November 29, 2010

BFSI-Stockbrokers
Thematic

Indian Stockbrokers: Their Turn

Awaiting

Analyst contact
Pankaj Agarwal, CFA
Tel: +91 22 3043 3206 pankajagarwal@ambitcapital.com

Indian listed brokers have underperformed the broader market for most of the current rally and they are still trading 50-75% below their peak valuations from December 2007. This underperformance is driven by the fact that revenue and profitability of stockbrokers has been flat between FY08-10 due to lower delivery volumes, lower retail participation and brokers’ inability to scale up the businesses they started in FY08. However, past experience shows that stockbrokers outperform the broader market significantly in the last leg of the bull market (brokers were up 141% to 500% v/s 55% for Sensex between Mar-07 to Dec-07) as retail participation, delivery volumes, capital raising and margin financing pick up in this phase. From this perspective, the recent trends are encouraging because they show that: (i) retail investors are slowly coming back to markets (enthusiastic response to Coal India IPO and Power Grid FPO); (ii) delivery volumes are increasing (cash delivery volumes are 27% of total cash volumes v/s 17% three quarters back); and (iii) capital raising and margin financing activities are also gaining traction. Hence we expect brokers to outperform the markets from hereon. Even in the longer term we are bullish on the Indian brokerage sector owing to underpenetration of equities (~9% of household financial savings) in the Indian household savings pie. On the presumption that this ratio will rise as per capita income increases, the opportunity before Indian brokers is huge given that India has one of the highest savings rates in the world at 32% (a rate that according our Economist, Ritika Mankar, will rise to 39% by 2015). Motilal Oswal Financial Services (MOFS.IN, BUY, 28% upside) is our top pick in the sector. MOFS is one of the best broking franchises in India with a strong presence in both retail and institutional broking. Amongst the listed brokers, MOFS has the highest contribution (~87%) from broking and other fee-based businesses in its revenue pie and hence should be the biggest beneficiary in the climactic phase of a bull market. Edelweiss Capital (EDEL.IN, HOLD, 8% upside): We are initiating coverage with a HOLD on Edelweiss Capital as the company has the lowest contribution from broking and investment banking in its revenue pie (~45%) and hence is the least likely to benefit from a surge in volumes. Moreover, arbitrage yields are showing a downward trend and this will likely keep earnings muted. The biggest risk to our stances on these stocks is the broader market moving downward. However, this risk is significantly mitigated by the ~10% correction that the Indian market has undergone from its recent peak with stockbrokers correcting by 20-25% during the same period and hence trading at the lower end of their cross cycle PEs.

Krishnan ASV
Tel .: +91 22 3043 3205 vkrishnan@ambitcapital.com

Poonam Saney
Tel: +91 22 3043 3216 poonamsaney@ambitcapital.com

Motilal Oswal- BUY
CMP: Target Price: Upside (%): EPS (FY11): ADV: Beta: Rs161 Rs206 28 Rs11.3 Rs20mn/$0.4mn 1.2

Edelweiss Capital- HOLD
CMP: Target Price: Upside (%): EPS (FY11): ADV: Beta: Rs50 Rs54 8 Rs3.6 Rs143mn/$3.1mn 1.2

Other stocks mentioned in this report
Company: ADV: India Infoline (IIFL.IN) Rs239mn/$5.3mn

Company: Religare Enterprises (RELG.IN) ADV: Rs93 mn/$2.1mn

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

BFSI-Stockbrokers

Brokers lagging the broader market
Whilst the broader stockmarket has rallied by 150% since February 2009 and has nearly touched the previous peak it reached in January 2008, stockbrokers who should be leverage bets on the broader markets, have languished. Whilst most of the stockbrokers have performed in line with the broader market in the current rally (which started in March 2009), their share prices are still ~50% short of the peak valuations they achieved at the peak of the last bull market in December 2007. This is obviously due to the fact that these brokers have significantly underperformed the broader market between December 2007 and February 2009 (exhibit 1).
Exhibit 1: Brokers have underperformed the broader market
100 80 60 40 20 0 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Sensex
Source: Bloomberg

IIFL

MOFS

EDEL

JM Fin

Ibull

Exhibit 2: Revenue & profitability growth of major brokers
Growth (%) Revenues MOFS EDEL IIFL Net profits MOFS EDEL IIFL -47% -32% -18% 91% 23% 49% -13% 3% -11% -35% -14% -9% 42% 2% 30% -3% 17% 14% FY09 vs FY08 FY10 H1FY11 vs vs FY09 H1FY10

The reason for the brokers’ underperformance in this market is that despite market volumes rising with the broader stockmarket (market volumes are up 234% and 76% respectively in October 2010 v/s February 2009 and December 2007), the revenues and earnings for brokers have not kept pace with volumes of the broader market.
Exhibit 3: Continuous rise in stockbroking volumes 1400 1200 1000 800 600 400 200 0 FY95 FY97 FY99 FY01 FY03 FY05 FY07 250% 200% 150% 100% 50% 0% -50% -100% FY09 FY11YTD

Source: Company fillings, Ambit Capital research

Average Daily Volume (Rs. bn) (LHS)
Source: NSE, BSE, Ambit Capital

YoY Growth (%) (RHS)

There are three distinct reasons for the brokers’ inability to grow in line with market volumes:

Disproportionate increase in option volumes v/s cash delivery volumes: Most of the growth in market volumes has come from low yield options whereas “cash delivery” volumes (which are higher yielding trades) have remained muted in this rally. This phenomenon has pulled down broking yields by ~30% (from around ~7bps in FY08 to ~5bps in FY11). Hence despite a
2

Ambit Capital Pvt Ltd

cash delivery trades should increase. BSE. financing. which makes us believe that as Indian markets mature the share of F&O trades should come down. Moreover. 3rd party distribution. 9 16 10  100 100 100 Source: Company fillings. Ambit Capital Q1FY09 Q3FY09 Q1FY10 FII Q3FY10 Q1FY11 DII Prop  Inability to scale up other businesses: In the final phase of the last bull run. many brokers had entered other capital market businesses such as financing. third party distribution. Our discussions with industry participants suggest that the lack of retail participation is the fallout of investors’ memory of the heavy losses suffered by millions of retail customers in the previous bull market (post being lured into the market in FY08 by brokers relying on weighty advertising and hard sales pitches). they have been heavily affected by this phenomenon. leading to a drop in the brokerage commission pool despite higher volumes ADV (Rsbn) Cash -delivery Cash-intra day Futures Options Total volumes Total brokerage commissions (Rsbn) Source: NSE. invst & dividend income Asset mgmt. our discussions with stockbrokers suggest that lack of faith in the direction of the market has resulted in market participants executing fewer delivery trades.e.7 % change -35% -29% -38% 718% 26% -15% Cash -Delivery Cash-Intra day Futures Source: NSE. Since Indian listed brokers are predominantly retail brokers. BSE.196 29. Ambit Capital Q3FY08 75 188 608 78 948 34. Ambit Capital Exhibit 6: Revenue breakup of leading brokers (%) FY10 (%) Equity brokerage & related income Invst. other income Total MOFS 71 10 9 IIFL EDEL 55 3 26 27 9 53 Whilst it is difficult to pinpoint the reason for the sudden spurt in option volumes and the muted growth in cash delivery volumes on Indian exchanges. Once market participants become more confident of the direction of the market. banking fee Net fund based income incl.BFSI-Stockbrokers 26% increase in market volumes from the peak of the last bull market (i. 2QFY11 v/s 3QFY08). the revenue pie for the sector has shrunk by ~15%. Exhibit 4: Disproportionate rise in option volumes … 100% 75% 50% 25% 0% Q1FY08 Q3FY08 Q1FY09 Q3FY09 Q1FY10 Q3FY10 Q1FY11 Options Exhibit 5: . data shows that in most of the leading developed markets the share of F&O trades as a percentage total equity trades is in the range 26%-56% (v/s 84% in India). arbitrage. The dream of building a large diversified financial services business was and is an attractive dream for the promoters of most brokerages who crave for a more stable. asset management and wealth management.9 Q2FY11 48 133 374 640 1.. Ambit Capital research Lower retail participation: Another notable feature of this rally has been the lack of growth in retail participation. Exhibit 7: Retail participation yet to pick up significantly 100% 75% 50% 25% 0% Q1FY08 Q3FY08 Retail Source: NSE. BSE.. more robust revenue stream versus that which is 3 Ambit Capital Pvt Ltd .

However. the trading velocity (i. total traded volumes as a percentage of total market cap) on Indian exchanges is still much lower versus other developed and developing markets (exhibit 8). However. However.BFSI-Stockbrokers driven entirely by the yo-yoing stock market. we are bullish on the long-term prospects of the Indian brokerage sector on the following counts:  GDP growth and liquidity to drive volumes: Market volumes are a function of total market cap and stock specific liquidity. despite the fact that total market volumes are up 30% in FY10 v/s FY08. long term story is very much intact … Despite the short term headwinds for the sector owing to higher option volumes.1x increase in GDP. India Infoline’s third party distribution income has fallen 25% between FY08 and FY10 and Edelweiss has had to reduce headcount in its wealth management venture.5% 125. Ambit Capital Pvt Ltd 4 . as Indian corporates (including PSUs) issue more capital to grow their businesses. Given expected nominal GDP growth rate of ~14% over the next decade. Exhibit 8: Turnover velocity in India is one of the lowest Country India China Taiwan Korea US Exchange BSE NSE Shanghai SE Shenzhen SE Taiwan SE Korea Exchange NASDAQ OMX NYSE Euronext Turnover velocity* 20% 58% 182% 378% 164% 162% 332. For instance. promoters (including Indian government) will have to dilute their holdings. the lack of retail participation and regulatory and economic changes impacting the non-brokerage businesses. it would be safe to expect that the total market cap on Indian exchanges will grow by at least a CAGR of ~20% over the next decade.e. Ambit Capital research. Over the last decade the total market cap of Indian exchanges has grown by ~7. However. due to various reasons most brokers have been unable to scale up the intended non-broking businesses: 1. The liquidity scarcity post the Lehman debacle in September 2008 and the higher loan losses affected brokers’ ability to scale up their financing businesses. For instance higher loan losses on the retail book led to India Infoline discontinuing the unsecured loan segment while liquidity scarcity and risk concerns forced Edelweiss to sharply reduce its promoter financing portfolio to Rs5bn in FY09 from Rs10bn in FY08. Whilst the trading volumes on Indian exchanges have increased at twice the pace of market cap over the last decade. 2. 3. Turnover velocity here is defined as monthly trading volumes as a % of total market on the exchange. Motilal Oswal’s margin financing book has shrunk 40% over the stated period. The scrapping of entry load on mutual funds in August 2007 by the Securities and Exchange Board of India (SEBI) and the capping of charges on ULIPs in December 2009 by the Insurance Regulatory Authority of India (IRDA) affected brokers’ third party distribution businesses and wealth management businesses. lack of retail participation has constrained brokers’ ability to provide margin financing. That in turn will increase the free float in the market.8x v/s a 3.8% Source: Nilsen Indian Equity investors survey-2010. The reason for the low trading velocity is the low free float in Indian companies (59% of the outstanding stock in Indian companies is held by promoters) as well as the relatively low retail participation. in this bull run. Margin financing was an attractive business in the FY07-08 bull run. For instance.

* Stocks Korea China US Japan UK India* 32% 31% 34% 22% 38% 9% Other financial assets 68% 69% 66% 78% 62% 95% Source: World Bank.4% 9. brokerage yields (cash and F&O) in India have decreased from ~100bps to ~5bps. However. At such low yields and given the scale of investment required.173 1. On the presumption that this ratio will rise as the country gets richer. will rise to 39% by 2015). Ritika Mankar. *For India the data represents percentage of incremental financial savings by Indian households over last 60 years.640 registered brokers v/s 63 in Korea and 285 in China). Ambit Capital research  Consolidation is on the cards: The Indian broking industry is one of the most fragmented in the world (9. and the scale of the investment required will likely force many brokers out of business. The fragmentation is more prominent in retail broking where there are more than 300 active brokers with sizeable operations. due to the spread of financial education and increase in income levels. This will require significant investments from the brokers (both in terms of expensive hires and systems and controls).8 125 3 3. clients are increasingly demanding more products and services such as research.4% of Indians invest in equities versus 5%-10% in other major developed and developing countries. However.4% 16. Growing need for heavy investments: Most of the retail brokers have survived because of their personalized services to their clients. internet trading portals. smaller brokers will be unable to stay in the game.54 1. Only 1. Ambit Capital Pvt Ltd 5 . we think that consolidation is imminent in the Indian retail broking space owing to reasons stated below: 1. there is a huge untapped opportunity for Indian brokers given that India has one of the highest savings rates in the world at 32% (a rate that according our economist. Ambit Capital research. The top 10 brokers contribute only ~25% of the total volumes in India versus more than 45% in China and Korea.4% 2.55 10 14. Falling broking yields: Over the last decade. wealth management advice etc.4% 4. Exhibit 10: Lower retail participation in Indian stock markets Demat Accounts Population Demat/ in Million in Million Population (in %) India China Russia South Korea UK USA 16.330 139 48 61 310 1. Source: Nielsen India Investors Survey-2010.7% Exhibit 9: Equities form a relatively lower share in Indian customer’s financial savings wallet.BFSI-Stockbrokers  Mobilization of retail financial savings into equities: The share of equities in financial savings at ~9% is dismally low in India and far lower than the corresponding ratios in other developing and developed countries. 2.2% 7.

Previous market cycles show that normally retail investors become super active in the later stages of a bull market. apart from broking volumes rising with the stock market.000 18. we believe even in short term.000 8. Exhibit 11: Volumes rise along with the broader market 1. Exhibit 12: Delivery volumes rise with market levels 40% 35% 30% 25% 20% 15% FY03 FY06 Q2FY08 Q1FY09 Q4FY09 Q3FY10 21. Given that stockbroking volumes have a strong correlation with the direction of the broader market (Sensex grew at 38% CAGR between FY03-08 whilst market volumes grew at a CAGR of 68% during the same period).400 1. we expect stockbroking volumes to move with the Sensex.000 3.000 Q2FY11 Delivery volumes as % of cash volumes (%) (LHS) Source: Ambit Capital research BSE Sensex (RHS)  Increased retail participation: Unlike the last bull market. Bn) (LHS) Source: Ambit Capital research BSE Sensex (RHS) We note more encouragingly.200 1.000 15.000 Q4FY07 Q2FY08 Q4FY08 Q2FY09 Q4FY09 Q2FY10 Q4FY10 Q2FY11 Average Daily stockbroking volumes (Rs.000 18.000 14.000 6. retail investors have not been active in this bull market. this will not only increase trading velocity. it will also help Indian listed brokers disproportionately as most of them are predominantly retail brokers. Even fund flows into equity mutual funds and the subscription of the retail portion of the IPOs shows lack of retail investor activity in the market. Once retail investors become active.000 20.000 12.000 9.000 16. The enthusiastic retail response for the Coal 6 Ambit Capital Pvt Ltd .000 12. historical trends show that cash delivery volumes and retail equity participation increases with the level of the stock market:  Increase in cash delivery volumes: Cash delivery volumes are the most lucrative trades for brokers generating ~20bps in commission v/s ~4bps-5bps for non-delivery cash trades and F&O trades. the trends are encouraging. The past trends (table 10) show that cash delivery volumes have a strong correlation with broader markets and their percentage share in total volumes increases with the level of the stock market.000 10.000 800 600 400 200 22.BFSI-Stockbrokers … in the short term the scenario is not that bad Whilst we are bullish on the long-term prospects of the sector. The last three quarters’ data is already showing such a pick-up in delivery volumes.

SEBI’s website. Exhibit 13: An uptick in retail volumes is already visible 700 600 500 400 300 200 100 0 Q1FY08 Q3FY08 Q1FY09 Q3FY09 Q1FY10 Q3FY10 Q1FY11 65% 62% 59% 56% 53% 50% F&O Retail Volumes ADV (Rs bn) Retail volumes as a % of total volumes Source: Ambit Capital research Cash retail volumes (Rs.BFSI-Stockbrokers India IPO and the Power Grid FPO indicates that retail investors have slowly started returning to the market. shows that more than 40 companies are lined up to raise fresh capital of between US$8-US$10bn from the markets in the next six months. Ambit Capital Pvt Ltd 7 . This will not only increase investment banking opportunities for the brokers but will likely also help increase their financing income by providing margin funding opportunities during IPOs (many retail and HNI investors tend to subscribe to IPOs using margin funding). Bn)  Increased investment banking and margin financing opportunities: Data at the market regulator.

673 3.8 0.2 23.6 NA 1.8 NA NA 3.4 NA NA 20.BFSI-Stockbrokers Valuation Since stockbrokers are leveraged bets on the Indian economy.7 318.574 - 1.8 NA NA 13. Inc.095 1.3 NA 35.8 13.221 2.3 1.001 $1 11. This should lead to the valuation multiple of brokers converging towards the broader markets and thereby market outperformance of the brokers.6 2. At present.1 NA 11.4 0. Indian brokers are trading at a 30% discount on forward P/E to their eastern Asian peers despite having better ROEs. All of this suggests that Indian brokers are not getting the valuation multiples they deserve.6 NA NA 9.021 221 937 397 2.333 29..7 NA 1. Mirae Asset Securities Co. Ltd. we expect history to repeat itself with stockbrokers’ earnings growing at a rapid pace.4 4.2 NA 12.7 $5 18.2 NA 3.0 10.0 NA 47.4 1.9 12. Northeast Securities Co.1 2.1 2.0 2.2 NA NA 3.2 8.544 9.8 NA NA 8.272 - 13.5 NA 6.414 801 - 1.2 NA NA 2.8 NA NA 15. Exhibit 14: Indian stockbrokers appear inexpensive on relative valuation Price Market (local cap currency) Indian peers India Infoline Ltd Indiabulls Securities Ltd JM Financial Ltd Motilal Oswal Financial Services Ltd Religare Enterprises Ltd Edelweiss Capital Ltd Average for Indian brokers Asian peers Nomura Holdings..1 NA 7. historic data shows that stockbrokers outperform the broader market the most in the final phases of a bull market when retail activity is highest. Indian brokers do not have a long trading history as most of them were listed in the last phase of the FY08 bull market.860 $4 $51 $10 $2 $3 $42 $2 6. CITIC Securities Hyundai Securities Co.8 0.3 4.8 NA NA 17.3 16.3 0. Sinolink Securities Co.8 2. Ltd. In the current rally.1 0.290 209.247 171.1 NA 1.8 1.3 NA NA 33.. delivery volumes are at their peak and the market is full of equity capital raisings providing investment banking and financing opportunities to brokers.982 Ambit Capital Pvt Ltd 8 . Mizuho Securities Co. Ltd.8 NA 2.6 8.7 1.304 17. Moreover.1 14.3 NA NA 2.7 NA 13.0 NA 24. Ltd. as we enter the more advanced phase of this bull market. This gap should narrow if the Sensex continues to rise.4 36.3 NA NA NA NA NA 4. the broader India market is trading at a forward earnings multiple of ~18x versus a band of 11-14x for listed Indian brokers.7 NA NA NA NA NA 4.1 NA 1.6 1.365 - 322. Ltd.9 0..200 1. as discussed above. Samsung Securities Co.6 0.2 NA 11. Daiwa Securities Group Inc.5 10.510 2.648 3.8 1.8 NA 12.3 4. Haitong Securities Co.4 NA NA 15.4 NA 2.9 NA NA 11.2 NA 3.6 15.418 1. Ltd.6 NA NA 20.3 NA 30. Ltd Average Source: Bloomberg Asset size ROE (%) ROA (%) FY11E FY12E P/BV(x) P/E (x) ($ mn) (US$ mn) FY11E FY12E FY11E FY12E FY11E FY12E 81 22 30 161 490 49 - 508 110 486 501 1.683 6...3 91. Indian brokers have traded at a discount to the broader stock market due to their earnings not growing with the broader stock market.9 NA 17.554 10.8 NA 5.8 8. However.8 $2 18.1 NA 2.771 2.7 18. they should trade at a similar multiple to the broader market.9 NA NA 4. The relative valuation of three brokers (see table on next page) shows that based on FY11 P/E Edelweiss Capital appears the most expensive while India Infoline looks to be the cheapest among these three brokers. However.9 NA NA 2.3 NA 13..193 1.

where stockbrokers have no visible competitive advantage. Hence the Axis-Enam deal and similar deals in the months ahead have set the scene for a bout of re-rating for the Indian stockbroking sector. However. This has led to the stock underperforming peers and the stock market for the most part of the current rally. the lack of retail activity and higher option volumes in this bull has meant that MOFS’ earnings have remained muted between FY08 an FY11YTD. one of the better equity research teams in India and a sensible promoterled management team with 20 years of experience in the industry.IN. Edelweiss Capital (EDEL. However. increased cash delivery volumes and higher investment banking and margin trading activity should benefit MOFS disproportionately. Even more pertinently. following its successful IPO in December 2007 the company failed to live up to expectations. The company has a well established retail broking franchisee and its stature in institutional broking has increased multifold over the last three years. the company has shown signs of a recovery in the past five quarters. However.BFSI-Stockbrokers Catalysts that could push brokers’ multiples upward Traditionally.IN. Ambit Capital Pvt Ltd 9 . This has led to the stock outperforming its peers and the broader markets in FY11YTD. and (ii) promoter financing book 6x over the last six quarters. BUY. The company grew at a phenomenal CAGR of 133% between FY05-08. the entry of retail investors. India Infoline is the only successful new entrant in institutional broking in India over the last five years partly due to the company attracting top talent from the then (May 2007) market leader. As the bull market matures. With the Axis Bank-Enam deal (dated November 17. 2010) now lighting the touch paper. insurance etc. It has maintained its market share in institutional broking whilst scaling up its (i) investment banking business (revenues up 5x in last five quarters). 8% upside): India’s biggest derivatives broker with sizable financing and arbitrage operations.6bn and thereby added Rs1. Company-specific summaries Motilal Oswal (MOFS. However. partly due to a decrease in arbitrage opportunities (as a brutal bear market kicked in) and partly due to its reduced market share in institutional broking and inability to scale up the businesses inaugurated at the fag end of FY08.IN. HOLD. Indian stockbrokers have been happy to focus on corporates’ equity capital needs and most of the listed brokers generate around 5-10% of their topline from ECM. However. the valuation at which at Axis Bank has acquired Enam (21x FY11 earnings) has highlighted we believe the strategic value inherent in the boardroom and investor relationships that the better Indian stockbrokers possess. India Infoline (IIFL. However. the stock has significantly underperformed the broader market and peers. investment banking and asset management and has stayed away from capital intensive businesses like retail financing. there is a bigger opportunity for capital raising intermediaries who approach corporates with both debt and equity capital raising propositions.1bn to its topline. 28% upside): Arguably one of the best-run listed Indian brokerage houses with a large (1.500 outlets in 600 cities) branch network. Over the past 15 months IIFL has failed to meet the market’s expectations with static market share in broking. At the same time it acquired retail broker Anagram Capital in January 2010 for Rs1. as Kotak has shown over the past twenty years and as Standard Chartered and Deutsche Bank are showing now. loan losses on its unsecured loan book and a dip in its third party distribution income (post SEBI and IRDA lowering intermediation costs). after the spectacular outperformance of the stock in the first three months of the current rally (February 2009 to May 2009). CLSA. The company has maintained its focus on non-capital intensive fee-based businesses like broking. more Indian brokers will look to tie up with domestic or foreign partners in the months ahead. NOT RATED): Arguably. the current valuations appear to be factoring in these positives and we expect modest upside in the stock from here.

India Infoline could be one of the beneficiaries from the entry of retail investors into the market in the climactic phases of this bull market. Right now only brokerage and financing businesses are cash flow positive for the company and hence upside for the stock is entirely dependent on the company’s success in its new businesses. NOT RATED): Religare has significant presence in retail broking (40% of revenues) and asset financing (~32% of revenues) and is trying to build multinational investment banking and asset management business with a focus on Emerging markets.BFSI-Stockbrokers Given that 60% of its revenues arise from the broking business and given its sizeable retail presence.IN. However. The company has been acquiring boutique asset managers and brokerage firms across the globe for its asset management and investment banking businesses and has made some very senior hires over the past year from bulge bracket firms to run these businesses. Religare Enterprises (RELG. a further drop in third party revenues and persistent NPAs on its lending book could be the major negatives for the stock. Ambit Capital Pvt Ltd 10 .

673 1. Investors should consider this report as only a single factor in making their investment decision. wherein Stock Information stockbrokers have no visible competitive advantages. 2010 Motilal Oswal Fin.500 outlets in 600 cities) branch network. to Sensex -13. the entry of Poonam Saney retail investors. insurance etc.2x on FY12 BVPS.590 1.4 -13. MOFS’ business model should Recommendation help the firm manage its profitability better versus peers on a cross-cycle basis CMP: on the following counts:  A focus on non-capital intensive businesses: MOFS has maintained its Upside (%): focus on non-capital intensive fee-based businesses such as broking.20mn/$0.1 share.328 3.8 -16.3  Rs24bn/US$517mn Rs232/135 Rs.com franchises in India with a strong presence in both retail and institutional Krishnan ASV broking.com earnings have remained muted between FY08 and FY10 (flat between FY0810 v/s 67% CAGR between FY06-08). As a result. in the FY09 bear market.5 No v-09 A pr-1 0 Sensex Sep-1 0 M o tilal Oswal Source: Bloomberg.627 895 6. However. investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report.707 11. a cost of equity of 15%.2 -7. . increased cash delivery volumes and higher investment Tel: +91 22 3043 3216 poonamsaney@ambitcapital.136 5.611 11. CFA Tel: +91 22 3043 3206 India’s most direct broking play Motilal Oswal Financial Services Ltd.2x 19. For example. As the bull market matures.465 17. Ambit Capital research 1 0. Serv.4 1.com banking and margin trading activity should benefit MOFS disproportionately.482 1.3 1. Flexible cost structure model: MOFS has successfully built a franchiseebased retail broking model which is non-capital intensive and helps MOFS manage its cost structure better (even in a bear market) as all the fixed and operating costs are borne by the franchisee in lieu of a cut from total brokerage commissions.000 Exhibit 1: Key financials Year to March (Rsmn) Total income Operating profit Net profit EPS (Rs) BVPS (Rs) P/E (x) P/B (x) Source: Company.4 x.1 92 11. Please refer to disclaimer section on the last page for further important disclaimer. MOFS’ revenues were down 35% but its operating margin was flat at 36% (v/s fall of 6% for EDEL and 7% for IIFL).9 66 13. Moreover. lack of retail activity and higher option volumes in this bull run (as opposed to higher cash delivery volumes) has meant that MOFS’ Tel. our DCF model values MOFS at Rs206 per Absolute Rel.893 2. Bloomberg: MOFS IN EQUITY Reuters: MOFS. Furthermore. The P/E multiple is broadly in line with the marketwide multiple.: Beta: BSE Sensex: Nifty: Target Price: Rs161 Rs206 28% Rs 11. and a sensible promoter-led management team with 20 years of industry experience.5x on FY12EPS and P/B multiple of 2.000 that MOFS is currently trading at FY12 P/E of 11. investment banking and asset management and has stayed away from EPS (FY11): capital intensive businesses such as retail financing.222 2.4 FY11E 6.4mn 1.000 1 5. (MOFS) is one of the best broking pankajagarwal@ambitcapital.3 2.3 78 14.000 1 90 1 70 1 50 1 30 FY09A 4. whilst volumes in the market fell by 15%.1 FY12E 8.367 2.3 56 25.9 FY10A 6.8 -3. daily vol.BO BUY Analyst contacts Pankaj Agarwal. Ambit Capital research Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports.4 -1. This implies an earnings multiple of 14. Mkt cap: 52-wk H/L: 3M Avg. Consensus EPS estimates imply Performance (%) 230 25.BFSI-Stockbrokers November 29.6 4.2 was 38%). 20.020 14.: +91 22 3043 3205 vkrishnan@ambitcapital.5 2.680 2.478 3.8 FY13E 10.752 Valuation Stock Performance (%) Assuming revenue CAGR of 19% between FY10-15 (FY06-10 CAGR was 24%) 3M 12M YTD 1M and an average operating margin of 38% between FY10-15 (FY06-10 average -17. we believe MOFS is one of the best-run broking franchises in India with a large (1.2 109 9.5 2. among the better equity research teams. 28% upside from current levels. which is a 5% premium to 21 0 Indian peers.

2 4.074 2. Company Financial Snapshot Profit and Loss (consolidated) Total Income Operating expenses Operating Profit PBT Net Profit EPS (Rs)-Basic EPS (Rs)-Diluted Profit and Loss Ratios Operating Margin % PAT Margin % P/E (X) FY10 6.7% 9.1 Company Background Motilal Oswal is among the largest stockbrokers in India with significant presence in both retail and institutional stock broking.629 5.320 6.680 4.460 1 1.5% stake in the company.629 4.8 Broking Market Share (%) Broking Yield (bps) Loan portfolio Total AUM (Rsbn) FY10 3.9 FY11E 6.075 11.1 14. The company went public in 2007 and raised Rs2.126 13.9 FY11E 3.3 FY12E 8.600 16.184 6.4% 19. The company was started by promoters Ramdeo Agarwal and Motilal Oswal in 1987 as a sub-brokerage firm that subsequently got a broking license in 1990.9 11.367 3.9 38 24 11.083 897 13.4bn Source: Company.600 6.0 5.091 18.534 1.552 9.320 25.456 1.590 2. Ambit Capital research Consistent operating margins 45% 40% 35% 30% FY06 FY07 FY08 FY09 FY10 Operating Margin (LHS) ROE (%) (RHS) 40% 35% 30% 25% 20% 15% 10% 5% Ambit Capital Pvt Ltd 2 .7% 15.673 2.255 3. Operating Metrics (consolidated) FY11E 13. followed by its entry into investment banking in 2006 and mutual fund management in FY10.2 6.400 1.721 14.6% 16.1% 1.115 1.552 2.982 -563 14.1 42 27 13.5bn by offering a 10.683 2.1 1. The company started offering portfolio management services in 2003.222 3.478 5.094 1.3 11.534 2.091 2.0 5. The company launched its institutional broking business in 1994 and expanded its retail broking business by acquiring some regional stock brokers in 2005-06 and starting an internet trading portal in 2005.707 11.534 13.8% 2.4 5.0% 2.3 Revenue Breakdown Segment Equity brokerage & related income Net Interest Income Investment banking fees Asset Management Fees Other income Total FY10 Revenues 71% 9% 10% 6% 3% 100% Rs6.184 30.0 Balance Sheet (consolidated) Total Assets Net Fixed Assets Current Assets Other Assets Total Liabilities Networth Borrowings Others Balance Sheet Ratios ROA ROE Debt/Equity P/BV (X) FY10 10.Motilal Oswal Fin. Serv.611 11.6% 15.6% 0.1 39 24 13.552 10.020 14.3 FY12E 3.4 FY12E 14.075 2.

Motilal Oswal Fin.2 Ambit 6. We believe this is largely because brokers are extrapolating current trends and assuming lower market volume growth (in line with recent experience). Comments Expect revenues to grow at 27% in FY12 v/s FY11 on the back of rising market volumes and slightly higher yields due to the increase in cash delivey volumes with rising markets. we are taking a conservative estimate of 22% growth in market volumes between FY10-13.20% 3.1% FY09 -42% -36% -47% FY10 42% 65% 87% 38.0% FY12E 27% 24% 25% 37. Hence consensus estimates on MOFS contain limited data. which will help both the i-banking and margin financing businesses.17 -2% 6.00% 5. Operating profit to grow in line with revenues in FY12 because of the variable cost structure of the company. We do not see broking yields falling from current levels given they are already 40% lower than yields in developed markets.3% 42.478 11. 4.00% 5. Key assumptions & estimates Exhibit 2: Key assumptions and estimates for MOFS (all figures in Rsmn unless otherwise mentioned) Assumptions Growth in overall stock market volumes Brokerage market share (%) Broking yield (bps) Growth in nonbrokerage income Operating margin Key output (YoY growth) Net revenues Operating profit Profit after tax FY09 -17% FY10 56% FY11E 28% 2. As explained above.3 14.5 26% Comments Although market volumes have grown at a CAGR of 40% over FY05-10.20% 5. Serv.3 14. Bloomberg Consensus 6. We expect financing.8% FY11E 5% -3% -5% 38.96% 5.680 8. asset management and investment banking revenues to pick up because of increased capital raising by Indian corporates. However our EPS estimates are in line with consensus as we are factoring higher employee to bring down profit margins.7% FY13E 22% 21% 22% Source: Ambit Capital research Ambit Versus Consensus Bloomberg provides estimates on MOFS from only three other brokers. We expect operating margins to fall slightly going forward due to higher payroll expenses.518 11.1 % change 0% 13% 0% -1% Ambit Capital Pvt Ltd 3 .5 26% FY13E 20% 3. Our revenue estimates appear to be slightly higher than consensus. MOFS maintains its market share on the back of its strong distribution channel and strong advisory capabilities.14 50% 36.15 10% FY12E 20% 3. Exhibit 3: Ambit v/s consensus (Rsmn) Total income FY11E FY12E EPS (Rs) FY11E FY12E Source: Ambit Capital research.651 7.

To use its strong institutional and retail distribution to grow its ECM business. Low operating leverage because of the franchiseebased business model (which keeps MOFS’ fixed costs low but also means that MOFS has to share its brokerage income with franchisees). The larger franchisees tend to push for higher commission share with the implicit threat that if such concessions are not granted.500 branches in 600 cities countrywide.  Source: Ambit Capital research Ambit Capital Pvt Ltd 4 . Reliance into the both institutional and retail broking market.Motilal Oswal Fin. Experienced and conservative management team with more than two decades of experience in the Indian stock market.  Opportunities Threats  Opportunity to act as a consolidator in the Indian broking market as this market heads towards consolidation. they will move their franchise elsewhere.    Entry of new players such as Religare. Strong distribution channel with 1. Serv. Exhibit 4: SWOT analysis of MOFS Strengths Weaknesses  Stable operating margins across the cycle because of the franchisee-based business model which allows MOFS to operate with low overheads (since the franchisee bears the overheads). The ECM business accounted for 10% of MOFS’ revenues in FY10. To leverage its retail distribution platform to sell third party products such as insurance and mutual funds.    Low diversification as ~70% of revenues come from broking and all of the company’s businesses are highly dependent on general capital market activities.

(FY09=4. Our FCFE metric is cash profits . Given MOFS’ higher return ratios (ROE of 20% in FY10 v/s 15% for IIFL and 11% and EDEL).5% in FY12. Lower-than-expected increase in MOFS’ market share in broking Cross Cycle Valuation MOFS is trading at a forward PE of 13. MOFS is currently trading at an FY12 P/B multiple of 2. Rs167 Upside of 4% Source: Company filings. we believe MOFS deserves a higher P/B multiple versus peers.96% until FY12. FY10=42%) Rs. Rs333 Upside of 107% Base Case Total market volumes growing at CAGR of 21% between FY10-15 (FY05-10 CAGR of 40%) MOFS’ maintaining its current market share in equity volumes at 2.5x FY12 EPS). Valuation We have valued MOFS using free cash flow to equity (FCFE) model. 206 Upside of 28% Low Case Total market volumes growing at CAGR of 15% between FY10-15 MOFS’ market share in equity volumes falls to 2.7x (on consensus estimates) which is at a 11% discount to its long term average forward PE of 15.5% between FY10-12. Other income growing at a CAGR of 30% between FY1015 An average operating margin of 38% between FY10-15. FY15-20: We fade the revenue growth gradually so that by FY20 the revenue growth is 5% and operating margins fade to 35%.increase in working capital.4x.1x. Other income growing at a CAGR of 15% between FY10-12 An average operating margin of 35% between FY10-15 . MOFS is currently trading at an FY12 P/E of 11. Ambit Capital research The key downside risks to our Positive stance are:   Lower-than-expected growth in stock market volumes. Our FCFE model has three distinct phases:    FY10-FY15: We model each year in detail and broadly assume that (i) revenue will grow at 29% and (ii) operating margins would fade down to 37% by FY15.2%. Serv. our FCFE model values MOFS at Rs206 per share (implied valuation of 14. which is at slight premium of 5% to its Indian peers but at a discount to broader stockmarket which is on ~15 FY12 EPS. However.4x (calculated based on the period from September 2007 to November 2010). Ambit Capital Pvt Ltd 5 .Motilal Oswal Fin. Based on these assumptions and assuming a cost of equity of 15% and a terminal growth rate of 5%. From FY20 FCFE grows at a CAGR of 5%. Exhibit 5: Valuation sensitivity to key assumptions Growth in stock market volumes MOFS’ market share (equity volumes) Other income Operating margins FCFE valuation (Rs) Upside High Case Total market volumes growing at CAGR of 30% between FY10-15 MOFS’ market share in equity volumes goes up to 3. which is a ~30% premium to peers.2%) Other income growing at a CAGR of 21% between FY10-15 (FY06-10 CAGR of 64%) Operating margin fading down to 37% by FY15 (FY09=38%). FY10=3.

Serv.Motilal Oswal Fin. Exhibit 6: MOFS is trading at the lower end of its historical PE multiple 500 400 300 200 100 0 Mar-08 Mar-09 May-08 May-09 Mar-10 Jan-08 Jan-09 Sep-07 Sep-08 Sep-09 Jan-10 May-10 Nov-07 Nov-08 Nov-09 Sep-10 Jul-08 Jul-09 Jul-10 Nov-10 MOFS stock price 30x 20x 10x Source: Bloomberg Ambit Capital Pvt Ltd 6 .

091 1.739 8.534 FY13E 15.465 17.075 FY12E 13.792 109 Ambit Capital Pvt Ltd 7 .060 13.basic EPS (Rs).320 1.579 46 1.455 13 7.094 41 1.333 514 2.982 -48 14.184 -365 14. Exhibit 7: Income statement Y/E Mar (Rsmn) Brokerage income Net interest income Other fee income Total Income Operating expenses Direct costs Employee costs Admin expenses Operating profit Depreciation Exceptional items PBT Less:tax PAT Extraordinary items.611 11. minority interest etc.681 574 1.395 462 933 (38) 895 6.428 492 745 1.9 1.152 1.222 149 0 3. Serv.552 FY11E 11.500 -197 7.478 5.991 2.020 14.408 2.105 3.685 854 2. Ambit Capital research FY09A 3.4 FY13E 7.893 149 0 3.2 17.400 1.660 (49) 1.421 -48 16.075 78 6.629 6.630 1.1 14.435 2.608 16.9 11.707 11.diluted Dividend per share(Rs) Source: Company.328 6.968 56 4.744 1.939 80 1.960 778 1.074 996 2.2 1.426 6.937 613 2.268 461 753 4.367 687 2.213 2.452 613 2.203 681 1.590 133 0 2.673 149 0 2.083 -31 13.968 FY10A 9.551 553 1.552 1.534 92 8.473 613 2.792 5.221 -1.744 (40) 1. Ambit Capital research FY09A 7.255 1.2 FY11E 4.3 0.600 1.552 66 4.025 10.263 6.680 4.367 3.077 (57) 2.372 3.Motilal Oswal Fin.456 796 1.1 1.115 46 1.534 788 1.3 6.629 5.150 2.683 1.159 1.656 1.627 203 -30 1.7 Exhibit 8: Balance sheet Y/E Mar (Rsmn) Sources of funds Net worth Minority interest Borrowings Net deferred taxes Total sources of funds Application of funds Cash Investments Fixed assets Loan book Net working capital Total application of funds BVPS Source: Company.3 11.854 971 1. Net Profit EPS (Rs).530 (65) 2.705 10.3 1.460 40 1 -12 10.8 FY10A 4.1 FY12E 5.482 2.629 4.

3% -34.8% 22.5 2.9% 0.1% 26.1 57.8% 4.2% 6.6% FY12E 3.5 62.3 2. Exhibit 9: Key metrics (%) Broking market share (%) Brokerage yield Operating cost/income Debt to equity Revenue growth PAT growth Source: Company.0% 5.5 2.3% 9.1% 21.2 61.6% 16.0% 5.2% 5.0% Exhibit 10: Valuation and return ratios (%) P/E P/BV ROA ROE Source: Company. Ambit Capital research FY09A 4.7% 17.5% -47.2% Ambit Capital Pvt Ltd 8 .2% 9.0% 5.4% 19.7% FY13E 9.8% 11.Motilal Oswal Fin.9% 25.7% FY11E 3.5 62.9 10.9% -5.3 1.8 14.5 15.9% FY10A 13. Ambit Capital research FY09A 25.4% FY13E 3.2 63.4 1.4 18.7% 18.1% 90.6% FY11E 14.1 13.7% FY12E 11.0% 42.1% FY10A 3.6% 15. Serv.0% 15.

673 3. to Sensex -18. Arbitrage yields are falling: The arbitrage desk at Edelweiss contributes 37% to its topline. (ii) growing its investment banking business. Ambit Capital research Performance (%) 25.9 1.2 YTD 7. Edelweiss has the lowest contribution from feebased businesses such as broking and investment banking (45% v/s 80% for MOFS and ~60% for IIFL).000 No v-09 A pr-1 0 Sensex Sep-1 0 Edelwiess Capital 75 65 55 45 35 FY09 7.137 5.6 FY11E 9.8 Valuation Our sum-of-the-parts valuation (SOTP) model values Edelweiss at Rs54 (8% upside). and buying mid-sized retail broker. Hence we do not foresee the arbitrage business as being sustainable on its own in the long run as yields are expected to decrease further with Indian markets becoming more efficient.198 3.6 36 10.2 Source: Bloomberg.:+91 22 3043 3205 vkrishnan@ambitcapital. the business in the current form is not scalable as the promoter financing market is relatively small and IPO financing opportunities are sporadic.292 3.com Thriving Once Again After muted growth between FY08-10. Stability and scalability in financing business: Edelweiss is a leading player in the promoter financing and IPO financing business.0 -3.1mn 1.000 20. investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report.752  Stock Performance (%) 1M Absolute Rel. 2010 Edelweiss Capital Bloomberg: EDEL IN EQUITY Reuters: EDEL. As a result. .864 2. However the current valuation of 1.: Beta: BSE Sensex: Nifty: Rs37bn/US$787mn Rs68/39 Rs143mn/$3. the arbitrage yields are trending downward (from ~18% in FY08 to ~14% in FY11) as new players are entering the market coupled with the introduction of algorithmic trading software in the Indian market.582 5.1 30 16.0 -15. Recommendation CMP: Target Price: Upside (%): EPS (FY10): Rs50 Rs54 8 Rs3.975 4.432 4. mortgages. However. However.000 1 0. Investors should consider this report as only a single factor in making their investment decision.4 1.8 FY10 7. Ambit Capital research Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports.6  Stock Information Mkt cap: 52-wk H/L: 3M Avg.6 1.835 3.102 2.com Poonam Saney Tel: +91 22 3043 3216 poonamsaney@ambitcapital.4 FY13E 13.2 41 9. (iii) deploying excess capital to grow its financing book.6 32 13. we have valued these businesses at 1x the net assets employed in these businesses (Rs18 per share). CFA Tel: +91 22 3043 3206 pankajagarwal@ambitcapital. we believe. Exhibit 1: Key financials Year to March (Rsmn) Total income Operating income Net profit EPS (Rs) BVPS (Rs) P/E (x) P/B (x) Source: Company. We value the broking and other fee-based businesses at Rs36 based on an FCFE model.6 FY12E 11. daily vol. have the best growth potential in the long term.2 -3.6 12M 10. SME and infra financing).5x FY11 BV and 14x FY11 EPS already largely factors in these positives and we expect limited upside from current levels.226 5.5 28 20. Anagram Capital in 2010. Given the unpredictable nature of the arbitrage business and the scalability issues of the financing business and the lower ROEs (~8%) in both these businesses. We do not foresee visible competitive advantages in the other mainstream lending businesses it is planning to get enter (eg.9 1. Hence initiating with a HOLD recommendation.0 -9. Edelweiss has shown signs of recovery in the last five quarters by: (i) maintaining market share in broking.000 1 5.869 3. These fee-based income streams.668 3.com Low contribution from broking and fee-based businesses: Amongst the main listed brokers.897 5. Despite our positive stance on the recommendation is driven by three factors:  brokerage sector our HOLD Krishnan ASV Tel.450 2.2x 19. the highest ROE and the most direct correlation with market levels. Please refer to disclaimer section on the last page for further important disclaimer.467 1.9 1.BFSI-Stockbrokers November 29.BO HOLD Analyst contact Pankaj Agarwal.0 3M -4.

000 ~15.673 3.882 51.70% ~8. Balance Sheet (consolidated) Total Assets Net Fixed Assets Loan Book Other Assets Total Liabilities Networth Minority interest Borrowings Balance Sheet Ratios ROA ROE % Debt/Equity P/BV (X) FY10 51.9 41% 27% 13.384 5. In subsequent years the company entered institutional broking.7% 5.5% 280% 1.361 46.0% 8.6% 11.1 Profit and Loss Ratios Operating Margin % PAT Margin % P/E (X) 44% 29% 16.095 4.095 23.373 32.290 15.736 66.710 15.4% 13.198 5.4% 13.3% FY11E 2.046 3.5 18.6 3.0% ~16.0% 9.102 3.132 27.432 4.9 45% 30% 10.574 2.6 FY10 7.4 Revenue Breakdown Segment Net Interest Income Broking Income Other Fee Income Treasury.4 46.6 3.757 5. The company was started by investment bankers Rashesh Shah and Venkat Ramaswamy in 1996 as an advisory house focused on private equity and M&A deals.601 FY12E 107.0% 13.2% 4.8bn Falling ROEs and margins 55% 52% 49% 46% 43% 40% FY05 FY06 FY07 FY08 FY09 FY10 Operating Margin (LHS) ROE (%) (RHS) 40% 35% 30% 25% 20% 15% 10% 5% Ambit Capital Pvt Ltd 2 .582 6.292 3.975 5.4% 5.Edelweiss Capital Company Financial Snapshot Profit and Loss (consolidated) Total Income Operating expenses Operating Profit PBT Net Profit EPS (Rs)-Diluted Company Background FY11E 9.328 2.835 4.957 2.138 FY11E 96.5% 275% 1.5% 120% 1.874 4.444 96.4% FY12E 2.9 Edelweiss is amongst the Top 10 institutional brokers in India and one of the largest domestic brokers (~5% market share in institutional broking) with a sizeable financing book along with one of the largest arbitrage trading desks in India.791 Operating Metrics (consolidated) Broking Market Share (%) Broking Yield Loan Portfolio Yield on advances Cost of funds Arbitrage portfolio Gross arbitrage yield FY10 1.373 ~15.716 4.4% 4.844 22.7 53.000 15.189 5.450 3.844 589 18.710 49.736 74. It has recently entered retail broking by acquiring Anagram Capital along with launching its online trading portal. asset management and wholesale financing businesses.385 3.645 107.361 53.5% 10.716 27.6 FY12E 11.000 14. investment banking. Arbitrage and other fund based income Total FY10 Revenues (%) 18% 27% 18% 37% 100% Rs7. Edelweiss is starting its life insurance business in FY12 in a joint venture with Japanese insurance giant Tokio Marine.290 45.

Net revenues -14% 2% 27% 16% 14% Operating profit Profit after tax -24% -32% 0% 23% 19% 17% 27% 28% 13% 14% Source: Ambit Capital research Ambit versus consensus Bloomberg provides estimates on Edelweiss from only four other brokers.5 80% 4.101 3. our FY12 EPS estimates are around 11% above consensus. We expect asset management and investment banking revenues to pick up with the market Whilst Edelweiss is rapidly growing its financing portfolio.6 4. falling arbitrage yields and lower incremental yields in the financing portfolio result in 7% CAGR between FY10-13 in fund based income.Edelweiss Capital Key assumptions & estimates Exhibit 2: Key assumptions and estimates for EDEL (all figures in Rsmn unless otherwise mentioned) FY09 Assumptions Growth in overall stock market volumes Brokerage market share (%) -17% 56% 28% 20% 20% Although market volumes have grown at a CAGR of 40% over FY05-10.975 11.582 3.1 Ambit 9. EDEL increases its market share after acquisition of Anagram Capital. Whist we do not have access to the breakdown of consensus’ revenue forecast. Whilst our FY11 revenue and EPS estimates are in line with consensus. FY10 FY11E FY12E FY13E Comments NA 1.965 11.5 68% 4.5 15% 17% -18% 5% 4% 9% Operating margin 45% 44% 41% 45% 44% Key outputs (YoY growth) Expect revenues to grow at 19% CAGR between FY10-13 on the back of the Anagram acquistion. Exhibit 3: Ambit v/s consensus (Rsmn) Total income FY11E FY12E EPS (Rs) FY11E FY12E Source: Bloomberg.5 15% 4.2% 2.4% 2.7% 2. Hence consensus estimates on Edelweiss contain limited data. We do not see broking yields falling from current levels given that they are already 40% lower than yields in developed markets. Ambit Capital research Consensus 9. As explained above. rising market volumes and higher investment banking and financing revenues offset by lower arbitrage income.6 % change 1% 4% 1% 11% Ambit Capital Pvt Ltd 3 . We expect operating margins to fall slightly in FY11 v/s FY10 due to higher payroll expenses in the current year.6 4. However we expect it to increase in FY12 as a result of cost savings on lease rentals once the company moves its operations in its owned premises.4% Broking yield (bps) Growth in other fee income Grwoth in net fund based income NA -51% 5. our view is that consensus is not factoring in cost savings on lease rentals once the company moves to its owned premises in FY12. we are taking a conservative estimate of 22% growth in market volumes between FY10-13. Operating profit to grow higher than revenues in FY12 due to increase in operating margins as explianed above.

has been recently acquired and needs to be turned around and invested in to make it of a similar quality to its other businesses.  Source: Ambit Capital research Ambit Capital Pvt Ltd 4 .   Inability to successfully integrate Anagram Capital with the parent company. Now it has opportunity to scale up the Anagram retail business using parent company’s balance sheet strength (which will now allow Anagram to provide margin financing to its clients) and advisory capabilities.1bn) for Rs1. Edelweiss acquired Anagram (FY10 revenues Rs1. Derivatives broking desk is the largest in India and the overall institutional broking business (~US$45mn in revenues in FY10) is now amongst the largest in India (if we look outside the top MNC brokers)  A major portion of company’s current revenues are not scalable (. Edelweiss’ retail broking franchise – Anagram .e.g. Already.Edelweiss Capital Exhibit 4: SWOT Analysis Strengths Weaknesses  A strong management team which has repeatedly spotted new business opportunities ahead of its competitors e. arbitrage and promoter financing) because of limited opportunities in these segments and higher capital requirements. derivatives broking in 2001 and fixed income desk in 2008. in FY10 Edelweiss’ ECM business has made substantial progress with revenues growing by ~250%.i.7bn. Entry of new players such as Jefferies and Barclays Capital into the institutional broking market pulling down yields and EDEL’s market share.   Opportunities Threats  Opportunity to use its retail and institutional distribution to scale up its investment banking business.

Other fee Income growing at a CAGR of 10% between FY10-14.4% in 2QFY11.1x and FY11 P/BV of 1. Our FCFE metric is “cash profits less increase in working capital”. From FY20 FCFE grows at a CAGR of 5%. Rs29 0.4% between FY10-15 (~1. a) cost of equity at 15%.Edelweiss Capital Valuation We have valued Edelweiss using a sum-of-the-parts (SOTP) model with a free cash flow to equity (FCFE) valuation for its brokerage segment and fee income businesses and a book value multiple for its book-based businesses. implying 8% upside from current levels. Due to the low ROE in its financing businesses and lack of scalability and predictability in the financing and arbitrage businesses.0X net assets = Rs18 Rs54 Upside of 8% Total market volumes grow at CAGR of 15% between FY1015 Edelweiss’ market share in equity volumes falling to 2% between FY10 and FY15. and b) terminal growth at 5%. This translates to Rs18 per share for these businesses. Exhibit 5: Valuation sensitivity to key assumptions High Case Fee based businesses Growth in stock volumes market Total market volumes grow at CAGR of 35 % between FY10-15 Edelweiss’ market share in equity volumes going up to its previous high of 3% in FY15 from 2. Our FCFE model has three distinct phases:  FY11-FY15: We model each year discretely and broadly assume that feebased revenue will grow at 20% CAGR and operating margins should average at 43%.2X net assets = Rs22 Rs73 Upside of 46% Total market volumes grow at CAGR of 22% between FY1015 (FY05-10 CAGR of 40%) Edelweiss’ maintaining its market share in equity volumes at 2.7x).   Based on the assumptions shown above and assuming. our FCFE model values Edelweiss’ fee-based business at Rs36 per share. we have valued these two businesses at 1x the net assets employed in the stated businesses. Ambit Capital research The key downside risk to our HOLD stance are:   Lower-than-expected growth in stock market volumes. Ambit Capital Pvt Ltd 5 .8X net assets = Rs15 Rs44 Downside of 12% Base Case Low Case EDEL’s market share (equity volumes) Investment banking and other fee income Core FCFE valuation Financing. cash and investments and arbitrage book SOTP valuation Upside Source: Company filings. Other fee income growing at a CAGR of 25% between FY10-15.8% in FY09 and FY10) Other fee income growing at a CAGR of 15% between FY01-15 (FY05-10 CAGR of 54%) Rs36 1. Lower-than-expected increase in market share. Hence we arrive at a total valuation for the company at Rs54 per share (implied FY11 P/E of 15. FY15-20: We fade the revenue growth gradually so that by FY20 the revenue growth is 5% and operating margins fade to 41%. Rs51 1.

0x (on consensus estimates) which is at a 12% discount to its long term average forward PE of 15.9x (calculated based on the period from September 2007 to November 2010).Edelweiss Capital Cross Cycle Valuation EDEL is trading at a forward PE of 14. Exhibit 6: Edelweiss is trading at a discount to its long term average PE 180 150 120 90 60 30 0 Mar-08 Mar-09 Mar-10 Sep-08 Sep-09 Dec-07 Dec-08 Dec-09 Sep-10 Jun-08 Jun-09 Jun-10 20x 10x EDEL stock price 35x Source: Bloomberg Ambit Capital Pvt Ltd 6 .

008 175 4.133 3.957 1.166 5.6 4.993 10.514 3.363 11.736 66.763 1.4 FY10A 3.362 13.752 4.295 527 3.736 74.063 5.063 2.425 4.441 1.864 2.795 (122) 2.560 18.504 2.406 107.673 3.199 2.328 879 2.079 1.161 2.926 16.512 697 1.844 15.1 2.361 24.757 5.2 Exhibit 8: Balance sheet Y/E March (Rsmn) Sources of funds Net worth Minority interest Borrowings Total sources of funds Application of funds Cash and bank FDs Investments Loan book Fixed assets Net working capital Total application of funds Source: Company.878 184 6.132 27.095 FY12E 27.150 2.385 2.439 6.6 FY13E 8.292 3.945 1. Ambit Capital research FY09A 2.413 1.450 122 3.659 3.966 2.432 4.Edelweiss Capital Exhibit 7: Income statement Y/E March (Rsmn) Fee based income Equity broking Other fee based income Net fund based income Interest income Arbitrage income Investment and dividend income Less interest expense Total income Operating expenses Operating costs Employee costs Operating profit Depreciation PBT Less:tax PAT Minority interest Net profit Basic-EPS (Rs) Diluted EPS (Rs) Source: Company.943 7.467 177 3.441 1.215 Ambit Capital Pvt Ltd 7 .716 FY13E 31.243 3.582 6.492 2.596 8.835 4.154 2.542 1. Ambit Capital research FY09A 21.869 160 5.624 30.187 3.226 7.073 62.149 7.6 3.315 2.456 3.393 4.716 23.734 5.145 4.748 193 7.290 1.844 FY11E 23.637 96.5 2.997 (100) 3.046 1.2 5.224 5.361 26.710 1.189 5.614 4.532 (100) 3.381 4.361 25.215 19.896 1.9 FY11E 5.710 9.903 4.073 53.668 4.337 7.710 4.393 121.455 342 1.648 793 5.102 145 3.384 3.290 4.198 152 5.165 4.713 3.377 51.574 2.622 3.874 3.389 2.980 3.091 (227) 1.086 5.357 4.926 FY10A 22.897 5.791 107.073 6.138 51.073 46.373 589 14.590 30.975 5.201 2.794 5.601 96.449 (157) 2.6 FY12E 6.095 19.736 84.590 2.104 121.

5 56% 120% FY11E 2.4% FY10A 16.6 3.5% FY11E 13.2% 4.2 3.9 1.8 5.5% FY12E 10.4% 13.4% 4.5 55% 275% FY13E 2.6 5.6 1.7% 5. Ambit Capital research FY09A 20.4% Ambit Capital Pvt Ltd 8 .9 1.6% 11.5 56% 271% Exhibit 10: Valuation and return ratios (%) P/E P/BV ROA ROE Source: Company.3% 9.4% 4.4 1.5% FY13E 9.4 59% 280% FY12E 2.Edelweiss Capital Exhibit 9: Key metrics (%) Brokerage market share Broking yields Operating cost/income Debt to equity Source: Company.9 1.4% 13.4 3. Ambit Capital research FY09A NA NA 55% 36% FY10A 1.5% 10.

com ritumodi@ambitcapital.Institutional Equities – (022) 30433174 saurabhmukherjea@ambitcapital.com rajeshravi@ambitcapital.com subhashinig@ambitcapital. Retail.com chandranide@ambitcapital.com Managing Director .com pankajagarwal@ambitcapital.Ins Equity Senior Manager Equities (022) 30433229 (022) 30433295 (022) 30433289 (022) 30433053 alokdhoshi@ambitcapital.com ashvinshetty@ambitcapital.com poonamsaney@ambitcapital.com nitinbhasin@ambitcapital. Automobiles) Desk-Phone (022) 30433202 (022) 30433211 (022) 30433209/3221 (022) 30433285 (022) 30433252 (022) 30433210 (022) 30433203 (022) 30433255 (022) 30433205 (022) 30433241 (022) 30433206 (022) 30433201 (022) 30433216 (022) 30433259 (022) 30433274 (022) 30433175 (022) 30433292 (022) 30433264 (022) 30433054 E-mail amitahire@ambitcapital.Edelweiss Capital Institutional Equities Team Saurabh Mukherjea Research Analysts Amit Ahire Ankur Rudra Ashish Shroff Ashvin Shetty Bhargav Buddhadev Chandrani De Chhavi Agarwal Gaurav Mehta Krishnan ASV Nitin Bhasin Pankaj Agarwal Parikshit Kandpal Poonam Saney Puneet Bambha Rajesh Kumar Ravi Ritika Mankar Ritu Modi Subhashini Gurumurty Vijay Chugh Sales Alok Doshi Deepak Sawhney Dharmen Shah Dipti Mehta Manager Sales VP .Ins Equity VP .com Industry Sectors Telecom / Media & Entertainment IT/Education Services Technical Analysis Consumer Power/Capital Goods Metals & Mining Infrastructure Derivatives Analysis Banking Infrastructure NBFCs Construction / Real estate BFSI Power/Capital Goods Cement Economy Metals & Mining IT/Education Services Consumer (incl FMCG.com ashishshroff@ambitcapital.com deepaksawhney@ambitcapital.com vijaychugh@ambitcapital.com gauravmehta@ambitcapital.com diptimehta@ambitcapital.com ankurrudra@ambitcapital.com puneetbambha@ambitcapital.com ritikamankar@ambitcapital.com Ambit Capital Pvt Ltd 9 .com parikshitkandpal@ambitcapital.com dharmenshah@ambitcapital.com chhaviagarwal@ambitcapital.com vkrishnan@ambitcapital.com bhargavbuddhadev@ambitcapital.

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