KFINTECH — earnings call

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Prepared remarks

Moderator · Conference Operator

MR. ABHIJEET SAKHARE – KOTAK SECURITIES LIMITED KFin Technologies Limited July 31, 2023

Questions and answers

Moderator · Conference Operator

We will now begin the question-and-answer session.

We have our first question from the line of Faisal Zubair Hawa from HG Hawa & Co.

Please go ahead.

Faisal Z. Hawa

Is there any way that this can be disrupted by a blockchain-based system also which could cost much lesser and are we also looking at some alternatives?

Sreekanth Nadella

See, I would answer in this way.

Newer technologies are always important to bring the cost to shove down as in India processing millions of transactions a day and trillions of rupees worth of transactions each and every day.

We have been steadily reducing the cost to serve within the industry over the past decade plus to-date, We believe that this industry is already served at possibly the lowest anywhere in the world.

I think a typical cost per folio for an entire year is just about Rs.30.

You compare and contrast that to any other industry, including demat accounts or bank accounts, accounts where you will run into hundreds of rupees.

The technologies that we have already embraced and adopted are cloud and native mobility solutions.

Blockchain itself is a very complex solution and it is not a software, I just want to clarify that it is not something that KFintech alone or any other entity alone can embrace and say that look, now, I have a better solution to do it.

Blockchain works on trust, blockchain works on an integrated solution which requires not just the registrars but also the stock exchanges, the depositories, the distribution network, the asset management companies, the clearing corporations, everybody to be on the same platform for a blockchain to run for the very simple reason that any transaction that we process today necessarily goes through all of these hoops.

Right?

So, for example today you were to buy us in, one unit of a mutual fund of any fund manager, you will need the bank, you will need the clearing corporations, you will need payment aggregators, KRAs, registrars, depository so on and support.

So, unless there is a solution which is top-down which requires the entire industry to be elevated to a blockchain we believe that it is not a software that can just be implemented to gain efficiencies.

There is a working committee currently constituted by the country's regulator, where we are part of it.

There are discussions ongoing.

In time to come we will see in terms of how the blockchain could be broadly adopted by the entire infrastructure required in capital markets.

Moderator · Conference Operator

We have our next question from the line of Aejas Lakhani from Unifi Capital.

Please go ahead.

Aejas Lakhani

First question is that in the issuer solutions business, if you were to look at it from a revenue per folio, we used to earn about Rs.8 to Rs.9 which has tapered lower.

So, could you comment is there anything there, because the revenue per folio is much lower?

Sreekanth Nadella

Yes, most certainly.

See, the revenue per folio is the currently there are 5,000 clients, as I said roughly and the unit pricing that is a folio pricing for each of the entity is a negotiated rate, this is not a regulated rate so to speak.

And hence the total cumulative folio rate that you see in any quarter on any given day is a factor of where there has been more retail expansion in terms of the client base.

For example, if I were to have 10 clients where the unit price is Rs.15 and another 10 clients where the unit price is say averaging around Rs.8, now the retail expansion can happen in any way, which I cannot redetermine, in the example that I just took, if there has been a much broader retail expansion amongst the clientele who have had a smaller unit for you as compared KFin Technologies Limited July 31, 2023 to that of the entities where I have a better pricing mechanism, it is possible that the overall average tends to come down for that specific period.

Now, as we move into the next month or the next week or the next quarter based on the results, if the other entities at that point in time have a broader retail expansion, the unit price will again go up.

So, all I would say is that this is a point in time and this is a market-driven number, this is not a negotiated number, this is not discounts if I were to clarify that if that's what you have in your mind, this is a play in terms of the market dynamics, which would move up and down into various months and the quarters.

Vivek Mathur

I would just add to Sreekanth, the issuer solutions revenue comprises of three components.

One is folio-based revenue, second is corporate actions and third is the various value-added services that we offer like e-voting, e-AGMs and all.

So, in fact our folio revenue based on the new clients has actually gone up.

There is reduction in the overall average revenue per folio because of lesser number of corporate actions in the first quarter as compared to the previous year same quarter, and that's the impact that you would have seen about 4.4% reduction on year-on-year quarterly reduction.

Amit Murarka

Just adding more to this, while Vivek was alluding that while my specific folio revenues has gone up by 6%, almost year-on-year basis in the first quarter and as we move into the subsequent quarters and all, these corporate actions which typically happens in the Q2 to Q3, which last year was a little different year, I mean wherein we have preponed of several corporate actions in the first quarter of FY23 which we are not seeing and this is more a normalized year compared to the last year.

As we move along into the subsequent quarters and all, I mean this thing would get normalized and you would see the average numbers would pan out similar to what we had last year numbers.

Aejas Lakhani

On the international piece, could you speak a little bit about, you've had a few wins, when does the revenue traction start to build from that, I heard you mentioning it earlier that 2Q onwards.

So, could you just give some sense of the existing wins, how revenue scale ups will take place there and other businesses that you're chasing in the region?

Sreekanth Nadella

Look, we should look at the international business or most of, I guess, the kind of work that we do into two components.

There is an existing client base which has already been transitioned and has been in steady state delivery, so that is the base revenue, the recurring annual revenue annuity, however you would like to call it.

The second component is the wins that we have typically take anywhere between three to six to maybe sometimes some complex transitions can go up to even eight to nine months of transition.

Now, I had called out that two such deals, which we have won in the past, the transitions have been completed in the month of July earlier this month, and hence that line of revenue will kick in immediately from this month onwards… when I say this month, I'm talking about August onwards, right.

Then we have deals which we have signed in the recent past into the last two to three months which need to be transitioned into KFin for the revenue to kick in.

That is the recurring revenue, even as there will be a certain one-time revenue for the transition itself, which effectively means there is a revenue stream that we will get even for closed deals.

Let me call out the sizable ones, the deal that we have won in Thailand is that of our fund administration work for the third or fourth largest bank-based asset KFin Technologies Limited July 31, 2023 management company in that part of the world.

This is our first client.

And we have had conversations including that of demos, we had to re-platform our entire solution to meet the requirements of the Thai regulator and the Thai business equilibrium.

And for that we took the past X number of months and have proven to the satisfaction of the client that our solution works just as well in Thailand.

Now, the transition for that would start pretty much immediately, and we believe that it is a four to five months transition as I said for which there is a one-time episodical revenue we will get, post which there is a recurring annual revenue.

As far as the additional funds that we won from the largest client that we have in Philippines is concerned, the transition has already begun for those funds.

The additional revenue that we will get will be on top of the new flows that will happen into those funds from here on, which means that is again pretty much immediate, whereas there is a significant near about $15 billion worth of assets lying with the same schemes in the current context which are yet to be transitioned.

Now, the moment that happens, that would also kick in as additional revenue.

So, long and short of it is, there is not a significant lag or lead time for all of these, some of these revenue would be recurring revenue for the contracts that have been transitioned or some of the other deals, it will be the transition revenue because we just won and we are in the process of transition even as all the old and existing deals will continue to provide the recurring annuity revenue if I may.

Aejas Lakhani

So, if I were to reiterate what you're saying is, you're saying old wins where the months of transition are over will start now, the new wins which you have won, the transitioning income will be there for the next few quarters before they move to recurring.

Is that understanding correct?

Sreekanth Nadella

Absolutely correct.

Aejas Lakhani

Couple of other things, on the employee cost side, so I just want to understand that has there been increments in this quarter and is this the new normalized employee cost base?

Vivek Mathur

So, this is a nominal increase that we have given to retain certain talent and give for market corrections, and the actual increments will take place from July and that impact you will see in the next quarter which will not be abnormally high, but there will be some impact.

Aejas Lakhani

Vivek, a follow up on that is I remember there were these episodic increases to retain talent that took place in the previous year because KFintech was going through its own employee upgrades from a pay perspective.

So, is that behind us or is some part of it still continuing.

Vivek Mathur

That's already behind us.

That was an abnormal increase as you know, for IT and engineers to retain them that was in the range of almost 50% to 60% and that had a one-time impact on the cost.

Now, it is running.

So, that's behind us.

This is a nominal increase that you give in the range of 7% to 8% per annum to maintain the task force that we have.

So, that impact will come in the next quarter, but nothing abnormal is going to happen like it happened last year.

Sreekanth Nadella

I'll just add some more color to that if I may.

On the IT front for example, even as there were average comp increases that were accorded because of the overall wage inflation that happened KFin Technologies Limited July 31, 2023 not just for us but across the sectors in India and abroad.

We have since then rationalized the total headcount itself down by nearly 120 people, which is roughly a 14% rationalization of IT manpower headcount.

So, what you're really seeing is an increase in average comp largely offset by productivity gains through either better automation or if it comes to technology through better bottom of the pyramid management as we move into tier 2 cities, for example, we have since we last spoke, expanded our operations in Bhubaneswar quite sizably, and provides us a very strong resilient player of committed workforce at a lower price point and therefore overall impact on the payroll would be marginal to that extent.

So, it's not just the increase of comp that should be looked at in terms of the overall cost expansion that would be forecasted, but also what are we doing to drive the productivity and take the headcount out, which to a large extent negates any impact on the payroll cost.

Aejas Lakhani

What I understand is the annual increments will take place from Q2. This was more to retain a certain part of the tech team and incrementally you are setting up centers in tier 2 locations like Bhubaneswar where the cost structure is lower.

Is that understanding correct on the employee side?

Sreekanth Nadella

Absolutely.

And it is not a future activity.

We have already completed that activity.

So, we have today about near 100 people, which we are doubling up and hopefully we will soon start moving the operations, not just IT into other locations as well.

The answer is yes, and it's already done, I mean, we are continuing to progress in that.

Vivek Mathur

One more addition to that is integration of WebileApps that we acquired; their employee cost is also included in this quarter.

Aejas Lakhani

Just on the other expenses, you've been investing ahead of the curve in technology.

How are we thinking about that line item for '24?

Sreekanth Nadella

For '24 our journey line for innovation is very, very interesting and substantive actually.

While the overall quantum of the cost could be similar, we are doing it materially differently from the past, largely driving through partnerships with the industry.

For example, since we last spoke, we have created a strong partnership with AWS and with several other industry participants, whether it is on the data center side, whether it is on the application layer, whether it is on the data layer, and basically taking the burden of the cost and the innovation together, but at the same time taking to the market together so that the power of compounding comes together, right.

We have a series of assets as early as I think 15th August for the Independence Day we have launches lined up, which are several very cutting edge, first in the industry, not just in India but across the world if I may.

Very excited to make our own little mark in terms of the financialization of the country.

So, we have created a hot site for our DR capabilities significantly enhancing and creating a benchmark of standards if I may within the country, as has been duly recognized by the regulation as well.

And in addition to just the hardware expansion, the technology is associated with that.

It is truly the products, platforms and the data monetization that would I believe drive the revenue pools into the coming years even as the quantum of investor base expands.

So, we have about five new products or platforms into the alternative KFin Technologies Limited July 31, 2023 investment space.

Couple of them in the corporate registry space especially with the regulation on PIT with the regulation on insider trading, so on and so forth, solutions that needed to be created in the country are created at this point in time.

Likewise, in the case of the mutual funds too, where we believe the market share expansion is important, our clients growth, in addition to processing we need to help them grow and that's where I guess a decent amount of our tech solution spend also is going.

Not to forget the important aspect of geographical expansion, as I said, as we move into Thailand and we need a platform that's ready.

So, the last few quarters, for example, some amount of effort and burn has already been baked into creating the platform for a country.

At any given point in time, these solutions will have a long-lasting economic impact for the company as we have the ability to then expand the client base on the same platform.

Aejas Lakhani

Could you just speak about the Rs.130 crores payout that is due, is it in October?

Vivek Mathur

Yes, that's right.

And that is something which is subject to the board approval, which will come up in the next board meeting.

Subject to the board deciding to approve that, we will repay Rs.134 crores in October.

Moderator · Conference Operator

We have a next question from the line of Devansh Nigotia from SIMPL.

Please go ahead.

Devansh Nigotia

Just wanted to understand in case of number of folio, let's say if Reliance demerges the separate company, then how does that changes our revenues and number of folios count?

Sreekanth Nadella

It changes, it adds to a completely new revenue pool for us.

So, for example for the question that you asked, there is a one-time fee that we have agreed with the client for the demerger activities which is quite complex and needs to be done in a time-bound fashion.

Beyond the demerger activity fee itself, the folios that get created within the new entity, that is the Jio financial services will yield the revenue for the agreed unit price that we have with the client.

Devansh Nigotia

So, does that mean that the folio income actually doubles in that case, except the corporate action income?

Sreekanth Nadella

It will go to commensurate to the number of new retail holders into the new entity, yes.

Devansh Nigotia

And in terms of international, it's still not clear that the number of clients have increased significantly, but how will it translate in terms of the revenue flowing in?

And also if you can share your outlook for the next two years in terms of revenue growth, what are our aspiration in international business?

Sreekanth Nadella

See, the international today is largely limited to Asia, right, and we are calling it international, it is largely Malaysia, which is the largest geography for us followed by Philippines, we have one client each in Hong Kong and Singapore and we just won one in Thailand at this point in time, right?

It is a fair question in terms of the quantum or the number of clients may seem not commensurate to the revenue pool, especially when you extrapolate that in the Indian context, right?

I mean, 25 asset management companies in India are giving about Rs.600-odd crores of KFin Technologies Limited July 31, 2023 revenue, whereas that's not the same case in the case of the countries that we are working there.

So, this goes back to the growth path itself if I may, right.

See, as we start a new country, right, and especially when we started our journey just about 4.5 years back or 5-years back to go beyond India, we needed to create one platform which never existed, so that took us a couple of years to do so.

And starting pretty much bottom up in countries where outsourcing was never done before.

In all these parts of the world that I spoke about, the entire delivery continues to be done in-house.

We have in fact orchestrated this model of how we do it in India in those parts of the world.

Now, as one would expect, typical to such complex models and generational shift of doing probably the one of the most mission critical work for any asset manager, the larger asset management companies did not initially participate.

Ergo, though the number of client base is very large, many of them are the smaller and medium tiered funds.

If you were to compare in India, for example, comparing with the top three, top four AMCs probably in the bottom leg of the AMCs, you would understand how different is it the AUM profile, revenue profile is associated.

Now, that's one of the reasons why the revenue does not look commensurately as high as the quantum of the clients.

Second is the fact that as we win, there is a transition revenue, but the run revenue will always be higher as you would expect.

So, we are constantly seeing transitioning multiple clients at a given point in time, which means that we truly never had a full year revenue of all the clients put together.

What has started to change in the last one-half to two years especially after COVID is the participation of the large AMCs in discussions with us in negotiations and one of that in fact, as I said has just fructified in Thailand, which is one of the largest asset management companies there where we have just signed the contract or the letter of award just about last week, speaks about the transcendental shifts in terms of the larger AMCs now part taking the journey of the RTA model which we have orchestrated.

So, very simply put, the past four years the growth from nil to where we are today marks obviously exponential growth, albeit on a zero basis.

From here on, the growth would largely come in the form of larger asset management companies, who are now signing up, many of whom can easily give a revenue profile which can be not a percentage but multiples of the current revenue itself.

As I said, you compare the country's largest AMC with that of probably the 30th or the 35th and you see that one such contract you win is going to multiply your revenues two or three, four and not 20% or 30%.

So, that's the way the international would expand.

Now, while that is on the Asia side, as I clearly mentioned, our intent into this year is to move to west.

We have made sizable progress both in terms of our understanding of the market, customization of the products and platforms, so on and so forth, and probably into the coming quarters we'll have something more clear to explain, but broadly speaking, as I said earlier, our intent is to be probably global fund administrator of repute from India, and to be the first one from it.

Moderator · Conference Operator

We have a next question from the line of Pranuj Shah from JP Morgan.

Please go ahead.

Pranuj Shah

First question was what is the attrition rate for your business in the second half of FY23 and in the first quarter of FY24?

Sreekanth Nadella

Sure.

I think the H2 of FY23, the attrition had tapered down to close to 14%, leaving overall yearly average of 22% for the year that had gone by.

Q1 of this year, it was marginal at 4.6% was the attrition that we have seen.

KFin Technologies Limited July 31, 2023

Moderator · Conference Operator

We have a next question from the line of Abhijeet Sakhare from Kotak Securities.

Please go ahead.

Abhijeet Sakhare

First question is on the MF RTA business.

So, we see like 1% or 2% decline QoQ in terms of the realizations.

So, firstly, if this decline sort of indicative of what is built into the slab-based pricing or there has been some form of renegotiations that have happened during the quarter?

Sreekanth Nadella

It is a combination of all.

One is if you see the growth profile of my clients for the Q1, there was a good quantum of growth that was generated by the larger asset management companies vis-à- vis the medium-tiered AMCs.

Now, as we know the yield that we get from the larger AMC by virtue of telescopic pricing kicking in will always be lower than that of when compared to smaller and medium tiered AMC.

So, where the growth comes, it's not just the overall growth, but which AMC/AMCs are giving growth is very important as well.

And as I said in Q1, the growth we have seen were largely coming from the larger AMCs and our growth yield that was associated was slightly lesser.

Abhijeet Sakhare

Should we expect like a step change or a more drastic impact sometime during the year from any of the contract renewals or nothing this year?

Sreekanth Nadella

No. So, there is no question of any step change and as you are aware and we have already articulated earlier, every year even that slab change or any renegotiated contract level impact on the revenue is largely under 1% or rather the revenue that you see every year for example probably shows under 1% of revenue that had been forgone because of those discounting if I may.

There is no step change.

There will be an impact as AMCs move from slab-to-slab and as they grow faster, but all of that impact would be very, very marginal in the context of the growth that we have seen.

Abhijeet Sakhare

So, second one, just coming back to the international business, while I'm sure pricing is not the only driving factor, but it would help if you can give us a sense of where does your pricing come to versus the current incumbents if at all, or if you have any understanding of what's the overall cost of an in-source model and where does our value proposition come in, in terms of the cost reductions?

Sreekanth Nadella

Our yield from our international business at this point in time is slightly above five basis points, right, which marks near 25% higher yield as compared to that of Indian AMC scenario at this moment in time, point number one.

Our growth, as you rightly said, is not just based on the pricing, also the style of commercials, for example, we have minimum fee that we derive irrespective of the growth of an AMC within that part of the world.

Now, these are some of the things that we obviously have learned in terms of the mistakes that we've done here in terms of the contracting over the last 35-years, which helps us in terms of whether there is a market downturn or etc., given our costs not go away, there is a minimum certain amount of fee that we charge.

Point #3, the yield coming from the international market we believe will expand over time.

As our services have now started expanding in two different angles, one, for the same client for whom we were only delivering transfer agency work, we are now also delivering fund KFin Technologies Limited July 31, 2023 accounting and fund administration work, which typically could be anywhere between 3 to 4 basis points when it comes to mutual funds.

So, that means that if today if I'm drawing five basis points from a client X delivering only tier services, should I go on to also render FA services that I may become anywhere between 7 to 8 or 9 basis points.

So, the yield per client can grow as my overall service portfolio has increased for the same set of clients.

Point #4, in terms of the asset classes itself, while the mutual funds give you a more rationalized structure simply because of the volume, the alternative slab clearly gives you a higher number.

And globally, if you see the fund administration business, it is anywhere between 7 to 15 basis points, I mean that is, of course, for the larger entities such as JP Morgan and BNY Mellon, State Street, etc., what they charge to the asset managers, and whilst we aren't there, we believe that our journey is firmly to that direction actually.

Moderator · Conference Operator

We have our next question from the line of Pranuj Shah from JP Morgan.

Please go ahead.

Pranuj Shah

Sir, did you already addressed the question?

Sreekanth Nadella

I think the question was what was the attrition in H2?

We were at about roughly 14%, Q1 of this year it was much more rationalized, I think we are at 4.6% is attrition that we have seen in Q1.

Pranuj Shah

So, like if you were to look at your employee cost, obviously you had explained in detail earlier why it is risen.

So, this should be the base we should take from here on, right, going ahead?

Sreekanth Nadella

Yes, so subject only to business development that we would do.

So, there are areas that we want to grow.

See, it's not a mature business, in the sense that we're not just running the same thing over and over again.

We are intentful of growing much faster, we are intending of expanding geographically in asset classes.

An entity like that will continue to invest on two critical components -- product innovation and platforms -- to basically address the new markets, asset classes, etc., And second in order to make sure that those reach the end market, certain amount of money will be on the business developmental activities.

So, if we were to run our core business without any adventure or intent to expand our profile, then yes, our cost in fact won't even be the same where they are, they will even come down, but we've been incurring sizable expenses for driving growth into the future.

So, broadly like-to-like cost for the same set of operation, I would expect to see a 10% dip as we have seen year-after-year largely on account of the productivity that we drive, even accounting further payroll increases because of wage inflation.

However, our overall cost has seen slight increase as you would see, but that's largely on account of the business development, innovation, etc., expenditure for the new lines of businesses products and. platforms that we are acquiring.

Pranuj Shah

And the last one was on the international and the other AUM piece.

I think you already talking about the yields earlier that your international is north of five basis points.

But if I see on the total overall piece, I'm getting it around 4.5 for your international plus other AUM.

So, fair to say that the AIF fees, and pension fees command a much lower yield as compared to the rest of the business.

KFin Technologies Limited July 31, 2023

Sreekanth Nadella

Very true.

See pensions, commercial model itself is very different, right, Pensions, we are not an RTA, we are a central record keeping agency, CRA, under again licensed by the Pension Fund Regulatory Development Authority of India.

The CRA has contracted rates with the regulated which are pretty much sacrosanct.

It is not negotiated by the client in the form of POP or the PFM, right, or at an investor level so to speak.

It is a flat fee; it roughly averages to about Rs.90- 100 if I may, right, for every subscriber for every year.

So, the growth out there is only and only in the form of adding the number of subscribers.

There is no discretion in terms of charging higher or lower fee.

There is no discretion in the form of value-added solution what have you.

When you calculate the yield if it is divided by the AUM that we are managing for the pension funds then, it is not even a direct correlation because we are not charging on the AUM, but it is charged per consumer.

Pranuj Shah

So, the decline in this quarter would be entirely on the basis of the pension, not on the international, and the AIFs.

Is that the correct understanding?

Sreekanth Nadella

That is correct, yes.

Moderator · Conference Operator

Ladies and gentlemen, that was the last question for today.

I now hand the call to Mr. Abhijeet Sakhare for closing comments.

Over to you.

Abhijeet Sakhare

Thank you all for joining the call today.

Have a good day.

Moderator · Conference Operator

On behalf of Kotak Securities, that concludes this conference.

Thank you for joining us and you may now disconnect your lines.