SKS Microfinance

A bit of a light hearted take on data I pieced together from the web. We know that JPMorgan did not get the mandate for the SKS IPO, but there are indeed some dark stories that have come out re SKS – upward bias of interest rates, insider trading allegations and all that. Some of these successive downgrades may have been dipping the toe in the water kind of cautious missives – but the latest one that drops the ball right down to 200 is a nice, clean cut. 


License to Bank

The Finance Minister during his Budget speech for the year 2010-’11 had promised new issuances of banking licenses to private sector players and Non Banking Financial Companies (NBFCs). Which really seems to have lighted up hopes and share tickers in anticipation of the grant. It could very well be a grand party, but the RBI promptly stepped in on the back of this announcement (post the Budget ’11 speech and the subsequent soundbytes) declaring that all the norms of due diligence would be strictly adhered to and that a few more screws would be tightened. We all now await the screws. I have a feeling that the apex bank may not be too keen to dole out banking licenses to corporate houses and might toy with upping the net worth criteria (currently Rs. 300 crores). The policy announcement regarding these eligibility norms are now awaited – expected shortly.

I think such prudence is called for, whatever be its reason. The Indian banking sector has come out relatively unscatched from the global banking turmoil partly because of the fact that it’s still small in size in comparision and closed (to the outside world of free capital flows). Seeking a widening of base by inducting new players into the fold seems to be the right thing to do at this point, but will more of the same spread the roots? One of the most important functions that banks serve is to lower the cost of capital available for economic activity. They can do this since they have access to low cost funds – the interest that banks need to pay on current accounts and savings accounts (CASA) is lower that what an institution would have to bear if it were to raise the money from other sources. This therefore lowers the hurdle rate that the economic deployment of such funds should earn.  That explains, in part, what has got the NBFCs and the private financial institutions all excited. But apart from that there are other parameters which also might get considered by the RBI – those of geographical coverage and reach into the poorer sections of the society. I later pick on two institutions (towards the end of the post) which I feel are good candidates, each covering one of these two objectives with one of them also being a prime trading call from my perspective today.

But some history first: RBI seems not to be too inclined towards this policy and looks like it has had to toe the line cast by the Finance Ministry. The last time that this was done was in the early ’90s. In fact, no new Indian bank  has been set up since the advent of liberalisation in 1993. Some of the NBFCs that were allowed to get converted into banks were Yes Bank, Kotak Mahindra Finance Limited and 20th Century Finance. While Kotak diversified into full service banking services, 20th Century Finance became Centurion Bank and was eventually taken over by a bunch of private equity investors only to finally land in the lap of HDFC Bank. HDFC Bank itself started life in the early ’90s and along with Axis Bank (formerly UTI Bank) has become a very successful private Indian bank. Then there was the case of UBS that had to wait for nearly 3 years before getting its banking license from the RBI. The matter had to do with disclosure norms and UBS being a Swiss Bank (perceived to be stolidly protecting of its customers’ interests and assets) may not have been too comfortable disclosing certain information about its customers, including Hasan Ali Khan, the Pune based stud farm owner. Standard Chartered Bank was not allowed to sell off its Mutual Funds business to the UBS Securities. SEBI had barred UBS Securities from issuing offshore derivative instruments for one year.  Was this a tactic to delay, we know not, but for sure what comes out is that the Indian banking scene is tempting enough for global players, burnt from the sub-prime arson, to ignore. Recently, the Credit Suisse group received the green signal to start core banking activities. In December of last year, the RBI finally accorded its assent to convert the Orissa State Cooperative Bank into a full fledged bank. It had to wait for 43 years till it became eligible to sit on the high table. Interestly, of the 31 state co-operative banks, only 15 have managed to secure banking lincenses. The deadline for them expires in 2012.

Given that backdrop, lets look at the names published in the media regarding the current hopefuls: Reliance Capital, Bajaj Auto Finance, Mahindra & Mahindra Finance, L&T Finance, IFCI, Indiabulls, Religare, Aditya Birla Financial Services, SKS Microfinance et al. The CEO and MD of IDFC has ruled out his company from applying. The news certainly seems to have set the shares of some of these companies on fire – with a promise of more to come.

There are two companies that I want to mention. First being SKS Microfinance, which has submitted its (draft?) Red Herring Prospectus (RHP) for its IPO that is soon due. I guess it should also be keen to apply for banking license. While I don’t know what happens in such cases – i.e. when the objects of business change drastically enough to warrant a re-look at the financials, prospects etc, then does the RHP have to be pulled back and re-submitted? While there may be an ethical debate regarding SKS Microfinance and the threat of defaults on micro-lending activity might be higher, the logic that such companies can reach the poorer sections of the society and introduce banking to them is impeccable. The fact that N.R. Narayana Murthy’s Venture Capital (VC) fund Catamaran Investment Pvt. Ltd. may also dip its toe will definitely make people eye the IPO.  Is the Bangladesh based Grameen Bank a full fledged commercial bank? Need to check, but to borrow a line from my previous “Hot Pani Puri” post: Micro sized sales units sold at low prices but in large numbers is the essence of India. But I do not apply for IPOs so no show there for me.

The second company being IFCI. It has been playing quite a tango with the Government so far and seems to be a prime candidate for receiving a banking license this time around – solely for that reason alone. The Government had wanted to divest its stake in IFCI and had made an announcement in early 2007 but the front running joint bid from Sterlite Industries & Morgan Stanley got stopped in its tracks since the Government would not come clean on what it proposed to do regarding the conversion of institutional debt (that IFCI held on its books). If this was to be converted to equity, then it would obvisouly be less attractive to the winning party. So the party was called off. The Finance Minister (Chidambaram) must have smarted privately and had promised to make amends in the future. Given that the banking licenses are now to be handed out, interest in IFCI has peaked and the stock has moved up well. IFCI had earlier made an attempt to make itself into a bank, but that earlier attempt had failed. All others (ICICI, UTI, IDBI, HDFC) went ahead while IFCI was left out. But It looks likely to pass muster this time. What will happen if it becomes a bank? Its cost of capital will come down improving its profitability and new avenues of business will open up. It would be fair to compare it with the valuation ratios of other banks and expect the market to crank up its valuation of IFCI to match these levels.

For the year that ended Mar, 2010, the equity base is Rs. 738 crores and its net worth is Rs. 3,152 crores. Given the face value of Rs 10 per share this gives a book value of (3,152/73.8) = Rs. 42.7 per share. The Current Market Price (CMP) is Rs. 56.75 (before opening bell on 5th July, 2010) giving us a P/BV ratio of 1.32. The PAT for the previous financial year was around Rs 671 crores giving us an earning of 671/73.8 = Rs. 8.55 per share. This implies a trailing 12 month price to earnings multiple of (56.75/8.55) = 6.64. Lets compare that to the number that other banks are reporting:

Incidentally, the reason I’ve highlighted Karur Vysya Bank in red is because that was a trading call I’d entered into at Rs. 475 on 27May’10. Translates to a 25% return in 39 calendar days. The reason I’m digressing is because I am now faced with a decision on whether to hold or sell. Which will be the subject of one of my future posts. When to buy is not the important thing, when to sell is the most critical piece. What do you think? Should I take the money and run?

Now, coming back to IFCI, its logical to expect the share to jump up to a 10x earnings multiple if it becomes a bank and increase its P/BV ratio by 50% to bring it somewhere in the middle of the table. Therefore, lets watch it up to Rs 70 per share giving a return of 23% or so (hopefully). I’m getting in given the above logic, however will be ready with an appropriate stop loss should something spook the banking license party.

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