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India’s foremost rating agency CRISIL recently bought 8.8 percent in rival CARE for Rs 436 crore, or Rs 1660 per share.While prima facie this appears to be a financial transaction, we feel this may just be the beginning of an oligopolistic industry riding on several favourable macro tailwinds.

How should investors be positioned?

The Indian rating market is oligopolistic as is the nature of this industry globally. The three listed entities reported a combined revenue of Rs 2166 crore in FY17 and rating revenue of Rs 962 crore. In the ratings market in FY17, the market leader was CRISIL followed by CARE.

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Thus the No 1 player picking up a stake in No 2 is more than just a financial transaction.

Macro Opportunity

Ratings business globally is a high entry-barrier market and players in this segment benefit from the macro opportunities. In India, rating agencies are likely to benefit from the secular growth owing to the RBI’s initiatives to deepen the under-penetrated bond market and untapped potential from the small and medium Enterprise (SME) segment. The ongoing clean-up of the bad loans in the banking sector coupled with the resumption of long-buried capex cycle are the other tailwinds that the industry can look forward to.

CRISIL vs CARE

While CRISIL is a much bigger entity and has a larger market share in the rating business, over the years, the faster growth in other businesses has resulted in a decline in share of ratings business. In the past four years, while CRISIL’s overall revenue has grown at a CAGR (compounded Annual Growth Rate) of 12 percent, the growth in ratings was a much more modest 4 percent.

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CARE, on the other hand, with a singular focus on ratings, grew its revenue at a CAGR of 9 percent in the past four years to occupy the second position in this highly margin accretive business. Although CARE lacks the revenue diversification, its position in the ratings business has strengthened and the company derives 90 percent of its revenue from corporate bonds and bank loan rating whereas SME rating is yet to make its mark.

So from the perspective of the rating business, the coming together of the two entities makes business sense.

Why an integration cannot be ruled out

The shareholding pattern of the two entities makes us think that this is not altogether improbable. CRISIL has a rating company parentage with global rating agency S&P owning 67 percent of the entity, CARE, however, doesn’t have a backing of any notable rating agency and, in fact, has a diversified shareholding with no identified promoter. For an acquirer, that makes the task of upping stake from a position of minority to majority an easier task.

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Does the valuation still make sense for an investor?

The recent transaction of CARE took place at a valuation of 32 times its reported earnings of FY17, which is at a discount to the reported valuation of CRISIL at 42X its reported earnings.CRISIL is the market leader and has a strong global parentage (hence, always enjoys an embedded de-listing premium) and has multiple levers of growth.However, seen in the context of the inorganic opportunity, shareholders of CARE may have a rosier path ahead as the shareholding pattern, its dominant position makes it an ideal choice for future inorganic opportunities in this space.

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In terms of stock performance, CARE has outperformed its listed peers by a wide margin. In the past one year, the stock has risen over 61 percent in contrast to no returns generated by its rival listed peers. However, despite its superior margin profile, growth trajectory and the overt inorganic appeal, the stock still is the cheapest amongst its listed peers.Investors looking at long-term returns from the secular growth opportunity in the ratings space got to keep in mind the unique moats offered by CARE.

Last modified on Monday, 03 July 2017

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