Ujjivan Financial Services IPO: Concerns well captured

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After the blockbuster debut of peer Equitas Holdings on the bourses last week, expectations are high on Ujjivan Financial Services' initial public offering (IPO) of equity. The issue which opens for subscription on Thursday and aims to garner up to Rs 882 crore, including a fresh issue of shares worth Rs 358 crore. The rest is an offer for sale by some foreign shareholders.

The proceeds from issue of new shares will be used to augment the capital base. Given the strong track record, healthy financials and reasonable valuations, investors with a long-term horizon could subscribe.

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Given the similarities and timing, comparing Ujjivan and Equitas would be helpful. Both derive a significant part of their portfolios from the micro finance segment and both have bagged a Small Finance Bank (SFB) licence. Ujjivan is fourth largest among the country's micro finance institutions (MFIs) in terms of assets under management (AUM). Its market share was seven per cent as on March 2015, Equitas being close at five per cent, shows data from CRISIL Research.

Among the key reasons for their IPOs is to reduce foreign shareholding to the Reserve Bank's mandate of not exceeding 49 per cent for an SFB. This means that as with Equitas, foreign investors will not be participating in Ujjivan's IPO.

The difference between the two, albeit minor, is in the business model and return ratios. On the latter, Ujjivan is ahead. For the nine months ending December 2015, its average return on equity was 19.1 per cent, as against 13 per cent in the case of Equitas. Its business model explains the difference. Ujjivan derives a larger part of its portfolio (88 per cent) from the traditional group-lending MFI business; this is 53 per cent for Equitas (the rest comes from vehicle financing, home loans, etc). Since the MFI business yields higher margins, Ujjivan scores well in return ratios.

Ujjivan also has a more diversified geographical presence; Equitas has strong concentration in Tamil Nadu, from which comes 60 per cent of its AUM. In comparison, Ujjivan has presence in 24 states and Union Territories (through 470 branches). The east, west, north and south each account for 20-34 per cent of its AUM.

Ujjivan has started lending to the (individual micro) small and medium enterprises segment in the past three years. This, with the home loan segment, is 12 per cent of its overall portfolio. The company believes this portfolio will grow faster than the group lending business. While this is a positive, given the higher ticket sizes, this segment also carries higher credit risk and the company has started providing for this. Coupled with early recognition of bad and doubtful loans (from 150 days currently to 90 days), this will push up its credit costs in the coming quarters.

Also, as would be the case with any other entity, the transition to an SFB entails additional investment on branch upgradation and hiring, among others, and the need to maintain mandatory reserves, all of which will put pressure on overall profitability. Thus, its currently high growth rate (see table) and return ratios will head south in the next couple of years at least. While the management record provides confidence, an eye must be kept on the likelihood of rising competition from strong players in the SFB space.

Positively, the company aims to garner about 40 per cent of deposits from existing customers and tap newer ones in the low-middle class salaried and micro entrepreneur segments. Cost of funds will come down, as it can tap inter-bank funding and borrow from Nabard and MUDRA, among others. This, in turn, will support the margins. The actual impact will depend on the company's ability to quickly build a strong retail deposit base, as well as grow its loan book.

The valuations, however, more than capture the downside risk. On a post issue basis, the IPO is priced at 1.8 times the FY16 estimated book value, much lower than Equitas which trades at 2.8 times. SKS Microfinance, though a much larger entity, trades at about 5.5 times the FY16 estimated book.

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