The microfinance sector, which accounted for 40 per cent of all private equity deals in the country in the past 18 months, seems to have lost its charm. As valuations in the sector have skyrocketed, investors now fear a bubble and are approaching the sector cautiously.
“There is a bubble with relatively new companies raising capital at very high prices,” according to Mr Sumir Chadha, Managing Director at Sequoia Capital, which is the largest investor (25 per cent) in SKS Microfinance, touted as the world’s largest microfinance institution (MFI). “Everybody has seen SKS’s success and wants to get into the sector,” he added. The company currently operates in 19 States and is expected to go public early next year. Since 2008, $210 million has been invested in microfinance in India through 20 deals of which SKS accounted for 53 per cent while the rest were all small ticket deals of $1-2 million.
Going forward, the number of investments is likely to decrease as investors become more selective especially when funding start-up MFIs, says Mr Anurag Agrawal, Senior Vice-President of Intellecap, a social investment advisory firm. The secondary market for MFI investments will heat up as existing investors start looking for exits, he added.
Many investment firms, like Norwest Venture Partners and Mayfield Fund, have been looking at making investments in the space but have not closed deals citing inflated prices. “Current valuations of 5 to 6 times the book value, demanded by MFIs, are too high,” according to Mr Nikhil Khattau, Managing Director of Mayfield Fund.
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, another major 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.
Explaining the current trend of high valuations, Mr Vineet Rai, hief Executive Officer, Aavishkaar Goodwell, said that it is a demand supply issue. There are a large number of funds interested in investing in a small number of available targets which is pushing up valuations. Aaviskaar Goodwell is a UNDP (United Nations Development Programme) Award winning fund which invests in microfinance institutions in India. An investment banker familiar with the sector added that many investors are now facing the buyer’s regret. In an attempt to be part of a marquee deal at any cost, investors often end up overpaying.
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. According to the 2008 microfinance industry report by Intellecap, the current Indian MFI market is around $1.5 billion with a penetration of around 10 per cent while the overall market size is estimated to be as high as $50 billion.