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12th June, 2009

Deepak Chitroda
Outlook PROFIT
12 June 2009

A more diversified Indian company than this will be rare to find. Aditya Birla Nuvo (ABN) is a conglomerate in the true sense with more than ten different businesses ranging from fertilisers, textiles, insulators, financial services and telecom. But if one is buying into Nuvo, it will be more for its high growth businesses: insurance and telecom, which account for nearly half of its revenues.

One round of value unlocking happened for the company after it sold a 4.8 per cent stake in its telecom business last year. The market has been waiting for the next trigger to unlock the value embedded in the financial services business, particularly insurance. After the UPA win that trigger may have already played out for the stock as it surged 39 per cent after the UPA win. The market seems to have already counted in the chicken in the form of a hike in FDI for insurance from the current 26 per cent. If it happens, the company could cash in on its holdings - at least a part of it.

Already the company has been talking about creating a holding company to house its financial services business comprising asset management, insurance, stock broking and distribution and then roping in a private equity partner at the subsidiary level. "To create long term synergy and give a sharper focus to the financial services business, we are thinking of a common structure." says Sushil Agarwal, the newly appointed chief financial officer of Aditya Birla Nuvo.

In 2008, since its spin-off, Idea Cellular has grown bigger organically and also through the acquisition of Spice Communications. Idea later sold 20 per cent stake in its subsidiary company to private equity players. Providence and TMI, raking in $640 million in 2008.

Something similar for financial services will infuse cash into the company's books, which will address its high leverage and future growth concerns. "We keep on evaluating funding options and may unlock value for Nuvo and its shareholders by listing a few of these growth businesses after they attain the required size," says Agarwal. That's something the insurance and financial services businesses have achieved in recent years.

Feeling assured
Of the five businesses under the financial services group, life insurance and asset management have come out trumps. Nuvo holds 74 per cent in Birla Sun Life Insurance and 50 per cent in Birla Sun Life Asset Management Company, joint ventures with Canada's Sun Life. Besides, Nuvo recently bought Apollo Sindhoori from the Chennai based Reddy family to scale up its stock broking business and increased its stake in the distribution and wealth management company, Birla Sun Life Distribution, by purchasing Sun Life's 50 per cent stake.

But, for now, it's the life insurance business that is building up a tempo. Even in a tumultuous FY09, Birla Sun Life, the fifth-largest private life insurer, clocked robust volume growth and gained market share even as others struggled. The company's market share in new premium income increased from 7.8 per cent in March 2008 to 10.4 per cent by end of FY09. The company opened 261 branches during the year. thus, taking its tally to 600 branches. Besides, its direct sales force grew from 1.15 lakh agents to over 1.65 lakh agents. Consequently, the company's overall market share increased to 8.5 per cent from the 6.6 per cent it achieved in the previous year. Says Agarwal, "Even in such a challenging environment, Birla Sun Life's new business premium grew by 44 per cent against a 3 per cent de-growth for the industry."

The other side of the growth story is that the frenetic pace has resulted in the insurance venture's operating losses surging 57 per cent to Rs. 687 crore. Birla Sun Life will require funding over the next couple of years before it breaks even. In FY10, the company would require approximately Rs. 500 crore to sustain its growth. Though Nuvo's investment in the insurance business has traditionally been through its standalone balance sheet, its high debt equity ratio now makes fresh debt a risky affair.

Mutual gains
If the life insurance business has been a success story, so has been the asset management business which saw assets grow at an average 31 per cent in FY09 compared with the industry growth of 7 per cent. Birla Sun Life AMC also increased its market share to 9.5 per cent from 6.8 per cent in the previous year. More importantly, the mutual fund, which has more than 87 per cent of its total assets in the debt and liquid category, has managed to increase its net profit by 182 per cent to Rs. 7.9 crore. Cost efficiency and a wider distribution base worked in favour of the AMC.

Additionally, to take advantage of cross-selling opportunities with existing insurance and mutual fund business, the company acquired 76 per cent stake in Apollo Sindhoori Capital Investment, which had clocked revenues of Rs. 83 crore in FY09, for Rs. 252 crore. "This will strengthen our position as an integrated and broad based manufacturer and distributor of financial services," says Agarwal.

Investment potential
Even as the group revs up its financial services business, it would need to pump in funds and that's the concern. Last fiscal, the Birla group dropped its warrant conversion plan as the Nuvo stock was singed in the market meltdown. The company had allotted 2.05 crore preferential warrants in April 2008 at Rs. 1,997 (conversion was due in September) to its promoters. The conversion would have infused Rs. 4,000 crore into the company, but the almost 75 per cent decline in share price played spoilsport.

Though the company has once again revived its warrant conversion plan, the extent of fund infusion will be limited to only Rs. 1.000 crore. Analysts believe debt is the last resort for the company as leveraging (1.5x in FY09) is already high. In FY09, Nuvo raised Rs. 1.500 crore debt, hence, any fresh borrowings will be a dampener for the stock, say analysts. However, the market is feeling good about the equity infusion. "This could turn out to be a key trigger for a re-rating as the fresh equity infusion will bring down the interest cost and the performance of the stock may be better than estimated," says Abhijeet Bora, analyst with Sharekhan.

The Idea is working!
While the insurance business is in dire need of cash, Nuvo's telecom business is in a sweet spot. Idea has a sound balance sheet following the private equity placement. "Cash inflow from Providence Equity Partners is a cushion for financing new roll outs, expansion in existing service areas and 3G spectrum auctions," says Agarwal. Besides, FY09 turned out to be a good year for Idea Cellular as its subscriber base grew by 62 per cent compared with the industry growth of 50 per cent. In June 2008, Idea acquired Spice Communications, which gave it access to two new circles. Besides, the company rolled out services in three new circles during the year, which along with the acquisition of Spice, gave it a market share of 11 per cent.

The company is now planning to roll out services in six additional circles by December 2009. Analysts believe that though the expansion may put pressure on earnings over the next few quarters, Idea has the opportunity to create significant shareholder value if it executes its strategy well. Besides, what holds good for Idea in the near term is its 16 per cent stake in Indus, the three-way telecom tower venture between Bharti Airtel and Vodafone Essar. Nomura Securities has valued Indus, which has over 90,000 towers across 16 service circles, at $9.5 billion. If market sentiment stays bullish, analysts expect Indus to go the listing way.

Other businesses
If one looks beyond the two businesses, Nuvo looks a tad jaded. The economic slowdown has taken the steam off its textiles and garments businesses. Garments, which contribute close to 8 per cent of the revenues, suffered owing to higher discount offers and lease rentals, while textiles slumped on weak export orders. "The company is expecting to save around Rs. 100 crore in FY10 from its cost-cutting initiatives including rent re-negotiation, tighter working capital management and overheads reduction," says Bora of Sharekhan.

High-cost inventory in its businesses such as carbon black has also put pressure on profitability. While analysts expect profitability in these businesses to revive after existing inventory runs down, there is unlikely to be any significant improvement in their outlook. After posting a consolidated loss of Rs. 430 crore, analysts expect losses to come down in FY10 owing to lower raw material costs and cost cutting initiatives, besides fresh fund infusion. But, for analysts, telecom and financial services remain the largest value drivers.

Valuation call
Nuvo has a market cap of close to Rs. 7,250 crore. To put this in perspective, Reliance Capital, a pure financial services company, commands a market cap of Rs. 22,177 crore. On the basis of the sum-of-part valuations, most analysts value Nuvo at about Rs. 630 (after conglomerate discount of 30 per cent). At current prices, the stock is quoting at a 21 per cent premium to this valuation. At this price, there is nothing on the table for investors.