India’s largest fund house, HDFC Asset Management Co. Ltd, and Pramerica Asset Managers Pvt. Ltd, an arm of US-headquartered Prudential Financial Inc, have emerged as the frontrunners to buy the assets of Fidelity’s mutual fund in India—FIL Fund Management Pvt. Ltd.
Out of some 20 bidders, HDFC and Pramerica mutual funds have been shortlisted and their bids are in the range of Rs.400-500 crore, said two people with direct knowledge of
the deal, who spoke on condition of anonymity.
“There is close competition between the two funds and one of them will enter the binding bid agreement with Fidelity,” said one of the two people. Fidelity MF has about Rs.9,000
crore of assets under management.
HDFC mutual fund manages Rs.88,628.02 crore worth of assets. Pramerica mutual fund
manages assets of Rs.2,084.41 crore in India, mostly through debt-oriented schemes.
JPMorgan, Fidelity’s financial adviser for the deal, had circulated the so-called request for proposal to accept bids from prospective buyers till 15 February.
HDFC and Pramerica are among the top five asset management companies (AMCs) that have qualified for the second round of bidding to acquire the assets of Fidelity MF in India, but their bids are higher than others.
Milind Barve, managing director of HDFC mutual fund, declined to comment. Emails sent to Fidelity did not elicit a response. Lisa Villareal, vice-president, Prudential Financial, declined to comment.
HDFC and Pramerica’s bids value Fidelity MF at 4-5% of its average assets, a sizable amount in light of the AMC’s cumulative losses of Rs.333 crore. In 2011, its losses more than
doubled to Rs.62.39 crore over the previous year.
An interesting income-tax provision plays a key role behind the ongoing Fidelity deal, said the first person cited earlier. In normal course, under section 72 of the Income-Tax Act, a mutual fund is allowed to carry forward its losses for eight years. But, under section 79 of the law, this loss is not allowed to be carried forward if there is a change in ownership of the company.
Fidelity MF’s cumulative losses are the highest in the domestic fund industry. If a fund house directly buys the assets of Fidelity MF in India, section 79 of the income-tax law will be triggered and the buyer will have to bear the losses of Fidelity MF at one go. This can be avoided through another clause of section 79, which allows losses to be carried forward, post the deal, only if the Indian company is a subsidiary of a foreign company and the change in ownership arises as a result of amalgamation or demerger of the foreign company.
Fidelity MF in India is a subsidiary of Fidelity Mauritius, which in turn is a subsidiary of Fidelity Worldwide Investment, or FIL Ltd, that manages at least $212 billion. If a bidder buys Fidelity Mauritius and reverse merges the company with Fidelity MF in India, it will be able to carry forward the losses of Fidelity MF as there will not be any direct change in ownership of Fidelity MF in India.
If indeed this happens, the acquirer will not only be able to carry forward the losses of Fidelity MF for eight years but also save on taxes till such time its profit gets offset by past losses.
“For this reason, the bidders are willing to pay a little more than average valuations for an acquisition,” one of the people said.
For the fiscal year ended 31 March 2011, HDFC MF recorded a net profit of Rs.242 crore, the
highest in the industry after Reliance Capital Asset Management Ltd with a profit of Rs.261
Fund house acquisitions are valued on the basis of the asset mix, network strength, long-term earnings prospects and profitability.
Apart from the tax advantage, another positive for Fidelity MF is its high proportion of equity assets. Typically, equity funds fetch higher valuation as they earn more fees and commissions than debt schemes.
Directly buying a loss-making fund house has two major disadvantages. One, since the losses of the seller cannot be carried forward, it immediately brings down the net worth of the buyer by an amount equal to the total accumulated loss of the seller. Two, if the net worth of the combined entity turns negative after the acquisition, the fund house can neither avoid paying taxes on its profits in the subsequent years nor pay dividends till the net worth turns positive. Even if the net worth of the combined entity remains positive after the acquisition, it will be lower than the original net worth of the buyer and taxes would still be deducted on its profits every year.
There have been several acquisitions of Indian mutual funds with valuations ranging from 1.6% to 13% of AUM.
At the end of December, Fidelity managed assets worth at least Rs.6,184.61 crore in equity
schemes and Rs.2,695.84 crore in debt schemes, according to Value Research, a New Delhi-
based fund tracker.
There are 44 mutual funds in India with total assets worth Rs.6.81 trillion as of the quarter
Recently, Reliance Capital Asset Management, the mutual fund arm of the Anil Ambani-controlled Reliance Group, announced a 26% stake sale to Japan’s Nippon Life Insurance Co. for Rs.1,450 crore. The transaction values India’s second largest fund house at R
crore, or about 6% of its overall AUM.
In 2009, Japanese money manager Nomura Asset Management Co. Ltd picked up a 35% stake in LIC Mutual Fund Asset Management for Rs.3,080 crore, or 2.4% of the latter’s
assets at the time.
In the same year, T Rowe Price Global Investment Services Ltd picked up a 26% stake in UTI Asset Management Co. Ltd for $142.4 million, valuing the latter at about 3.25% of its average AUM then. In 2009, L&T Investment Management Ltd paid Rs.450 crore to buy out
DBS Cholamandalam Asset Management—1.6% of the value of the latter’s assets. HDFC MF bought Zurich AMC in 2003.
Of the 39 asset management companies that declared their earnings last year, 16 recorded a total profit of around Rs.1,100 crore and 23 booked losses that added up to
some Rs.550 crore.