From A Dream To A Nightmare - SKS Microfinance

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The story of SKS Microfinance is one of those success stories that others were waiting to emulate. This was the dream run others were aspiring for but as the events that have unfolded over the past few weeks, both in macro and micro perspective, have shown, the story is turning out to be a nightmare that others will hardly want to experience. On October 4, in a rare notice of its kind, SKS Microfinance informed the Bombay Stock Exchange that the company “had withdrawn all the powers and authority granted to CEO Suresh Gurumani or otherwise enjoyed by him.” The management and the board of the directors of the company argued for this high-profile sacking because of Gurumani’s incapability to handle the changing dynamics of the microfinance industry post the IPO. But there seems to be more than what meets the eye. Did the man who successfully anchored one of the most successful IPOs of 2010 in India and led to the growth of 220 per cent in bottomline since 2008 when he joined the company suddenly become incapable of handling the change and understanding the dynamics of the industry? Even on other financial parameters like return of assets and equity, the company excelled during his tenure and doubled to 4.91 per cent and 21.54 per cent respectively. Moreover, the person who has been elevated to the post of CEO now was always a part of the management as chief operating officer to assist the CEO. What further raises the question is that in a board meeting held on September 7, 2010, M R Rao was elevated as deputy CEO.

Vikram Akula, the company’s founder chairman, admitted to interpersonal issues and conflicts between the MD and rest of the senior management team, including most of the MD’s direct reports, during a media conference called in Mumbai to clear the air about the sacking of the CEO. But all the rationale offered by him turned out to be unpersuasive, unconvincing, and unclear. The share prices of the company did not remain immune to these events. Though the listing gain was not spectacular and yielded only 10-15 per cent of gain (depending upon the type of investors since a retail investor got a discount of `50), the next one month was definitely impressive in terms of returns. On September 28, SKS’ share reached to its all-time high of `1,402 on closing basis, thereby providing return of 42 per cent in a time span of a little more than a month. But what followed in the next two weeks due to these events was more dramatic and the share prices plummeted to an all-time low of `1,079 by October 18, eroding `1,900 crore of the shareholders’ money. This can also be partly explained by one of the ordinance on microfinance by the Government of Andhra Pradesh, known as the [PAGE BREAK]

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golden field of microfinance and the biggest market for the company. This is not the first case of high-profile people leaving SKS. The other three eminent people acting as trustees of SKS Mutual Benefit Trusts (MBT) who left the organisation are Gurcharan Das, (former CEO of Procter & Gamble India), Anu Aga of Thermax, and Narayan Ramachandran of Morgan Stanley, in a run-up to the IPO as differences surfaced with Akula over how the IPO money would be put to use. There have been other incidents in the last few years when people like Praseeda Kunam and Raghunatha Reddy, who were instrumental in leading the company to the place where it is now, had announced untimely exits from the company due to differences with the founder chairman. In addition to this, there are also 72 cases of employees having been sacked by the management of the company in just a matter of one year. This microfinance industry is supposed to maintain a fine balance between profit-making and philanthropy. But as time elapsed a fork appeared in the path and the management decided to go choose capitalism over socialism. The glib argument given by the management to choose this path was that this was the only way to serve the vast poor of the country.

If we scratch the surface we find that even the successful listing of the company’s share at the bourses serves the same purpose of making rich the shareholders (read investment bankers and private equity investors) at the expense of the poor. Out of the total public issue of 1.67 crore of equity shares, the sale of only 0.74 crore was fresh issue that will go for lending purposes while the rest i.e 0.93 crore shares was offer for sale by different investors that directly went to their kitty, thus making them rich by crores. Most of them have recovered the entire investment and are still holding considerable shares in the company. India, which houses one of the largest poor in the world with more than 55 per cent of its population still living below the poverty line, according to the measure of Multidimensional Poverty Index (MPI), makes for one of the largest potential markets for microfinance in the world. SKS Microfinance, which started as SKS Society (Swayam Krishi Sangam) in 1997 as an NGO, has come a long way since then (see the timeline of SKS Microfinance) and has turned itself into a profit-driven company. An organisation that was supposed to help the poor is actually milking them due to lack of opportunity for them to borrow from other sources. In sharp contrast to the Grameen Bank, which has been an inspiration for many microfinance companies around the world charges on an average 18.5 per cent interest [PAGE BREAK]

per annum, SKS’ interest rates are as high as 28 per cent.  This rate will further rise if we include the normal insurance and other processing fees levied by the company before handing out the cash. Even if we compare it with any private sector bank’s unsecured personal loan which hardly crosses 20 per cent per annum, the rate charged by SKS is indeed very steep. Another way through which this company is benefiting at the expense of the bottom of the pyramid is by RBI’s priority sector lending policy which requires domestic banks to lend some portion of their loan portfolio to underserved sectors and small producers. Since MFIs mainly lend to the poor who qualify for Indian banks’ priority sector lending requirements, these MFIs sell their portfolio to these banks who many a times cannot meet the RBI’s criteria of lending to them. This again puts cash in the hands of the company that they re-direct to lend to the poor at high rates of interest. This is not something new but not many are aware of such transactions. The Reserve Bank of India officials have raised the question of whether commercially-oriented MFIs should continue to qualify for priority sector loans from banks if the benefits of growth accrue to private investors, given that the purpose of this aspect of priority sector lending is to benefit the poor rural people. Therefore, the higher spread enjoyed by the company (for Q1FY11 it was 6 per cent) may come down.

Another major macro incident which might hamper SKS’s profitability is the cap on interest charged by the company though-nothing concrete has been done yet. But the recent cases of suicides and assaults related to MFI clients may expedite the process. Even if we see from a valuation point of view, SKS is clearly an outlier. On price-to-earnings multiples, it is currently trading at 41.67 times of its FY10 earning, clearly ahead of all its other peers and many banks, including the well-established HDFC Bank which is trading at 38 times. The other important multiple to gauge the attractiveness of a financial company is its price-to-book value. For SKS it is again on the higher side and currently it is trading at 4.3 times its book value which looks quite expensive as almost all the Indian banks, expect HDFC Bank, are trading at below 4.1 times of their book value. Even if we look at the ROE which is positively related to the price-to-book value (PBV), it is at 21.5 per cent (FY10) for SKS as against 24 and 26 per cent for PNB and UBI, and trading at less than three times its PBV. Hence we advise our readers to book profit (if any) and exit the counter.