CAMS IPO Analysis by GSN Invest

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Before we get into the nitty-gritty of the core business that CAMS engages in, it is important to note how the market it serves and drives most (85%+) of its revenue from is poised to perform - the Mutual Fund market in India.

The Market Question

While the current sentiment around Mutual funds has been anything but impressive on the back of weak performance over a relatively long period of time, the secular drivers in favour of mutual funds are overwhelmingly positive.

India is a country of savers with our gross domestic savings rate at 30% ahead of developed countries UK and US at 16% and 18% and the global average at 25%. Falling rates, with the FED increasingly demonstrating intent to keep them low is likely to keep rates for the fixed income instruments Indian traditionally loved low, moving more money to the equity markets. This combined with an aggressive campaign has led to a 16% growth in total fund AUM over the 16-20 period, with a 18% growth in the Equity AUM (both funds houses and RTAs earn a higher take in the Equity segment). While India's market under-penetration led growth story is used in everything from toothpastes to autos, this is one of the few places it has a possibility of manifesting.

The Market Share Question

With that out of the way, lets understand what CAMS does and how it is performing in the segment. The firm acts as a registrar and transfer agent, managing everything from origination including KYC, transaction management, risk management, compliance and customer support.

There are three major registrar and transfer agents in the country - CAMS with ~70% Market share, Karvy with 27% Market share, and Franklin with 3% Market share.

For all practical purposes however it is a two player market. The small either continue to get smaller (eg: Franklin which serves only its own fund, dropped from 6% to 3% market share) or have been eaten by by a larger player (eg: Sundaram was acquired by Karvy), which leaves Karvy as the only legitimate competitor for CAMS. The question then is will this move towards a winner take all market or will it continue to exist as a competitive duopoly.

Both these players have created strong moats around themselves with a combination of strong branch networks ( 271 for CAMS, 203 for Karvy) and compliant and secure technology. It is also a relatively low cost item from the MF perspective, making switching both risky and not too financially fruitful.

A point to note here is that CAMS has 4 of the top 5 Mutual funds as clients, and these players are gaining share at a faster pace vs competition, which means CAMS will in all likelihood see improving market share without much effort at its end.

Other bets - The firm also has exposure to the AIF and insurance space, but it will be sometime before they are material drivers of the firm's growth/valuations.

The Pricing Question

With the customer stickiness relatively safe, lets look at the next part of the equation - how much can these firms make from their customers. The % of AUM fees that they charge clients varies with the amount of paper based transactions and the AUM. Meaning as firms grow larger, the percantage of the AUM they pay will go down, and as paper based transactions reduce, the % of AUM they pay you will go down.

With the big getting bigger emerging as a clear trend in the Mutual fund space, and paper based transactions going down in an increasingly digital world, the drivers on pricing are both secular and downward. The rates for Debt, Liquid and Passive funds AUM are even lower acting as a further dampener on pricing. As SEBI clamps down on the expense ratios of these firms, MF RTAs are bound to take a share of the hit.

In an otherwise rosy story this acts as a dampner. In any growth story you want to own the player who can take home most of the winnings from the growth, and in terms of MF RTAs this seems clearly missing.

The good bit is possibility of the competition undercutting and driving down rates further is extremely low. While CAMS runs at a 23.9% net margin and 3% return on Equity, its next (and for all practical purposes, only) competitor Karvy works at a 1% net margin and 3% return on Equity.

The Expense Question

Now that we know the drivers of revenue out of the way, let's look at the next piece of the puzzle, the key expenses the firm has and how they could move.

Employee expenses are the most important piece of the puzzle and has been moving between 35%-40% of topline. The firm employs 4200+ employees, including 2600+ back office, 500+ call center and 400+ software solutions employees. While the firm may see some relief on this line item in FY21 on the back on COVID backed paycuts, the expansion of the Mutual fund industry into B30 towns (towns other than the top 30) which will see lower AUM per branch and possible saturation in automation levels will likely seen this item staying high.

One key item where you could potentially see the benefits of scale kicking in is the service and software based expenses which have seen a secular decline across line items over the previous period. As the regulatory environment and competition settles, the rate of upgrades and changes can come down allowing for some incremental operating leverage to kick in.

Other important cash flows

As a final check lets have a look at working capital and capex intensity and whether either could be a major drag on cash flows. While its receivables have grown a lot faster than its payables, growing from 225cr to 320cr vs a 336cr to a 360cr growth in payables, the firm still maintains a negative working capital, While the growth in receivable days is slightly concerning, it is unlikely to be a major drag on cash flows anytime soon.

Capex intensity has been tapering from 6.5% to 2.1% over the last three years. With computers and equipment forming a bulk of the asset base, it would be fair to expect the item to see an uptick whenever these need a replacement (3-6years).

In summary - A good clean company in an attractive duopolistic market with exposure to the attractive Indian Mutual fund end-market offset by reduced pricing. Major expenses likely to be rigid limiting the margin expansion story.

If you would like to read our indepth analysis of 70 market leading Indian stocks analyzing stability, governance, growth and moats, head over here!


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