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Sceptics Knock Success

First, here is the good news. In July and August this year SKS Microfinance, a microfinance company based in Hyderabad, India, offered shares for sale in an Initial Public Offering (IPO). When the offering period closed the shares were 13 times over-subscribed by a mixture of institutional and retail investors, and the shares rose 11% on their debut trading day. The price struck for the shares valued the company at around $1.5bn and raised more than $350mn in cash, which the company will invest in expanding its products and services.

Founded in 1997 as a not-for-profit company, SKS was converted into a Non-Banking Financial Company in 2005 and a Public Limited Company in 2009. These legal changes have allowed the company easier access to capital, enabling rapid growth in size and impact. By March of 2010 the company had 6.8 million borrowers, with a loan book of $624mn, making it the largest micro-lender in India and one of the largest in the world. By selling around 20% of its shares through the IPO, the original investors in SKS have taken profits for themselves while raising capital for future growth.

Now, here is the bad news. Quite a few people in the microfinance industry are less than pleased by the success of the IPO. The critics fall into two groups. First, those people who are worried that SKS will become increasingly commercial in its outlook, sacrificing its original mission in order to maximize shareholder value. Second, those people who object to the fact that the early investors in SKS, including Vikram Akula its founder, have become very wealthy as a result of the deal.

Taking these points in turn, some critics of the deal point out that the high share price at the IPO leaves SKS under significant pressure to increase profitability to reward its new shareholders. Back in 2007 when Compartamos, a Mexican microfinance company, went public using an IPO, the share-price reflected an earnings multiple of 27, well below the figure of 40 achieved by SKS. If the public's enthusiasm for the SKS deal has led investors to pay over the odds for the shares, then they might try to put the Board under pressure to focus more on profitability than, say, improving service quality or keeping prices low.

However, SKS has only sold a fifth of its shares through this IPO, leaving the original investors fully in control of the company's strategic direction. Furthermore, given its rapid rate of growth to date and the huge potential size of the Indian microfinance market, estimated at 150 million households, it is arguable that the high share price appropriately reflects the fact that SKS has better prospects in the medium term than many other microfinance companies, including Compartamos. In other words, SKS should be able to generate healthy profits without deviating from its mission to serve the poor.

The second set of critics believe that it is inappropriate for those individuals and funds involved in setting up and running microfinance companies to profit so handsomely from their endeavours. Vikram Akula is thought to have benefited personally from a previous sale of shares worth $10mn and his remaining shares and share options are thought to be worth a further $50mn. Other early investors, including Vinod Khosla (co-founder of Sun Microsystems) and Sequoia Capital (a US based investment firm) are thought to have stakes worth $50mn and $200mn respectively. Accusations of profiteering have been made, by those who believe that microfinance companies should all be run on a not-for-profit basis.

Yet this criticisms also seems to miss the mark. The decision to raise capital from the mainstream markets reflects the fact that SKS has been very successful and needs access to new sources of finance to continue to grow and develop. The windfall gains of the early investors are a by-product of a sensible commercial decision for the company. These gains will allow the investors - whether individuals or funds - to make further investments in other enterprises, which in turn will increase the amount of capital committed to poverty alleviation in India and elsewhere. Vikram Akula, for example, is quoted as saying that he will "continue with SKS until poverty is eradicated in India".

For all the hyperbole of its critics, the fact remains that SKS Microfinance has been able to access significant amounts of capital on commercial terms because it has a robust and scalable business model, and has been very successful in delivering a good product to customers in what is probably the largest domestic market for microfinance in the world. This success should be celebrated within the microfinance industry, not least since it provides solid evidence that the champions of microfinance are right to make such strong claims for their product.

There are always sceptics to knock the successful, but the real lesson from SKS is that "scale is the key to success".

© Mark Hannam June 2010