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.
My concern also touches on the big risks involved in this move which could be avoided going at a less aggressive speed and so I am asking:
When does SKS transform from a non-bank financier into an at least micro-deposit taking institution?
According to its web page SKS has already 45 partner banks for re-financing with sophisticated instruments. Slowing its current growth rate of 1000% in three years down a bit, the necessary regulatory capital could be set aside. This time of less aggressive growth would allow building up the necessary infrastructure in the company (IT, products, education of employees) to offer the clients the so much needed saving facilities.
Since IT infrastructure is excellent according to SKS’ web page and SKS’ employees are “drawn from top management schools, corporates and best-practice microfinance and enterprise development institutions” who are offered “excellent career opportunities”, this transformation process could be handled by SKS completely on its own and should go very smooth.
Teaching customers about how to save and to set aside funds for unforeseen events in their business will enable them to grow and bind them to SKS for the long term future since the successful clients could transform into individual (instead of group based) clients over time taking out much larger loans secured with part of their then accumulated assets.
With going public, SKS needs now to continue showing huge growth rates offering the new stakeholders the expected returns. These returns will be there until the market is absorbed in the sense that small customers that never received loans before can be mobilized. Beyond this the potential for growth is limited for SKS due to its limited services.
Depending on possible changes in banking regulation and movements by the other four big MFI competitors as well as the for example fast growing SelfHelpGroup-Bank linkage programs, these growth rates for SKS can decline rather sooner than later.
According to a UN report of 2007 about 800 million (m) people in India are extremely poor – a newer UN report disputes this concluding less than 300 m people. Assuming that there are on average 5 people in a household and one person takes the loan, there are thus “only” 800m /5 = 160 m potential new borrowers in the target group based on the old UN report. More than 42 m of these are already served through the SelfHelpGroups, another 7 m are served by SKS, etc.
From the view point of a public equity investor this does not matter that much as long as he/she pulls out at the earliest rumor about a changing situation (e.g. discussions about changes in regulations). However for SKS and their clients this would be devastating.
I am interested if SKS will now give priority to putting its business on a wider platform that offers more business opportunities for them regarding financial products and better financial services for their clients. Now where the outcome of the IPO was so overwhelming, there is enough capital at hand to transform into a licensed bank and thus mutually enjoy the benefit of sustainable long term customer relationships.
Xavier … I do not begrudge them the financial windfall, they richly deserve it.
I do however share your concerns with what happens in the aftermath of the IPO, the pressures from the stock market and more so from the analysts. I very much hope that SKS does not unshackle itself, even if slowly, and meander away from its mission due to market pressures.
They have clearly shown that small loans can be profitable if one can scale and grow one’s operations.
And they like a few others have reiterated that in order to scale one needs access to the capital markets.
And they do however, and now more so than before, be extra vigilant on keeping market pressures at bay and not succumb to short-term profits at the expense of their clients.
Wish them well.
Something sensible can only be discussed when knowing a bit more about the investors and the founder’s objectives for SKS’ transformation.
Are we talking about a Microcredit Institution that provides tiny loans to people targeted for socio-political objectives or about a financial services company that aims at integrating so far unbanked people into the formal financial sector. That would explain better perhaps who are prepared to pay so much money for SKS’ shares.
And as stated before, that could explain as well whether this MFI wants to assist poor people in better planning the little money they have to live or whether it wants to continue putting the weakest into debt without any consideration for the environment they live in (income, physical, legal insecurity, instability and no education) with no choice but to be a subsistence “entrepreneur”.