India: Microfinance’s Small-town Success Attracts Venture Investors

Jul 2009
India, July, 13 2009 - MFIs have seen the most active venture capital deal flow within the banking and financial sector since Jan 2008.

Thrissur in Kerala, Tiruchirappalli in Tamil Nadu and Haveri in Karnataka are unlikely towns investors will be herded into. But they recently entered India’s venture capital (VC) map, thanks to the booming microfinance industry. 

Unbanked population: Udaia Kumar of SHARE Microfin says there is a strong demand for organized forms of banking which cater to India’s poor. Penetration of banking services is around 10% of the requirement. INDIATODAYIMAGES.COM

On 22 June, Thrissur-based ESAF Microfinance and Investments said it landed Rs12 crore from Dia Vikas Capital, an arm of Opportunity International Australia, while Haveri’s Navachetna Microfin Services Ltd received Rs1.5 crore from a few high networth individuals and IT professionals. A day later, Tiruchirappalli-based Grama Vidiyal Microfinance Ltd said it raised Rs20.4 crore from MicroVest, Unitus Equity Fund Lp and venture capitalist Vinod Khosla. This is the second round for Grama, which had raised Rs14.7 crore in 2008.

The deal flow in microfinance has got stronger with investors looking at tier III towns such as Thrissur and Haveri. The microfinance industry has seen the most active venture capital deal flow within the banking and financial sector since January 2008.

Of about 50 private equity deals worth $1 billion (Rs4,940 crore) in banking and finance in the last 18 months, microfinance alone accounted for 20 deals worth at least $200 million.

If this was not enough, last week SKS Microfinance, the largest microfinance institution (MFI) in India, announced a $10 million strategic investment from general and life insurance firm Bajaj Allianz Life Insurance Co. Ltd. The two firms had come together last year to launch the first micro-insurance product for the rural poor. The deal signals the significance of how the client network built by MFIs could serve as a distribution channel for products besides credit.

A large chunk of these deals are funded by microfinance funding institutions such as Lok Capital Llc, Aavishkaar Goodwell India Microfinance Development Co. Ltd, Bellwether Microfinance Fund and Unitus Equity Fund Lp. They provide start-up capital, help MFIs build capital and asset base, and make them ready for larger rounds with financial institutions and venture capital firms. Since many MFIs are funded and have built scale, a whole new bunch of Silicon Valley VC firms and private equity funds are waiting to enter.

Many other VC firms have already declared their keen interest in the space. They include Norwest Venture Partners, Mayfield Fund and Lightspeed Venture Partners, among others. “Our preference would be companies that have strong management and internal controls as well as reasonable traction on the portfolio side and the banking relationship side,” said Bejul Somaia, managing director, Lightspeed Venture Partners.

Besides SKS, firms such as Equitas Micro Finance India Pvt. Ltd, Bhartiya Samruddhi Investments and Consulting Services Ltd (Basix Group), SHARE Microfin Ltd, Bandhan Microfinance, and Ujjivan Financial Services Pvt. Ltd have acquired larger customer and capital base. So, the sector is bracing to see at least a couple of big ticket fund raisings in the coming months.

SHARE Microfin and Spandana Microfinance are in the process of raising rounds between $50 million and $60 million, say some industry representatives.

There are several reasons for the huge investor appetite in this space. “There is a strong demand for organized forms of banking which cater to the bottom of the pyramid,” said Udaia Kumar, managing director, SHARE Microfin. The credit requirement in India is huge and market penetration is still believed to be around 10% of the total requirement. In fact, 40% of India’s population is unbanked, while MFIs have been able to reach only 114 million people with a loan portfolio of over $1 billion, leaving scope for growth.

Now many sector-focused MFI investors are looking at areas where MFI penetration is low. Also the industry has grown by 100% year-on-year (y-o-y) over the past few years, even when the rest of the Indian economy had slowed down amid the global meltdown. So there is a decoupling factor attached to it. “Poor people are generally unconnected to the global economy and as a whole the sector that has done extremely well during the difficult economic climate in past year,” said Eric Savage, managing director, Unitus Capital, an investment banking group that helps MFIs raise capital.

With the rise in investor interest, valuations of MFIs have also skyrocketed. For instance, valuation of SKS rose to at least Rs2,000 crore in its recent round, and Spandana is expecting a valuation of at least Rs1,800 crore for its latest round. Most MFIs are raising funds now at approximately 10 times their earnings while many are doubling earnings annually, said Savage.

Niren Shah, managing director of Norwest Venture Partners, said several companies were seeking to raise capital at seven-nine times their book value; whereas there are publicly listed banks, which are available at 0.6-1 times their book value. This is one of the reasons why many funds have stayed away from this field. “Even though we really like the sector, the reason we have not invested is that we find the valuations to be high relative to the risks we see and also relative to the valuations of other companies which serve the unbanked or credit deprived segment,” said Somaia.

MFI sector has only seen money coming in till now, and no money has gone out. But we may not be too far away from a public listing in MFI space. Two of the largest players in the sector, SKS Microfinance and SHARE Microfin, plan to hit the capital markets in the next two years. The sector is also likely to see consolidation in coming months. “You might see M&A (mergers and acquisitions) in areas such as north-east and east India, where MFIs working in a niche have created a regional stronghold,” said Abhijit Maheswari, founder of Sloka Capital Advisory Services Pvt. Ltd.

Though the sector paints a pretty picture, there are a number of challenges going ahead, players believe. Multiple borrowings by the same customer and hiring of staff to keep up with the growth have emerged as impediments. Also a need for legal and regulatory framework is felt by the sector which has seen rapid growth.

Most of the large MFIs— even though registered as non-banking finance companies— are not allowed to accept savings. Despite all of this, Indian MFI sector is growing at 100% y-o-y, one of the reasons for the deal flow in the space to remain robust for some time.

Source :

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