Crisil should acquire a smaller player rather than splurge on buybacks

Well. Let me first clarify that this is purely my thought and therefore the analysis carried-out in the article need not have had the desired impact as proposed.

Here are some data points to begin with. Crisil India, a subsidiary of S&P, has a market capitalization of Rs. 6,700 crores or US$1.3 billion. During the last year, Crisil made a net profit of Rs. 206 crores on operating revenues of Rs. 807 crores, on a consolidated basis. Its latest balance sheet suggests that the company is debt-free and has cash and cash equivalents worth Rs. 258 crores.

Crisil has done well for itself as well as for its shareholders. Over 2007-11, Crisil’s revenue and net profit recorded a CAGR of 19% and 25% respectively. If one had bought shares worth Rs 1 lac in Crisil in Dec 2007, the shares would be worth more than Rs 2.5 lacs as of date with some extra earnings in the form of dividends.

Crisil has managed this feat through both organic as well as inorganic growth. Crisil acquired Pipal Research in October 2010 for US$12.75 million, paying 1.6x sales for the same. Crisil had acquired another research firm named Irevna few years back for US$12.0 million, paying 2.2x sales. It is easy to conclude that both these acquisitions have been very fruitful for Crisil because research division is now the single largest contributor to the overall revenue of Crisil. Last year, the research division contributed 52.5% to the overall revenue, followed by Ratings (40.4%) and Advisory (7.1%).

Now, let me change the track to what I wish to communicate. The legendary investor Warren Buffett had recently announced a stock buyback, the first by Berkshire. Stock/Share buybacks are usually considered as a means to return excess money to shareholders. They also indicate that the company is not finding any other attractive investment opportunity for the cash it holds. Simply put, if Berkshire is doing a stock buyback, the management probably thinks that the best investment option (given the current market conditions) is to invest in its own stock.

Crisil too has engaged in quite a few stock buybacks. It recently closed a buyback program, purchasing shares worth Rs. 80 crores (USD16 million) from the open market. My moot point here is: Crisil could actually have put this money to better use, than do buybacks.

My theory behind this reasoning is simple.

With a M-cap of Rs 6700 crores, Crisil is currently trading at 8 times its sales, and 32 times its earnings. During the last five years, it traded at an average sales and earning multiples of 6x and 23x. In other words, this means that the market usually values Crisil at 6 times sales and/or 23 times earnings. ICRA, which is in similar business as Crisil, also trades at 8x sales.

Now assume that Crisil had actually used the money spent on last stock buyback to acquire another company similar to Irevna or Pipal and strengthened its research division further. In fact, a company in similar business is actually located in the vicinity of their Mumbai headquarters and clocks annual revenues of USD10 million. Taking cue from earlier acquisitions of Pipal and Irevna, we can safely assume that they could have scooped-up this company for anything between USD16-USD22 million.

The new acquisition could have added USD10 mn to the topline and USD60 mn to the market capitalization of Crisil.

I hope someone in Mape Advisory, which advised Crisil in previous acquisitions, reads this and helps Crisil become a Rs. 10,000 crore M-cap company soon.