Sks Microfinance Ipo Update

Visit us at www.sharekhan.com July 26, 2010

SKS Microfinance
IPO Fact Sheet

Issue details Microfinance too can be traced to a non profit non-
Issue opens : July 28, 2010 government organisation (NGO), Swayam Krishi Sangam
(SKS) Society. SKS Microfinance in its current avtar came
Issue closes : August 2, 2010
into existence in 2009 when it converted itself to a public
Issue size (amount) : Rs1,427-1,654 crore limited company (from a private limited company).
Offer size (no. of shares) : 16,791,579 shares
Led by an experienced senior management (ex-bankers,
Fresh issue : 74,453,23 shares
consultants), the company has grown its operations very
Offer for sale by Sequoia : 9,346,256 shares rapidly over the years. As on September 2009, the company
Of which, operated in 19 states with 1,627 branches covering 5.3
million members with outstanding portfolio of Rs2,800 crore.
- QIB portion : 60%
The rapid growth has been aided by financial support from
- Non-institutional portion : 10% private equity investors.
- Retail portion : 30%
Key positives
Face value : Rs10/share
Mammoth business opportunity...
Price band : Rs850-985 per share
India offers a mammoth business opportunity—unparalleled
in size—for MFIs. Of the total Indian population, there are
Object of issue
approximately 825 million poor people in India. The
Through the initial public offering (IPO) the company intends penetration of microfinance in these households (as per 2009
to augment its capital base to meet the future capital Bharat Microfinance by Sa-Dhan) is estimated to be at just
requirements arising out of growth and to achieve the 22.6 million MFI clients and 63.6 million SHG clients. This
benefits of listing on the stock exchanges. implies a vast untapped market for MFIs in India. The
following map clearly highlights India’s position relative to
Share-holding pattern
the other nations. SKS Microfinance being the leading MFI
Pre-issue Post-issue in the country is well placed to capture the opportunity
Others offered by the huge demand-supply mismatch for
3% Public microfinance in India.
23% Promoter
Group
Institutions % of households with account in a financial institution
Others 37%
Promoter
41% 3%
Group
56%

Institutions
37%

Company background
SKS Microfinance is a leading MFI providing loans to individual
members (women) in a group (it follows the JLG business
model) with each group consisting of five members. In line
with the transformation of the microfinance industry from
non-profit activity to a for-profit business, the roots of SKS Source: ‘Finance for all’, World Bank 2007

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Mumbai – 400 042, Maharashtra.

sharekhan ipo flash SKS Microfinance

What is microfinance? With increased area of operation and scaled-up activities,
Microfinance is the extension of very small loans microfinance is increasingly gaining credibility in the
(microloans) to the poor and is designed to spur mainstream finance industry with many traditional large
entrepreneurship. Those living in poverty lack collateral, finance organisations contemplating a foray into this
steady employment and a verifiable credit history, and business. From geographical perspective, the microfinance
therefore cannot meet even the most minimal qualifications activity has traditionally been concentrated in southern
to gain access to traditional credit (through banks). India (57% of the microfinance institutions (MFIs) and
Moreover, despite increased penetration of banking services approximately 71% of the microfinance borrowers of the
since the nationalisation of banks in 1969, rural India country are from this region).
remains underserved by banks. Microfinance has attempted Types of business models
to fill the void left between mainstream commercial banks
The basic business model being used in commercial
and private money lenders, and has emerged as a fast-
microfinance in India was innovated by Grameen Bank
growing provider of financial services to the poor.
and later improvised by several players over the past
Transformation to for profit model quarter of a century across India with a varying degree of
What started as a not-for-profit activity funded by donors success. Some of the models are Joint Liability Group
and philanthropists has gradually evolved into the current (JLG), Self Help Group (SHG) and individual banking
commercial format of microfinance in India. The scale-up among others. Of all these variations, the grameen type
of activities was a major catalyst in this transformation. of business model seems to have been more effective
and popular, going by its dominant share in outreach (refer
Region-wise distribution of microfinance chart below).
100%
7% 10%
90% 12% 3% Trend in outreach (borrowers in millions)
80%
30%
16
70% 21% SHG
14
60% Ind Bkg
12
50% Grameen
10
40%
30% 60% 8
57%
20% 6
10% 4
0% 2
2004 2009 0
South East & NE West North 2002 2004 2006 2009

Comparative analysis of Microfinance services offered to the poor
Parameter Money lenders Commercial banks Govt sponsored Financial programme
programs of MFIS'
Ease of access High Low Low High
Lead time for loans Low Very high Very high Low-medium
Repayment terms Very short Extreme long Extreme long Short
Interest rates Fixed and rigid Fixed and easy Fixed and easy Flexible
Incentives None None None Repeat and larger loan
Repeat borrowing Possible Possible but likely Possible but likely Stream credit is assured
Loan access procedure Very quick Extreme time consuming Extreme time consuming Simple and quick
Collateral and demand Mandatory Required but Not required although Not required social collateral
promissory note hypothecation a charge on the assets is used for physical collateral
of asset may suffice become automatic

Sharekhan 2 July 2010


Microfinance supply and demand in India, FY2008 conducting their financial affairs and are prompt in repaying
60
51.4
their loans. Failure by an individual member to make timely
50 loan payments will prevent other group members from being
able to borrow in the future. Hence, the group typically
In USD billion

40
makes the payment on behalf of a defaulting member or in
30 the case of wilful default, uses peer pressure to encourage
20 the delinquent member to make timely payments.
10 4.3 Effectively, this model provides an informal joint guarantee
on the member’s loan.
0
Microfinance Supply Microfinance Demand Enviable asset quality
Source: DRHP, Sharekhan Research
The secret of the healthy asset quality, despite the risky
...and conducive policy changes... nature of customer segment and the scorching balance sheet
The policy of the Government of India has long favoured growth, lies in the business model. SKS Microfinance
the continued development of the microfinance industry in organises prospective clients into groups so that they could
India. The Reserve Bank of India (RBI), the Small Industries address the issue of information asymmetry and lack of
Development Bank of India (SIDBI) and the National Bank collaterals by transferring what could be an individual
for Agriculture and Rural Development (NABARD) are the liability to a group liability and holding the group morally
largest and most active government affiliated entities responsible for repayment. Some of the other key factors
regulating and supporting the industry. Collectively, these contributing to the health of its loan book are:
organisations have initiated significant legislation and
Credit is granted for productive purpose rather than
funding with the intent to support the microfinance
consumption, ensuring the generation of additional
movement in India. Some of the measures include diversion
income for borrowers and hence the repayment of loan.
of credit to MFIs under priority sector targets for banks,
initial funding from SIDBI among others. The low income nature of the customer segment is not
as exposed to economic downturns and fluctuations
...leading to rapid balance sheet growth
because it is relatively insulated from the general
SKS Microfinance is amongst the fastest growing MFIs in economy of the country. This independence, or economic
the world and ranked number nine in the top 100 MFIs detachment, from the effects of the economy ensures
globally (source MIX). The company has scaled up its loan higher repayment rates.
book from around Rs271 crore in 2007 to Rs2,827 crore by
September 2009. The growth rate should remain robust in SKS Microfinance lends to only women as they are
light of the existing demand-supply mismatch coupled with generally more risk averse, co-operate better in groups,
low penetration of microfinance in the country. and are generally more accessible than their working
husbands and can meet regularly to handle the repayment
Trend in growth of their loans.
8000
2005 2006 2007 2008 2009 2010 Peer pressure mechanism through group lending (as
7000
discussed above).
6000

5000
Asset quality: a peer comparison
CAGR 139%
CAGR 165% 1.80% 1.65%
4000 PA R>30 1.55%
1.60%
3000 1.40%
CAGR 139%

2000 1.20%
1.00%
1000
0.80%
0 0.60%
0.34% 0.39%
Braches Clients ('000s) Loans outstanding Rs Cr 0.40% 0.29%
0.20%
0.20% 0.11%
Group lending: Key to success 0.00%
GFSPL
Spandana

SKS
Share Mfn

South Asia
Basix
Average

The credit disbursement is done under group lending model
Average
India

to provide unsecured loans to borrowers. The group lending
model ensures that individual members are prudent in
Source: MIX



Superior returns Pradesh contributing a maximum of 28.8% of its outstanding
The pricing power due to the demand-supply mismatch, loan portfolio as on September 30, 2009. Its diversified
the benefits of scale and an effective business model (from geographical presence allows it to derisk itself from local
the asset quality perspective) have culminated into superior economic slowdowns and political uncertainties.
return on assets (RoA). For FY2009, SKS Microfinance
Apart from a diversified geographical presence, SKS
reported a return on risk assets (RoRA) of 4.57% with the
Microfinance also has a diversified product offering. In
gross yield as high as 31.6%. The RoRA of 4.57% is quite
addition to loans the company offers insurance products
superior compared with the RoA of banks (1-2%). Despite
and productivity loans (ie loans designed for purchase of
the robust RoRA, the return on equity (RoE) is in line with
goods that enhance the productivity of members). A
that seen in the banking space, due to frequent capital
diversified product basket allows the company to increase
raising and lower leverage.
its revenue stream and create brand loyalty amongst
RoRA break-up for FY2009 members. Even within loans, the activities for which loans
35 are given are diversified, thus mitigating the risk to any
30
particular sector.
25 11.09
Break-up of loan portfolio by economic activity
20
Other economic Productivity
15 31.59 loans
12.66 activities
12% 2% Trade
10 0.77 A gri related
4% 30%
5 2.5
4.57 Production
0
9%
Gross Financial Opex Loan loss Taxes Return on
Yield Costs Risk assets

Trend in return ratios Services Livestock
21% 22%
25% 6.00%
Return on Equity
Return on Asset RHS 5.00%
20% Leveraging the geographical reach
4.00% SKS Microfinance has built a large distribution network in
15%
3.00% rural India that can be leveraged to distribute financial
10% products of the other institutions. Currently, SKS
2.00%
Microfinance has a distributor relationship with Bajaj Allianz
5% 1.00% Life Insurance for the sale of the latter’s life insurance
0% 0.00% products. The stable fee income lowers the revenue risk
FY07 FY08 FY09 FY10 exposure to longer-term interest income based products.

Diversification of geography and products Adequately capitalised
SKS Microfinance has a diversified geographical presence As per the RBI mandate, SKS Microfinance is required to
spread across 18 states and one union territory with Andhra maintain a minimum capital adequacy ratio (CAR) of 12%.
The company with a CAR of 24.4% is well above the RBI
Geographical break-up of loan portfolio
requirement.
Chhattisgarh
1.7% Haryana Trend in capital adequacy
Jharkhand
Kerala 0.6%
1.9% Delhi
1.8% 45.0%
Gujarat 0.6%
Uttaranchal 40.0%
2.4%
0.4% 35.0%
Uttar Pradesh Others
3.2% 0.1% 30.0%
Rajasthan 25.0%
3.5% Andhra Pradesh
28.8% 20.0%
Madhya Pradesh 15.0%
5.3%
10.0%
Bihar
5.0%
6.8%
0.0%
Maharashtra West Bengal
Orissa FY07 FY08 FY09 H2FY10
7.4% Karnataka 13.8%
10.7% CAR Mandatory CAR -Mar'11 Mandatory CAR
11.0%



Risks & concerns assigned. Though the assigned loans, in absolute terms
Geographical concentration: Despite increased efforts by and relative to loans outstanding, have dipped significantly
the MFIs in general and by SKS Microfinance in specific, a in FY2010, a return to previous levels could increase the
major part of the microfinance business remains off balance sheet risks for SKS.
concentrated in southern India. This concentration of loan
Trend in loans assigned
exposure to certain states increases the risk to the
120.0%
company’s asset quality. Moreover, with too many MFIs Loans assigned to gross loans
operating in these states, the borrowers may over-leverage 100.0%

by borrowing from multiple MFIs, thereby increasing the 80.0%
risk of defaults.
60.0%

Equity dilution: In light of the scorching pace of the growth 40.0%
in its balance sheet, SKS Microfinance has raised equity at 20.0%
regular intervals (it has carried out capital infusion every
0.0%
year since FY2006) which has contained the RoE. Though FY08 FY09 H1FY10
the company has headroom to fund its balance sheet growth
by optimally leveraging the equity, regular equity dilutions ALM mismatch: SKS Microfinance maintains a medium- to
may continue to contain the RoE. This, in turn, would act long-term borrowing profile, against which its lending
as a cap on the valuations. maturity is within one year. This creates a significant asset
liability mismatch and exposes the company to interest rate
Unseasoned portfolio: MAlthough more than 99% of the
risk.
portfolio (based on SKS Microfinance’s internal
classification) has been standard for the past two years. Asset Liability mismatch
However, it should be noted that the loan portfolio has 10,000
Assets less Liabilities
moderate seasoning in view of the three years’ track record 8,000
and therapid growth in the portfolio, hence its performance 6,000

over a longer economic cycle is yet to be seen. 4,000
2,000
Political risk: A possible political intervention remains the 0
-2,000 0-30 31-90 91-180 181-365 >365
single largest risk for the MFIs in India. A case in point
-4,000
would be the loan waiver scheme announced by the
-6,000
Government of India providing relief to small and marginal
-8,000
farmers from loan obligations towards banks. With the low- -10,000
income segment being a major vote bank, such political
intervention could have significant financial implications Points to ponder
for the domestic MFIs. Management cashing out: Corporate governance has been
an area of concern for MFIs in general. Based on the details
Regulatory risk: Currently, NABARD holds the right of
in the DRHP, it seems that the key people in the top
regulatory oversight over the MFIs (except the non-banking
management have decided to cash out in the run-up to the
finance companies [NBFCs]). However, there exists a
IPO by selling all or major part of their allotments under
significant regulatory risk as the government may create a
both the stock option and stock purchase plans at a
separate regulator for all the MFIs. More importantly, the
significant premium. Collectively, the transactions
high interest rates charges by the MFIs may attract
(mentioned in the table below) would imply a sale of 1.42
regulatory actions from the government or regulators, which
million shares (8.4% of the IPO size). Though the
may have a material impact on the ability of the MFIs to
transactions have been approved by the RBI and there is
sustain high returns.
nothing illegal about encashing investments, but it raises
Off balance sheet risks: One of the sources of funding for a larger question of commitment on the eve of a public
SKS Microfinance is through the assignment of loan pools issue. Another related fact is that of the total issue size of
to commercial banks. Considering the commercial aspects 1.68 crore shares, a major part (55.7%) is offer for sale by
of assignment, SKS Microfinance assigns such loans on a Sequoia Capital.
“full recourse basis”, ie assuming all the risks of loans



Sumary of transaction Large Indian NBFIs also have excellent management teams
Person Designation Sale/Agreement to sale and sound systems, according to CRISIL Ratings (2009)
Month Shares Price/share
Mr Akula Promoter Feb-10 945,424 636.0 The Indian MFI market is significantly concentrated, and
Mr Gurumani CEO Jan-10* 225,000 636.4 this trend is growing: the top five MFIs already account
Mr Rao COO Jan-10* 62,500 636.7 for more than 60% of total clients and are leveraging
Mr. S. Dilli Raj CFO Jan-10* 25,000 636.7 their scale and capital market access to grow at 2.5 times
Other employees Jan-10* 160,000 636.7 the rate of the next 10 MFIs (according to M-CRIL 2009)
* Agreement date for sale of shares to Tree Line
Growth over profitability?
High rewards: Another aspect pertaining to the corporate Clearly, the private equity investors are assigning more
governance is the high remuneration offered to the current importance to income growth potential rather than RoEs
chief executive officer (CEO) and managing director (MD; (as evident in the table below). However, it should be
Mr Gurumani). Mr Gurumani is entitled to a consolidated remembered that this high pace income growth is result of
salary of Rs15,000,000 per annum and a performance bonus higher than global median leverage and excess capital flows
of Rs1,500,000 per annum with annual increments up to with increased business concentration in select regions of
maximum of 100% with the board having the liberty to India. Moreover, number of clients does not necessarily
approve any further increase over and above the 100%. In translate into growth in earnings or solid profitability.
addition, Mr Gurumani was paid a one-time bonus of
Rs10,000,000 in April 2009, barely five months after joining
Country Median PBV Median RoE Median Income
the company. In total, Mr Gurumani received Rs2.5 crore, growth
which forms 2% of the total personnel expenses of SKS Bolivia 1.1 19.3 33.5
Microfinance for FY2009. Cambodia 1.9 28.5 26.4
India 5.9 16.1 121.9
Peer comparison Mongolia 2.1 18.7 28.0
Indian MFIs attract significant premium Nicaragua 1.3 29.1 20.3
Peru 1.2 21 30.1
Globally, valuations for microfinance companies have
Tajikistan 1.4 3.3 89.0
continued to rise. MFIs in the private equity market traded
Uganda 0.9 11.5 22.0
at a median of 2.1x book value—a 62% increase since 2007 Africa 1.6 8.1 22.3
that reflects sustained demand for microfinance equity. Asia 2.5 15.9 52.5
India in particular has been showing unusually high ECA 1.8 19.1 31.0
valuations, with large MFIs trading at nearly 6x their book LAC 1.3 20 25.5
value, or nearly 3x the global median. Source: CGAP

Median Historical P/BV ‘Scarcity premium’ pricing positives
Region 2005 2006 2007 2008 2009 SKS’s leadership position in microfinance, scorching growth
Africa 0.9 1.2 1.6 1.8 NA rate, high yields and return ratios, enviable asset quality
Asia 1.7 2.0 5.1 2.9 5.0 sets the company apart from traditional financial services
ECA 1.8 1.3 1.0 2.1 2.2 companies. Moreover, SKS would be the only microfinance
LAC 1.4 1.2 1.1 1.2 1.3 company with market cap of around $1.3-1.4 billion (at
ECA = Eastern Europe and Central Asia; LAC = Latin America and Caribbean. upper and lower end of price band) available in the listed
Source: CGAP
space and is likely to command scarcity premium. The same
Following could be the reasons for the steep premium is also reflected in the offer price. At the upper and the
assigned to Indian MFIs: lower end of offer price, SKS is valued at 3.85x-4.2x its
post issue book value which is comparable to premium
Indian MFIs have enjoyed the world’s highest growth valuations commanded by leading bank (HDFC Bank trades
rate in both assets and net income over last five years. at 4.2x its FY10 adjusted book value) and NBFCs (Shriram
Transport Finance trades at 3.5x its FY10 adjusted book
They have maintained excellent asset quality (2008 value).
median PAR30 at 0.36% vs 2.98% globally for NBFIs) and
a low-cost model, with a median efficiency ratio of 11%
compared to 19.8% for NBFIs globally.



Peer comparison
Company Gross PAR>30 Yield on gross RoA RoE Operational Opex/assets
loan portfolio (%) portfolio (nominal) (%) (%) Self Sufficiency
(USD) (%) (%) (%)
GFSPL 22,687,237 0.20 32 0.17 1.16 101.94 12.23
Spandana 245,209,050 0.11 31 6.9 51.2 166.29 5.97
SKS 278,710,715 0.34 36 3.7 19.0 128.53 10.62
South asia average 5117639 1.65 23 1.1 10.4 108.17 10.17
India average 5,940,731 0.39 25 2.2 15.0 112.83 8.58
Share Mfn 190,831,717 0.29 29 6.0 37.0 151.72 8.53
Basix 73,600,059 1.55 30 2.0 16.0 114.12 14.53

Financials
Profit & Loss acctount Rs (cr) Balance sheet Rs (cr)
Particulars FY06 FY07 FY08 FY09 H1FY10 Particulars FY06 FY07 FY08 FY09 H1FY10
Interest income 0.6 4.0 13.3 44.2 28.5 Sources of funds
Other operating income 0.8 4.1 14.9 46.2 31.3 Shareholders funds 13.9 26.6 44.6 59.0 60.7
Income from operations 9.0 44.5 162.5 506.0 341.4 Reserves & surplus 1.7 44.8 167.7 605.9 710.0
Other income 1.0 1.2 7.5 48.0 43.3 Net worth 15.6 71.4 212.3 664.8 770.7
Total income 9.9 45.7 170.0 554.0 384.7 Loan funds 69.2 249.0 789.8 2136.6 2602.6
Interest expenses 2.6 13.1 52.2 174.8 114.5 Deferred tax liability 0.3 - - - -
Other financial expenses 0.0 0.1 0.4 2.0 1.3 TOTAL 85.1 320.4 1002.1 2801.4 3373.3
Financial expenses 2.8 13.9 56.5 194.4 127.4 Application of funds
Personnel expenses 2.8 13.0 47.8 137.7 94.6 Fixed assets 0.9 2.1 7.9 12.4 14.1
Operating and other expenses1.9 9.9 27.5 73.5 46.8 Gross block 1.0 3.7 12.3 25.1 30.4
Depreciation and 0.8 2.4 5.1 10.8 5.3 less: Accumulated Dep 0.1 1.6 4.8 12.7 16.4
amortisation Net block 0.9 2.1 7.5 12.4 14.1
Provisions and write offs 0.8 2.0 4.2 13.5 24.9 CWIP 0.0 0.0 0.4 0.0 0.0
Total expenditure 9.0 41.1 141.1 429.9 299.0 Intangible assets 4.0 3.1 6.6 6.6 6.1
PBT 2.9 4.5 28.9 124.1 85.7 Gross block 4.8 4.8 10.0 12.1 13.1
Tax Expenses 1.2 2.3 12.3 43.9 29.8 less: Accumulated Dep 0.8 1.7 3.6 6.6 8.1
Profit after tax 1.6 2.2 16.7 80.2 55.9 Net block 4.0 3.1 6.4 5.6 5.0
CWIP 0.0 0.1 0.2 1.0 1.1
Investment 0.9 0.9 4.2 8.0
Net current assets 80.2 314.3 986.7 2778.2 3345.0
TOTAL 85.1 320.4 1002.1 2801.4 3373.3

The "views" expressed in this report are our views only and have been arrived at after analysis of the public offering details.
This is not a recommendation under our "Stock Idea" category. It may/may not be included in the Stock Idea by our analysts
at a later date.

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