SKS Microfinance: An IPO at a PE multiple of 50 reminds one of the era of tech boom   

July 28, 2010

 There are other issues like commitment of the top management, high remuneration paid to top executives, geographical concentration of business and mismatch in its assets and liabilities

The much talked about initial public offering (IPO) of India's largest microfinance lender, SKS Microfinance Ltd, hits the capital market today with a price band of Rs850 to Rs985 per share. The issue closes on 2 August 2010. The issue opened for subscription yesterday for anchor investors. SKS is issuing 1.67 crore equity shares of Rs10 each.

With earnings per share (EPS) of Rs32.98 as on 31 March 2010, SKS trades at price earnings ratio of 26 at the lower band and 30 at the upper band. The issue consists of a fresh issue of 74.45 lakh shares with 50.37 lakh shares reserved for retail investors. Qualified Institutional Buyers (QIBs) will be allotted one crore shares. The company is expecting to raise Rs1,427 crore-Rs1,654 crore through this IPO. 

Financials and other information provided by SKS appear good on paper. However, there are some issues with the company, like high valuation of the IPO, question of commitment from the top management, high remuneration paid to top executives, geographical concentration of business and mismatch in its assets and liabilities.

At the upper price band of Rs985, the company is demanding a valuation of almost 50 times its FY10 earnings. For a non-banking financial company (NBFC), which has a limited period of operational history and no dividend record, the valuation looks very much stressed.

Although the company in its draft red herring prospectus (DRHP) claims that it has no competitive peers, SE Investments Ltd, a microfinance lender, is already listed on the Bombay Stock Exchange (BSE). SE Investments' EPS stands at Rs1.21 in the first quarter of FY10. The company posted a net profit of Rs17 crore. Based on the EPS of the first quarter of FY10, its P/E works out to 11 (annualised), which is lower than the PE of SKS.  

SKS reported a net profit of Rs174.8 crore on total revenues of Rs958.9 crore and an operating revenue of Rs873.50 crore for the year ended 31 March 2010. It had a negative cash flow of Rs541.20 crore for the year ended March 2010.

According to the DRHP, the key management of SKS Microfinance has decided to sell their stake in the run-up to the IPO under both stock option and stock purchase plans at a significant premium. Collectively, the transactions would imply a sale of 1.42 million shares or 8.4% of the IPO size. Although the Reserve Bank of India (RBI) has approved the transactions and there is nothing illegal about en-cashing investments, this raises a larger question of commitment on the eve of an IPO.

Another related fact is that out of the total issue size of 1.68 crore shares, more than half or 55.7% shares are put on sale by Sequoia Capital.

According to KA Prasanna of firstchoiceipoanalysis.com, the IPO of SKS Microfinance will make the promoters, and other venture capitalists including some private equity funds that have stakes in these companies, millionaires. The hapless borrowers continue to live in abject poverty, he added. Earlier in February, SKS Microfinance's founder and chairman Dr Vikram Akula sold 9.45 lakh shares at Rs639 per share to Tree Line Asia Master Fund (Singapore) Pte for $12.9 million, Mr Prasanna added.

SKS Microfinance also offers high remuneration to its top management. Its chief executive and managing director, Suresh Gurumani, is entitled to a consolidated salary of Rs1.5 crore per annum, besides a performance bonus of Rs15 lakh per year, with annual increments up to maximum of 100% with the board having the liberty to approve any further increase over and above the 100%. Another shocking part is that Mr Gurumani was paid a one-time bonus of Rs1 crore in April 2009, barely five months after joining the company.

SKS Microfinance maintains a medium- to long-term borrowing profile, against which its lending maturity is within one year. This creates a significant asset-liability mismatch and exposes the company to interest rate risk.

SKS has expanded its membership to 6.8 lakh across 19 States during FY10 from 2.02 lakh in five States from FY06. Currently the company has 2,029 branches with total outstanding loans worth Rs2,936.70 crore as on 31 March 2010. During the same period, its debt to equity ratio stood at 2.84:1 with net non-performing assets (NPAs) of Rs4.8 crore or 0.16% of outstanding loans.

SKS provides small loans exclusively to poor women located in rural areas across India. The loans extended are purely for business and other income-generating activities and not for personal consumption. The company will use the IPO money to meet future capital requirements. 

With increased area of operation and scaled-up activities, microfinance is increasingly gaining credibility in the mainstream finance industry with many traditional large finance organisations contemplating a foray into this business. From the geographical perspective, microfinance activity has traditionally been concentrated in southern India as 57% of the microfinance institutions (MFIs) and about 71% of the microfinance borrowers of the country are from this region.

Currently, the National Bank for Agriculture and Rural Development (NABARD) holds the right of regulatory oversight over MFIs except NBFCs. However, there exists a significant regulatory risk as the government may create a separate regulator for all MFIs. More importantly, the high interest rates charges by these MFIs may attract regulatory actions from the government or regulators, which may have a material impact on the ability of these institutions to sustain high returns. For the year to end-March, SKS charged an interest rate ranging from 26.7% to 31.4% to its customers.

Recent rules require NBFCs to maintain a capital adequacy ratio of at least 12% by 31 March 2010 and 15% by March next year. SKS' capital adequacy ratio was much higher at 28.3% as on 31 March 2010.

Kotak Mahindra Capital Co Ltd, Citigroup Global Markets India Pvt Ltd and Credit Suisse Securities (India) Pvt Ltd are the lead book running managers to the issue.

Rating agency CARE has assigned an 'IPO Grade 4' to the SKS IPO indicating 'Above Average' fundamentals.

Background

Swayam Krishi Sangam (SKS) Society, a non-profit, non-government organisation (NGO), converted itself into SKS Microfinance, a non-banking financial company-non deposit taking (NBFC-ND) in 2005. Later in 2009, SKS Microfinance became a public limited entity from a private limited company. In addition to loans the company offers insurance products and productivity loans or loans designed for purchase of goods that enhance the productivity of members. SKS Microfinance has a tie-up with Bajaj Allianz Life Insurance Co Ltd and as of March 2010, had sold 2.9 million insurance policies.

SKS uses a village-centred, group-lending model to provide unsecured loans to its members. SKS Microfinance organises prospective clients into groups so that they can address the issue of information asymmetry and lack of collateral by transferring what could be an individual liability to a group liability and holding the group morally responsible for repayment. If one member fails to make the loan payment on time, the company may not extend any to that particular group in the future. Thus, the group can make payments on behalf of the individual defaulter.

According to the 2009 'Microfinance India State of the Sector' report, the average loan outstanding per client increased 23.8%to Rs5,200 in 2009 from Rs4,200 in 2008. — Moneylife Digital Team