IDFC First Bank Limited

I’ll agree with @RaghuG on this one. One has to understand how PE works.

The money in private equity usually comes in tranches which is then allotted to specific product (a closed illiquid fund) with a maturity date in 5/8/10/12 years. So when the fund reaches maturity they will have to sell all of its holding whether they are publicly listed or privately held and return the money back to the investors (the investor has to pay tax on the gains he or she has made at the end of the). Just before they liquidate the fund, PE firms will open new products (funds) for subscription. The idea being the investor who is about to receive his money from liquidation will once again subscribe to the new fund if he or she made a decent profit. Shall the investor decide to stay with the same PE and subscribe to a new product, the manager of the product (fund) might end up buying even the same stock few months later!

Understand the incentives over here: The PE makes a handsome 2% over the duration of the fund as management fees (on the AUM) and another 20% when assets are liquidated as performance fees. If the investor is lucky enough to make a profit he/she/it will have to pay capital gains tax and the after tax capital is once again reinvested into the new product for another 5-12 years! If the investor suffers a loss at the end of the duration the PE still ends up making 2% every year for the entire duration of the fund! So your sell decision should not depend on what PE firms do (my opinion).

If you want more insights on what I just said there is a podcast which interviewed the CEO/Chairman of Danaher Corp. (It’s a 2 hour interview with Patrick O’shaughnessy titled the art of compounding).

My valuation for IDFCFB is as under as of today (I just happened to look at their financials today):

Over the next five years I expect the funded assets to be around 315,000 crores (assuming a 14% CAGR in loan book). I expect PAT margin in the range of 1.7% – 2.4% percent (I am assuming VV is as good as Uday Kotak and he’s trying to build another Kotak bank and that he is successful in doing so). This translates to a PAT of 5300 Cr to 7500 Cr. Giving it a generous multiple of 18, Mcap could be around 94,400 Cr – 136,000 Cr (115,000 Cr at the midpoint). Assuming no equity dilution and the outstanding shares at about 700 crores (after reduction in OS from merger plus addition from stock options), the share price comes to around Rs. 164 (a 2x in about 5 years). I know my valuation technique is debatable!

Good luck and have a nice weekend!