> Posted by Anna Kanze, Chief Operating Officer, Grassroots Capital Management

The initial public offering (IPO) of Chennai-based Equitas Holdings Ltd., the holding firm for the fifth-largest microlender in India, was very successful, raising nearly US$235 million (Rs 1,525 crore) and demonstrating the maturation of the microfinance and financial inclusion sectors in India.

When the stock opened on April 7 to the domestic market, the demand greatly exceeded the number of available shares (16x oversubscribed) and provided a strong exit (an average multiple of 3.6x) for Equitas’ shareholders, which included a mix of social and responsible investment funds and traditional private equity investors. The stock opened to international buyers on April 21 and closed with a price on the first day of trading 23 percent above the issue price.

Funds managed by Caspian Impact Investment Adviser (Caspian), an Indian investment management and advisory services company that invests capital in businesses delivering both financial and social value, were early investors in Equitas and active in its governance. (Another Caspian-­backed microfinance firm, Bengaluru-­based Ujjivan Financial Services Ltd., the fourth-largest microfinance lender in India by assets under management, raised approximately Rs 900 crore in an initial public offering that opened on April 28 and was nearly 41 times oversubscribed as of closing on May 2, 2016.) Given this market activity, we at Caspian and Grassroots Capital Management PBC, who work together closely on this and other investments, are prompted to take a closer look at what this IPO means for the company, its clients, and the industry.

The Company

The performance of Equitas as a leading and responsible lender is as much driven by its solid fundamentals as its careful product design and human resource practices, the “hardwiring” of its social commitment, and its client-centric practices.

Founded in 2007 to provide the underserved and disenfranchised people of Tamil Nadu with reasonably and transparently-priced microcredit, the Equitas company diversified after the microfinance crisis in 2010 into affordable housing, small and medium enterprise (SME) and vehicle loans. Traditional microlending now makes up only slightly more than half of the total portfolio. In September 2015, Equitas was one of ten companies to receive in-principle approval from the Reserve Bank of India (RBI) for the Small Finance Bank (SFB) license.

Since inception, Equitas has been one of the fastest, if not the fastest, growing company in the Indian financial inclusion sector. Only two years after its launch, Equitas was serving one million clients. As of December 2015, it had nearly 3 million clients, a gross loan portfolio of US$800 million, and a return on equity (ROE) of around 13 percent. Equitas’ rapid growth was driven by investments in technology, a focus on efficiency, a steadfast commitment to governance and transparency, and a set of unique social policies: a cap on interest rates of 26 percent even before rates were subject to regulatory caps; an informal cap on ROE of around 20 percent; a cap on CEO salary of 40x the lowest paid employee; and an annual 5 percent allocation of company profits to social programs. Managed by a separate trust, these social programs were an essential part of the company’s operations, and Equitas was at the forefront of measuring outcomes, most recently participating in efforts by Freedom from Hunger and the Microcredit Summit Campaign to integrate microfinance and health. Equitas was certified for strong client protection practices by the Smart Campaign, and CEO H.K.N. Raghavan appears in this video commenting on the value of certification.

The IPO

The IPO on April 7 was the largest “only” domestic Indian IPO in the banking and financial services industry and the first to be oversubscribed without any foreign participation.

Intended to bring down the foreign shareholding from 93 to 49 percent to meet the RBI’s requirements for a SFB license, the price band was Rs 109-110 per share. The attractive price galvanized investor demand, which was over 17 times the offered shares with strong interest from all categories of investors. The institutional investor category was subscribed nearly 15 times; the retail and high net worth individuals (HNIs) categories were subscribed 1.4 times and 57.3 times, respectively. From a responsible exits perspective, the attractive pricing of Equitas shares, the high domestic demand and the high participation of retail investors make it a model, with pricing in line with the underlying business and client base compared to the overvaluations that prevailed before the Indian microfinance crisis and that characterized previous IPOs.

The stock continued its robust performance when it opened to international buyers on April 21, and closed on April 28 at Rs 139 and is continuing to outperform other listed stocks. By way of context, the S&P Bombay Stock Exchange Sensitive Index (S&P BSE Sensex) has had a soft year, with 5.5 percent decline.

This solid performance of Equitas stock offers convincing evidence that the Indian financial inclusion sector has rebounded from the liquidity crunch following the 2010 Andhra Pradesh crisis. However, for pure financial investors like conventional private equity or VC funds, Indian press speculated that the returns may not be “satisfying, especially when compared with the returns they get from sectors such as information technology.”

What Does This Mean?

This question gets to a core issue for Grassroots and Caspian: how can social and financial returns be balanced to deliver on the promise of the “double bottom line” and demonstrably build impact investing as an alternative to conventional investing? As we have argued in several blogs and papers, profit vs. impact choices may arise when managing a “social” business, particularly one with poor or vulnerable people as the primary clients or suppliers.

For example, Equitas could have decreased or eliminated its allocation to health and other social programs to increase its financial bottom line, especially during the immediate aftermath of the Andhra Pradesh crisis, when many microlender’s returns were under severe pressure. However, one of the main reasons founder Vasudevan launched Equitas – and why Caspian and Grassroots have been dedicated supporters – was to improve the quality of life of those who don’t have access to formal financial and related services.  The social programs were an integral part of the company’s mission and corporate culture. Vasudevan ensured that each investor was aware of and committed to the profit allocation before making an investment. Likewise, the decision to diversify its business from microcredit into related financial products was driven by both the need to mitigate risk and the desire to be true to mission and more comprehensively meet client needs. Indeed, these new business lines typically have lower margins than microloans. Vasudevan himself doesn’t act like a typical commercially-minded bank CEO, voluntarily capping his own salary and keeping his share of the company at only 3 percent.

Grassroots calls these features – like caps on ROE, interest rate, and salary and profit allocation – “hardwiring” the social mission. Combined with operating discipline, innovative product and process design, and agile use of technology, these policies created the value proposition that motivated the Caspian funds’ early investments in Equitas and they have helped drive consistently robust returns, both financial and social.

The Future Looks Bright…

The Equitas IPO is, to date, a solid success for shareholders and the Indian financial inclusion sector. However, as an upcoming Grassroots paper will discuss, there are factors that distinguish this IPO from others, including the unique policies of the company itself. In addition to the social aspects outlined above, Equitas’ diversified portfolio, professional management, and dedication to transparent and qualified governance set it apart from many other so-called “social” or “impact” companies, enabling Equitas to obtain the SFB license.

The operating environment has also experienced a significant overhaul since the SKS IPO in July 2010 and the Andhra Pradesh MFI crisis that began in October of that same year. The industry has rebounded and grown on the basis of a credit bureau infrastructure and strengthened regulatory framework, and with measures in place to protect consumers and their well-being.

Nevertheless, questions linger about the large amount of investment coming into the sector, the valuations and expected returns and, therefore, the required growth rates, and the dangers of irresponsible lending and overindebtedness. Client protection and responsible growth should always be at the forefront of any industry dealing with the poor and vulnerable. The response to the IPO suggests that Equitas’ emphasis on clear corporate priorities in dealing with underserved and vulnerable clients, client protection, and responsible growth have positioned it well for continued success. The Equitas IPO sets a standard of transparency and double bottom line corporate behavior, brings visibility to the financial inclusion agenda and the broader impact investing sector, and introduces a wide range of investors to impact investing.

Image credit: Accion

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