive approval from RBI to adopt the IRB Approach, our business may be affected.
For CRISIL, rating business contribute to 33% of the sales and about 50% of the profits for the quarter through Sep 2012.
For ICRA, rating of the corporate bank loans form a significant portion of the revenue and profits. When we read through the risks of the business in the annual report, there was not even a mention of IRB. This raised a red flag for us.
For care, the revenue breakdown is as follows from the prospectus. (Page 94 of the prospectus) 60% of the rating assignments for CARE was related to BASEL II rating assignments. Now re-read the two risks listed above before we continue further.
Looks like RBI laid out the norms for IRB's late last year. (see end of the post for the document) A cursory glance through the document showed that the requirements were quite high for the IRB status. While we are of the opinion that from a systemic point, an external third party rating agency is better equipped to evaluate risks and rate better than banks themselves (who wants to call their child ugly), the banks are incentivized to make the move.
We decided to check and see how serious the banks where and whether they were making any plans for the future.
We did not find any reference on ICICI annual report. State Bank of India turned out to be totally different.
SBI Link
SBI is setting up exactly what RBI has proposed.
we also saw a recent request for proposal from bank of Maharashtra to help implement for the same mechanism.
As we stated before, we are not trying to predict the performance of the stock. We see some strong concerns for the base business. While we are confident that not all banks will switch overnight, and it will be a long time till all banks switch. Other markets like bond ratings and credit derivates are still in a nascent stages in the Indian market, that will provide opportunities. Oversees operations are another facet that CARE might exploit. At 20 times earnings, the risk might / might not be fully priced in. For us, it is too big a risk with 60% of the business in the banking rating sector. They have to grow other pieces of businesses to just replace the existing business. We like to buy great businesses at good prices that sustain over a long period of time. We cannot see where this business will be ten years from now given that the main bank rating business will not grow as in the past.
RBI Link
First and foremost, words from Warren Buffett on IPO's
Warren Buffett recommends avoiding IPOs, for the following reason: "It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer(investors)."
We truly buy that theory and we are generally leery about investing in IPO's. Despite that I decided to look carefully at the CARE IPO.
The big disclaimer here is that we have no clue whether the stock price will go up or go down when the IPO is completed. We are value investors who try to buy great businesses at good prices. The reason we looked at CARE was because we like the business model a lot. It is a simple business model with a lot of promise.
Before that, we have to disclose that ICRA has been an important position for us close to a year. We bought ICRA during the lows in Dec 2011 at an average cost of INR 800. After researching the CARE IPO and re-reading the CRISIL and ICRA reports, we exited the ICRA position as well at INR 1353 with a neat 75% gain in less than 11 months.
The CARE IPO has been positioned very attractively at 20-22 times earnings. (EPS was around 17.50 for the first half of the year) ICRA is trading at 23 times earnings and CRISIL at 37 times earnings.
The CARE financial details are as below (from http://www.chittorgarh.com/ipo/care_ipo/358/)
| Particulars | For the year/period ended (in Rs. Million) | ||||
| 31-Mar-12 | 31-Mar-11 | 31-Mar-10 | 31-Mar-09 | 31-Mar-08 | |
| Total Income | 2,171.93 | 1,722.55 | 1,520.26 | 999.31 | 549.11 |
| Profit After Tax (PAT) | 1,157.02 | 879.49 | 856.90 | 523.99 | 266.85 |
About 0.7 crore shares will go public in this IPO with about 2.8 crores shares outstanding (25% of the company will be sold to the public)
The price for the CARE IPO is very attractive. Having held ICRA before, we are very much attracted to the business model. Barriers to entry are huge with government limited competition and very good pricing power in the market. It was actually the pricing power that led us to take the position in ICRA before.
When we were reading the prospectus, something caught our eye. We pay special attention to the risks section.
On page 16 of the prospectus (http://www.sebi.gov.in/cms/sebi_data/attachdocs/1317804515879.pdf)
If the banks whose clients avail credit rating services under the Basel II framework migrate to the
internal rating based approach for credit risk (the “IRB Approach”), it could have an adverse effect on our rating business, which may in turn have an adverse effect on our business, financial condition, results of operations and revenues. RBI has pursuant to a circular dated July 7, 2009 advised banks that they may apply for migration to an “internal rating based” approach for measuring credit risk from April 1, 2012 onwards. The IRB Approach will allow the banks, subject to the approval of RBI and fulfilling certain requirements, as may be applicable, to use their own internal estimates for some or all of the credit risk components in determining the capital requirement for a given credit exposure. RBI has pursuant to a circular dated August 10, 2011
(the “Circular”) issued draft guidelines for computing the credit risk capital charge under the IRB
Approach. As per the timeframe specified for implementation of the IRB Approach as set forth in the Circular, RBI may, subject to an 18 months detailed analysis of the applicant bank, commence grant of approvals by March 31, 2014. For further details, see the section “Regulations and Policies” on page 103 of this Draft Red Herring Prospectus. In the event that banks whose clients avail credit services from us apply for, and receive, approval from RBI to adopt the IRB Approach, it could have an adverse effect on our rating business, which may in turn have an adverse effect on our business, financial condition, results of operations and revenues. "
And on page 103,
Government Policies and Regulations
We are regulated by the SEBI CRA Regulations and are subject to detailed supervision and regulation by SEBI. In accordance with such regulations applicable to us, we require regulatory approvals, sanctions, licenses, registrations and permissions for operating our business, including our credit rating license. Our credit rating license expires on November 4, 2011 and we have applied to SEBI for grant of certificate of permanent registration, which is pending approval. We are also required to disclose key operational data and subject our operations to audits as per such regulations. See the section “Regulations and Policies” and “Government and Other Approvals” on pages 103 and 190 of this Draft Red Herring Prospectus. The laws and regulations applicable to us could change in the future, which could lead to higher compliance costs, reduce business opportunities or otherwise affect our business and results of operations.In addition, our business is driven, in part, by bank loan and facility ratings that we provide under the Basel II
framework. RBI has, pursuant to a circular dated August 10, 2011 (the “Circular”), issued draft guidelines for computing the credit risk capital charge under the “internal rating based” approach (“IRB Approach”). As per the timeframe specified for implementation of the IRB Approach as set out in the Circular, while banks would be permitted to apply to RBI from April 1, 2012 to migrate to the IRB approach, the RBI may, subject to an 18 month detailed analysis of the applicant bank, commence granting approvals by March 31, 2014. The IRB Approach will
allow the banks to use their own internal estimates for some or all of the credit risk components in determining the capital requirement for a given credit exposure. For further details, see the section “Regulations and Policies” on page 103 of this Draft Red Herring Prospectus. To the extent that banks whose clients avail debt rating services from us apply for and receive approval from RBI to adopt the IRB Approach, our business may be affected.
For CRISIL, rating business contribute to 33% of the sales and about 50% of the profits for the quarter through Sep 2012.
For ICRA, rating of the corporate bank loans form a significant portion of the revenue and profits. When we read through the risks of the business in the annual report, there was not even a mention of IRB. This raised a red flag for us.
For care, the revenue breakdown is as follows from the prospectus. (Page 94 of the prospectus) 60% of the rating assignments for CARE was related to BASEL II rating assignments. Now re-read the two risks listed above before we continue further.
Looks like RBI laid out the norms for IRB's late last year. (see end of the post for the document) A cursory glance through the document showed that the requirements were quite high for the IRB status. While we are of the opinion that from a systemic point, an external third party rating agency is better equipped to evaluate risks and rate better than banks themselves (who wants to call their child ugly), the banks are incentivized to make the move.
We decided to check and see how serious the banks where and whether they were making any plans for the future.
We did not find any reference on ICICI annual report. State Bank of India turned out to be totally different.
SBI Link
Risk Management in SBI
Risk Management Structure
• An independent Risk Governance Structure is in place for Integrated Risk Management covering Enterprise, Credit, Market, Operational and Group Risks. This framework visualises empowerment of Business Units at the operating level, with technology being the key driver, enabling identification and management of risk at the place of origination.
Basel Implementation
• In accordance with RBI guidelines, the Bank has migrated to the Basel II framework, with the Standardised Approach for Credit Risk and Basic Indicator approach for Operational Risk w.e.f. March 31, 2008, having already implemented the Standardised Measurement Method for Market Risk w.e.f. March 31, 2006.
• RBI has issued Guidelines on Implementation of Basel III Capital Regulations in India on 2nd May, 2012. These Guidelines will become effective from January 1, 2013. Bank is in the process of putting in place appropriate mechanism to comply with these guidelines.
Enterprise Risk Management
• During the year, the Bank has set in motion the due process required for filing of application/letter of intent to RBI for implementing Advanced Approaches under Basel II, comprising of the three Pillar I Risks viz. Internal Rating Based (IRB) approach for Credit Risk, Internal Model Approach for Market Risk and Advanced Measurement Approach for Operational Risk.
• The Bank has in place the Internal Capital Adequacy Assessment Process (ICAAP) Document as required by Pillar II of New Capital Adequacy Framework under Basel II as prescribed by RBI.
• The ICAAP process covers identification, measurement, management, capital assessment and stress testing of material risks and also detailed additional capital requirements on account of such risks. Besides the aforesaid three Pillar I Risks, the ICAAP also covers Pillar II Risks such as Liquidity Risk, Interest Rate Risk in the Banking Book, Credit Concentration Risk, Reputation Risk, Strategic Risk etc.
Credit Risk Management (CRM)
• In addition to implementing the Standarised Approach, well defined credit risk practices such as use of Credit Risk Assessment (CRA) Models, Industry Exposure Norms, Counterparty Exposure Limits, Substantial Exposure Norms, Macro Economic Stress Tests etc., have also been put in place to improve credit risk management
• The Bank has now set in process a project to migrate to Internal Rating Based (IRB) Approach.
- Models for estimation of Probability of Default (PD), Loss Given Default (LGD), and Exposure At Default (EAD) are being developed.
- Credit risk data mart is being set up.
- Retail scoring and behavioural scoring models are being implemented.
SBI is setting up exactly what RBI has proposed.
we also saw a recent request for proposal from bank of Maharashtra to help implement for the same mechanism.
As we stated before, we are not trying to predict the performance of the stock. We see some strong concerns for the base business. While we are confident that not all banks will switch overnight, and it will be a long time till all banks switch. Other markets like bond ratings and credit derivates are still in a nascent stages in the Indian market, that will provide opportunities. Oversees operations are another facet that CARE might exploit. At 20 times earnings, the risk might / might not be fully priced in. For us, it is too big a risk with 60% of the business in the banking rating sector. They have to grow other pieces of businesses to just replace the existing business. We like to buy great businesses at good prices that sustain over a long period of time. We cannot see where this business will be ten years from now given that the main bank rating business will not grow as in the past.
RBI Link
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