MICROCAPITAL.ORG STORY: Is The Microfinance Sector Losing Its Appeal To Investors As A Result Of High Valuations?

In a report by the Hindu Business Line entitled ‘Microfinance sector losing sheen due to high valuations’ [1], reporter Mr Sagar Bhadra observes that the microfinance sector, which he stated accounted for 40 percent of all private equity transactions in India in the last 18 months, ‘seems to have lost its charm’. Valuations in the sector have ‘skyrocketed’ with the consequence that ‘investors now fear a bubble and are approaching the sector cautiously’. Some market participants feel that investments in the sector is likely to decrease as investors become more selective, particularly when funding start-up MFI, according to Mr Anurag Agrawal, Senior Vice-President of Intellecap [2], a social investment advisory firm. Mr Agrawal added that the secondary market for MFI investments will start to pick up as existing investors start looking for exits.

There has been much commentary about there being a ‘bubble’ in the microfinance sector as private equity valuations soar upwards. This trend was discussed in a recent article entitled ‘A Global Surge in Tiny Loans Spurs Credit Bubble In A Slum’ that was published in the Wall Street Journal [3]. Mr Sumir Chadha, Managing Director at Sequoia Capital [4], which is the largest investor (25 per cent) in SKS Microfinance (SKS) [5], was quoted as stating that ‘There is a bubble with relatively new companies raising capital at very high prices’. He added many participants were keen to enter the sector and emulate SKS’ success. SKS was stated to be currently operating in 19 Indian states and is expected to go public early next year. Since 2008, it was stated in the report on the Hindu Business Line that USD 210 million has been invested in microfinance in India through 20 deals, 53 percent of which were transactions involving SKS. The remaining percentage were all ‘small ticket deals’ of USD 1-2 million. Previous transactions involving SKS have been covered in Microcapital.Org publications which are referenced in the ‘Bibliography’ section below [6], [7], [8].

Many investment firms, like Norwest Venture Partners [9] and Mayfield Fund [10], have been looking to invest in the microfinance sector but have not closed deals due to inflated prices. Mr Nikhil Khattau, Managing Director of Mayfield Fund, was quoted as stating that “current valuations of 5 to 6 times the book value, demanded by MFIs, are too high”. Mr Niren Shah, Managing Director of Norwest Venture Partners, believes that valuations on average have to be below four times book value for the investment opportunity to be viable. Spandana [11], another major Indian MFI, is believed to be in the process of raising money at valuations of 6 to 7 times the book value, according to industry insiders. Past transactions involving Spandana have also been captured on the Microcapital.Org portal [12], [13].

Mr Vineet Rai, Chief Executive Officer, Aavishkaar Goodwell [14], attributed the high valuations to a ‘demand-supply issue’. He claimed that there are a large number of funds interested in investing in a small number of available targets which is pushing up valuations. Mr Rai added that many investors are now facing the ‘buyer’s regret’ and some investors end up over-paying in an attempt to be part of a marquee deal at any cost. Investment firms which have paid ‘top dollars’ are justifying their investments with the strong growth potential in the sector. MFIs have reported growth in outstanding portfolio at a CAGR (Cumulative Annual Growth Rate) of 80 per cent and ROE (Return on Equity) of 30 per cent between 2003 and 2008. Mr Bhadra notes that according to the 2008 microfinance industry report by Intellecap [15], the current Indian MFI market is worth around USD 1.5 billion with a penetration of around 10 per cent while the overall market size is estimated to be as high as USD 50 billion.

By Chinq Yee Chong, Research Assistant

Bibliography

[1] Hindu Business Line article entitled ‘Microfinance sector losing sheen due to high valuations’ http://www.thehindubusinessline.com/2009/08/18/stories/2009081851280600.htm

[2] Intellecap: intellecap.com/

[3] Wall Street Journal article entitled ‘A Global Surge in Tiny Loans Spurs Credit Bubble In A Slum’ http://online.wsj.com/article/SB125012112518027581.html

[4] Sequoia Capital: www.sequoiacap.com/

[5] SKS Microfinance: www.sksindia.com/

[6] MICROCAPITAL STORY: SKS Microfinance Raises $75.4m in Equity Capital in Transaction Led by Sandstone Capital

[7] MICROCAPITAL STORY: SKS Microfinance Raises Rs. 75 Crore (USD 15.8 million) Debt and Lists Bonds on Bombay Stock Exchange

[8] MICROCAPITAL STORY: SKS Microfinance Plans to Raise USD 104 Million in Rated Debt

[9] Norwest Venture Partners: www.nvp.com/

[10] Mayfield Fund: www.mayfield.com/

[11] Spandana India: www.spandanaindia.com/

[12] MICROCAPITAL STORY: Hyderbad-based Spandana Microfinance Seeks to Raise Rs 300 Crore (USD 63.7 million) by June

[13] MICROCAPITAL STORY: JM Financial India Fund in Conjunction with Old Lane Partners Invests USD 10 million into Spandana Microfinance Institution

[14] Aavishkaar Goodwell: www.aavishkaargoodwell.com/

[15] Intellecap report on Indian microfinance sector: http://intellecap.com/news/2008/11/01/intellecap-publishes-the-report-inverting-the-pyramid-2008/