Mutual Fund AUM penetration in India is 12% of GDP vs the global average of ~60%. Emerging markets such as Brazil and SA are at ~50%. Overall MF in India has crossed INR 30 Trillion in FY21 by growing just under 20% over the last 5 years. As per estimates, overall MF in India will double over the next 5 years.
This capital light business has tremendous economies of scale since AMCs typically do not have to spend more in investment management and admin related expenses as they scale (this is a key reason why SEBI has set lower TERs for higher AUMs).
Moreover, this is a business where the big gets bigger since investors are more likely to park their capital with big recognized brands and also they are charged a lower expense ratio (owing to higher AUM sitting with the big brands)
By total QAAUM, UTI AMC is the eighth largest MF in India. It is one of the three AMCs listed. In an industry where AMCs are fighting tooth and nail over market share, if over the next 5 years, UTI AMC is able to grow its MF equity market share to 6.00% from 5.40% (as of FY21; 0.60% is huge when we are talking about an industry with INR 30 T in AUM) and maintain its market share in other MF segments and at the same time walk the talk around laser focused frugality (CEO has maintained that he is keeping a microscopic focus on employee expenses that are the most critical cost line item), then the current market valuation of INR 11,000 cr is very reasonable. Swings in projected market share and expenses either way reflects in the fair valuation.
Industry
Within MF, ETF (others) is the fastest (72%) growing category, following by Equity (26%)
Debt(income) has been on the decline, while equity has been sturdy at 42% and ETF(others) has been gaining AUM share.
As per CRISIL, Equity is estimated to increase its share to 46% and overall MF AUM is expected to double over the next 5 years.
Why MF segment composition is important? Mutual Funds are permitted to charge certain operating expenses for managing a mutual fund scheme โ such as sales & marketing / advertising expenses, administrative expenses, transaction costs, investment management fees, audit fees โ as a percentage of the fundโs daily AUM. All such costs for running and managing a mutual fund scheme are collectively referred to as โTotal Expense Ratioโ (TER), calculated as a percentage of the Schemeโs average Net Asset Value (NAV). SEBI has set different TERs for different asset classes. While, equity is allowed to charge a higher TER, whereas ETF being a passive investment segment has a significantly lower TER. Why this business has tremendous economies of scale? For schemes within each asset class, TER reduces with increasing values of AUM. The rationale of charging lower TER (on higher AUM) is that operating expenses for AMCs do not increase much with rising AUMs. While AMCs may be required to shell out more on marketing and sales, but admin and investment management costs typically do not increase as they scale and acquire higher AUM. Understandably, SEBI does not let AMCs charge the same TER as they scale since this business has tremendous economies of scale.
UTI AMC
Mutual Fund: UTI AMC Domestic Mutual Fund QAAUM was INR 1,829 billion as of 31 March, 2021, which accounted for approximately 5.69%, or the eighth largest amount, of the total QAAUM invested in all mutual funds in India. Of all the asset classes or segments within MF, equity (including hybrid) have higher yields. When AMCs talk about MF AUM, the first question one should ask is how much of it is ETF (which is very low yield), how much of it is equity (high yield) and how much of it is debt (med yield). AMCs hardly make money on ETFs, since they does not require active management. As of 31 March, 2021, 40% of UTI AMC’s MF was equity-related (included hybrid) and 23% was ETF. Rest was debt (income) and liquid.
Portfolio Management Services (PMS): UTI AMC has got the mandate to manage 55.0% of the total corpus on 31 October, 2019 of the Central Board of Trustees, EPF, accounting for INR 6,635 billion as on 31 March, 2021, which is 84.65% of their PMS AUM as of 31 March, 2021. This is great, but it is of low value since PMS has a very low yield (refer exhibit-5)
Refer to exhibit 5. Equity (and hybrid) asset class has a significantly higher sales of service (or investment management revenue) as a % of QAAUM. It has been reducing since not only the segment AUM has increased over the years, but also the investment management revenue % is based on net daily AUM (which is highly contingent upon everyday inflows and outflows) and not the average AUM by the end of a quarter or fiscal. Moreover, in FY21, industry equity AUM witnessed a net outflow, hence AUM increase was entirely as a result of equity appreciation.
1. Revenue Projections
In my bear case, I assume that UTI will be able to sustain the same market share across all MF segments. With UTI’s focus towards grabbing a higher market share, I assume slightly higher market shares in my base and bull cases. Across the three cases, I assume that PMS, IB and RS AUMs will grow at inflation rate. UTI intends to develop its AIF business so I have assumed 2x inflation growth rate for this business. Now this very well may not be true, but I can live with these assumptions for now since they do not move the needle a lot (unless of course the AUMs in these business grow substantially). I will change my assumptions as and when I hear any specific management commentary on these subsidiaries.
Refer exhibit-7. For each of the MF segments, I have projected investment management fees as a % of respective AUMs based on historical numbers. I have assumed a slightly declining trend since TERs reduce with rising AUMs. Note that I have combined equity and hybrid and started with a weighted average in management fees in 2022. For subsidiaries IB, AID and RS, I have taken the past 4 year average management fees %.
Based on the forecasts in exhibit 6 and 7, I project out revenue over the next 5 years. Revenue = Projected Investment Fees % of AUM (exhibit 7) x Projected AUM (exhibit 6).
2. Cost Projections
There is a lot of analyst and management commentary on employee expense in the earnings call transcript since it is the most critical cost line item. I have considered the management communicated employee net fixed cost decline of ~65 cr (or 0.65 B; over the course of next 4 years) as a result of their ongoing employee retirement program. Moreover, I have also baked in the remaining ESOP expenses of 17 cr of the next two year as per the management commentary. Although, this business has significant economies of scale, they are required to pay for sales related performance incentives in order to gain market share. I computed unit variable expenses per billion increase in MF AUM (sans ETF and Liquid) in FY21 and used it to project variable expenses in future years. I assumed that rest of the fixed employee expenses increase at inflation rate.
Then I go on to extrapolate historical Fees & Commissions and Other expenses as a % of MF AUM and Depreciation & Amortization as a % of gross assets to project these expenses in the future.
3. CapEx Projections
In FY21, UTI AMC did a CapEx of close to INR 60 cr or INR 0.6 B. To project capital expenses, I compute the gross assets required to increase one billion MF AUM in FY21 (i.e. total gross assets in FY21 / increase in MF AUM). Let’s call it “CapEx increase factor”. Since this is a capital light business, it does not require significant capital expenses as they scale, hence I decline this factor over future years to project out the CapEx needed every year. I assume that maintenance CapEx needed every year is last year’s depreciation and amortization expense.
4. Working Capital Projections
This is fairly straight forward. I baseline current assets and liabilities baselines as a % of revenue and use the baseline to extrapolate current assets and liabilities in the future. I use the same working capital projections for my three cases.
I use these projections to build the P&L
Valuation
With all ingredients estimated, I go onto value the UTI AMC’s equity.
Free Cash Flow to Equity = Net Profit + Depreciation – CapEx – Change in Working Capital
I assume that the business will grow at the risk free rate in perpetuity. I go on to discount the estimated FCFE using firm’s cost of equity to arrive at the fair equity value of INR 10,286 Cr (or INR 102.86 B)
Summary
As per my base case, the equity is slightly overpriced by 9% as of 7/18/21. I’d call it is reasonably valued. In my bear case, I assume that UTI AMC sustains its market share across all MF segments. Bear case is in no way harsh since even sustaining market share require a lot of work with all AMCs competing for higher share.
By total QAAUM, UTI AMC is the eighth largest MF in India. In this business, the big gets bigger since institutional and retail investors (particularly, direct retail) are more likely to park their capital with a big recognized brand and also they are charged a lower expense ratio (owing to higher AUM sitting with the bigger brand). What is going well for UTI AMC is that it has the highest penetration in B30 cities that command a higher MF AUM yield as compared to T30 cities. If UTI AMC is able to leverage its existing distributor B30 (and T30) footprint to increase market share and at the same time walk the talk around frugality (CEO has maintained that he is keeping a microscopic focus on employee expenses), then my base (and even bull case) is probable.
Hope this has helped. Give me a shout out for any questions on valuation. I will likely make a video in one of the coming weekends to give a detail walk through on modeling all the financial statements of UTI AMC. Please note that this writing is purely for educational purposes. Investors are advised to do their own analysis.
Thanks for reading.