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Divestment of its Asset Management business will further strengthen the balance Sheet

* L&T Financial Holdings (LTFH) has entered into a definitive agreement with HSBC AMC, in which the latter will acquire 100% stake in L&T Investment Management (LTIM), the investment manager of L&T Mutual Fund (LTMF), for USD425m. In addition, LTFH will also be entitled to excess cash (INR5- 7b) in LTIM’s books until the completion of this divestment/acquisition.

* Including the excess cash (except the minimum cash requirement of INR0.5-1b) that LTFH is entitled to, the total sale consideration would be INR37-39b (4.6-4.8% of current AUM).

* HSBC AMC would merge its existing Asset Management business (Sep’21 AUM of INR117b) with that of LTMF (Sep’21 AUM of INR803b). Subject to all regulatory approvals, LTFH expects this transaction to be completed within the next 9-12 months (i.e. by Dec’22).

* Consequent to its last rights issue in Feb’21, wherein LTFH raised INR30b, its capital adequacy is at a healthy ~25% (Tier I: 20%). While the sale of the Asset Management business will take another 9-12 months to be consummated, we believe LTFH will utilize the proceeds primarily for risk capital (improving the provisioning cover) and only a small portion for growth capital (given its already healthy capital adequacy). Alternatively, part of the gains from this transaction could also be paid out as dividends.

* As highlighted earlier, LTFH is near the bottom in terms of consolidation of its loan book and should start exhibiting loan growth in 2HFY22E. NPA recognition of a large Real Estate account in 2QFY22 has removed an overhang of potential asset quality stress and will allow LTFH to work towards its resolution. We have not made any changes to our estimates (as yet) and factor in a 7%/11% loan growth in FY23E/FY24E. We maintain our Buy rating with an unchanged TP of INR110 per share (1.2x Sep’23E consolidated BVPS).

Did LTFH get a fair valuation for its Asset Management business?

* Among listed peers, UTI AMC, with an AUM of INR2.3t, is the closest to L&TMF at INR812b. In terms of market capitalization-to-AUM ratio, UTI AMC trades at 5.6%, whereas P/E on an annualized 1HFY22 earnings stands at 18.2x. As per the deal contours, L&TMF’s assets have been valued at 4.6% of AUM and 19.3x annualized 1HFY22 P/E, which appears reasonable (refer Exhibit 3).

Sensitivity Analysis: Impact on EPS, book value, and capital adequacy

* The divestment of the MF business will result in an extraordinary EPS of INR7.6 in FY23E (refer Exhibit 4).

* Ceteris paribus and assuming the entire proceeds from the sale of the MF business is retained for growth and risk capital, this will increase BVPS by 6-8% and CRAR by 150-190bp over FY23-24E (refer Exhibits 5 and 6).

A value accretive acquisition for HSBC AMC at reasonable valuations

* The combined entity will be the 12th largest player in the industry in terms of total AUM (~INR940b, refer Exhibit 1).

* In terms of product mix, while HSBC AMC garners 56% of AUM from liquid and debt schemes, LTMF derives 59% of its AUM from equity and balanced schemes. The combined entity will command 43% from liquid and debt schemes and 56% from equity and balanced schemes. Equity assets earn higher yields (80-90bp) v/s debt (35-40bp) and liquid (12-14bp) schemes.

* LTMF has a higher share of Retail assets, which are relatively stickier in nature. Retail contributed 32%/11% of AUM for LTMF/HSBC AMC. The combined entity will command 29% of Retail assets (refer Exhibit 1).

* With regards to geographic spread, LTMF, owing to its wide distribution reach, has been able to garner 12% of its AUM from B30 assets as compared to 7% for HSBC. The combined entity will garner 11% contribution from B30 assets (refer Exhibit 1).

Valuation and view

* Divestment of the Asset Management business to HSBC AMC is in line with LTFH’s objective of unlocking value from its subsidiaries and strengthening its Balance Sheet for the Lending business. Given its healthy capital adequacy of over 25% and expected proceeds from the sale of the MF business, LTFH is now in a position to aggressively push forward towards its stated long-term goal of retailization of its lending portfolio.

* Our recent channel checks suggest that while rural demand was recently impacted because of unseasonal rainfall and delay in farm cash flows, this segment (except 2W) has maintained the run-rate achieved in Sep’21 in 3QFY22 as well. We reiterate our view that LTFH is near the bottom in terms of consolidation of its loan book, with an expected pickup in Infra disbursements and Retail Housing/LAP. Even though we remain watchful of potential slippages in Real Estate Finance in 2HFY22, given the buoyancy in the Real Estate sector, we expect resolutions of such exposures to be relatively quicker.

* LTFH carries adequate additional provisions (including OTR provisions) of 2.2% of standard loans. These are over and above ECL provisions and should provide the necessary buffer to protect against contingencies in Micro loans and the Real Estate segment. We have not made any changes to our estimates (as yet) and maintain our Buy rating on the stock with an unchanged TP of INR110 (1.2x Sep’23E consolidated BVPS).

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