Market share gainer, while maintaining best-in-class margins: CARE is the second largest rating agency in India, with large PSU banks such as IDBI, Canara and SBI, being its prominent shareholders (pre-offer combined shareholding of 58.2%). CARE has garnered market share from its globally affiliated peers in the past few years and even while doing so, it has maintained its superior margins. Overall the operating margins for CARE have been significantly higher, as unlike its other two listed peers, its sole business segment currently is rating services, which has enjoyed higher margins than research or any other division. Even comparing the ratings business, CARE has witnessed impressive EBIT margins (71% in FY2012) which are substantially higher than that of its peers (ICRAs 48% in FY2012, and CRISILs 40% in CY2011), which as per the management, is primarily due to a) lower employee costs owing to its low-cost centralized back office at Ahmedabad (staff costs as a percentage to revenues are almost half vs. peers) and b) relatively lower SME/MSE ratings business (which involves lower margins on account of its lower revenue per customer).
Rating business to primarily drive top-line growth for next few years: Rating business will remain company’s sole business segment at least in the next few years. Considering credit growth estimates of 15-17% over the next few years and efforts for growing our nascent debt market, we expect CARE to register at least similar kind of growth in its volume of debt rated. However, considering the fact that its revenue stream has stabilized now, and intention to increase presence in SME/MSE ratings, we expect growth in its revenue to be approx. 200-300bp lower than the growth in its volume. Migration to IRB approach, in our view will affect the most to the rating agency which has major part of its business coming from SME/MSE ratings (as smaller enterprises normally take loan from a single bank as against larger ones which usually avail loan from consortium of banks, all of whom might not be approved for IRB). Having said that, a relatively smaller SME/MSE rating business for CARE (entered only in FY2011) and ample time to develop other alternative revenue streams (as impact of IRB on business will not be before FY2016), gives us adequate comfort to believe that the impact would be manageable for the company.
Outlook and valuation: The stock is valued at 17.9x at upper band on TTM earnings (taking 2HFY2012 earnings to be 60% of entire FY2012), which is at a ~18% discount to ICRA and ~45% discount to CRISIL. Even on a TTM EV/EBITDA basis, it is valued at ~39% discount to CRISIL and ~33% to CARE. However, on a TTM EV/Sales basis, it is valued at ~27% premium to CRISIL and ~63% premium to ICRA, which is due to its high margins (likely to have a downward bias from here on). Moreover, the company has reported cash and current investments worth `91/share as of 1HFY2013. Overall, considering the high intellectual capital/knowledge-oriented and cash generating nature of the business, combined with reasonable 12-15% revenue growth expectation, we believe the IPO is reasonably priced at the upper band. Hence, we recommend subscribe to the issue.

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