Pricing reasonable, but risks galore

Pricing reasonable, but risks galore

Mumbai: The initial public offering (IPO) of Muthoot Finance Ltd, which opened on Monday for subscription and has garnered 16% subscription on the first day, appears reasonably priced, but the company faces several long-term risks relating to corporate governance and regulatory issues, analysts said.

Muthoot Finance, India’s largest gold loan finance company, will sell 51.5 million shares at 160-175 apiece to raise 886-964 crore, which would make it the country’s largest IPO so far in 2011.

In a year that had only one IPO with an issue size greater than 200 crore, that of PTC India Financial Services Ltd for 438.76 crore, the fate of Muthoot Finance will be keenly watched by other promoters that have obtained regulatory approvals, but chosen to stay away from the primary market so far.

A key concern about Muthoot Finance stems from the fact that the company is trying to transfer the Muthoot brand name and logo to the promoters, which they think was inadvertently transferred to Muthoot Finance. In return, the promoters will grant the company a non-exclusive licence to use the Muthoot trademarks for an annual royalty equivalent to 1% of the gross income of the company.

In a 14 April pre-IPO research report, Santosh Singh and Karthik Velamakanni, analysts at Espirito Santo Securities Ltd, a Portuguese investment bank, have pointed out that the fees being charged by the promoters is “hefty". The duo have also questioned the directors’ commitment to Muthoot Finance since they have other financing businesses fully owned by them.

On corporate governance norms, the company’s track record has been far from ideal. All executive directors are Muthoot family members and they have rewarded themselves quite handsomely. Compensation to directors in 2010 was 19.2 crore, which amounts to 8.4% of net profit. Even in absolute terms, this is higher than what most other firms in the non-banking financial services sector pay.

Its listed peer and the second largest gold loan finance company, Manappuram General Finance and Leasing Ltd, for instance, pays 9 lakh, or 0.08% of net profit as compensation to directors. Muthoot Finance had also failed to disclose litigation pending against a group company, Muthoot Vehicle and Asset Finance Ltd, in its red herring prospectus. A complaint by Kolkata-based Pressman Realty Ltd to market regulator Securities and Exchange Board of India forced Muthoot Finance to disclose additional pending cases through advertisements in several newspapers on 14 April.

“The concerns on corporate governance as also on regulatory issues are quite valid," said Apurva Shah, head of research at Prabhudas Lilladher Pvt. Ltd. “The company would trade at a discount over the long run if these concerns are not addressed."

Muthoot Finance typically lends to lower middle class and poorer sections of the society and that could make it a target of regulatory activism. The company provides short-term personal and business loans secured by gold and the average amount outstanding per loan account was 31,553 as of November. It faces risks of regulatory intervention from the Reserve Bank of India (RBI), which regulates all non-banking financial companies (NBFCs), as well as different state governments that are increasingly trying to cap interest rates charged by NBFCs.

On 3 February, RBI said gold loans can no longer be classified as priority sector lending, thereby depriving the industry of a low-cost source of funding. Some state governments such as that of Kerala want to regulate these NBFCs under a state moneylenders’ Act and had asked them to register with the government. The Kerala State Money-lenders Act caps interest rates charged by moneylenders at 2% above those charged by banks. Kerala accounts for nearly 23% of Muthoot Finance’s branches, according to a research note by Shah of Prabhudas Lilladher.

However, Shriram Transport Finance Co. Ltd, another NBFC, has filed a petition challenging the applicability of the law to NBFCs and the case is still pending with the Supreme Court.

Regulatory pressures might affect the growth of the gold loan industry and crimp margins.

Despite these concerns, analysts such as Shah said the issue could be a good short-term investment opportunity as the pricing appears reasonable. Silky Jain of Nirmal Bang Securities Ltd too has recommended investors to subscribe to the issue.

The company’s growth has been impressive so far. The loan book has grown at a compounded annual growth rate (CAGR) of 44% over the past three years. The company’s profit has risen at a CAGR of 53.59% over the same period.

Non-performing assets are below 0.5% in this business, as the loans are short-term and the amount lent varies between 60% and 90% of an internally fixed price per unit of gold deposited, which tends to be at a discount to the market price.

The anchor investor portion of the IPO was fully subscribed, Reuters news agency reported on Saturday. Muthoot Finance allotted 7.7 million shares, or 15% of the offering, to anchor investors at 170 apiece.

Typically, subscription picks up only on the final day of an IPO, which in Muthoot Finance’s case is Wednesday for institutional investors and Thursday for retail investors.

Sujan Bandyopadhyay and Ashwin Ramarathinam contributed to the story.