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IDFC: Is the IPO worth it?

Swapna Medhe | July 19, 2005

The Initial Public Offering of Infrastructure Development Finance Company is currently on (closes on July 22, 2005).

Should you go for this IPO?

Here's to help you make up your mind.

The business

IDFC is a Non-Banking Finance Company engaged in the business of lending money for infrastructure projects.

It operates in three predominant areas: transportation, energy and telecommunications.

Besides providing debt finance (lending money), recently the company has started investing in the equity (shares) of a number of companies. This is then sold later to generate solid returns.

IDFC also floated a subsidiary - IDFC Asset Management Company — that manages a venture capital fund with a corpus of Rs 850 crore.

IDFC is in a lucrative business. Tremendous amount of money is going into infrastructure. Even the Prime Minister believes that India's Gross Domestic Product will grow at 7% to 7.5% with a huge chunk of this growth coming from infrastructure sectors like power, energy, telecom, ports, railways and aviation.

Given IDFC's expertise and knowledge-led management, the scope for lending (and subsequent profits) is considerably huge.

All said and done there are some pitfalls too.

Given the concentrated nature of IDFC's business, the company remains vulnerable to incidences of project failure (the case in point is the debacle of IFCI and later IDBI which had lent to the controversial Dabhol Power Company).

The competition

- The negative

Without doubt, the business of financing infrastructure is fiercely competitive.

Ironically, IDFC's promoters State Bank of India, IDBI and ICICI Bank are its chief competitors. 

While they finance infrastructure projects at attractive rates, IDFC, being an NBFC, lacks access to low-cost, short-term money. This is because regulations in India prohibit NBFCs from accessing funds in the same way that banks can.

Nevertheless, IDFC's cost of funds (cost at which they get access to money) for the financial year 2004-05 stood at about 6.5% compared to its competitors' 5% (just a 1.5% difference).

Having said that, it is worth noting that the difference of 1.5% between the rates at which IDFC and its competitors borrow and subsequently lend money, makes a huge difference in a capital-intensive business like infrastructure finance.

- The positive

On the positive side, IDFC's cost-to-income ratio of 11% fares significantly better than the competition which is 40% to 60%.

Simply put, cost-to-income ratio gives a sense of what part of the company's income are costs made up of. For instance, IDFC spends just Rs 11 out of the Rs 100 that it earns while the competitors spend Rs 40 to 60 out of an income of Rs 100.

To give you a better perspective, IDFC's profits stand at Rs 89, while the competition stands at Rs 40 to Rs 60, out of total income of Rs 100.

This gives IDFC a sharp edge vis-à-vis competition.

The price

Is the issue attractively priced?

At a price band of Rs 29 to Rs 34, the answer is a resounding yes.

Given IDFC's net profit of Rs 304 crore for the year ending 2004-05, the Earnings Per Share works out to Rs 3.04.

At this EPS and considering the upper end of the price band of Rs 34, the Price Earnings multiple works out to 11.18.

This leaves a lot on the table for a substantial price appreciation.

Secondly, the Price to Book Value of 1.5 also works out in favour of investors.

Book value is what would be left over for shareholders if the company were sold and all its loans were paid off.

It is calculated by subtracting total liabilities (money owed) from total assets (all that it owns) and dividing the result by the total number of shares.

In technical terms, BV is the accounting value of a firm.

So a BV of Rs 19 would indicate what each share owner would get at this if the company liquidated.

In this case, the Price/Book Value ratio = 1.5.

A low PBV leaves ample scope for price appreciation.

Considering the PE multiple and PBV multiple, the offer is attractively priced considering that the potential for growth in its domain business is huge.

Is IDFC growing?

Yes.

The Return On Net Worth has jumped from 11.58% in the year 2003 to 16.10% for the financial year ended 2005, indicating a growth of 39%.

This is the ratio of an organisation's net profit to its net worth. It provides a measure of the rate of return on a shareholder's investment.

EPS has increased from Rs 1.80 in the year 2003 to Rs 3.04 in the year 2005.

Profit After Tax soared from Rs 193.12 crore in the year 2002 to Rs 304.02 crore for the year ending March 2005, a jump of 57.42%.

Net cash generated from operations has skyrocketed 269%, from Rs 52.93 crore to Rs 195.34 crore for the above corresponding period.

In its main business segment of infrastructure lending, revenues have grown a phenomenal Rs 267.35 crore to Rs 681.79 crore, a growth of 155%.

However, while advances (loans) to the infrastructure sector has grown 31% per annum from 2002, pricing pressure due to intense competition has clipped its spread (difference between rate at which money is borrowed and subsequently lent) from a solid 7.04% to 4.52%, a steep decline of 36%.

This remains a cause for concern going forward.

Nevertheless, a margin of 4.52% appears quite comfortable for the company as of now.

The good news is that the company has a low debt-equity ratio of 3.3 for the year ended March 31, 2005.

For NBFCs, regulations permit a maximum debt-equity ratio of 10. This means that IDFC can take its debt to 10 times its equity. IDFC's debt-equity of just 3.3 is very safe. This means that if IDFC sells equity (shares) worth Rs 10 to the public, against that Rs 10 it can borrow Rs 100 to finance its growth.

The debt-equity ratio is arrived at by dividing total liabilities (money owed) by total equity (number of shares). A high debt ratio is an indication that the company may have difficulty meeting its loan obligations.

Briefly (as some analysts believe), IDFC can be another HDFC in the making in the infrastructure sector.

The price band of Rs 29 to Rs 34 fixed for the issue (with a face value of Rs 10) will provide short-term as well as long-term investors with decent returns.

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