Are MFIs in India Overvalued?
This is one of those one million dollar questions present at many microfinance forums. A CGAP and JPMorgan report on equity valuation in microfinance in the context of the financial crisis is shedding new light on this debate. Based on our admittedly limited dataset of 21 private equity transactions, MFIs in India are trading at 5.9 their historical book value or close to 3 times the world average. So, are MFIs in India overvalued?
For sure, with 600 million people living below USD 1.5 a day, India has enormous potential for microfinance and as many observers keep repeating, penetration at the national level is still low and uneven. Moreover, the milestones of the sector are truly impressive: according to MIX, from 2003 to 2008, Indian MFIs have enjoyed the world’s highest growth rate in both assets and net income (over 100% per year on each metric over the last five years). They have maintained excellent asset quality (2008 median PAR30 at 0.36%) and a low-cost model, with a median efficiency ratio of only 11% compared to 19.8% for NBFCs globally.
Despite these impressive statistics, current valuation levels are a cause for concern. Just few thoughts steaming from the report to stimulate a debate:
First, the earning prospects of Indian MFIs do not justify such high level of valuations.
Current profitability is moderate. Microfinance NBFCs in India are only generating a median ROE of 14.4% (although the largest five institutions show substantially higher numbers). Moreover, I see few prospects to increase profitability. Interest rates are more likely to go down as a result of competition. MFIs might not be able to sustain such record high level of asset quality over the long time, as we have seen in other fast growing markets. Finally, there isn’t much room for increased equity leverage as NBFCs already have a 7.2x debt-to-equity ratio, more than double the global average for NBFC.
Second, overvaluation might be driven by excess capital flows. A significant share of equity investment in India comes from investors whose objective is to realize profits by floating or otherwise exiting their investments in a relatively short time frame. In many cases in the past this type of capital has produced overvaluation of equity prices in the short term and disappointment in the long term. After all, India is the only microfinance market that has attracted large private equity funds.
But I might be missing the upside. Perhaps investors are expecting MFIs to boost profits through other ways, for example, they might value MFI extensive distribution platforms for goods and services beyond finance?
I recognize that our dataset is limited and may not be representative of all MFI equity deals in India. A number of domestic microfinance investors, such as SIDBI, are known for investing at lower valuations. Thus, opportunities for reasonably-valued equity investments still remain, but the majority of recent transactions by foreign-owned funds suggest that finding such opportunities is not necessarily an easy task.
Another reason for the apparent high level of faith equity investors have in MFIs in India is a result of the intentions of some MFIs to go for IPOs, which sends plenty of signals.
The debate on over valuation of MFIs in general and NBFC type in particular, is more biased to supply side I would like to draw attention to other one of those one million dollar questions “Whether these factors like ‘earning profit’ and ‘excess capital flows’ ‘going for IPO’ (Fahmeen)in MFIs be it in India or elsewhere, facilitate in getting the purpose of MF served namely ushering in poverty reduction from the demand side. The valuation or rating mechanism for MFI is incomplete without taking cognizance of the socialimpact of MF simultaneously on the poor clients’ wellness
Further in the context of poverty reduction and MDG goals, CGAP may think of ‘how to valuate the MFIs confining to micro credit ( minimalist approach -money lending business) only and those MFIs delivering other MF products like Micro saving ,Micro insurance , transfer of money either singly or jointly integrated with other services like Health, education (integrated approach -BRAC in Bangladesh) for a sustainable poverty reduction? Similarly, how to valuate the MFIs with poor and non poor clients (MIX ) and those MFIs with the poorest and the poor ?
In country like India with the given level of poverty, and client drop out rate resulting financial exclusion ( 43% of SHGs reporting client exit as per Srinivasan’s report on MF sector India ) the question ‘ how the challenges of poverty reduction is addressed by these MFIs in India ? appears to me , is more important than the question on over valuation or under valuation of MFIs in India
Poverty reduction is obviously the prime important consideration. But off late the approach of MFIs to towards resource generation, particularly when they eye on capital market, genuinely bring this valuation issues into forefront. High valuation will attract many large investors to park their fund and obviously many small investors will follow the same. Time may come when this bubble may brust to the disapointment of all concerned. So, valuation of MFIs should be accurate and also is useful.