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His Next Big Thing
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Jain and his colleagues were meeting for a brainstorming session: what should his company aspire to be in five years' time? This is the second time that Jain, a senior vice-president at Edelweiss Financial Services (it was Edelweiss Capital till 1 August), had taken part in such an exercise; the first time was in 2005 when the company was much smaller than it is now.
"In 2005, it was about what our aspirations were, as individuals and as an organisation, and setting goals accordingly," says Jain. "For all of us — there were about 100 people in the company then — it was about becoming a major player in financial services by 2010." What the exercise boiled down to in 2005, when Edelweiss had been in existence for 10 years, was a number: 10 by 10, or Rs 10 billion (Rs 1,000 crore) in revenues by FY2010.
In FY2011, the company's revenues had ballooned to Rs 1,491 crore, with an after-tax profit of Rs 233 crore (in 2005, the company's revenues were in the region of Rs 70 crore).
The firm achieved its ‘10 by 10' goal in 2007, helped in no small part by the rapid expansion of the financial services industry in what were boom years.
So now what? Edelweiss' rivals such as Religare Enterprises have clearly indicated their interest in a bank. The best investment banks in the world — think Goldman Sachs, Edelweiss's earliest aspiration — have shied away from banking (after the global credit crisis, Goldman had little choice but to become a bank).
Edelweiss founder chairman and CEO Rashesh Shah is not very forthcoming. Many considered his firm a prime contender before the Reserve Bank of India announced the draft guidelines for new bank licences; the draft guidelines constrain firms that derive a large part of their business from the equity capital markets from aspiring to be banks.
So if not a bank — at least not yet — then what's Plan B? Unlike vision or mission statements, aspirations are fairly amorphous; they are, to paraphrase Edelweiss chairman and CEO Rashesh Shah, about the next big thing. What is the next big thing for Edelweiss going to be? What exactly will Edelweiss do, and how?
To Be, Or Not To Be...
The answer to the question about the next big thing seems simple enough: going retail. Compare that to the firm's beginnings: a wholesale, niche sort of investment bank (mostly for entrepreneurial firms looking for private equity syndications) and institutional broker to large foreign institutional investors (FIIs).
But going retail means more than a shift in client base. It has been done, by the likes of Kotak Mahindra Bank, Reliance Capital and Housing Development Finance Corporation (HDFC). Many banks are conglomerates too, like State Bank of India or ICICI Bank.
Some have failed to realise the initial plans of their promoters, or readjusted their aspirations mid-stream. "Indiabulls Financial Services, for instance, was a firm you would have picked to be a leading candidate for this exercise," says a consultant with a leading global consultancy. "But perhaps a few ill-thought diversifications derailed that train of thought."
So why give up on a good thing? "Capital markets and investment banking are good cash flow businesses," says Himanshu Kaji, president and COO. "But it is not scalable beyond a point. Going retail, we will balance the agency businesses and the capital businesses."
Clcik here to read interview with Rashesh Shah
...Is Not The Only Question
"Financial services businesses are converging horizontally, like in unit-linked insurance plans, or Ulips," says Shah. "We are looking beyond that to the larger kind of convergence: between the investment side of financial services and the savings side. That is where the new opportunities are."
From about 100 people and mainly one city — Mumbai — Edelweiss expanded quickly, and now has nearly 300 offices and a staff of over 2,750 people in 100 cities. At September-end, it had an asset book of nearly Rs 10,900 crore, and a net worth of nearly Rs 2,600 crore.
(The last two quarters have not been kind, though. Revenues have not grown like they have in the past, and profit growth has declined. Financial services firms have been hit by the slowdown, yes, and things are not going to get much better in the next 2-3 quarters either.)
Edelweiss acquired the retail broking business of Anagram Finance for about Rs 160 crore in January 2010, but that was just the beginning. In October 2010, the retail housing finance business was launched. On 1 July 2011, the life insurance joint venture with Tokio Marine Holdings opened for business.
Credit — big ticket retail credit through IPO application funding for high net worth individuals, sponsor funding and promoter funding — has been in the works for a while, a natural extension of Edelweiss' capital markets business, a tactical move into an adjacent market.
So Far, So Good, But…
But retail businesses are highly competitive; in retail broking, for instance, there are a number of large, established players, chief among them banks such as ICICI Bank, HDFC Bank and Kotak Mahindra Bank (KMB), besides others like India Infoline (IIFL) and Motilal Oswal Finance (MOFL).
There are almost 20 life insurance joint ventures and subsidiaries, most of whom are struggling to become profitable after having been around for a decade; cynics say that Tokio Marine, Edelweiss' joint venture partner, is not exactly a marquee name (though many of the marquee names are not exactly sparkling successes thus far either). Banks have the edge in retail housing finance, and HDFC, the largest player, dominates that market.
Even as this story is being written, the financial services industry and the Indian economy are battling the throes of an economic slowdown (both global and domestic); add high interest rates to the mix, and you might see why most banks and financial services firms — and the rest of the corporate sector — are worrying about their balance sheet vulnerabilities and putting investment and expansion plans on the backburner.
Shah says that it was not easy when they started out either. When he and Venkat Ramaswami co-founded Edelweiss in 1995 — Ramaswami and Shah were together at ICICI (which later became ICICI Bank) and then at Prime Securities (then owned by the Sheths of Great Eastern Shipping) — the markets took a turn for the worse after some initial successes.
Doing It My Way
Every time they moved to new and larger offices, Shah says, the equity markets fell, and stayed that way for roughly three years. What made the difference, he thinks, is the way they spent those three years: putting great effort into making each downturn into an investment opportunity, and how they went about building relationships into opportunities.
Conditions helped, too. "Indian financial markets went through a golden period between the mid-1990s and 2007," says C. Jayaram, executive director at Kotak Mahindra Bank (KMB). "The capital markets were opened to competition, and attractive for players who went in and did things right, like Edelweiss."
From 1996 to 2000, Edelweiss was successful in raising capital for entrepreneurial ventures such as Daksh, Rediff.com and other medium to large Internet-based companies; they did the first report on the BPO sector, and took these companies public.
Clcik here to read interview with Rashesh Shah
Then came the dotcom bust in 2000, which led to a market fall and a lull in capital markets activity till 2003. "So we began to look at adjacent markets. Like credit, doing promoter and IPO sponsor funding, even financing employee stock option plans (Esops)," says Ramaswami, who heads the investment banking and asset management businesses.
They ventured into territory occupied normally by the business consulting profession, advising, among others, Café Coffee Day, Deccan Airlines and Reva. "That kind of value addition is not usually associated with investment banks," says Ganesh Shermon, director at KPMG, the global consulting firm. The last two were acquired by Kingfisher Airlines, on which Edelweiss advised Deccan Airlines, and Mahindra & Mahindra respectively.
The asset management business has two categories of funds: a domestic, long-only fund (that raised Rs 200 crore), and a set alternative investment funds for international investors: a special opportunities fund ($230 million invested in growth companies, mainly mid-caps, in debt and equity), a special assets fund ($50 million, for investments in companies that needed financial restructuring capital) and a crossover fund (investments in listed small-cap growth firms).
Your Life, Your House
The retail math is basically simple: for a capital markets player, the sandbox is a market of about $70 billion (compared to a savings and investment pool of $400 billion). Add new businesses like life insurance and housing loans, and the potential market becomes three fold. "And on that landscape, you can build scale, introduce new products and channels to deliver those products," says Shah.
But behind the simple math is a lot of intricate calculation, which is then boiled down to clear achievable and sustainable targets. Take life insurance. Deepak Mittal, president and CEO, Edelweiss Tokio Marine Life Insurance, expects to have 22 more offices in addition to the 19 he had at September-end selling policies by July 2012.
"We hope to sell 50,000 policies in the first nine months of operations," he says. But in the current environment, how will he be able to differentiate his firm's offering from those of the rest already in business? Ulips are the most popular insurance product accounting for 75 per cent of all policies sold, and those issued by one insurance company are almost identical to those sold by any other.
"We have an active customer base of over 300,000 customers across our retail businesses (mostly retail investors who use the retail brokerage services)," Mittal says. "Our philosophy is that we will sell our clients what they need based on their savings requirements." But, he acknowledges, between product push and customer push, the latter is likely to be slower.
Housing finance — the retail home loan business, in other words — started earlier than the life insurance business in September 2010. The business is operational in Mumbai and Delhi, with starts being made in Bangalore, Chennai, Pune and Ahmedabad. By the end of the year, another three cities — Vadodara, Surat and Hyderabad will join the ranks.
"Ninety-five per cent of the mortgage market is located in 19 cities," says Anil Kothuri, executive vice-president and head of retail finance. "The current total market size of Rs 1,50,000 crore will double in the next five years. Even 1 per cent of that market, for us, will be Rs 3,000 crore by 2015."
Modest enough; however the growth of the market is never linear. Already, high interest rates are slowing market growth in Delhi and Mumbai, which currently account for 40 per cent of Edelweiss' home loan portfolio.
But the firm is not exactly shooting for the bottom of the wealth pyramid, or the mass affluent; the average ticket price of Edelweiss' current home loan portfolio is above Rs 40 lakh.
It has a wealth management practice with fairly wealthy clients who are in the middle of the wealth pyramid, for most of whom a real estate investment (like a home or even second home in the metros) is an essential part of their portfolios.
Going into the larger market, like Tier-III and Tier-IV towns, and where the mass affluent live — and where Edelweiss will undoubtedly go — is fraught with big risks. Kothuri is aware of that, which is why he is being very careful. "Success in the retail business is all about detail," he concedes.
We The People
Here is an important detail: success in the retail financial services business depends on having the right people in the right place. That applies to both management and staff, besides ensuring loyalty and retention. Most of the senior management at Edelweiss has been with the company for at least 12-15 years, 10 since inception.
Clcik here to read interview with Rashesh Shah
One thing that has helped employee retention is stock options. "Employees own about 20 per cent of the company (excluding the founders and management, who own 33 per cent)," says Shaily Gupta, executive vice-president and head of human resources. "So there is a sense of belonging, of ownership."
It is also a young people's organisation; the larger part of second tier managers are in their 30s; the average age of that block is 27 years, Gupta says. KMB's Jayaram appreciates the people quality at Edelweiss, though he could be talking just about the senior leadership. "They have very good people," he says. "As a competitor, we respect their talent and abilities."
That said, it is also true that setting a new basis for the next big thing will be a testing time for Edelweiss' human resources. Going retail at the pace the company has set thus far will involve further rapid expansion of the ranks. And here, youth could become a little bit of a liability.
Experience suggests that attrition in the life insurance business, for instance, is very high. What's more, it is greatest among the feet-on-the-street people, which makes finding the right people that much harder. Hiring people with a long-term focus, and staying power is an intrinsic part of Gupta's job. "So far, so good," she says. "It is a company people want to be with."
Big Bets, Big Risks?
Finding the right people may not be the only problem that growth brings. As Edelweiss moves from an agency-led business to a capital-led business — interest income currently accounts for nearly half of total income — risk management becomes a critical element.
"In the lending business, growth is always a risk," says Ajay Srinivasan, managing director, Aditya Birla Financial Services. Two questions become important: first, is the growth sustainable, and second, how are the risks associated with growth mitigated?" Srinivasan points to a range of risks, from internal operating risk through individual borrower risk to sector-level risk.
Rujan Panjwani, president and head of treasury at Edelweiss, is acutely aware of this. "We have grown the balance sheet with a great deal of attention to risk management," he says. "In the trade off between asset quality and profitability, we come down on the side of asset quality."
And, he adds, let's not forget about liquidity. During the recent global crisis, people had assets but no liquidity; even bank certificates of deposit were trading at crazy rates, he says. His firm's balance sheet is inherently liquid: 50 per cent is held in cash or cash equivalents. "The Reserve Bank of India's (RBI) standards and guidelines were very helpful," he adds.
Edelweiss' treasury had multiple frameworks for assessing risk, and has built metrics and variables around each, besides constant monitoring. The focus on risk management especially gains in attention when it comes to the retail business; retail risk is generally more systemic, and more operational than financial. And it calls for more standardisation, greater systems and processes.
Of course, many of the various businesses have been housed in subsidiaries — broking and housing finance, for example, which makes Edelweiss a holding company along the lines that the RBI seems to prefer for regulatory purposes. "But structure is not as important as what we can do, or not do, from a risk management perspective," says Panjwani.
One For All, All For One
The various pieces look good, but what of the whole? Planning for future competition by a firm that is already among the top two or three in a number of areas is very forward thinking in many ways, but if only it were that easy or enough. "However much you'd like to buck the trend, you have to evolve with the markets," says Srinivasan. "The organisation will have to evolve, too."
Retail broking is the easy part; it is a nuts and bolts business in many ways. But the industry itself is having a difficult time just now making money (lots of firms are closing down as independent brokerages).
Does it make sense for Edelweiss to get into an overcrowded business like insurance with a long gestation period? Competing with a bank in housing finance will be hard, but KMB's Jayaram acknowledges that if the aspiration is feasible and doable, then it is possible.
Rashesh Shah himself is not too concerned with the doubts. "Companies grow in a variety of ways," he says. "We have expanded first into adjacent markets, and built capacities in them. Sure, it will be difficult. If it weren't everybody would be in it, and I wouldn't have to spend my time thinking about how I am going to build a differentiated business and organisation."
So far, at least when Shah has gone against the odds, he has been mostly right. But he is no reckless risk-taker, studying and considering each critical step carefully, just like he prepares for running marathons. He runs them whenever and wherever he can, most recently in far-away Norway, while on a holiday in June. His view of his firm also embodies that interest; it is in a marathon, not a sprint.
(This story was published in Businessworld Issue Dated 07-11-2011)