Source: Economic Times
Recently, three micro finance institutions (MFIs) of varying sizes collectively received private equity (PE) investments of around Rs 550 crore (USD 115.5 ml). So, what is making the micro finance sector more attractive, especially at a time when marque names among corporates are struggling to keep their heads above water? Recently, three micro finance institutions (MFIs) of varying sizes collectively received private equity (PE) investments of around Rs 550 crore. While SKS, the country’s largest, tied up Rs 336 crore worth investments, two-year-old Ujjivan Financial Services got Rs 94 crore, compared with Rs 75 crore that it originally set out for. Spandana, the second largest by assets, has seen an infusion of Rs 100 crore. It is the kind of money that could potentially bailout quite a few companies across sectors hit by the ongoing financial crisis. Till recently, such investments went into retail or real estate. So, what is making the micro finance sector more attractive, especially at a time when marque names among corporates are struggling to keep their heads above water? Private equity is not new to MFIs. Ever since the sector adopted a for-profit approach a couple of years ago, small but significant amounts of private equity have been trickling in. Typically, high net worth individuals who identified with the larger cause of removing poverty like Vinod Khosla or Michael and Susan Dell, or social capitalists like Lok Capital or dedicated micro finance funds like Unitus or Bellwether Microfinance put in their money. What’s noteworthy now is the arrival of pure-play venture capital funds that are sensing opportunity at the bottom of the pyramid. Sequoia Capital, Sandstone and JM Financial are among those that have bet on this sector. This shift in the nature of the investor has been driven by scorching growth in the micro finance sector over the last two years. MFIs, especially the larger ones, most of whom operate as non-banking finance companies (NBFCs), have been consistently growing at 200%-plus. SKS and Spandana would both fall in this category. Some like Bandhan in
This means that in terms of the risk-return profile, MFIs are emerging as the next asset class for PE funds where the risk levels are moderate to high and the returns are always high. However, the money is not flowing into the sector as a whole. PE players are hand-picking MFIs that they believe can turn into profitable corporate entities. Not only are they looking for the MFIs’ ability and preparedness to service the growing demand, they are also keeping an eye on profitable exit options in the medium-term. This explains why the same set of MFIs are continuing to attract capital. Market observers believe that both SKS and Spandana would be ready to hit the IPO market sooner than later. Says Mohit Bhatnagar, operating partner with Sequoia Capital: “What we are seeing now is a flight of capital to quality within the priority sector.”
According to him, an investment-worthy company is defined by “a 24 carat gold plated team, a market that allows you to grow and products that you can offer to that growing market.” Clearly, those MFIs that have strong leadership teams, are scalable and process driven are coming up trumps. Interestingly, most pure-play PE funds are investing in only one MFI. Other than Sequoia Capital, which has invested in both SKS and Ujjivan, others have stayed with just one investment. JM Financials, for example, has not invested in another MFI after Spandana. For Sandstone, its recent investment in SKS is its first. So what does this mean for the highly competitive MFI environment? “With the entry of PE players, there is a sharper focus on growth because that would give them better returns,” says Mr Natarajan. As Mr Bhatnagar puts it: “Anybody who puts in money cannot allow the quality of the portfolio to fall. PE funds would not typically come in short-sighted. They see the potential to grow the market.” They have thus helped initiate the process of transforming individual-run institutions to professionally-run companies. Pros will ensure the rigours of the lending business, they believe, while the founders would ensure mission fulfilment. This would improve service quality, enable higher growth rates and improve the quality of competition, they say. It could perhaps also lead to lower interest rates through lower transaction costs. As the big grow bigger, consolidation is inevitable where the smaller micro finance players will have to either sellout or create a niche for themselves. “In this rush to grow, MFIs may soon start servicing a different class of poor leaving the poorest of the poor out in the process,” says Mr Natarajan.