Valuations are factoring deep into the future
When Reliance AMC announced its IPO last year, the big question was why does an AMC need an IPO and a listing? After all, an AMC is in the business of managing money on behalf of retail and institutional investors. Mutual fund inflows have been quite robust and funds like HDFC AMC have seen robust flows through the Equity SIP route. The question became more pertinent after HDFC AMC got a phenomenal response to its IPO and also listed at a whopping 65% premium. Of course, the AMC also has senior managers with stock options and they need a benchmark for valuation. But should investors really buy the story? Here are 3 things that investors planning to invest in HDFC AMC need to be clear about.
How are AMCs valued?
Investors looking to buy the HDFC AMC stock need to realize that AMCs are valued based on their AUM. HDFC AMC is among the largest AMCs in India and manages close to Rs.305,000 crore in terms of AUM. Globally, AMCs with a strong equity franchise (like HDFC AMC) get valued at around 7% of AUM in a best-case scenario. That is the sale value of an AMC and that brings HDFC AMC valuation to approximately Rs.21,000 crore in a best-case scenario. As against that, the HDFC AMC stock is currently quoting at a market valuation of Rs.38,000 crore, implying a valuation of 12.46%. This is much higher than any deal that has happened in the past.
What about growth?
Stock market analysts normally argue that valuations are based on future growth. In the last 3 years, the AUM of HDFC AMC has grown from Rs.1.69 trillion to Rs.3.05 trillion, implying CAGR growth of 21% annualized. Remember, these were the best years of MF flows and may be hard to replicate. Even assuming that HDFC AMC does replicate that kind of growth, we are looking at an AUM of Rs.5.40 trillion by July 2021. So the current valuation of Rs.38,000 crore assigned to HDFC AMC virtually values the AMC at 7% of 2021 AUM assuming very aggressive growth to continue. That leaves very little on the table for even the most optimistic of investors in India.
TER could be the big challenge
But the biggest challenge for HDFC AMC will be the Total Expense Ratio (TER). This is the biggest source of revenues and is likely to come under pressure. Firstly, SEBI is very keen to get all AUMs to reduce their TERs, especially on equity funds. Currently, TERs on equity funds range from 2.3% to 2.5% but this could be trending down as more people shift to Direct Plans. With a TER that is trending down, AMC may be under more pressure to justify such aggressive valuations. Investors who are looking to put their money into the stock must just stop and consider the facts. Valuation story may not be compelling!
