Microfinance IPOs – downfall or salvation?
MFTransparency CEO Chuck Waterfield debates the role of IPOs in microfinance at the Microcredit Summit.
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Microfinance IPOs – downfall or salvation? Microfinance Focus, November 16, 2011
As hardly anyone needs informing, SKS went public last year. This IPO came three years after the famous (infamous, perhaps?) IPO of Mexican MFI Compartamos in 2007, which was notorious for widely-publicised three-figure interest rates charged to clients while the investors (some of which were putting in public donor money) got very rich.
If you had told someone in mid-2010 that a year and a half later, SKS’s share price would be a tenth of its peak, and about an eighth of its listed price, they would be probably flabbergasted. SKS had posted outrageously impressive growth in the months and years leading up to the IPO, and a lot of people were going to make a lot of money.
In retrospect of course, the signs were there. And according to Sanjay Sinha of M-CRIL, who wrote the paper that was the subject of a much-awaited session at the Global Microcredit Summit 2011 (Initial Public Offerings: The Field’s Salvation or Downfall?) – the SKS IPO holds no small blame for the crisis in Indian microfinance itself. It may not have been the sole cause – but it was a serious one.
Sanjay opened this discussion – in which rival arguments were to be put forward, the abstracts of which are available on the global microcredit summit website: each arguing either that IPOs are the ‘salvation’ of microfinance, or that they will be the industry’s ‘downfall’. Sanjay broadly argued the latter; his hypothesis being that the IPO constitutes “the ultimate in the acceptance of an activity by commercial investors; with: difficult to control processes; and the market geared to profit maximisation in the short term.
But, he argued, “Microfinance is a development activity that needs greater sensitivity”.
An IPO has as its objective price maximisation and expectations of future increases in market value, he said. In India, and with SKS, this meant in practice ambitious business plans, high valuation on MFIs, and high growth demands. The high valuations went beyond SKS as a company to publicly list: it was true for others that were attracting more and more commercial private equity too, and investment from non-social HNIs. Combine this with the success of Compartamos for investors, and the motivations were clear.
Sanjay’s argument is that from the 2007 Mexican IPO, SKS sought to maximise its valuation, so went all guns blazing for maximum growth – a point he made compellingly with a succession of ‘hockey stick’ graphs. As SKS accelerated, other leading MFIs were sold to private equity at high valuations based on ambitious plans.
So new NBFCs sprang up, there was a “Get rich quick” rush for the “low hanging fruit’, the consequential proliferation of multiple lending, a decline in customer service, pressure on managements, staff and targets, and perhaps client coercion too. The signs really were all there.
So then the IPO happened in July 2010. Shares sold at 985r, Listed at 1088, and rose to 1402 by October. Unfortunately, SKS had sought a lot of media attention before the IPO to drum up publicity and valuation. The irony is that the media that arrived at SKS’s behest dug around, only to reveal the overindebtedness crisis in the Indian sector.
Now the share price is at 142r. The future looks bleak for SKS.
And it looks bleak for Indian microfinance too. The leading MFIs grew 80-100% per annum from 2007-2010. Now, in the last 12 months, there has been a 33% decline.
But, Sanjay argued, IPOs can have a positive impact, if
1. They don’t get carried away with rhetoric
2. They Maintain balance and sensitivity to the needs of their clients
“We don’t need to be pessimistic about the potential for successful and positive IPOs in the future, we just need to learn the SKS lessons”, he said.
Carlos Danel, co-founder of Compartamos responded to Sanjay’s presentation and paper. A man of admirable clarity, moderation, and composure in the face of oftentimes-hostile receptions, he said “I don’t think IPOs are necessarily a downfall. But they are not the salvation of the industry either”.
“What we need is the perspective of time…with the question of what might or might not happen after you do an IPO. At the heart of Sanjay’s paper, there is a concern, a sensible one, a possible one, but I don’t think necessarily inevitable….[of IPOs leading to] mission drift” he said.
“There is an assumption”, Carlos said, “that investors will behave in a predictable way: push for higher rates, profits etc, at the expense of the clients”.
There are some investors, he conceded, who behave that way, but doesn’t think it’s inevitable for an institution to act like this.
Making the case for Compartamos, four and a half years later, clients reached have gone from 600,000 to 2.2m. The company correctly anticipated decelerating growth rate: 35% the year after the IPO, and year 20%. 98% of clients are still women. Average loan sizes have gone from $400 down now to $360. Average outstanding loan balance is under 5% of GDP per capita.
He descried a new housing product that 200,000 clients have signed up for, as well as microinsurance and efficiency gains, and a decline in interest rates (down 18% from before. He argued compellingly, too, that the IPO stimulated the market as a whole in Mexico. In 2007, the competition had 400,000 clients. Now it has 3m. The number of competitors has increased several-fold to a large group of over 1000 institutions, many offering strong services.
“We are not just creating an institution but creating an industry”, Carlos claimed.
He finished by outlining three things needed for an IPO to avoid the Indian disaster:
1. Appropriate regulation;
2. Consumer Protection; and
3. Balanced governance, especially important if an institution is pulled in many different ways.
Chuck Waterfield of MFTransparency stood up, and was predictably critical of Carlos’ arguments – though not at all his presence.
He outlined what he considered the two rationales for IPOs:
1. Additional resources for growth, and
2. Financial reward for initial investors.
Regarding Compartamos, he observed that the average RoE was 50%. He told the story of the IPO, including the disgraceful fact that the American taxpayer gave US$1m to USAID, which gave it as a grant to Accion (an NGO), which gave it to its own Gateway Fund (for profit) which invested in Compartamos, and got back $350m for its troubles. Which it kept. The audience whistled in disgust at this misuse of American public funds.
“Do we actually need IPOs to stimulate growth?” Chuck rhetorically asked.
He listed other options for generating that growth, including savings mobilisation; the Grameen option (in which 96% of shares are owned by clients); or the Pro-Credit model, in which there is a limit of 15% on RoE and only accepting funding from investors who are willing to take a social ‘discount’ on returns.
He finished by listing Gandhi’s ‘seven deadly social sins’:
• Wealth without Work
• Pleasure without Conscience
• Science without Humanity
• Knowledge without Character
• Politics without Principle
• Commerce without Morality
• Worship without Sacrifice
“Stick to them…”, Chuck said, “and we will get to an industry of real responsibility”.
Anne-Marie Chidzero is CEO of Africap Microfinance Investment Company, which was heavily involved in the IPO of Equity Bank in Kenya – which started out as a humble building society.
“Africa has a huge demand for financial services for the poor”, she said.
But the reason the Equity Bank issue was generally well received, she argued, is that “Kenya has a strong central bank, so the regulations were enabling, but [they] also suppressed high profit making”.
Finally, P.N Vasudevan, CEO of Equitas Microfinance in India – an MFI which he admitted will one day pursue a public offering itself, said that four years ago, when Equitas started, he knew what microfinance was. “Now, I am confused!”
“There are NGOs charging 30% interest rates, but the services are poor, and the funding comes in spits and spats”, he said.
Compare this to a for-profit MFI, which offers a whole lot of better social services, even if its interest rates are somewhat higher, and which knows its funding can be relied upon. It is not clear, Vasu said, that the former is better for clients than the latter.
The day before at this summit, Vasu said, there was a plenary session on social businesses, with Muhammad Yunus providing his never-changing speech on the evils of profit in microfinance.
“I would like to pitch, by contrast, ‘responsible business’. There are profits, but they are reasonable and modest and responsible. Can this work in microfinance?”, said Vasu.
He finished with a panel of people nodding along, as he said we want an IPO with a responsible microfinance, and that such a thing is possible. A Cap on RoE of 20% is possible. A cap on interest rates is possible. And a cap on managerial salary ratios to other employees is possible.
At the start of the session, Larry Reed (the incoming head of the Microcredit Summit Campaign and chair of this packed-out session), asked the audience who thought IPOs are the salvation of the industry (virtually nobody), how many thought they were the downfall (some) and how many didn’t feel they could be sure (most).
He finished the session by asking for salvation (virtually none), downfall (fewer than before) and “neither – but potentially they can be good for microfinance clients” (almost all).
We will need to ensure that the next IPO learns from the mistakes both of Compartamos and SKS to prove this last thesis right.