The Consultative Group to Assist the Poor (CGAP), a policy and research center housed at the World Bank dedicated to advancing financial access to the world’s underprivileged, released a path breaking 40-page report in February 2009 entitled, “Shedding Light on Microfinance Equity Valuation – Past and Present,” produced with limited analytical support from banking firm JPMorgan Chase & Co. The white paper is notable in providing an empirically grounded analysis of how financial valuation methods are actually applied by external actors to MFIs and other lending institutions with poverty alleviation goals. This is made possible by CGAP’s collection of information on 144 private equity transactions, the largest such dataset gathered to date, as well as information on 10 MFIs and other low income focused lenders that have raised funds through the issuance of securities. The original report is available at: http://www2.cgap.org/gm/document-1.9.9021/OP14v3.pdf.
What follows is a summary of the final two major sections of the report – detailed surveys of private equity placements involving MFIs and then public transactions involving MFI type entities. A previous report on MicroCapital covered the first two sections – an introduction to the broad issues facing prospective investors and then a review of alternative valuation methods. While technical terms are utilized in as limited a fashion as possible, the subject matter at hand necessarily requires some familiarity with financial statement analysis.
MFI Valuation in Private Equity Transactions
The sample involves transactions that occurred between January 2005 and September 2008 – thus ending before the recent credit crisis came into full force. While private equity valuations ran from 1.3-1.9 times historical price-to-book, and 7.2-7.9 historical price-to-earnings during the period, there is reason to believe that such multiples will diminish significantly in the wake of fall’s broader economic events. While imperfect corollaries to MFIs, valuations for listed emerging market banks are down roughly 50% since Lehman Brothers’ bankruptcy, and the authors believe over the next year a matching price-to-book value in any private equity actions would thus not be unreasonable. At the same time, the robustness of the microfinance industry makes recovery all but certain once wholesale capital again begins to flow, and hence valuations should rebound in turn. Consequently, planned initial product offering by MFIs in 2008 have been put off, as these organizations would clearly be ill advised to give away equity on the cheap.
More specifically, while expectations about income are a major determinant in the valuation process using either relative or absolute methods, current profitability in terms of return on equity does not translate over well to present price-to-book value for MFIs. Simply put, there is no clear link between present profitability and present valuation. There are also significant regional disparities to be reckoned with. The African MFIs studied, despite having a negative return on equity, exhibit a decent markup in price-to-book value of 1.5 times. Meanwhile, Indian deals have price-to-book medians of 6.7 times, in part due to pent up demand for funds in India, and also due to exuberance over the long term outlook for the nation’s MFIs. Likewise, historical price-to-earnings multiples and net income growth move together in the expected direction, the former rising with the latter, but once more there appears to be idiosyncratic regional differences.
Alternatively, the degree of leverage had inconclusive effects, while the debt-to-equity ratio of the MFIs has no effect whatsoever. A number of other factors such as MFIs age, rate of delinquent loans, legal status, etc. were also considered, yet theoretical predictions were either inconclusive or not born on by the empirical analysis. That said, transaction size does matter – investors clearly consider the extent to which their own capital can increase the bottom line of the MFIs they place funds with. Therefore, to summarize, the authors find that in the private equity arena both net income growth and transaction size are the key drivers of valuation.
Low-Income Financial Institution Valuation in Public Transactions
Low-income financial institutions (LIFIs) provide financial services to the poor (consumer and microenterprise loans, payments, and insurance), but do not necessarily have a double bottom line in mind. The authors identified 10 listed LIFIs with a broad microfinance focus, on the logical grounds they are comparable to traditional MFIs from an operational perspective. The group included two publicly listed MFIs (Compartamos in Mexico and Equity Bank in Kenya), four banks with an emphasis on small-to-medium enterprise and microenterprise lending, and four consumer lenders.
They then created a weighted, Low-Income Finance Index including six of these organizations. The authors found that the Index traded at a premium on a price-to-book basis compared to traditional banks up until late in 2007, when a decline began which by 2009 would lead the Index to be trading at a forecasted discount of 22 percent. This decline in valuation embodies the sharp reversal in the performance of the Index compared to the broader MSCI World Financials Index, falling from 238 percent stronger to just 8 percent above in late 2008. Therefore, on the whole, while publically traded LIFIs outperform traditional banks, their success has been battered by the onset of broader capital markets turmoil starting as far back as 2007.
Likewise, LIFIs when disaggregated outperformed their own national banking sectors. However, the authors contribute part of this success to the scarcity of IPO’s involving LIFIs, despite tremendous investor interest. Outliers include Mexican microfinance institutions Compartamos and Independencia, which have underperformed, yet at the same time they are over 2/3rd’s composed of foreign holdings, and hence are subject to greater volatility.
Finally, turning to the matter of listings, the authors note that operations do not appear to be systematically affected. Loan issuances do not always expand rapidly, nor are net interest margins increased by cheaper capital as LIFIs try to gain market share by decreasing lending rates. Conspicuously, 85 percent of total capital raised in microfinance IPO’s goes to early investors who in turn use the funds to exit their positions. Effectively, new equity substitutes for the old, which may explain the mitigation of operational changes.
The Authors
The authors of this report are Nicholas P. O’Donohoe and Frederic Rozeira de Mariz, both with JP Morgan, and Elizabeth Littlefield, Xavier Reille, and Christoph Kneiding of CGAP.
CGAP is a policy and research center dedicated to advancing financial access for the world’s poor. It is supported by over 30 development agencies and private foundations who share a common mission to alleviate poverty. Housed at the World Bank, CGAP provides market intelligence, promotes standards, develops innovative solutions, and offers advisory services to governments, microfinance providers, donors, and investors.
JPMorgan Chase & Co. is the United States’ largest banking institution by market capitalization and deposit base, with assets of 2.3 trillion USD, or approximately 1/6 of the nation’s annual GDP. It operates in every major segment of financial services, and maintains a global footprint.
By Yanni Hao
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