NBFCs stare at valuation hurdle, IPOs in pipeline may see tepid interest

Initial public offerings (IPOs) of non-banking finance companies (NBFCs) will find market headwinds a hindrance to their valuations even as a big question mark hangs over investments in excess of $2 billion made by private equity (PE) and venture capital (VC) funds in them over the past three years.

Investment bankers say the change in the growth perception and business models of NBFCs after the blowout at Infrastructure Leasing & Financial Services will force them to re-align valuations. This is expected to have a bearing on the IPOs of Srei Equipment Finance, Muthoot Microfin, and Spandana Sphoorty — all of which have received the Securities and Exchange Board of India’s nod and collectively seek to raise Rs 42 billion from the bourses. The recent IPO of Jaipur-based Aavas Financiers — an affordable housing financier — which sought a price-to-book multiple of 4.5 times is a case in point.

The issue was not fully subscribed to (it was just 0.97), and fell by as much as 13 per cent from its issue price on listing day. It has recovered and currently trades 2 per cent above the issue price of Rs 821 a share. Backed by PEs Kedaara Capital and Partners Group, the issue saw partial exits by the two during the IPO.

A senior banker said given the pressures on capital and the new norms set to be rolled in by the Reserve Bank of India (RBI) on NBFCs leverage, some of the better-performing private banks and small finance banks (SFB) are a better bet.

Over the past three years, private banks and SFBs raised $2.5 billion from PEs and VCs. These include three SFBs — Bandhan Bank, which raised $176 million from the International Finance Corp, GIC Private and SIDBI Venture Capital; A U Small Finance Bank ($146 million from Temasek), and Janalaxmi Small Finance Bank ($100 million from HarbourVest Partners). In the case of PEs and VCs, investments in NBFCs were premised on business models with a leverage in excess of nine per cent of their equity capital.

Analysts point out that investors will be more selective in the future while taking bets on NBFC IPOs.

“We expect funding divergence to emerge, and hence, different loan growth rates across strong and weak liability franchises in the near to medium term,” Morgan Stanley analysts said in a recent note.

Anand Shah, head of investments and deputy chief executive officer of BNP Paribas MF, said, “NBFCs which are more consumption-oriented are unlikely to have many issues, but those into B2B (business-to-business)-loans may even face credit risks in their loan portfolio. Investors would need to be wary of such businesses and take a close look at these companies’ fundamentals”.

Within the NBFC space, housing finance companies (HFCs) are likely to find few takers.

The combined loan book of NBFCs and housing finance companies (HFCs) grew to Rs 24 trillion in FY18, up from Rs 11 trillion in FY13; at an annual growth rate of 17 per cent.

“Thanks to the tighter liquidity scenario, these growth rates are unlikely to sustain,” said analysts at Prabhudas Lilladher in a note. It was pointed out: “Difficulty in securing short-term funding from money markets, refinancing and asset-liability pressures, likelihood of stricter lending controls from regulator and portfolio sell downs should lead to scaling back of growth targets for NBFCs”.

NBFCs have attracted huge interest from both private equity PEs and VCs over the past few years amounting to over $2 billion, given the inability of banks to cater to credit demands, in particular to segments which have traditionally been off their radar. Foreign investors picked up substantial stakes in NBFCs given that 100 per cent foreign direct investment is allowed under the automatic route, even as there remains a single-entity cap of 5 per cent in the case of banks. The period also saw NBFCs grow their books substantially.