AK Capital Services Ltd - CSF Stock for March 2011

A.K. Capital Services Ltd. (CODE – 530499 ): 

A.K. Capital Services Ltd. (CODE – 530499 ) HBJ Capital, India Web: www.hbjcapital.com E-Mail: info@hbjcapital.com Call: +91 98867 36791 HBJ Capital’s “CSF” pick for the month of Mar’11 Leader in private placement of debt, with over 30% share in domestic market

Best Buying Price…: 

Best Buying Price… 2 Phase Buying Strategies Suggested…. 1 st Phase : Buy at the current price range 350-450 [60%*] 2 nd Phase : Add if the price falls down to Rs 300 [40%*] *investment in terms of value

Slide 3: 

A.K. Capital Services Ltd. – Overview

Basic Details..: 

Basic Details.. Winner of “Entrepreneurship Excellence Award 2010 – for development of Indian bond market” Winner of “IFR – Asia bond deal of the year”, for successfully structuring & placing India’s first perpetual bond issue The company has over 30% market share of corporate bond market, an unparallel track record of delivering near 100% strike rate in bond placement , and offers a plethora of services for the evolving finance market. It is a SEBI registered Category – I Merchant Banker and is viewed as “most market friendly bond structuring specialist”. It has been an undisputed leader for almost a decade, and has grown its market share from a mere 2% at inception. It is also one of the few merchant bankers to have direct access as a counter party to almost each and every domestic bank/ institution. The company’s future growth is driven by its focus on bond market instruments, which would be the most sought after means, not only for investments but also for raising funds. The company has been ranked #1 arranger of debt through private placement since FY03

Contd..: 

Contd.. Private placement of debt – NCD, CP, Securitization Public issue of debt – the company has managed 1/3 debt IPOs issued in the Indian capital market so far. It was the lead manager, ranked amongst top 2 mobilizes in public issue of NCDs aggregating to INR 10,000 million by Shriram Transport Finance Company Ltd. Corporate Bond – Secondary market - The secondary market trading is now becoming an attractive option and is gaining interest amongst investors. The company is amongst pioneers in the Corporate Bond trading in India, with a large network of Primary Dealers, FIs, Banks, Retirement Trusts, MFs, Insurance Companies, HNIs, and Retail investors. IPO/FPO, Private placement of equity - The company possesses strong relationship with PE investors, and has raised funds for some of India’s renowned PE funds Mergers and Acquisitions -The company with its exceptional team and abilities, is pioneering its services in this domain as well QIP of equity Project finance and loan syndication - The company undertakes syndication of loans for various corporates , and has successfully raised project financing and loan syndication in past few years. And has been associated with term loan syndication assignments aggregating over INR 50 billion Structured products – Securitization, Tranching , Credit Enhancement. The company is actively engaged in arranging structured finance, either in form of securitization or credit enhancement financing Retirement trust solutions – Investment Advisory, Active Investment Management. Being a pioneer in the debt markets, the company has been able to spread its reach among retrial trusts across the country and has vast experience of providing intermediary services to more than 1000 trusts. With already built-in skill set in the form of advisory for corporate treasuries, where it manages assets worth more than INR 350 billion, best professional resources, and vast experience in debt markets, the company strives to excel in the domain

Company’s Division..: 

Company’s Division.. A.K. Capital Services Ltd. A.K. Stockmart Pvt. Ltd. Stock Broking activities, registered with SEBI A.K. Capital Corporation Pvt. Ltd. A.K. Capital Finance Ltd. NBFC not accepting public deposit

Industry – Bond Market: 

Industry – Bond Market The Indian financial system is changing fast, marked by strong economic growth, more robust markets, and considerably greater efficiency. Both the government and corporate bond markets have grown in size, but they remain illiquid. The corporate bond market, in addition, is still under-developed with respect to its global peers, size and domestic funding requirements. In USA debt market is 10 times the equity market, whereas, in India it is less than 1/10th of equity market. Corporate debt market in India is in its infancy , both in terms of microstructure as well as market outcomes. Primary issuance market is dominated by NBFCs and relatively small amount of funds are raised through issuance of debt by manufacturing and other service industries. This therefore requires creation of new market sectors such as foreign exchange derivatives contracts, relaxation of exchange restrictions, and an easing of investment mandates on contractual savings institutions to attract a greater variety of investors (including foreign) and to boost liquidity. There are three main segments of the debt market in India: Government Securities - The market for government securities comprises the central government securities such as T-bills and state government securities. Public Sector Unit (PSU) bonds - The PSU bonds are generally treated as surrogates for sovereign paper, sometimes due to explicit guarantees and often due to the comfort of public ownership. Some of the PSU bonds are tax-free, unlike most other bonds, including government securities. Private Corporate Securities - Private corporate securities include corporate bonds and debentures, which are mostly medium-term papers with maturities up to seven years, and commercial paper, which is a short-term corporate debt instrument with maturities from 15 days to one year.

Industry – Bond Market: 

Industry – Bond Market The development of financial markets started in the early 1990’s . Since then, a series of reforms - both structural as well as institutional – have been initiated with a view to having market determined interest rates. The other objectives of these reforms have been to improve transparency, efficiency and accessibility of the debt market. The Government started the reforms by borrowing from the market at rates determined through auctions. Previously, this was being carried out at pre-announced rates. Other reforms include – Introduction of new instruments such as - zero coupon bonds, floating rate bonds, capital index bonds Establishment of specialized institutions such as Discount and Finance House of India (DFHI) and Securities Trading Corporation of India (STCI) Setting up of the Negotiated Dealing System (NDS) and Implementation of the Patil Committee recommendations for corporate bonds.

Industry – Bond Market: 

Industry – Bond Market Corporate debt grew from 3.9% (of GDP) in FY08 to 4.72% (projected) in FY10. But is still far behind Korea (61%), Singapore (31%), Thailand (15%), Malaysia (37.5%), and developed economies. In India AAA corporate bonds are available at 9% against 4-5% elsewhere Corporate bond space is dominated by financial sector with more than 64% share, rest being with manufacturing and services sector. Moreover, bulk of corporate debt is raised by PSUs FII limit of $15 billion for corporate bonds was almost exhausted with FIIs subscribing to $3.5 billion in March – April 2010. And limit for GSECs, $5 billion, is already exhausted. Finance Minister has therefore further raised total FII limit for investment in corporate bonds to $40 billion. Primary market for GSECs grew by 10 times between 90-91 and 98-99, following reforms by regulators Like in many emerging East Asian bond markets, the investor base remains narrow in both government and corporate bond markets, with limited foreign participation India’s government bond market has grown steadily in size, largely due to the need to finance the fiscal deficit Private placement of Bonds has been steadily growing since last three years at 34% CAGR Trading of Bonds has been steadily growing since last three years at 33% CAGR (and by 50% in FY10), coupled with initiatives taken by RBI, SEBI, and Finance Ministry to evolve the market.

Global Bond Market: 

Global Bond Market Private placement of debt continues to dominate the market Debt market in Japan (largest in Asia) picked up after 1985, following relaxation of market eligibility standards, establishment of rating agencies. And state of bond futures trading followed by liberalization of financial transactions The main investors in debt instruments, including corporate debt, are institutional investors In US banks play a major role in facilitating issuance and distribution of marketable debt, and also hold such instruments in their portfolio for treasury operations Mutual funds, insurance companies are major investors in debt funds. And debt markets continue to be dominated by institutional investors in both primary and secondary markets in US Countries with large and developed government debt markets have large corporate debt markets, as well 92% of trades in US are done on OTC Overall corporate bonds are predominantly unlisted, and traded on OTC

Regulatory Reforms in India: 

Regulatory Reforms in India Till date corporates were not comfortable in raising debt from public, owing to a number of unfavorable/stringent disclosure norms, and tax policies. Moreover, banks and financial institutions preferred loan over bonds because there was no marked-to-market requirement for loans. But ongoing reforms in financial sector, has tilted the scale in favor of corporate bonds – TDS on corporate bond has been rolled back. Corporates are now allowed to sell bonds with maturity of 91 days, against earlier limit of minimum 364 days. Banks, till date, are allowed to lend to corporates below PLR. But implementation of base rate mechanism, has brought an end to this practice, hence, corporates are being suggested (by banks) to go to commercial paper/bond route which can be bought by them below base rate. Banks have till date preferred loans to bonds, under Basel – I norms, which mandated marking to market for bonds but not loans. But under Basel – II norms loans would also be required to be marked to market. Long term investors like pension funds, which till date are required to invest a minimum percentage in GSECs, may be allowed to invest in rated corporate debts as well. And minimum limit on GSECs investment may be removed. Finance ministry has urged RBI to allow banks to guarantee bonds issued by local firms (01 July 2010), which may further enhance credibility of the issuers

Slide 12: 

Growth Drivers Bond market in India is quite nascent as compared to developed economies but none the less is now catching eyeballs of the investor community in India as well as abroad. Bond market is becoming preferable choice for the fund raisers to raise the required capital while investors find a safe haven to park their monies and assure themselves with the fixed income returns. Bond market in India is expanding and is expected to contribute to 55% of GDP by 2016 as compared to 40% of GDP in 2009 Corporates , so far, have been comfortable with loans from FIs, because they are provided a credit limit and charged only for the limit used. But this creates asset liability mismatch with FIs, which is now catching up and their appetite for term debt is likely to decline in future. So, they may not be in a position to meet demand of term funds from the industry and infrastructure sectors in future The recent turbulence in financial markets due to securitization, is primarily due to shift in focus from “managing risk” to “disowning risk”, and regulators in India are treading the path cautiously with stringent disclosure and risk management norms. The regulations have so far limited the growth rate, but are expected to develop the market in a sustainable manner. Still, securitization of retail loans, both ABS and RMBS reported a 61% increase in volume in 2009–10. The Retirement benefits space in India has largely been perceived to be static over the years. But the developments in Retirement Fund Industry in last two years along with changed dynamics of debt markets has changed the way in which the retirement funds operate and function in India. Retail investors predominantly invest in FDs of Banks and FIs, but some Corporates have had success in recent times in distributing high yielding bonds to them. The market size, though small is expected to increase in future. Bond issuance by Municipal corporations may pick up in next five years, although the finance ministry has asked them to put a limit on their borrowings.

Financials..: 

Financials.. Debt: The company is in business of private placement of bonds/equity, and this requires it to have exposure to them for some duration of time. Therefore, a low debt strategy keeps risk at minimum. Equity: Reduction in share capital on account of conversion of 6% convertible preference shares to common equity. Dividend Policy: The company has maintained stable dividend payout even during tough times. And has increased it from this fiscal. Capex Plans: The company is developing a new office at Bangalore.

Robust growth…: 

Robust growth… The company is growing unabated, defying both slowdown and competition (from banks). It is a services company, with negligible fixed assets. Its key strengths are its employees and network. Thereby, enabling it to post robust operating margins ~ 40-50%. The company is not expected to increase debt : equity beyond 0.5, which would keep a check on risk. Equity may get diluted at higher levels at appropriate time.

Cash Flows..: 

CFO for FY10 is negative on account of higher profit generated from investments (which are categorized under CFI). FY10 PAT 80cr (FY09 58.3cr). Company made net investments of 19.8cr in FY10 (net of profit from investments ~ 77.6cr). Company earns majority of profits from investments, which may get affected in downturn. And it thus keeps debt at very low levels. Cash Flows..

Competition: 

Competition There is no listed competitor, who is focused on bond market. The company has performed consistently over a decade, and returned best ROE. Its ability to maintain high operating margins and ROE, hint at wide economic/operating moat which the company exploits for benefit of stakeholders. It is due for a P/E re-rating given consistent performance and exponential market growth All peers trade at higher valuation than the company, despite lower ROE and Operating Margins AKCAP Reliance Capital IDFC IIFL Motilal Oswal PAT TTM (crores) 62.1 380 1223.1 216.56 164.7 MCAP (crores) 291 14270 22754 2168 1906 ROE FY10 31.36% 15.1% 15.8% 14.1% 9.4% Dividend 9 6.5 1.5 3.0 1.2

Shareholding Pattern: 

Shareholding Pattern Majority of shares are held by first generation entrepreneurs and associates. DIIs seem to have focused on the stock, and the company also has plans to raise 400cr by QIP of equity.

Investment Rationale..: 

Investment Rationale.. The company is in an industry, which has huge barriers to entry, evident from few new entrants, high operating margins, and regulations. Hence, present stock price is lower than valuations from both peer comparison and financial ratios point of view, and warrants a re-rating. A P/E re-rating before QIP issue should raise its MCap to 895cr. Management plans to issue 20L shares for raising 400cr through QIP, which translates to INR 2000/share The stock is likely to catch eyes of Institutional Investors in near future, and would command much higher valuations once all the finance sector reforms are in place.

Thank you: 

Thank you