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Kotak Mahindra: Betting on subsidiaries

May 25, 2001

Non-banking finance (NBFC) sector is facing tough times with increasing competition from banks and financial institutions. Very few NBFCs have survived in the last decade and Kotak Mahindra Finance Ltd. (KMFL) is one of them.The company has taken severe hit in its profits in the last two years by making higher provisions for non-performing assets. Its main business is vehicle financing and corporate lending which contributes over 55% to its total income. The company’s subsidiary model has proved to be a successful. Apart from car financing, it is also engaged in investment banking, mutual funds, insurance and personal loans businesses.

During the year, the company has restructured the business model, which is expected to boost its revenue growth. KMFL has divested the stake in its IT subsidiary Matrix Information Services Ltd. to Friday Corp and incurred a loss. But it has come out of this non-core business. The company has exited the business of consumer durable financing which it started in early 1999, under the ‘K Value’ brand name. The business was making losses due to high administrative costs.

It has acquired the business of Kotak Securties (KS), which is one of the most profitable firms by announcing a merger with Pannier Trading Company. Pannier holds 75% stake in KS, which consequently will come under the direct holding of KMFL. Another strategic move was the acquisition of forex broking business of Uday Kotak through a subsidiary of the company. KMFL has recently entered the mutual fund business in a joint venture with OM Mutual of UK. It has invested Rs 740 m for 74% stake and plans to sell about 25,000 policies in the current year.

For diversifying the revenue base, KMFL has entered into structured financing which is relatively a new concept in India. The company gets around 10% of its revenues from this business with low risk. KFFL lends to the low rated companies but its future cash flows are secured from a superior rate companies. Thus, the risk gets minimized. But the securitisation laws are not very clear in India. As a result, the business will take time to pick up.

Interestingly, KMFL has decided to open a wholly owned subsidiary for commercial banking. The company has already applied for the RBI license. The banking business has a lot of synergies associated with the lending business of the company with its current client base of about 150,000. It will have an opportunity to cross sell its products through these subsidiaries, which would boost its sluggish topline growth. The company’s total income for the first nine months of FY01 increased by 10% and profits grew by a mere 0.7%. It however aims to achieve higher growth rates in future with the increasing proportion of revenues from subsidiaries.

At the current market price of Rs 55, KMFL is trading at a P/E of 5 times 9 months FY01 annualised earnings. Its price to book value ratio of 0.5x reflects the concerns of investors over the success of NBFC companies in this competitive scenario. The earnings growth of KMFL is likely to remain depressed in the medium term with the high cost of funds and a slowdown in the industrial activity. The challenge for the company now is to generate returns from its investments in insurance, mutual funds and other investment subsidiaries.

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