SKS IPO Success and Excess
By market standards, the SKS IPO is a great success. Institutional investors have over-subscribed their allocations by 13 times, and the company’s valuation of USD 1.5 billion came in at the top end of the offer band price.
This sky high valuation represents 6.7 times the company’s post issue book value, and about 40 times the company’s fiscal year 2010 earnings.
Such multiples are not in line with market peers. In emerging markets, banks are valued at 3 times the book value, while finance institutions serving low-income customers are trading at 2.6 times the book value. The SKS valuation is even higher – by a margin — than Compartamos’s valuation in its landmark 2007 IPO. At listing, Compartamos was valued at 27 times the company’s historical earnings although its 2006 return on equity (ROE) at 55% was more than double the ROE of SKS today.
Earning prospects at SKS are attractive, but on their own don’t justify such a high valuation. On the positive side, SKS still has a lot of room for growth. It has ambitious plans including offering new financial products, distributing goods and services beyond microfinance at the bottom of the pyramid, and transforming into a universal bank. But there are clouds on the horizon. Portfolio yield might stagnate as increased competition and political scrutiny put pressure on interest rates. The cost of risk will likely go up in the absence of a well-functioning credit bureau. Transaction costs for group lending will also increase as SKS focuses its growth on underserved, harder-to-reach clients and states.
So what might explain the unrealistically high valuation? This “irrational exuberance” in the SKS IPO price is probably due in part to excess capital flow. It reflects strong institutional investor interest in microfinance combined with the dearth of publicly-traded microfinance securities. Investors are seeking more exposure to emerging markets and to alternative assets. They are eager to buy into the microfinance story and with only two pure microfinance institutions listed, prices are getting ahead of fundamentals.
One of my concerns is that investors buying at such a high level may pressure management to increase profitability, at the expense of clients’ interests and long-term company sustainability. There is indeed a risk that a focus on short-term profit and quarterly earnings might overshadow—if not clash—with the social mission of SKS. True, this did not happen in the Compartamos case (the company did not become more “commercial” after its IPO) but there is still a risk.
What does appear likely is that someone is going to lose as, over time, the SKS valuation should come in line with global standards. Will it be the latecomer investors who bought too high? Or will it be clients as the institution prioritizes profit maximization? And what about possible broader ripple effects? Unmet expectations might make it harder for other MFIs to go gain the confidence of the public markets.