Sebi's move on expense ratio puts paid to Avendus Capital-IDFC MF deal

The financial services firm revised its bid, fearing the new structure's impact on profitability

The capital markets regulator Securities and Exchange Board of India’s (Sebi) decision to tweak the total expense ratio (TER) structure for the Rs 24-trillion mutual fund (MF) industry is a key reason for the deal between IDFC MF and Avendus Capital collapsing, said people with the direct knowledge of the development. 

The deal between Avendus and IDFC had reached advanced stages. According to people in the know, Avendus revised its bid after the TER structure was tweaked, fearing impact on the fund house’s profitability. They added that as Avendus’ new offer was much lower than its earlier bid, IDFC had to turn down the offer.

As reported earlier, IDFC MF was seeking valuation of around Rs 35 billion. The revised bid of Avendus couldn’t be ascertained, but people in the know said it was “significantly lower” than what IDFC MF was expecting. In October, the regulator had capped the maximum TER at 2.25 per cent, from the earlier 2.5 per cent. The change in TER ceiling was seen as weighing on the near-term profitability of mid- and small-sized fund houses. In a research note, CLSA analysts said that the cut in TERs could have a 25 per cent impact on the mutual fund industry’s earnings.

“IDFC has decided to put the sale on hold. It will see how the changes to the expense structure impact its profitability over the next few quarters,” said a person in the know. 

At Rs 35 billion valuation, the multiple stood at 65 times IDFC MF’s FY18 profits. The fund house had seen its profits shrink over the past three years.  From Rs 1.1 billion in FY16, profits after tax halved to Rs 540 million in FY18. Equity-oriented funds, which typically have a higher contribution to profitability, accounted for 30 per cent of the firm’s total assets under management (AUM) of Rs 650 billion as of end-March.  In the last five years — between the September 2014 quarter and the September 2018 quarter — the average assets managed of IDFC MF grew 50 per cent. Over the same period, the industry assets have more than doubled.  

According to people in the know, IDFC had also reached out to Mahindra MF but didn’t find any takers there as the business focus of the two fund houses didn’t align. 

Reliance MF also pulled out due to valuations. According to an official, IDFC MF is seeing better growth opportunities in the retail segment. Analysts said that retail focus can also help the fund house in improving its bottom-line growth, which could lead to better value for the overall business.

Meanwhile, KKR-backed Avendus’ MF foray is on the drawing board. Sources said Avendus will continue to look for opportunities in the MF industry and broader asset management space if valuations are attractive. The firm has already made a foray into the alternate investment funds (AIF).