Tuesday, November 15, 2011

Why I purchased SKS Microfinance at Rs 142(all time low!)

SKS Microfinance(ticker SKSMICRO) is a Cindrella turned nightmare. When it got listed last October, it seemed to herald a new dawn for 'responsible finance', 'inclusive finance' etc. The few critics who found the huge investor profits unpalatable, were ignored. But a year past, tables have turned and the stock having lost 82% since inception, it still has few buyers. Let us see why
  • Microfinance backlash in Andhra Pradesh:-Nearly 40% of the gross portfolio is concentrated in Andhra Pradesh, where the state Govt passed a legislation which curbed several business practices such as weekly meetings etc.To its defence, SKS states that other states(nearly 60% of portfolio) have recovery rates as usual(99% or so) and that it expects the Andhra Pradesh HC to rule on the AP legislation soon. 
  • Poor financials:- SKS has faced recovery issues in the state, and has had to write down its books substantially. This has eroded its book value for the past few quarters, to just Rs 163 per share, and there have been operating losses too.
  • Corporate governance and adverse press may lose banking/NBFC license chance:- Though the Reserve Bank announced guidelines for banking licenses, the gold rush has begun. And given the adverse press around sacking of its CEO(just post IPO), reported customer suicides and founder's personal problems; it is unlikely that RBI will prefer SKS over say Tata/Bajaj/Bandhan Microfinance. And while the NBFC-MFI category would suit SKS well for reducing its borrowing costs and conferring tax benefits, that is subject to a possible constitutional challenge. 
  • Central legislative logjam and political crisis in Andhra Pradesh:-Since the past year, Telangana activists have been agitating for a new state to be carved out of Andhra, and have
However, the reason I purchased SKS is
  •  Improved investor relations disclosures:- They have finally learnt the adage 'when in doubt, disclose'. Their investor presentations are consistent and detailed. That allowed me to analyze the operational performance, and appreciate their cost cutting efforts.
  • Potential shortterm upside from central legislation:-The stock had touched levels of Rs 300 odd on speculation that it would get greater regulatory protection/recognition from the RBI by way of banking license/NBFC classification. That issue will be decided by Nov/Dec-11, so there is ample scope for fluctuation till then.
  • Andhra Pradesh HC verdict potential upside:-By Jan-12, the Andhra Pradesh HC is expected to deliver its verdict on whether the State Govt's microfinance bill is within the Indian Constitution or not. While legal eagles are (naturally!) divided on the issue, my take on it is that the bill will be atleast partially struck down, since it infringes the freedom of business of MFIs, without an equal limitation on money lenders.
  • Management change likelihood:-As per media reports, the controversial albeit colourful founder Mr Vikram Akula has been asked to take a non executive role. If that materializes, the stock should move up in relief, given that his distraction with personal matters(bitter child custody dispute with ex-wife) has taken its toll on the company's performance and image.
  • Capital raising chance:-If a PE fund/WB decides to invest, it would be at a premium to the market price as per existing preferential allotment guidelines of SEBI. That would boost the share price for some time
  • Too big to fail like Satyam Computers:-Given the inclusive finance agenda of the Central Govt(and all regulators), it would be embarassing if SKS Microfinance is allowed to rot. That would deter further foreign investments in the sector, and add political risk to the vast number of other risks faced by India. So far, political reasons(especially state level issues in Andhra Pradesh) have bound the hands of the Centre, but it has made its intentions clear through the RBI, and given that the political party at both levels is the same(Congress), the result is a foregone albeit long drawn conclusion
I would not however, hold the stock beyond Jan-12 or Rs 240(P/BV of 1.5), whichever is earlier. That is because the regulatory risks would be largely settled, but not the political ones.

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