SKS Microfinance IPO - Invest or Wait?

On one hand it is the IPO of the most aggressive player in the most promising market, and backed by noted VCs like Sequoia and Quantum, but on the other hand it is not only fully priced, but presents some confusion regarding how far will it go with a potentially lesser role for founder Vikram Akula. Will probable investors go for it now or wait for truer price discovery post-listing is the billion dollar question before SKS. The deciding factor is likely to be the presence of respected investors like NR Narayana Murthy of Infosys and Vinod Khosla, co-founder of Sun Microsystems.

SKS Microfinance Ltd’s initial public offer that will open on July 28 is one of the keenly watched IPOs not only in India, but in many parts of the world, where either microfinancing or microfinance investments are in vogue. But investors, especially retail investors and HNIs are still mulling over whether to invest in SKS Microfinance through this IPO or not. Both the keen interest and the continuing investor doubts have strong reasons behind.

The IPO enjoys a grading of 4 that signals above average fundamentals, while the company is backed by high-profile investors like NR Narayana Murthy of Infosys and Vinod Khosla, co-founder of Sun Microsystems.

The IPO is making waves in the US too for a different reason. The recent closure of noted philanthropic microfinance accelerator company Unitus and their PE arm getting ready for windfall profits through the IPO is behind the controversy. SKS has benefited from larger-than-life philanthropists like Bill Gates through Unitus. SKS is special in that it lends only to women.

Though microfinance shot into limelight thanks largely to Nobel laureate Dr. Muhammad Yunus founded Grameen Bank of Bangladesh, SKS Microfinance is all set to upstage it shortly to become the largest microfinance institution (MFI) in the world. SKS, founded by Vikram Akula, has been moving up at a high growth rate of 200% in 2007 and 2008, and even now is estimated to have a growth rate of over 100%. Though both organizations are all about small loans to poor lenders who form self-help groups, their growth strategies have been quite different. While 94% of Grameen Bank’s equity is still held by its poor borrowers, SKS has leveraged private capital from West to scale up, resulting in significant dilution for the original small-scale equity holders. But the result of this SKS strategy is quite impressive – it has achieved similar milestones as Grameen Bank in less than one-fifth of the time.

If this sums up the main reason behind the keen investor interest, the second reason is even more appealing. India is the largest microfinance market in the world - estimated to have a demand of over Rs. 2.5 lakh crore – due to its high population, high poverty levels, and high percentage of unbanked citizens.

Thirdly, SKS Microfinance has been consistently satisfying the transparency requirements of demanding institutional investors through internationally accepted accounting and reporting standards, as well as a state-of-the-art MIS, which is now being upgraded to a full-fledged ERP solution. All these factors combined have helped in attracting investors like Sequoia, Sandstone, George Soros' Quantum Fund, Vinod Khosla, and Infosys Cofounder NR Narayana Murthy’s VC fund, Catamaran. Murthy agreed to fund SKS after his pre-condition of creating an advisory council headed by him was met by the company. The council advises SKS on better corporate governance, better disclosure standards, and helps in charting the next stage of growth.

The profile of founder and current Chairman Vikram Akula has also helped the company, as he is seen as a worldwide authority in scaling up microfinance. Akula, a Fulbright Scholar like Dr. Muhammad Yunus, took his Bachelors from Tufts, Masters from Yale, and his doctorate thesis at University of Chicago was on the impact of microfinance. After founding Swayam Krishi Sangam (SKS) as a non-profit NGO, he shifted to McKinsey, and later came back to reinvent SKS as a for-profit NBFC that enabled the significant scaling up.

However, there are several reasons behind continuing investor doubts regarding SKS Microfinance’s IPO. At the higher end of the offer price band of Rs. 985, SKS is offering its share at a price-to-earnings (P/E) of 35.37 and price-to-book-value of 4.76, with both ratios signaling high valuation. But such hefty pricing is the norm rather than the exception when industry leaders go for their IPOs, and considering the unique industry and growth model that SKS is pursuing, there will be investors who will be comfortable with this kind of pricing. But many investors will also be wary and will wait for a truer price discovery that will ensue after the listing. Troubling such investors are recent price points like Rs. 300 and Rs. 636 at which key investors like Catamaran and Bajaj Allianz invested in SKS. Murthy’s Catamaran is expected to rake in three-fold profits after the IPO, though it won’t be selling the stake due to a two-year lock-in period.

Another point of confusion for investors is Chairman Vikram Akula’s current and future hold over the company. Since he has cashed out most of his stake prior to the IPO, and holds only around 6% stake now, there is some uncertainity regarding the future direction of SKS. Even with his earlier stake, a reportedly more socially conscious Akula had trouble balancing his vision for the company with that of the Board appointed CEO Suresh Gurumani who is a high profile banker aiming at maximizing the profits. Interestingly, Sequoia and other PE funds had to turn into promoter role to make this IPO possible as Vikram Akula’s stake was deemed too small a promoter stake by SEBI.

Kunnath Pharma's Musli Power X-Tra Passes Fifth Test for Viagra, Cialis, Steroids

Maharashtra Government’s Drug Testing Lab has become the fifth in the country to fail in finding any alleged allopathic molecules in the rapid selling ayurvedic product, Mulsi Power X-Tra, manufactured by Kerala based Kunnath Pharmaceuticals. Earlier, the NIPER Institute in Chandigarh, Sargam Laboratories in Chennai, and Government Drug Testing Labs in Trivandrum & Ernakulam had failed to find the presence of allopathic drugs in this ayurvedic formulation. Specifically tested molecules were erectile dysfunction drugs like Sildenafil (Viagra), Tadalafil (Cialis), and synthetic steroids. A couple of foreign labs had also yielded similar results on Musli Power X-Tra. Speaking on the development, Kunnath Pharma founder and Managing Director KC Abraham told Seasonal Magazine, “Some of these tests were voluntary and some based on samples randomly confiscated through raids and other means. The fact that both kinds of tests have failed prove that Musli Power X-Tra is a pure ayurvedic herbo-mineral formulation that doesn’t need adulteration with harmful allopathic molecules to be effective.”

Why Engineers India Counter Calls For Extreme Caution

With the FPO opening date finally fixed for July 27, the stock of this buzzing PSU is again showing signs of climbing. But high overvaluation, significant erosion in cash reserves, the gathering slowdown in their core refining sector, and possible high-stake punters’ play due to the low-float makes not only the FPO but the very counter of Engineers India Ltd (BSE: 532178, NSE: ENGINERSIN) risky for investors now. From a 52 Week High of Rs. 538, that happened as recent as May 7, the stock had corrected deeply to Rs. 311.70 on July 1st, losing 42% of investors money. Now it has climbed again to 340-350 levels.

As the next PSU on block for a follow-on public offer, the Engineers India Ltd (EIL) counter is again witnessing a run-up in prices - which is fundamentally not rational - that can hurt retail investors if they are not cautious.

The FPO price will be fixed only on the day before the FPO opens, by the assigned Group of Ministers (GoM) for the Issue. This can turn the counter very speculative in the run-up to the FPO, and even afterwards.

Engineers India Ltd (EIL) currently trades at 26.91 times its trailing twelve months (TTM) earnings, which is rather high, translating to a yield of 3.72% annually, less than half of bank interest rates. In contrast, a much bigger but comparable player like Punj Lloyd trades at a reasonable P/E of 12.52.

Book value wise also, the pricing is not comfortable for investors as EIL trades at 8.52 times its book value of just Rs. 40.82. With comparable counters like Electrotherm available even below its book value, this doesn’t bode well for Engineers India as an investment option.

That leaves the question of how Engineers India has witnessed such a run-up in its share price and whether it is sustainable. One strength of the company has been its cash-in-hand, which has been until recently upwards of Rs. 1000 crore. But EIL’s chief promoter, Government of India, has stripped the company of much of its cash reserves by availing an unprecedented 1000% dividend, well before the FPO. This all-time record dividend rate in corporate India was despite the fact that weeks later the company was set to announce a 21% dip in Q4 net.

Ever since its inception in 1965, EIL has been a cash cow for the Government, paying it Rs. 600 crore in dividends on a rather small share capital of Rs. 25 lakhs. That is only about dividends, with the Government enjoying 90% of Engineers India’s over Rs. 12,000 crore market capitalization.

But the same cannot be said about EIL’s retail participants, especially those who invested in the counter seeing the recent run-up on news about the disinvestment, dividend, bonus, and stock-split. From a 52 Week High of Rs. 538 on May 7, the stock had fallen steeply to Rs. 311.70 on July 1st, a loss of over 42%.

One possibility is that large-scale punters have been at play, trying to pump-and-dump this scrip. The low public float of 10%, and the sudden spurt in liquidity due to the bonus and split enabled such operators to undertake such exploits, exposing retail investors in this counter to much danger.

Now with the public float itself all set to double to 20%, the concern is whether the stock will correct even more deeply, getting nearer to its true value. Interestingly, even at its 52 Week Low of Rs. 143.38, the stock is reasonably valued at a P/E of 11.10, which will be comparable to Punj Lloyd, and by price-to-book-value comparable to Texmaco at 3.43 times.

The Q4 dip in profits might be signalling gathering clouds in its core sector of refinery and petrochemical engineering, that is not expected to add much Greenfield projects. Also, nothing from the FPO proceeds of around Rs. 1200 crore will come into the company, as unlike many of the upcoming PSU FPOs, EIL’s is a pure disinvestment plan by Government, with no issue of fresh equity.

Due to the French auction route failing to garner retail support in the case of NTPC, REC, & NMDC, the Government will be reverting to the conventional book-building route in the case of Engineers India. But modalities like the extent of retail discount and how it is to be implemented in a volatile market needs to be fine-tuned. The widely anticipated 5% discount will be a difficult lure for investors as there is no guarantee that the share price won’t fall much beyond this discount at this fundamentally overvalued counter. Making matters worse is the knowledge that Engineers India will have to go in for a further 5% stake sale soon after the FPO to comply with the new 25% public holding norm in listed entities.

Why isn’t Lodha Developers Going Public?

Mumbai based Lodha Developers claims the third largest size in Indian realty. The sector enjoys 40% profit margins. Lodha’s draft red herring prospectus was filed on 30th September 2009. But even after 9 months, the Lodhas haven’t been able to carry out the IPO. After the debacle in DB Realty and Nitesh Estates, Indian investors have been waiting anxiously for a realty IPO that can deliver profits. Markets are not sure why the Lodhas are not going for the IPO yet.

The official reason, right from Abhisheck Lodha’s desk is that markets are not ready. But markets have risen moderately by around 3% from September 30 2009 to today. Not a bad rise at all, compared with the international situation. If that is not bullish enough for the company, there were intervening bullish phases, and if the company was looking for bearish phases to time their IPO, there were enough corrective phases too. Still, the IPO didn’t happen.

Is it because of their negative cash flow? Or is it because the IPO won’t be attractive on valuations? Not really. With the realty average P/E ranging between 20 and 30, not much above the Sensex/Nifty forward P/E of 18 to 20, a share sale offer from a highly branded builder like Lodha should have been lapped up by investors in no time. This should have been the case even if Lodha had priced it rather heftily on the book, some 3 to 5 times of the actual value much like how DLF and Unitech trade these days. Because, every day, investors buy/sell more than 30 high-profile realty stocks at these kind of valuations, for a net amount which is at least three-times that of what Lodha wants from investors through their IPO.

In other words, Lodhas can any day go to the market with a P/E of 20-30 and a P/B of 3-5. The issue will be oversubscribed by at least half a dozen times. Still, it is it not happening. But who wants to go for an IPO like that? When DLF went for its IPO in 2007 June for Rs. 550 a share, its last audited EPS (of FY 07) was Rs. 2.66 and book value was Rs. 4.27. In other words, on FY’07 earnings and book, DLF was offering their share at a P/E of 206.76 and a P/B of 128.80, that is over ten times today's industry P/E and 50 times the industry P/B.

In such a world, who can blame the Lodhas for not going to the market to sell shares at realistic valuations? In fact, Abhisheck Lodha has made it clear that his main concern is that investors would lose money on his stock in these uncertain markets. If the IPO is DLF-style, such a crash will definitely happen. That concern should be appreciated, as peers who apparently did not share such concerns recently like DB Realty and Nitesh Estates were corrected by the markets. At least, as of now, nobody is cringing that they lost money on Lodha stock.

But the highly enterprising Lodhas have other resources. PE funds for one example. Traditionally, private equity has been high-flying entrepreneurs’ best friend, by willingly entering into the investment game on high valuations, and later escaping by transferring the risk conveniently on unsuspecting retail investors through an IPO. Lodha Developers has been enjoying the wholehearted support of some of India’s and Europe’s largest PE funds like the investment arms of ICICI, HDFC, & Deutsche Bank. In fact, it has been reported that the German major is one of the forces forcing Lodha to go for a specific sized IPO so that they can exit with a specific profit. Otherwise, the Deutsche Bank arm has to undertake headaches like taking ownership of two Lodha projects that they had invested in.

PE funds are also Lodha’s strength when it comes to funding projects it evidently can’t do on it own, like the World One project, the world’s tallest residential-only tower. But the uncertainties regarding the financial closure (FC) of World One shouldn’t be criticised taking into account the funding required for the project, which is more than Rs. 2000 crore. The figure is pretty interesting as India is yet to have a real estate developer who has invested or attracted investments of more than Rs. 350 crore into their company. At the end of the day, blown-up market caps don’t complete projects, only hard cash does. But, of course, the Lodhas have also been quite savvy on the debt front. For example, it is known that they have restructured their debt efficiently to avoid repaying anything of their significant Rs. 1000 crore debt during this year. Another couple thousand crores for World One shouldn’t hurt, though it may stall the IPO even further due to unattractive debt-equity ratios.

Lodha Group is promoted by Mangal Prabhat Lodha, the richest state legislator contesting last elections, and sons Abhisheck Lodha and Abhinandan Lodha. Chairman Mangal Prabhat Lodha’s BJP affiliation has given them political opponents always, like how the Shiv Sena is now raising an uproar over World One. It is up to key director Abhisheck Lodha to ensure that Shiv Sena’s allegations are baseless and to give India something to be proud in World One, and to give Indian investors a great investment opportunity through their IPO.