Shedding Light on Microfinance Equity Valuation: Past and Present
This report is the result of a collaboration between CGAP and J.P. Morgan. Our objective is to provide benchmarks for valuation of microfinance equity, both private and publicly listed. Our analysis is based on two datasets: a sample of 144 private equity transactions, which represents the largest such dataset gathered to date, and data on 10 publicly traded micro finance institutions (MFIs) and low-income consumer lenders.
MFIs will certainly be affected by the financial crisis ricocheting across the globe, but we believe that the sector is fundamentally sound. Larger institutions, especially those with diversified funding sources, such as retail deposits, are best positioned to manage the effects of economic and financial contraction. Valuations may change, but we believe the long-term outlook for equity investment in microfinance is positive.
Private equity valuations for MFIs have varied widely over the past few years. Historical median valuations in our private sample have varied between 1.3x and 1.9x historical book, and between 7.2x and 7.9x historical earnings over the four-year period, as shown in Table 1 on the next page. The considerable range of these indicators may indicate the lack of market consensus on MFI valuation.
Publicly listed low-income finance institutions (LIFIs) have outperformed traditional banks. Since its creation in 2003, our Low-Income Finance Index has outperformed the Global MSCI World Financials index2 by 238% (and has outperformed this benchmark by 8% since the Lehman bankruptcy in September 2008). LIFIs now trade slightly higher than traditional banks on price-to-book basis (1.9x 2008 book for LIFIs versus 1.5x for emerging banks as of January 28, 2009). On a 2009 price-to-earnings basis, LIFIs are trading at a 22% discount to traditional banks.
Investors should not value MFIs the same way they value traditional banks. We highlight five characteristics that differentiate MFIs from traditional banks, and justify a slightly different valuation approach: a double bottom line that aims for both social and financial returns, excellent asset quality, high net interest margins (NIMs), high operating costs, and longer term funding available from developmental investors.
Book value and earnings multiples are the most widely used valuation tools but we also recommend the residual income method. Relative value valuation methods, price-to-book, and, to a lesser extent, price-to-earnings multiples remain the most common valuation methods in microfinance equity. An absolute valuation method, the residual income method, would also be appropriate for MFIs because it combines the current book value with future earnings.