Stake-sale talks open race between rating agencies

Stocks of Indian rating agencies have been witnessing unusual action of late, with stake-sale talks doing the rounds. CARE’s four principal shareholders holding 45 per cent stake in the company, have made public their intention of off-loading their holdings; they have also increased the limit for FII investment to 74 per cent. This was followed by Moody’s open offer to up its stake in rival ICRA by 26.5 per cent.

While CARE’s stake sale hasn’t gone as planned, with the shareholders rejecting the only bid, it is clear that foreign rating agencies as well as PE investors are taking an active interest in the rating agencies. Only last year, S&P, the parent of CRISIL, had made an open offer to increase its stake in the company to 75 per cent, and took its stake up to 68 per cent.

Rating agencies represent an indirect bet on the nascent Indian corporate bond market. Both bank loan ratings and corporate bond ratings account for a significant portion of rated debt. The size of the debt market (as a per cent of GDP) in India is at a fraction of that in developed markets. This presents a huge business opportunity for rating agencies to grow their mandates and thus their rating fee income. Recent moves by the Government and regulators to deepen the bond market are expected to brighten the prospects of Indian rating agencies.

A peaking out of the domestic interest rate cycle should also help issuances. As the Fed gradually reduces its bond purchases in the US, global players may also look for opportunities in the emerging markets to drive incremental growth.

In India, of the six ratings agencies, ICRA, CARE and CRISIL hold the lion’s share of 85 per cent in the market. Both CRISIL and ICRA have foreign ownership, while CARE doesn’t have one. Globally, Moody’s and S&P have equal market share of 40 per cent each. However, there is a key difference in the extent of involvement they have in their Indian counterparts.

In the case of ICRA, Moody’s holds a non-controlling 28.5 per cent stake. This is in stark contrast to S&P which has a controlling stake of 67.7 per cent in CRISIL. ICRA’s ratings revenues contribute close to 60 per cent of total revenues, while outsourced services which mainly comprise of work from Moody’s is only 9 per cent of revenues.

In the case of CRISIL, ratings revenues make up 40 per cent and more than a third of this is from services provided to S&P. CARE on the other hand, is a pure Indian rating agency, and has only recently started to expand internationally.

After the recent announcement by Moody’s to up its stake in its Indian arm at a 26 per cent premium to its prevailing market price, the stock of ICRA has shot up by 20 per cent. On multiples, the stock now trades at par with CRISIL at 23 times one-year forward earnings. ICRA has always traded at a discount of 18-20 per cent to CRISIL. But Moody’s higher stake in the company may bring in revenue opportunities for ICRA taking up its valuation in the coming months.

The stock of CARE has remained at a valuation of just 15 times forward earnings, a significant discount to the other two. The lack of diversification in its revenue base and global growth opportunities a la CRISIL has curtailed valuations. But CARE does have a relatively healthy share in rating revenues, and sports operating profit margins of about 65 per cent vis-à-vis other players at 30-35 per cent. If its shareholders hold out for a premium from interested foreign players, there may be further scope for the CARE stock to play catch up with its larger rivals.