Verdict: Attractively valued growth MFI

IPO Snapshot:

Spandana Sphoorty is entering the primary market on Monday 5^th August 2019 with a Rs. 1,201 crore IPO – split as fresh issue worth Rs. 400 crore and an offer for sale of about Rs. 801 crore, comprising up to 94 lakh equity shares of Rs. 10 each by promoters and a clutch of PE investors, in the price band of Rs. 853 to Rs. 856 per share. Issue represents 22% of the post issue paid-up share capital and closes on Wednesday 7^th August, with listing likely on 19^th August.

Objects of Issue and Shareholding:

Fresh issue proceeds of Rs 400 crore will augment capital base, while OFS will provide part exit to corporate promoter, individual promoter and PE investors (some like Valiant and Helion invested since as early as Dec 2008 and Oct 2011), as detailed below:

^consortium of Kedaara Capital, George Soros’ Quantum, Ontario Teachers’ Pension Plan and US fund Maple Mountain Holdings, invested Rs. 900 crore in March 2017 to help company successfully exit CDR post 2010 AP crisis. 

Company Background:

Spandana Sphoorty is India’s fourth largest micro finance institution (MFI), with gross AUM of Rs. 4,437 crore (31-3-19), 92% of which is lent in rural areas, to 2.46 million active borrowers, served by 7,060 employees across 929 branches in 16 states and 1 union territory. However, over 70% of this portfolio is concentrated in 5 states alone - Madhya Pradesh (20%), Odisha (20%) Karnataka (13%), Maharashtra (11%) and Chattisgarh (9%). Since exit from CDR, company’s credit rating (by ICRA) has improved from BBB- (Stable) in Aug 2017 to BBB+ (Stable) in May 2018 and to A- (Stable) in Mar 2019 which has helped it access funds from multiple sources to fuel growth in AUM at 85% CAGR between FY17-19. But attrition (for branch manager and above levels) remains high, at 25%, posing a challenge for the entire sector. MFI loans being unsecured in nature, carry higher risk than secured lending. However, in a declining interest rate regime, company is partially insulated from yield contraction, as loans carry fixed interest rates, while borrowings are largely on floating rate basis.

Financials:

FY18 and FY19 are the only two meaningful historical years for review, as company was under CDR prior to that, starved of funds and hence muted growth. On disbursement growth to Rs. 4,969 crore, FY19 revenue and net interest income (NII) stood at Rs. 1,043 crore and Rs. 640 crore, up 78% and 88% YoY respectively. PAT grew 66% YoY to Rs. 312 crore, leading to an EPS of Rs. 53.35 on an equity of Rs. 59.6 crore.

On net worth of Rs. 1,889 crore, BVPS is Rs. 317. Company boasts of the highest RoA in the NBFC industry - 8.20% for FY19. While lending rate for the sector is capped by RBI at lower of cost of funds +10% margin or 2.75x quarterly average base rate of 5 largest commercial banks, legacy loans taken at high interest rates of ~14% enable the company to earn higher yields (including processing fees and assignment income) of 25.96% in FY19, resulting in 16.39% NIMs, again higher than all its peers. While yields will decline as cost of borrowing drops, margins should continue to be healthy. Since leverage is low (debt equity ~1.6x), RoE of 16.5% is also good, but not the most superior. Asset quality is impeccable with Net stage 3 (excluding AP portfolio) at 0.01%.

Valuation:

At Rs. 856 per share, company’s market cap will be Rs. 5,505 crore, leading to a PE and PBV multiples of 16x and 2.7x, on historic basis. Find below comparison with other MFIs/banks dominant in micro loans:

* as of 2Jul19, before merger with Indusind

A common underlying across all the above companies is FY19 AUM growth rates have been healthy, with outlook also positive. India’s largest MFI Bharat Financial and only AP-facing MFI to not go into CDR, prior to its July 2019 merger with Indusind Bank, had a diversified loan book (max exposure to single state at 15%) with highest RoE, due to debt equity ratio of 3.5x. Creditaccess (share price up 17% in last one year since IPO), despite 53% portfolio concentrated in Karnataka and 26% in Maharashtra is ruling at historic PBV of 3.2x, given its excellent asset quality of nil NPAs. On the other hand, Satin Credit’s multiples rule lower due to high stress on its book, despite AUM being as large as Creditaccess’.

While Ujjivan, Equitas are under overhang of tweaking the corporate structure upon conversion to small finance bank, while Bandhan Bank commands a premium PBV multiple among banks, due to its double-digit NIMs and presence in under-served markets of East India. 

In this back-drop, Spandana with 8% RoA, 16% NIMs and low NPAs looks attractively placed vis-à-vis peers. Given healthy growth visibility, sustainable margins and likely expansion in RoE, on FY20E basis, PBV and PE multiples are 10x and 1.9x respectively which are not stretched, even in current market conditions.

Pointers on Pricing:

1. Company’s valuation expectation (on per share basis) has not reduced from DRHP filing (June 2018) to now. Only number of shares offered under OFS has been lowered by all selling shareholders, except the individual promoter. However, healthy growth in financial performance over FY19 partly justifies the unchanged price expectation.
2. Also, just 4 days prior to DRHP filing, on 21Jun18, company did a private placement (not exercise of ESOPs) of 21.3 lakh equity shares to 5 persons (including Managing Director, Chief Strategy Office, an independent director) at Rs. 235.48 per share which is not only much lower price than fair value, but also unusual, as this is different from ESOPs. Since company is also looking to sell 47 lakh new shares for Rs.400 crore, via the private placement, it has in effect let go of anywhere between Rs. 60-130 crore, based on then estimated fair value and employee discount. 

Conclusion:

Company has demonstrative strength post exit from CDR and looks capable to replicate the growth of past couple of years. Despite weak market sentiments, especially towards the financial sector, since issue pricing is not aggressive, one can apply in the IPO as a quality mid-cap holding in one’s portfolio.  

Grey Market Premium (GMP) of Spandana Sphoorty: Grey Market Premium of Spandana Sphoorty is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in Pathshala column.

Disclosure: No interest.