• Date 06^th Aug; IPO Opens 5-7^th Aug at Rs. 853-856
• Valuations: P/E 17.6 times TTM, P/B 2.4 times (Post IPO)
• Mid Cap: Rs. 5,505 cr. Mkt cap
• Industry – NBFC MFI
• Advice: SUBSCRIBE

• Overview: Spandana is a rural focused NBFC-MFI with a geographically diversified presence in India. It offers income generation loans under the joint liability group model, predominantly to women from low-income households in rural areas. They are the 4th largest NBFC-MFI and the 6th largest amongst NBFC-MFIs and SFBs in India, in terms of AUM. Revenues, NII and profit for FY19 were ₹1,049 cr., ₹640 cr. and ₹312 cr. resp. Capital adequacy is 39.6% which is very safe. Spandana exited from CDR in March 2017 and the operations are stable now. At a P/B of 2.4 times & PE of 17.6 times (post IPO), the valuation look attractive.
• Risks: 1) Economically and politically sensitive sector 2) Significant exposure to unsecured loans.
• Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Here is a note on Spandana Sphoorty Financial (Spandana) IPO.

IPO highlights

• The IPO opens: 5-7^th Aug 2019 with the Price band: Rs. 853-856 per share.
• Shares offered to public number 1.40 cr. The FV of each is Rs. 10 and market Lot is 17.
• The IPO in total will collect ₹1,200 cr. while selling 21.8% of equity. IPO is both an Offer for Sale by current shareholders (OFS) and a fresh issue of shares. The OFS proceeds would be ₹800 cr. at UMP and fresh issue size is ₹400 cr.
• The Promoters are Padmaja Gangireddy, VSR Reddy Vendidandi and Kangchenjunga Ltd. that own 81.22% in Spandana which will fall to 62.58% post-IPO. The major selling shareholders are Kangchenjunga, VSR and Padmaja Gangireddy, see Exhibit 1(a). The IPO is being launched to provide partial exit to existing promoters as well as for Spandana to augment the capital base (Fresh Issue).

Exhibit 1(a) – IPO Selling Shareholders; Exhibit 1(b) – Shareholding pattern

• The IPO share quotas for QIB, NIB and retail are in ratio of 50:15:35.
• The promoter Kangchenjunga Ltd is a holding co. incorporated in Mauritius. It is a private company with limited liability, which holds a Category 1 Global Business License to carry out activities as an investment holding company and to acquire, invest in and hold securities of Spandana. The Class A shareholders of promoter Kangchenjunga are seen in Exhibit 1(b).

The unofficial/ grey market premium for this IPO is Rs. 18-20/share. This is small.

Introduction

• Spandana is a rural focused NBFC-MFI with a geographically diversified presence in India. It offers income generation loans under the joint liability group model, predominantly to women from low-income households in rural Areas. As of FY19, they were the 4th largest NBFC-MFI and the 6th largest amongst NBFC-MFIs and SFBs in India, in terms of AUM. See Exhibit 2(a).
• Revenues, NII and profit for FY19 were ₹1,049 cr., ₹640 cr. and ₹312 cr. resp. It has 7,062 employees (June 2019). 85% of their gross loans were Abhilasha loans, and 86% of the loan book is unsecured.

Fig 2a – Loan products (above) and Fig 2b AUM Spread

• Spandana was incorporated as a public company in 2003 and registered as an NBFC with the RBI in 2004. Soon they registered as an NBFC-MFI in 2015. In October 2010, the MFI industry (including Spandana) was severely impacted as the govt. of AP promulgated the AP Microfinance Ordinance 2010, which enforced several restrictions on the operations of MFIs. This impacted Spandana collections, cash-flow, its ability to service debt, and so their growth and profitability.
• Spandana’s lenders referred them to the corporate debt restructuring (CDR) mechanism of RBI to restructure borrowings and revive business. The CDR plan allowed them to get cash-flow relaxations to continue their portfolio diversification, process improvement and cost rationalization. Their operations turned profitable from FY14.
• Spandana exited CDR in March 2017, which enabled it increase lender base, diversify its borrowings to new banks and NBFCs and also issue NCDs in the capital markets. As a result, during FY18, with increasing flow of capital, they expanded their operations and were able to utilize the existing branch network and employees (earlier underutilized due to lack of capital). Prior to their exit from CDR in 2017, they had limited access to capital, due to which they had to offer loans in lower ticket sizes than the demand from clients.
• Distribution is strong as in 2019 they cover 16 states and 1 UT across India through 929 branches.
• Leadership – Padmaja Gangireddy (MD), Sudhesh Chandrasekar (CFO), Abdul Khan (Strategy Officer).

News, Updates and Strategies of Bandhan

• Prior to 2010 Andhra Pradesh MFI crisis, 51% of Spandana loan book was concentrated in AP. Post the debacle they have tightened internal controls to manage risk better by restricting (a) loan book exposure to a max of 22.5% for 1 state (b) loan book exposure to a max of 2.5% for each district (c) loan book exposure to a max of 0.3% for each branch.
• Spandana’s business strategy is as follows:
• To leverage their popular income generation loan products to derive organic business growth.
• To leverage existing branch network by increasing loan portfolio and employee productivity.
• To increase its presence in under-penetrated states and districts.
• To further diversify their borrowing profile; and reduce their cost of borrowings.

Various shareholders invested in Spandana over the years. The average cost of acquisition per share for those shareholders is as follows:

Exhibit 3 – Cost of shares by investors

• In Jun 2018 20.3L shares were allotted to Padmaja Gangireddy and 72K shares to Abdul Feroz Khan by private placement at Rs. 235.4/share. In IPO this has grown by 3.6 times in just over a year.
• Spandana has raised Rs 360.28 cr. from 18 anchor investors by allotting 42,08,886 shares at a price of Rs 856, the upper band of its IPO. Among the 18 anchor investors, Wells Fargo Emerging Markets Equity Fund, Goldman Sachs India Ltd, ICICI Prudential Life Insurance Company and Bajaj Allianz Life Insurance Company have been allotted about 4.40 lakh shares each.
• Spandana IPO was subscribed 6% on the first day of bidding on Monday (5th Aug).

Micro Finance and Banking Industry Outlook in India

• Financing needs in India have risen along with economic growth over the past decade. By complementing banks and other financial institutions, NBFCs help meet this need.
• MFI is a volatile sector that can be badly affected by economic and political events. Spandana’s operations were also affected post AP ordinance in 2010. It went into CDR however later came out of it in Mar 2017. In Nov 2016, the Indian government announced the demonetization of currency notes of ₹500 and ₹1,000 denominations. Though demonetisation affected the retail sector’s credit performance in FY17, which dropped 300 bps from FY16, growth remained higher than industrial and agricultural credit growth in FY17. The retail segment was negatively impacted by the demonetization driven slump in the real estate sector. Retail credit grew 16% YoY, while industrial credit contracted YoY by 2%. Such events have affected collection efficiencies which could happen in the future as well.
• Spandana has a 2.6% market share basis its GLP. See Exhibit 4

Exhibit 4 – Market share and AUM growth for MFI players over the years

• The share of adults with a bank account in India has more than doubled to approximately 80% since 2011, largely supported by the Pradhan Mantri Jan Dhan Yojana (PMJDY) a scheme of the GOI, which led to account growth and traction in savings. However, while significant traction is present on the deposit side, India is still among the Top 3 nations with unbanked people in the world, reflecting the strong need for an enhancement of the financial inclusion agenda.
• The microfinance sector in India has grown at a CAGR of 23.1% over the past 10 years to reach ₹2,633 bn. as of FY19, despite some setbacks that have impacted the industry’s growth. The industry has evolved over time, starting with the Self-Help Group (SHG) Bank Linkage program and not-for-profit organisations (NGOs) being the key participants in the sector, to the scaling of NBFCs, the conversion of Bandhan Financial Services into a universal commercial bank and the launch of the Small Finance Banks. Presently, the demand for micro credit is primarily being serviced by industry participants such as MFIs, NBFC-MFIs, SHG, Banks, SFBs, NGOs, and other informal lenders.
• The MFI sector has potential to grow the client base as well as ticket size per borrower. The micro-credit opportunity is about ₹5-6 tn. supported, considering the addressable market of low-income households in India. The traction in disbursements is expected to sustain and the industry is projected to witness a portfolio growth in the range of 20-24% p.a. over the medium term. Within this, the pace of growth of the non-SHG portfolio is expected to be higher at 25-30% p.a. Further, the ticket sizes are likely to go up in the states where the penetration levels are high. Overall client growth may be 8-10% and loan outstanding per borrower may increase by 12-15%.
• Current challenges in the Indian BFSI sector include the collapse of IL&FS, a liquidity shortage in the BFSI sector, an NPA crisis in PSBs, real estate loans troubles and weakness in DHFL and Yes Bank.
• Per management, MFI customers are unaffected by these industry events and are doing better.

Financials of Spandana

Fig 5 – Spandana Financials

Note: 1) Data for FY15-FY16 are per Indian GAAP, FY17-FY19 is basis IND AS with FY18-FY19 are consolidated 2) NIM or Net Interest Margin = Net Interest Income / Annual Average Gross AUM (%)* 3) NIM-R is net interest margin computed as Average Interest Charged less Average Cost of Borrowing. 4) Diluted EPS has been calculated after considering fresh shares to issued post IPO.

• Spandana’s revenues, NII and PAT over the years are in Fig 5. Revenues, NII & PAT have grown at 33.9%, 34.5% and 31.2% resp. from FY15-FY19. These are good growth numbers.
• Spandana had a RoE of 16.51% and RoA of 8.2% in FY19. This is moderate and sustainable as the business operations have stabilized now. NIM and NIM-R have stabilized for Spandana over the last 3 years. NIM at 16.39% for FY19 is the highest in the industry.
• The PAT for FY17 surged 82.3% as it took a deferred tax credit of ₹421 cr. PBT for FY17 was ₹35 cr.
• Spandana has the best asset quality in the industry. The NNPA as of FY19 stood at 0.02%. The NPA’s have largely come from unsecured personal loans, agri loans as well as MSME loans.
• NBFCs are required to maintain a CRAR consisting of Tier I and Tier II capital which should not be less than 15% of its aggregate risk weighted assets on-balance sheet and of risk adjusted value of off-balance sheet items. The Tier-I capital was required to not be less than 8.5% by FY16 and 10% by FY17. Spandana has an aggregate CRAR of 48.96% and Tier 1 capital to the extent of 48.52%. This is much higher than what RBI has prescribed which is a positive.

Benchmarking

We benchmark Spandana against peers, See Fig 6.

Fig 6 – Benchmarking

• PE of Spandana is the lowest in the peer group. This makes the offering attractive on relative basis.
• In terms of PB, the valuations are average. This is on an adjusted basis post dilution.
• The 3 year sales and PAT growth is robust. However Bandhan continues to be the sector leader. The Cost/Income ratio too is low. The PAT margin (PAT/Income) as well as the NIM is highest amongst the peer group. This is a positive. The RoE is average among peer group.
• GNPA is very high while NNPA is fine. The reason for this is loans outstanding from the AP crisis of 2010. However these are provided for by Spandana.
• Overall we see Spandana as a MFI rapidly emerging from CDR and stabilizing operations well.

Positives for Spandana and the IPO

• Spandana has suffered heavily and learnt its lessons in the 2010 AP MFI debacle. It emerged from CDR in 2017 after repairing its books. It now has geographically diversified operations which help in risk containment and business resilience. It also will target 25% CAR to ensure safety of operations.
• They have a good branch network, with a current AUM of Rs 5 cr. /branch. Per management the focus now will on assets growth to Rs 10 cr. / branch.
• Spandana’s growth has been achieved despite difficult conditions in MFI industry. After the AP crisis in 2010, there was demonetisation in 2016 and many farm loan waivers. But Spandana did well.
• The asset quality of Spandana is robust with NNPA at 0.02% for FY19. Financially the firm is well managed with moderate return ratios, superior margins and has high growth rates. The IPO valuations at PE of 17.6 times and PB 2.4 times are also attractive.
• Spandana has an experienced management team. Ms. Padmaja Gangireddy has 24 years of experience in Indian MFI.

Risks and Negatives for Spandana and the IPO

• Spandana’s MFI loan portfolio is unsecured, and in the event of non-payment by a borrower, they may be unable to collect the unpaid balance.
• The operations are still concentrated in the states of Karnataka, MP, Orissa, Maharashtra and Chhattisgarh. Any adverse developments in these states could affect business.
• The promoters and certain directors have entered into ventures that may lead to potential conflicts of interest with their business. For instance, their Individual Promoter, Padmaja Gangireddy, owns 68.3% shareholding in Abhiram Marketing, a group company engaged in consumer goods, whose retail products are sold at their branches (and from whom they receive a sales commission). There is no assurance that the interests of Abhiram Marketing will align with Spandana’s business interests.
• Any downgrade of Spandana’s credit ratings may increase their borrowing costs and constrain their access to capital and debt markets and, as a result, may adversely affect their results of operations.
• MFI industry has enjoyed high growth and margins for the last few years. However the market may be getting crowded with several Private Banks acquiring or setting up MFI subsidiaries, Bandhan Bank getting a universal license and many MFIs getting SFB license.

Overall Opinion and Recommendation

• The microfinance sector promises to extend credit to the underbanked and informal sector people for financial services penetration into rural India. The potential is immense and is barely tapped.
• Spandana has a decent size, strong financial performance, recent recovery, good asset quality and an experienced management.
• It is now the 4th largest NBFC-MFI with AUM, and post CDR has grown rapidly. It has a different DNA and may remain sharply focused on a national presence in only MFI loans for the next few years.
• The management appears conservative and should able to target growth with lower risk taking.
• At a P/B of 2.4 times & PE of 17.6 times (post IPO), the valuation look attractive.
• Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake ownership or known financial interests in Spandana or any group company. Punit Jain intends to apply for this IPO in the Retail category. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.