Muthoot Finance Ltd IPO Closes today…will give strong gains on Listing…Problem is a Poor Allotment

OF

MUTHOOT FINANCE LTD (MFL)

RECOMMENDED FOR APPLICATION

Rs 160 – Rs 175 BOOKBUILDING RANGE

Size of Issue at Top end : Rs 901 Crs

Think Loan Against Gold…Think MFL….Two Rating Agencies,CRISIL and ICRA have given MFL a 4/5 IPO Rating indicating above average fundamentals with good growth

Promoter Pedigree

This is the third generation of Muthoots that are running MFL….and they too are either past retirment age or approaching it !

The First Generation, Ninan Nathai Muthoot set up a Trading Business in 1887…the Second Generation,M George Muthoot  set up the Gold Business in 1939…and the Third Generation of Four Muthoots have scaled up fast in the last three years and are taking MFL Public….The Four Muthoots are the Wholetime Directors and constitute 50% of the Board  which also has four Independent Directors

The Group has a host of companies across a host of businesses…from FM Radio Broadcating to Real Estate and Resorts

A Harder look at Promoter Intent & Mindset

Abetting in Private Equity Placement at Differential Pricing in the same month too ! 

But MFL is literally and figuratively the GOLD mine.Owned 100% by the Muthoots,the dilution to 93 % took place in the last year to Private Equity Players at Share Prices ranging from Rs 123 to Rs 173.50….including to Kotak Private Equity Fund and Kotak Investment Advisors….Kotak Bank too is a major financier of MFL receivables and Kotak Mahindra Capital is lead managing the issue.

Let’s  not start a debate here on Conflict of Interest and Investor Protection on Pricing and on who’s really steering the Ship here…the Promoters or the Private Equity Players and the Lead Manager !

Reward Self damn well but not the key employees

What catches the eye is this….Every one of the Four Muthoot Directors are currently getting this from the company,while the Top Employees are paid a pittance…top Finance Guy got just  Rs 10 lakhs for the whole year !…while MFL remained private it was nobody’s concern really but now with it going public there are a few eyebrows surely that will be raised 

• Basic Salary of Rs 20 lakhs every month with increments upto 25% in a year at the discretion of the Board
• Special Allowance of Rs 20 lakhs a month
• All Expenses paid for Housing,Travel,Telephones etc
• Incentive of Rs 1.8 crs or 1% of the Net Profit before taxes and before applying this incentive whichever is higher to be paid at quarterly intervals….FY 11 should close with EBT of close to Rs 600 crs…so that’s Rs 6 crores for each Director as incentive….November 30,2010 results for eight months already shows Rs 12.8 crs debited to Directors Remuneration….  FY 12 should see an EBT of over Rs 800 crs…so that’s Rs 8 crs that will be paid out as Incentive to each

MFL is the Market Leader

There is simply no doubt MFL is the Market Leader in LAG Segment…Impressive…Have a Look

As of November 30,2010,The Loan Book of MFL has climbed to Rs 13004 crs…It’s got a bigger share than even the big Southern Banks…and No ,Muthoot Fincorp is not a related company…so a potential and clear confusion and clash of Brand recall exists 

Interest Dynamics of MFL for the Eight Months at November 30,2011

Now that’s a fabulous mark up of 120% on Cost of Funds !…MFL simply plays the Numbers game with such  a great Net Interest Margin…It had 4.1 million accounts across 20 states (predominantly in the South),Delhi and Four Union Territories being serviced by 2263 Branches…it held 97.6 Tonnes of Gold as collateral…that’s worth over Rs 20000 crs against a Retail Loan Book of Rs 13004 crs.The Average Loan was Rs 31553 and Interest earned was an average of 1.67% every month….the Loan Book was funded by Muthoot Gold Bonds outstanding at Rs 3364 crs + Loans from Banks and Financial Institutions of Rs 4709 crs + Selling Receivables under bilateral assignments to banks of Rs 3246 crs….  

Network of Branches

As of February 28,2011 the branches were 2611,the accounts had swelled past4.5 million,the Employees were 15664 that served an average of 67953 customers every day in February 2011…there is no Labour Union…yet

Except 14 Branches which are owned by MFL,all Branches are rented or leased.It takes an average of Four to Six Weeks and Rs Five lakhs to Rs Ten Lakhs to set up a branch…each requires a Strong Room to hold the Gold Collateral plus a Burglar Alarm and Security Personnel Arrangements at high risk branches…Eight Months figures at November 30,2010 show the average cost of setting up a branch was Rs 6.5 lakhs

Three years ago as on March 31,2008 there were 2999 Employees…..the surge is therefore relatively recent as MFL acheived a 74% CAGR in AUM over the past three years

Customer Profile and Loan Criteria 

Customers are from the lower and middle income groups….small businessmen,traders,farmers or salaried people who prefer quick cash disbursments as a Loan against gold jewellery…MFL boasts of disbursing Rs 20000 within five minutes of a customer entering the Branch as they have trained and experienced Gold Appraisers at all branches….they receive training at MFL centres in Delhi and Kochi and regional centres at Bengaluru,Hyderabad and Chennai…Creditworthiness of the Customer  is not a criteria for lending as Defaults are settled by selling of the collateral gold…Merely Identity Proof and a Branch Webcam taken photograph suffice….A pledge and Loan agreement is generated for signing.Interest is payable only with the return of Principal…loans are of 12 month duration but most settle between 90 days to 180 days…Lending is at a Fixed rate per gram of Gold which is lower than the Market Rate as a further caution….Moreover it is against 60% to 90% of the Gold content appraised in the jewellery…that’s a further caution taken by MFL.The Gold is secured in a Polythene bag alongwith the documents and a tamper proof seal is applied and the bag stored away in the Strong Room   

Financials

Growth Propsects Good for MFL

Last three years MFL has achieved a incredible CAGR of 74%….With Gold Prices expected to continue northwards over the next few years,the health of the ‘Loan against Gold’ Industry should get a richer shade of pink

Estimated Indian Stock is 18000 tons of Gold,about a tenth of the global stock…every year 700+ tons add to it…80 % for jewellery fabrication….4.7% of the stock is pledged of which 75% is with the unorganised sector of moneylenders and pawnbrokers…increasingly more and more are now inclined to pledge Gold jewellery for short term loans and the penetration is bound to increase and in the year ahead it is likely that 8% to 10% of the gold stock would be pledged

MFL as a Systematically Important Non Deposit NBFC is leveraging well on this scalable opportunity that is presenting itself to develop the organised market and increase market share and penetration.From 97.6 Tons of Gold it held at November 30,2010 worth over Rs 20000 crs,it is expected that MFL will soon be able to double its business from the retail loan book of Rs 13004 crs on the same date….This IPO of Rs 901 crs will give added headwind to increase the Assets Under Management and lend more while maintaining healthy Capital Adequacy Ratios,above levels prescribed by RBI     

Some Risks

What’s the potential downside  ? It’s the Interest Spread…The current double digit spread will surely be impacted going forward on account of the following

• On February 2,2011,RBI issued a notification that clarified that Banks cannot consider Loan against Gold sourced by NBFCs as agricultural advances.This would also apply to their Investment in securitised pools or portfolios purchased through assignment of ‘loan against gold jewellery receivables’ originated by NBFCs….37% of MFL’s assets as of December 31,2010 were funded by banking limits classified as agricultural lending….going forward it would have to be funded from higher cost non agricultural lending…Interest Speads should be impacted by 0.5% to 1 % on this account  
• 23 % of MFL’s funding came through the assignment route as of September 30,2010.It shot up to 29% at November 30,2010.This door may close partially or even fully if RBI final guidelines on securitisation are applied to bilateral assignments too….these guidelines require that Loans should have a 24 month minimum contractual maturity and issuers need to hold it for a minimum period of 12 months before offering it for securitisation…currently MFL Loans have a maturity of 12 months…MFL would the have to seek bank borrowing at a higher rate 
• In order to capture stronger market share and increase the customer base,MFL may pursue a strategy like is is currently doing,of offering a lower interets rate to customers than it normally does
• Being a Systematic Important ND NBFC,MFL has restrictions on advertising it’s secured non convertible Muthoot Gold Bonds that it currently places to retail investors through it’s branch network
• As barriers of entry are low there could be an increased level of competition as new players too enter this lucrative LAG area
• MFL may be in contravention of Money Lending Statutes in many States…there is no clarity on this as Karnataka and Rajasthan exclude NBFCs from such statutes…but not many States….the matter is before the Supreme Court….penalties for non compliance are quite severe and will increase the cost of operations….many Statutes prescribe a cap on the lending rate…However currently RBI has not directed a ceiling on the lending rate that can be charged for Loans against Gold though it does require the Board to adopt an Interest Model that considers Cost of Funds,Margin and Risk Premium. 

• Having frowned at the Promoters, Muthoots Intent and Mindset
• Some cornering of shares evidenced by a coterie of Private Equity Players
• Chances of a Poor Allotment and therefore insignificant Gains in absolute terms
• Adverse Impact on the Interest Spread due to a host of reasons outlined above
• Back of the Mind recall of the Suzlon (Windmills…even MFL is flirting with them) Situation…a manipulated IPO pricing and pre IPO placement and  post Listing hysteria  and the subsequent fall from grace from a market cap of Rs 50000 crs to below Rs 5000 crs and of the recent SKS Microfinance Issue…another one that squeezed shareholders while raking in huge gains for the Promoters and Private Equity Players whom offloaded pre IPO and in the IPO in a big way
• feeling a bit squeezed like perhaps a MFL Loan Client who’s paying a High Interest on a partial Value Loan against his own Gold Jewellery instead of opting to sell it for full value !

But then putting on a Rational Hat,a sure Carrot is better than no carrot at all !…so apply and I daresay it may be wise to realise the gains and sell your small allotment as a Stag on Listing…think of it this way…its too insignificant to have kept anyway     

Cheers !

Gaurav A Parikh   www.gauravblog.com
98201 62597
[email protected]

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