Rating Rationale

Key Rating Drivers & Detailed Description

Strengths:

Expectation of strong support from promoters and promoter group companies

The promoters, Mr Nirmal Jain and Mr R Venkataraman are first-generation entrepreneurs and veterans in capital market businesses. Their experience has helped IIFL group diversify its operations across lending, securities and wealth management. The promoters and promoter group companies cumulatively held 33.39% stake in 5paisa as on June 30, 2023 and remain committed to the company’s future growth. They have participated in the capital raising activities of the company, including the last round of fund infusion of Rs 45 crore in August 2022 by the way of conversion of share warrants and Rs 250 crore infused in May 2021. The promoters continue to provide strategic oversight on an ongoing basis. Further, 5paisa benefits from its linkage to other promoter-owned entities – IIFL Finance, IIFL Securities Ltd (IIFL Securities; rated CRISIL A1+) and IIFL Wealth Management Ltd (‘CRISIL A1+’), which have demonstrated track record of providing funding support mainly via inter-corporate deposits (ICD). As of March 2023, the company has a board approved ICD line of Rs 600 crore collectively from IIFL Group Companies.

Stable market share in the equity broking segment

Despite having been in operations only since fiscal 2017, 5paisa has grown to become one of the top 10 discount brokers in India. The company mainly offers products and services through an online platform and mobile application. Backed by its low-cost pricing strategy, the company could onboard around 7.5 lakh new customers in fiscal 2023, resulting in a total client base of 34.9 lakh on the same date. However, the active client base has fallen from its peak level of 17 lakhs as on March 31, 2022 owing to decline in retail market participation (both in terms of frequency and volume) which had spiked in the aftermath of Covid-19 imposed lockdown. This trend was observed across the discount broking space. Resultantly, the market share of 5Paisa in terms of active client bases fell to 2.1% as of March 31, 2023 from 4.87%, a year ago and 4.47% as on March 31, 2021.

In terms of overall turnover, the market share[[1]] of the company for fiscal 2023 was ~1.2% in the cash as well as F&0 segment. The company’s overall market share for fiscal 2023 was ~1.2%, marginally lower than last year’s market share of 1.3% - influenced by decline in active client base. For the first quarter of fiscal 2023, the overall market share was 1.1%.

CRISIL Ratings has taken note of the appointment of Mr. Narayan Gangadhar as the new Chief Executive Officer (CEO) of 5Paisa, with effect from May 2023. He comes with a rich experience of two‐decades, covering technology, data systems, digital infrastructure, and financial services. The company is expected to benefit from his expertise as it scales its operations alongside upgradation in its digital infrastructure. Over the medium term,

he company’s ability to increase expand its base of active clients and maintain overall market share will remain a key monitorable.

Healthy capitalisation

Regular fund infusions have helped capitalisation improve significantly over the past few years. The promotors infused Rs 45 crore in fiscal 2023 by means of conversion of share warrants. Prior to this, the company had received Rs 250 crore via preferential issue in May 2021. These accretions have strengthened the company’s networth and gearing. Reported networth and gearing stood at Rs 463 crore and 0.4 times, respectively, as on March 31, 2023 (Rs 374 crore and 0.7 times, respectively, as on March 31, 2022). The company has deployed these funds in upgrading its technology infrastructure to ultimately improve the quality of service to its customers. After the advent of new regulations on margin funding,while borrowings have been increasing with growth in portfolio, overall gearing is expected to remain moderate at 1-1.5 times on a steady-state basis.

Networth remains comfortable for the current and proposed scale of operations and, will continue to lend stability to operations, particularly amid volatile phases in the capital market.

Weaknesses:

Exposure to intense competition and uncertainties inherent to capital-market-related businesses, including regulatory changes

As businesses are restricted within the capital market, 5paisa faces intense competition from multiple players offering low-cost products. The industry has seen a huge transformation in the last three years, with the entry of technology-based discount brokers, who are dominating the market share. The proposed entry of players with deeper pockets may intensify pricing pressure across the industry.

The key broking business remains exposed to economic, political and social factors that drive investor sentiment. Given the cyclicality associated with the capital market, brokerage volume and earnings are highly dependent on the level of trading activity. Specifically after March 2020, the stock markets saw high retail participation and daily trading volume on account of people staying at home during the lockdown to contain the Covid-19 pandemic. A significant proportion of client additions at the industry level are in the age bracket of 25-30 years without significant savings surplus. The upward movement of the key benchmark indices during this period had further contributed to the lure of stock market trading and potential gains. Subsequently, even though the lockdown restrictions were lifted by many state governments by July 2020, the momentum of increased retail participation continued to sustain over the trailing 12 months. While this benefited 5paisa as well as other broking players, the heightened retail market participation corrected to its pre-pandemic level after the macro situation restored in fiscal 2023. In the long-term, sustainability of the market momentum will remain a key monitorable.

Further, over the last couple of years, the broking industry has witnessed continuous changes in regulations. In order to enhance transparency and curb misuse of funds, SEBI has introduced few regulations in the last one year. These include upfront margin collection for intraday positions and restricting use of the power of attorney. Changes pertaining to margin collection and pledging practices also became effective from September 1, 2020. The newer margin collection practices will change the vintage business model of various small to mid-sized broking companies that relied on relationships, by offering differential leverage and margin payment avenues to clients. This may also lead to a decline in overall competitiveness towards larger digital and bank-based brokers.

Regulations of upfront margin collections for intraday trading are likely to reduce leverage to 4-5 times from 10-15 times prevalent across the industry. This reduction in leverage will also affect the level of positions (in terms of volume) taken by retail investors. Impact of this change on performance of 5paisa will be a monitorable.

Furthermore, as per new regulations, shares owned by investors can be lien marked with the respective broker instead of having to follow the current practice of transferring it to the broker’s pool account. CRISIL Ratings understands that most top brokers (including 5paisa) have already streamlined their systems in accordance with the new norms. However, small and mid-sized brokers could be more impacted, as they do not have advanced IT infrastructure and risk management systems. Though such revised regulations may impact the performance in the near term, the industry will benefit from increased transparency and the de-risk broking platform for retail customers in the longer run.

Moderate, albeit improving, earnings profile

5paisa reported a profit after tax (PAT) of Rs 44 crore on a total income of Rs 339 crore in fiscal 2023 as against PAT of 13.74 crore on total income of Rs 298 crore in previous fiscal. Though operating expenses were higher in fiscal 2023, its effect was offset by improvement in revenue led by higher interest income and increased market turnover, supported a 14% growth in broking & related income. For the quarter ended June 30, 2023, company earned a profit of Rs 14.5 crore on total income of Rs 84.5 crore compared with profit of Rs 7.4 crore on total income of Rs 84 crore for corresponding period of previous fiscal. This was supported by reduced operating expenses and stable total income.

Ever since it commenced operations in fiscal 2016, the company has made significant investments in technology infrastructure and hired relevant personnel across verticals. As it is still in the growth phase, operating expenses may remain high in the near term and thereafter, stabilize... Nevertheless, w the operating leverage and overall profitability should improve with economies of scale, and the cost-to-income ratio is expected to reduce from its current levels of ~74%.

While the company is diversifying across segments like P2P lending, cross sell etc., majority of these may take time to become significant contributors to profitability and broking revenue will be key to overall earnings. Ability to manage cost and improve earnings profile across market cycles will be a key monitorable.

[1] CRISIL Ratings’ market share calculation is based on a two legged approach (both buy and sell aspects of the transaction)