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Executive Summary
This report is the result of a collaborative effort between CGAP1 (Consultative
Group to Assist the Poor) and J.P. Morgan. J.P. Morgan analysts are solely
responsible for the investment opinions and recommendations in this report.
Our objective is to provide benchmarks for valuation of microfinance equity, both
private and publicly listed. Our analysis is based on two datasets: a sample of 144
private equity transactions, which represents the largest such dataset gathered to
date, and data on 10 publicly traded microfinance institutions (MFIs) and lowincome
consumer lenders.2
MFIs will certainly be affected by the financial crisis ricocheting across the
globe, but we believe that the sector is fundamentally sound. Larger institutions,
especially those with diversified funding sources, such as retail deposits, are best
positioned to manage the effects of economic and financial contraction. Valuations
may change, but we believe the long-term outlook for equity investment in
microfinance is positive.
Private equity valuations for MFIs have varied widely over the past few years.
Historical median valuations in our private sample have varied between 1.3x and
1.9x historical book, and between 7.2x and 7.9x historical earnings over the four-year
period, as shown in Table 1 below. The considerable range of these indicators may
indicate the lack of market consensus on MFI valuation.
Publicly listed Low-Income Finance Institutions (LIFIs) have outperformed
traditional banks. Since its creation in 2003, our Low-Income Finance Index has
outperformed the Global MSCI World Financials index3 by 238% (and has
outperformed this benchmark by 10% since the Lehman bankruptcy in September
2008). LIFIs now trade slightly higher than traditional banks on price-to-book basis
(1.9x 08 book for LIFIs versus 1.5x for emerging banks as of January 28, 2009). On
a 2009 price-to-earnings basis, LIFIs are trading at a 22% discount to traditional
banks, as shown in Table 2.
Investors should not value MFIs the same way they value traditional banks. We
highlight five characteristics that differentiate MFIs from traditional banks and that,
we argue, justify a slightly different valuation approach: a double bottom line that
aims for both social and financial returns; excellent asset quality; high net interest
margins (NIMs); high operating costs, and longer-term funding available from
developmental investors.
Book value and earnings multiples are the most widely used valuation tools but
we also recommend the residual income method. Relative valuation methods, such
as price-to-book, and, to a lesser extent, price-to-earnings, multiples remain the most
common valuation methods in microfinance equity. An absolute valuation method,
the residual income method, would also be appropriate for MFIs because it combines
the current book value with future earnings.
Microfinance valuations should benefit from a lower beta than banks, in our
view, but they also deserve a discount for the limited liquidity of the equity.
Because of the higher resilience of their business to economic shocks, MFIs’
earnings are generally less volatile than traditional banks’. At the same time,
valuations merit a liquidity discount because of the small transaction size in the
microfinance space. Unfortunately, no tools are available to quantify this discount.
Transaction value and net income growth are the main drivers of valuation, as
evidenced by our statistical analysis. We underline the importance of eight other
factors that we also view as important: (i) the type of buyer and its possible social
motivation; (ii) the country of the MFI; (iii) the legal status of the MFI, in particularif
it is a fully regulated bank; (iv) operating efficiency; (v) leverage; (vi) the reliance on
retail deposits (financial intermediation); (vii) asset quality; and (viii) profitability (as
measured by the ROE).
Table of Contents
Executive Summary .................................................................2
Introduction ..............................................................................6
1. Microfinance versus Traditional Banking........................9
What Makes Microfinance Financials Different? ........................................................9
A. Double Bottom Line................................................................................................9
B. High Net Interest Margins Driven by High Lending Rates...................................10
C. High Asset Quality Is Driven by Original Collection Method ..............................11
D. High Operating Costs Are Driven by Small Transactions ....................................12
E. Longer-Term Funding ...........................................................................................13
2. Technical Overview of Valuation Methods ....................16
Relative Valuation: P/BV Multiple............................................................................16
Relative Valuation: P/E Multiple...............................................................................18
Absolute Valuation: Discounting Future Flows.........................................................18
Remarks on the Cost of Equity ..................................................................................19
Remarks on Liquidity ................................................................................................21
Valuation Methods Complement Each Other ............................................................21
3. Valuation of Private Equity Transactions - Microfinance
Institutions ..............................................................................23
Valuation Between 1.3 - 1.9x Historical Book; 7.2 - 7.9x Historical Earnings .........23
Back to Basics: Drivers of Valuation Are Usually Profitability and Income Growth24
Transaction Size and Net Income Growth Are the Main Drivers of Valuations........27
4. Valuation of public transactions – Low-Income Finance
Institutions ..............................................................................32
Introducing the Low-Income Finance Index..............................................................32
Performance of Individual LIFIs Post Listing............................................................34
Convergence of Multiples..........................................................................................36
Impact of a Listing on an LIFI’s Operations..............................................................37
Conclusions............................................................................39
Appendices
Appendix I: Glossary..............................................................40
Appendix II: Multiples for Private Equity Transactions.......42
Appendix III: Listing Information...........................................44
Appendix IV: Emerging Markets Banks Valuations.............45
Appendix V: Description of LIFIs in Sample ........................49
The authors would like to acknowledge the contribution of Christina Leijonhufvud,
head of the Social Sector Finance team at J.P. Morgan, and Mia Feldman of the
Social Sector Finance team; Neil Gupte, analyst in Equity Research for Asian
Financials; Thomas Anduze-Acher in the Latin American Financials Equity
Research team; Richard Rosenberg, senior advisor at CGAP; Barbara Gahwiler and
Mathieu Lebegue, microfinance analysts at CGAP.
The authors also acknowledge the contributions at J.P. Morgan of Sunil Garg, head
of Equity Research for Asia; Aditya Srinath, head of Equity Research for Indonesia;
Victoria Miles, head of Emerging Markets Corporate Research; Paul Formanko,
head of Equity Research for Banks in Emerging Europe and Central Asia; Mervin
Naidoo, senior analyst for South African Banks; and Saul Martinez, senior analyst
for Latin American Financial Institutions.
Finally, we are thankful to Adrian Gonzalez from the Microfinance Information
eXchange; Deborah Drake and other CMEF members; Alex Silva and Brian Busch
of Omtrix; and Clay Obrian of Opportunity International, for sharing their views on
the microfinance sector and for their support.
The authors remain responsible for the opinions expressed in this report and for any
inaccuracies.
Introduction
Equity investment in microfinance is small, but growing fast. As of December 2008,
there were 24 specialized microfinance equity funds with total assets of
US$1.5 billion under management. Institutional investors are also showing interest in
this new market niche. Leading pension funds, such as TIAA CREF in the United
States and ABP in Europe, have made microfinance equity allocations of over
US$100 million as part of their socially responsible investment (SRI) strategies.
Others are researching the field and waiting for clearer market conditions to invest.
Venture capital companies such as Sequoia and a few large private equity funds such
as Legatum4 are testing the market with small equity investments in MFIs, with nearterm
potential for an initial public offering (IPO) in key emerging markets, like India.
While interest in microfinance equity investments soars, the actual microfinance
equity market is still in its infancy. Primary issuances are still limited by the small
pool of investable MFIs and by the absence of an organized secondary market. A
vast majority of transactions are in the form of private placements. To date, only two
pure microfinance IPOs have taken place (Compartamos in Mexico and Equity Bank
in Kenya), and current market conditions are not favorable to new ones.
The scarcity of information on microfinance valuation is a major challenge to
establishing microfinance equity as an investment niche. Investors and MFIs are
looking for reliable and accessible market references to improve equity pricing.
However, little research has been done on microfinance equity valuation, due to the
difficulty in accessing private data.5
This paper is an attempt to offer some useful benchmarks to investors, microfinance
managers and analysts and help build market transparency.
As we write this paper, we are caught up in an unprecedented financial crisis and a
truly global economic contraction. Liquidity shortages, currency dislocations and
global recession will all affect MFIs and their clients in different ways.6 The impact
of the crisis should become clearer over the course of 2009. In the short run, we
expect to see higher costs of funding due to tighter credit and to weaker emerging
markets currencies relative to dollar-denominated loans. In the medium term we can
foresee slower growth and lower earnings power.
MFIs will have to seek funding from public agencies and development finance
institutions7 to maintain their liquidity as commercial funders withdraw. They will
need to strengthen their asset and liability management capabilities and be ever more
vigilant about credit standards to maintain their outstanding asset quality. The crisis
may force some consolidation in the sector and it will almost certainly put pressure
on valuations. We anticipate no new listings in the short term. As for valuations, we
expect multiples of private transactions to drop toward 1x book value in 2009 from a
median of 1.9x in 2008. However, the strong fundamentals of the microfinance
industry and the commitment of public and socially responsible investors should
bolster pricing going forward. MFIs with a solid funding base and strong asset
quality should emerge stronger from this turbulence, and we can expect valuations to
bounce back in 2010.
Our ambition is to provide a benchmark for valuation. In this paper, we intend to
address some of the key questions facing microfinance investors and MFIs: What is
unique about the microfinance sector that may justify an original valuation approach?
What are the valuation methodologies used? What are the key valuation drivers for
private placements in microfinance? What is the performance of microfinance on the
private and public markets, in both absolute and relative terms? What are the
challenges ahead for this new market niche in the context of the financial crisis?
This paper consists of four parts. In the first part, we underline what makes MFIs
different from traditional banks. We then describe commonly used valuation methods
and their applications in the context of MFIs. In a third part, we look at data from our
sample of 144 private transactions and discuss the key determinants of valuation.
Finally, we look at the performance of publicly listed low-income finance institutions
and analyze the impact of listing on the franchise performance.
This report is the result of the collaboration between CGAP and J.P. Morgan. CGAP
brings its deep microfinance market knowledge and J.P. Morgan its equity research
skills and emerging markets expertise.
Methodology & Sample for the Study
Our analysis is based on two original samples: a private transaction dataset on the
performance of 60 MFIs and a sample of ten publicly traded low-income finance
institutions (LIFIs).
Data on private equity transactions were collected by CGAP in a strictly confidential
survey conducted in the summer of 2008. Four development finance institutions
(DFIs), 13 microfinance investment vehicles (MIVs), and 14 MFIs provided data on
their transactions from 2005 to September 2008. The sample consists of 144 equity
transactions, with 60 MFIs in 36 different countries. This is the most comprehensive
dataset on private equity placements in microfinance to date. We estimate that it
represents close to 50% of primary transactions and 70% of secondary transactions
over the 2005-2008 period. CGAP followed strict procedures to ensure full
confidentiality of the data reported. This includes confidentiality agreements with all
survey participants and restricted access policies to the database. Only four CGAP
staff authorized by CGAP’s CEO had access to the underlying data. CGAP was
responsible for quality control of the data and preliminary analysis. Only aggregated
benchmarks based on at least five data points were shared with J.P. Morgan. These
aggregated data are available on CGAP’s Web site, at www.cgap.org. J.P. Morgan
had no access to the underlying database.
The sample of publicly traded LIFIs was put together by J.P. Morgan analysts. We
identified 10 listed LIFIs with a broad microfinance focus. They include two publicly
listed MFIs (Compartamos and Equity), four banks with an emphasis on small- and
medium-sized enterprises (SMEs) and microenterprise lending and four consumer
lenders. We recognize that these institutions present a different risk and return profile
for investors than traditional MFIs. They do not necessarily have an explicit social
agenda, and their loan portfolio is less concentrated on microenterprise lending and
more exposed to economic shocks. However, these institutions provide interesting
valuation comparables for MFIs because they operate in the same market. A short
description of each institution is included in Appendix V at the end of this report.
Microfinance Equity Market
As of 2007, there were 397 banks and nonbank financial institutions reporting to the
MIX - the reference database for microfinance performance - with an aggregate
equity base of roughly US$5.2bn. 85% of the equity investment is concentrated in
the largest 100 MFIs. Eastern Europe and Latin America account for almost twothirds
of the microfinance equity. New share issuance is also increasing rapidly and
passed the US$1 billion milestone in 2007.8
MFIs have built an impressive track record and their financial performance has been
documented by the MIX since 1995. In 2007, the average asset size of microfinance
banks grew by a notable 40%.9 Returns are solid with a median ROE of 14.1% in
2007. Asset quality remains high, with a median portfolio at risk over 30 days
(PaR30) of merely 1.4%. However, MFIs are being affected by the global economic
crisis, and the performance of the microfinance industry is likely to deteriorate in
2009.
On the funding side, development finance institutions (DFIs) such as IFC, the KfW
and the EBRD have been early equity investors in microfinance. Their aggregate
microfinance equity portfolio was valued at US$900 million as of 2007 and is
growing very fast. The second group of investors consists of 24 specialized funds
with an equity focus, private equity funds or holding companies of microfinance
banks. These funds are still relatively small in size, but growing very rapidly. Their
total assets under management were estimated at US$1.5 billion in December 2008.10
Since 2007, large private equity firms such as Sequoia and Legatum11 have made
equity investments in select microfinance markets such as India. We estimate that the
total amount invested by these institutions is in excess of US$200 million. Finally,
leading pension funds with an SRI focus are making asset allocations in specialized
microfinance equity funds.
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