NEUTRAL

NBFCs
India FEBRUARY 21, 2017
UPDATE
BSE-30: 28,662

CRISIL: Analyst meeting notes- Research drives growth; ratings subdued. Weak
capex, low growth in mid-corporate segment, stricter norms in implementation of SME
ratings and strong competition have affected the prospects of CRISILs ratings business.
Momentum in its fast-growing research business (65% of revenue) through Irevna and
Coalition was tempered down declining global IB revenue pool and competition from
captive offshore research. Development of the corporate bond market in India and
mandate for higher rating requirements will boost domestic business over the medium-
term.

QUICK NUMBERS
Key takeaways from CRISILs analyst meeting

Research drives growth. CRISIL delivered 13% revenue and 10% earnings CAGR during Ratings business has
CY2011-16. Research drove this growth with 18% revenue CAGR compared to 7% for the 29% revenue
ratings business. Contribution of the research business has increased to 65% of revenues contribution;7%
compared to ~50% five years ago, with the share of ratings declining to 30% from 40% five revenue CAGR
years ago. during CY2011-16
Margin headwinds persist. CRISILs overall margins have steadily declined over the past few
High (18%) revenue
years to 31% in CY2016 from 36% in CY2011. Notably, ratings and advisory businesses have
CAGR during
seen maximum margin pressures likely due to the ongoing strong competition. Margins in
CY2011-16) in
research have been relatively stable between 30-34% over the past five years.
research business
Ratings business Well-positioned to benefit from revival in CAPEX and credit growth
Overall margins
CRISILs ratings business (29% of revenue and 30% of segmental PBT in CY2016) broadly down to 31% in
comprises three traditional lines bond ratings, bank loan ratings and SME ratings. CRISIL does CY2016 from 36%
not provide the break-up between the three lines; domestic bond ratings make the highest in CY2011
margins, followed by bank loan ratings and SME ratings. This also includes some ratings
outsourcing business for S&P. During CY2011-15, the business for S&P was 30-33% of income
of its ratings business.

Weak capex has put pressure on growth; competition on margins. Rating revenues
grew by 8% in CY2016 and 7% CAGR over CY2011-16, with margins declining to 31% in
CY2016 from 40% in CY2011. This is explained by declining credit growth in the large/mid
corporate as well as SME segments and competition as follows: (1) We have seen growth in
bond issuances over the last few years, but this growth is led by NBFCs/HFCs segment where
fees are capped beyond a particular size, in our view. (2) Market sources indicate that
margins in mid-sized corporate ratings are higher than ratings of large companies. (3) Low
credit growth environment along with higher competition from new entrants (like Brickwork Nischint Chawathe
nischint.chawathe@kotak.com
Ratings) has added to pressure on rating margins.
Mumbai: +91-22-4336-0887

Lower margins in S&P business. Nearly one-third of rating revenues are generated by M B Mahesh CFA
mb.mahesh@kotak.com
providing services to the parent S&P. The contribution has remained around 30-33% over
Mumbai: +91-22-4336-0886
CY2011-15. Margins in the segment of ratings business are likely to be lower than overall
rating margins. S&P is expanding the scope of outsourcing beyond credit ratings and with Abhijeet Sakhare
abhijeet.sakhare@kotak.com
part of the Platts (S&Ps commodities business) work also being outsourced to CRISIL. Mumbai: +91-22-4336-0889

Kotak Institutional Equities Research

kotak.research@kotak.com
Mumbai: +91-22-4336-0000

For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
India NBFCs

SME ratings division is expected to remain under pressure. Growth in SME ratings is
driven by government budgetary allocation towards subsidizing rating fees by SMEs. Last
years union budget (FY2016) had increased the allocation to `2 bn for FY2017 from
`370 mn spent in FY2016. However, the actual allocation was only `557 mn, partly due
to stricter implementation norms. Recent Union Budget has further reduced the
budgetary allocation to only `100 mn. Our interaction with industry players suggests
investments by rating agencies towards sales staff and analytics to benefit from higher
budget allocation last year. However, sharp reduction in subsidy will lead to near-term
pressure on revenues and margins from this segment until rating agencies are able to
redeploy staff and cut their costs.

Several measures will drive ratings business over the medium-term. Over the
medium-term, ratings business will benefit from a number of structural changes aimed at
developing the corporate bond market and the ratings industry: (1) RBIs norms to limit
bank borrowings by large borrowers; (2) increase in credit enhancement for bond
issuances; (3) enhanced standards for credit rating agency leading to enhanced disclosure
by rating agencies; (4) Ministry of Finance has encouraged rating agencies to introduce
expected loss; (EL) ratings to enable infra projects to borrow from bond markets;
(5) measures to accept corporate bonds under RBIs liquidity window (LAF); (6) RBIs
recent draft for CP market mandates ratings by minimum two rating agencies;
(7) bankruptcy code will lead to further development in bond markets and increased
investments by institutional investors.

Exhibit 1: High contribution of research in CRISILs income

CRISILs income break-up, calendar year-ends, 2014-15 (Rs mn)

2014 2015
Rs mn (% of total) Rs mn (% of total)
Total income 12,533 100 13,798 100
Ratings 4,450 36 4,341 31
S&P 1,320 11 1,437 10
Domestic 3,130 25 2,904 21
Advisory 635 5 660 5
Reseach 7,449 59 8,797 64
Irevna 5,439 43 6,967 50
Pipal 282 2 265 2
Coalition 1,945 16 2,092 15
Adjustments (217) (2) (528) (4)

Source: Company, Kotak Institutional Equities

72 KOTAK INSTITUTIONAL EQUITIES RESEARCH

NBFCs India

Exhibit 2: 13% revenue CAGR over FY2011-16 Exhibit 3: 31% PBT margin in CY2016
Segment-wise revenues, December year-ends, 2008-16 (Rs mn) Segmental PBT margins, December 2008-16 (Rs mn)

Rating services Advisory services Research Rating services Advisory services

18,000 Research Overall
50

14,400
40

10,800
30

7,200 20

3,600 10

- -
2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Company, Kotak Institutional Equities Source: Company, Kotak Institutional Equities

Research strong, stable growth but faces few headwinds

Research (65% of revenue and 67% of segmental PBT) broadly comprises outsourced
financial research, risk & analytics, corporate research, business intelligence and India
research. India research and corporate research are likely to be small contributors with
majority contribution likely coming from outsourced financial research and risk & analytics.
Business intelligence is carried out by an acquired subsidiary, Coalition. Over the past few
years, research business is transitioning towards differentiated research and high-end risk &
analytics model from purely head-count driven growth model.

Sell-side support drives financial research. This division started as an offshore research
service provider for sell-side clients, primarily in equity research and diversifying to other
asset classes. Growth in this business is linked to growth in the number of analysts in the
front offices and penetration i.e. number of analysts getting support from an outsourcing
location (India, Argentina, etc.). Key challenges in the sell-side support businesses are (1)
decline in global IB revenue pool impacting the additions of headcount at front offices;
(2) possibility of greater number of sell-side firms setting up captive research support
units. Identifying these trends early, CRISIL has diversified client profile to cater to some of
the largest asset management firms. Credit risk is another area where the company has
increased its focus.

Risk & analytics is another business segment. Risk & analytics services include risk
management, regulatory compliance, quantitative research, model development and
validation and actuarial services. Regulatory changes such as Dodd-Frank, Basel III and
Solvency III are driving need for analytics, stress testing, compliance reporting, etc. Risk &
analytics remains a focus area for the company, with multi-year growth prospects.

Irevna is the key driver in the research division. Financial research and risk & analytics
are provided through Irevna. This segment contributed to about 75% of the research
income or 50% of CRISILs total income in CY2015. We await CY2016 annual report for
latest disclosures. This business has reported 25-28% income growth in CY2014-15.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 73

India NBFCs

Coalition (business intelligence) contributes to 22% of research revenue. Coalition

is a UK-based business intelligence service provider catering to global financial services/ IB
firms using proprietary analytics and algorithms to provide intelligence on market size,
revenue opportunities, competitor gap analysis. It is the world's largest provider of equity
and fixed income research services supporting around 90% of global market or over
2,000 stocks. Coalition was acquired by CRISIL in CY2012 for `2.5 bn with CY2015
revenues of `2.1 bn and PAT of `532 mn, contributing to 22% of research revenues.
Revenue growth declined to 8% yoy in CY2015 from 22% in CY2014. We await CY2016
annual report for recent revenue trends.

Pipal (corporate research) remains small. This segment provides research services to
corporates for operations and strategy; this is done through Pipal. CRISIL acquired Pipal in
FY2010 for `580 mn. Pipal was headquartered in Chicago and has centers in Gurgaon,
Noida and Bangalore. The business remains small with revenue of `265 mn in CY2015
(down 6% yoy).

India Research is small. This segment provides independent research services covering
economy, industry and companies across all major sectors. This segment is relatively much
smaller and unlikely to be a major growth driver for the company.

Exhibit 4: Research contributes to 65% of revenues Exhibit 5: Research contributes to 70% of PBT
Segment-wise revenue break-up, December 2008-16 (Rs mn) Segment-wise PBT break-up, December 2008-16 (Rs mn)

Rating services Advisory services Research Rating services Advisory services Research
100
100

80 80

60 60

40 40

20 20

- 0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Company, Kotak Institutional Equities Source: Company, Kotak Institutional Equities

Advisory is small
Advisory business (5% of revenue and 3% of segmental PBT) comprises infrastructure
advisory and risk solutions services. Infrastructure advisory advices governments, multilateral
agencies, large public and private sector firms, and investors. Risk solutions segment
provides a range of risk management tools, analytics and solutions to financial institutions,
banks, and corporates. Margins in the segment have contracted sharply to 2% in CY2016
from 27% in CY2011. This is possibly due to lower demand for advisory services and high,
inflexible cost base, in our view.

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NBFCs India

Exhibit 6: Key financials of CRISIL's subsidiaries

Calendar year-ends, 2013-2015 (Rs mn)

2013 2014 2015 YoY (%)

Irevna 4,327 5,439 6,967 28
Pipal 327 282 265 (6)
Coalition 1,595 1,945 2,092 8
Total income 6,249 7,666 9,324 22

Irevna 79 696 404 (42)

Pipal 43 37 35 (5)
Coalition 498 514 633 23
Total PBT 620 1,246 1,073 (14)

Irevna 76 676 378 (44)

Pipal 30 25 24 (2)
Coalition 368 413 532 29
Total PAT 474 1,113 934 (16)

Source: Companies, Kotak Institutional Equities

About CRISIL
CRISIL, Indias premier rating agency, has positioned itself as a global, research and analytics
focused business along with strong linkage to domestic investment cycle and development
of capital markets. CRISIL operates across seven countries with delivery centers in India,
Poland, China and Argentina. It has rated over 23,000 large and mid-sized corporate
customers and over 100,000 SMEs.

Exhibit 7: CRISIL trades at 30X CY2018E EPS

Valuation comps of rating agencies, March fiscal year-ends, 2017-19E

CMP EPS (Rs) PER (X) RoE (%) BVPS (Rs) P/B (X) DPS (Rs) Dividend yield (%)
(Rs) 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E
CARE 1,379 52 60 69 27 23 20 35 37 38 155 174 198 9 8 7 21 29 31 1.5 2.1 2.2
CRISIL 2,060 45 55 68 46 37 30 37 38 37 133 157 200 15 13 10 27 29 NA 2.0 2.1 NA
ICRA 4,054 85 99 113 48 41 36 17 18 19 515 575 649 8 7 6 27 27 31 2.0 2.0 2.2

Notes:
(1) CRISIL follows calender year-ends. Its finacials reflect CY2016-2018E respectively.
(2) We have considered Bloomberg consensus for the above.

Source: Company, Bloomberg

KOTAK INSTITUTIONAL EQUITIES RESEARCH 75