Skip to main content

Over-priced Anomalies In Bear Markets

One of the alluring things about investing is the prospect of rare sightings of anomalies. In a torrid market, typically, the universe of value Longs tends to expand relative to bull times. The opposite - an anomalous over-pricing in certain pockets - is rarer.

One such example is OneLife Capital Advisors Ltd (Bloomberg: OCAP IN; "OCAL" or "Company"), a recently listed Indian company engaged in providing financial intermediary services, an aspiring equity broking franchise and portfolio management services company. 

'Aspiring' is the operative word, as OCAL was incorporated in 2007 and commenced business in September 2009. As the Company admitted, there is little to look at in their limited operating history. Nevertheless, market participants enthusiastically bought into the Company's prospective story. Overall IPO was subscribed 1.53x, with retail participation at 2.5x allotted portion and Institutional interest at 1.02x.  

Investment Banking franchise dynamics
People are an investment banking franchise's key source of competitive advantage. Superior deal sourcing, well-entrenched network of corporate relationships and deal history help differentiate one player from another in this competitive industry. Moat can also be derived by specialising in niche pockets (e.g., debt restructuring/resolution, mezzanine financing). A generalist investment banking franchise with limited history of operations, promoter pedigree and key employees (there were 11 employees as of the IPO filing) competes from a rather weak position. OCAL has all the ingredients of this eclectic combination.

Broking franchise dynamics
Broking is a fiercely competitive business, bearing a natural correlation with the capital markets. Except for instances where a broker serves an underpopulated segment in the market, pricing power is low and players compete fiercely in a race to the bottom of the price pyramid. Other means of building a moat is timely and best execution, low slippages, pre-trade investment research, post-trade execution services and attractive terms on margin funding. 

Revenues are primarily a function of volumes. As a result, waning volumes in a weak/sideways moving market has a negative impact on business. Well-entrenched incumbents tend to buy growth or rely on ancillary activities to drive revenues. A new, small-sized entrant would run into a gladiatorial arena full of competitors. OCAL is in such a position.

Portfolio Management Services dynamics   
This is a typical hedge fund structure, with respect to fees, that is. Performance-wise, there isn't much to be said about this group as a whole, in both absolute or relative terms. 

Revenues can form a good annuity stream (upfront yearly management fee) with optionality driven by Carry (a cut of profits). Recurring revenues are contingent on assets under management, which encourages management to embark on asset-gathering exhibitions to support revenue growth, sometimes to the detriment of investment performance.  
  
Differentiation is largely a function of investment performance than fee structures. Long history of superior performance under (hopefully) the same investment manager lends much credibility and strong competitive positioning. OCAL neither has the track record nor the personnel to guide this operation. A majority of its recent IPO proceeds (~35%) was earmarked for this venture, which hitherto contributed nothing to its topline. Attracting the right talent for this venture would not only prove difficult, given its history, it would also entail a large capital outlay; which will likely keep expenses on a rapid growth trajectory relative to revenues. It is difficult to envision OCAL achieving sustainable profitability, let alone cash flow, in the medium-term, given the scheme of affairs.

With this background, it is insightful to glance at a quick comparison, contrasting OCAL with a competitor, Brescon Corporate Advisors Ltd (Bloomberg: BFS IN). BFS IN is an investment banking franchise specialising in debt syndication, restructuring and resolution services. It is also involved in real estate and private equity financing.


OCAP IN has doubled since listing in mid-October.


An all-in bet on a perfect future
My interactions with the lead manager to the issue were illuminating. OCAL's current investment banking mandates = $95 mm (have to rely on the weight of words of the management). The revenue stream is a fraction of this value and payments are received based on achievement of milestones.

Working with a rather liberal 50% p.a. growth rate in mandates over the next 3 years and a 5% fee arrangement (typical, 1%-2%), the mandates would translate into revenues of ~$15 mm, which would accrue to OCAL over a period.  

Moving on to Portfolio Management Services. $2.5 mm is the initial funding received from IPO proceeds. Let's assume Management manages to grow assets under management (alliteration unintended) to $200 mm over the next few years and can charge 3% of AUM as fixed-management fee (typical, 1.5-2.5%). This would translate into revenues of $6 mm. 

Equity broking is a function of volumes. The largest company, Religare Enterprises managed volumes of $800 mm / day in 2010-11. Assuming OCAL manages 10% of this and using an average brokerage rate, this business would add ~$10 mm to OCAL's revenues. One of the ways of running a low-cost brokerage operation is to focus solely on execution, without adding ancillaries such as research (which add to costs). It was unclear, from my interactions, whether OCAL intended to take this route. 

Summing the three revenue streams up, one arrives at around $30 mm (cumulative, over a 3-year period). The largest integrated financial intermediaries currently trade at a Market value / revenue of ~2x, which is the multiple OCAL is discounting based on its prevailing market value. We haven't even touched upon profitability...

Parting thoughts
For a company with minuscule revenue, limited history and anything-but-upbeat business prospects, the stock enjoys good short-term momentum trading interests (daily traded value = $8 mm)The run enjoyed by companies like OCAL is a characteristic generally commonplace in bull markets. 

Market participants are expecting a stupendous show from OCAP IN over the next few years. With a drop in trading volumes and slowing investment banking mandates, the environment has been tough for players like BFS IN and indeed, for many players in the financial intermediation services industry. A situation that is likely to persist over the near-term. Another possibility behind the strong stock performance 2 months post-listing could be a take-over attempt by a larger rival, which appears remote.

These are the sort of occasions when one misses the ability to initiate a short.

Disclosure: No position

Disclaimer: This is not meant to be an invitation to indulge in speculative activity. Please consult your adviser, and more importantly, your judgement, before making investment decisions.   









      

Comments

Popular posts from this blog

Book review: In the Long Run we are all Dead

In the Long Run we are all Dead: A Macroeconomics murder mystery The US economy faces a deep recession, raging inflation and an impending run on the dollar. President Wedik likes economics as much as a fish likes land. Should he listen to the Keynesians, who favour government intervention or the Monetarists, who favour market fundamentalism?

Unable to decide, he delegates the tough decision to his Chief of Staff, Admiral Harcourt Green. Green laboriously goes through the process of coming up with an economic policy package...only to be mysteriously murdered on D-day. Details of the economic package dies with him...
Something has to be done soon to avoid an economic collapse. What? How?
Who committed the murder? And why?
The murder story could probably have been constructed better but the crux of the book is economics! Recommend it to those looking for a light read on macroeconomics without running the risk of drowning in jargon.
In this delightfully light read, Wolfson & Buranelli, weav…

Napoleon’s Lucky Generals: "I know he's a good general, but is he lucky?"

With most market participants making money this year, the timeless quote by Napoleon in the subject line rears its head, once again. Regular non-readers know the wonderment I have on the impact of luck on investment outcomes.
The markets have been on a tear (sure you didn’t notice), and my mailbox/chat is seeing two polarized stances. On one side is the Bullish Apology. Where market participants pre-emptively share justifications for continued strong markets everywhere. This group exhibits hyper optimism, using recent history as the periscope through which to peer at and gauge the future. 
The second, and potentially, the more interesting group, is the Bubble Babble crowd. This group looks askance at the rallies, and deems things a bubble. This year has given this group a great polarizer. Bitcoin. A tiny bit know much about it. Most know a bit about it; yet there is a growing supply of those sharing their two coins, calling Bitcoin a bubble.
Both groups share certain characteristics. The…

Mind Of The Market - I : Pavlovian Conditioning, Paradoxes & The Psychology Of Herding

In what should evolve into a multi-part series, Mind of the Market will endeavour to peer under the hood of the largest laboratory of human psychology in the world; the financial markets. Where frigid numbers and emotive participants spar enthusiastically in an elaborate and often bewildering drama-in-motion. Where apparitions and reality merge so finely as to be mostly indistinguishable. Where paradoxes and circular relationships reign supreme, frequently, and fervently, questioning the very essence of rationality and cause-and-effect.
Part I addresses the dynamics of Pavlovian Conditioning and market participant response to stimuli in investment decision-making. Intriguing paradoxes and the behaviour of asset prices - a cause (and consequence) of market participant response - is considered concomitantly. Finally, the psychology of herding closes Part I.
Pavlovian Conditioning and Asset Price Behaviour When Ivan Pavlov discovered his lasting contribution to humanity - Classical Condi…