How Lok Capital is making the best of the MFI crisis

Betting on microfinance has turned out to be not quite as rough as expected for Lok Capital, the Rockefeller Foundation-backed social venture capital firm. Last week, the firm staged its fourth exit from the sector with the sale of its stake in Delhi-based microfinance institution (MFI) Satin CreditCare Network. Sources close to the firm say that the exit earned Lok Capital a return multiple of 2X on its original investment. Following this exit, the Gurgaon-headquartered investor has returned 70 per cent of the principal corpus of its $22 million Lok Fund I, which was almost exclusively focused on the microfinance sector.

“Our MFI portfolio in Andhra Pradesh did take a beating following the crisis there. About 25-30 per cent of Fund I was invested there. However, in terms of returns from the fund, we are on track to meet the hurdle and deliver some profits to our investors,” Lok Capital co-founder and partner Vishal Mehta told StartupCentral this week. Besides Satin CreditCare, the firm’s other three successful MFI exits so far include Bangalore-based Janalakshmi Financial Services, Hyderabad-based Spandana Sphoorty Financial and Kolkata-based Arohan Financial Services.

Mehta is particularly happy with the way the Satin CreditCare exit worked out. The company raised $7.6 million (Rs 41 crore) from MicroVest II, ShoreCap II (managed by Equator Capital Partners) and Danish Microfinance Partners and the deal involved Lok Capital’s undisclosed stake being acquired by MicroVest. “More than 70 per cent of the round was primary money for the company, so it worked out well,” he says. The firm had invested a little over $2 million in the company over three rounds of funding since 2008. “We were able to help the company build as much value as possible within our resources. It’s the right time to exit,” he says.

Some gains, some losses

Not all of the MFI portfolio, however, will end on a happy note. When Lok Capital launched Fund I in late 2000, the domestic microfinance sector was on the cusp of what looked like a dream run that held the promise of lucrative returns for investors and widespread social benefits for borrowers at the bottom of the pyramid. That came to a crashing halt in late 2010. This was triggered by market leader SKS Microfinance, which had just become publicly listed,  and other players being accused of driving borrowers in Andhra Pradesh to suicide because of tough loan collection tactics. The state government issued an ordinance to regulate MFIs, which restricted them from collecting payments on loans on a weekly basis and barred them from issuing fresh loans to borrowers with pending loans. This effectively brought MFIs focused on Andhra Pradesh, which at the time accounted for one-third of the country’s MFI portfolio, to their knees. Read the Businessworld story ‘Abrupt Fall From Grace’ which traces the troubles inside SKS and the microfinance sector.

Lok Capital was among several private investors hit by what has now come to be known as the ‘AP crisis’. Overall, Lok Fund I had invested in nine MFIs. The portfolio has seen one write-off so far (Mehta did not disclose the name of the company). “We might have one more [write-off] on account of the AP crisis,” he said. Out of the remaining portfolio, three more exits, either partial or full, are planned during the course of the year.

The four successful exits so far have been a mixed bag in terms of returns. Two out of the four have earned IRRs (internal rate of return) of upwards of 35 per cent, one earned an IRR of 15-20 per cent and one was not profitable but the firm was able to recover its principal investment (details on which company earned what IRR were not available). Out of the four, Lok Fund I had the highest investment in Janalakshmi at Rs 16.37 crore had an investment of Rs 1.6 crore in Janalakshmi and it partially exited the investment in 2011. The investment in Arohan was about Rs 3.4 crore and this was exited before the company was acquired by Intellecash Microfinance Network last September. The exit from Hyderabad-based Spandana was a timely one in hindsight. Lok had invested about $2 million in the company over a period of time and it exited the company in 2010 just months before the Andhra Pradesh ordinance was issued.

Broader focus, but MFIs still on the radar

In the aftermath of the AP crisis, when Lok Capital entered the market to raise a second fund in 2011, it decided to change its focus from microfinance to broader social impact sectors. The $65 million Lok Fund II raised in December that year invests in four broad sectors — healthcare, education, financial inclusion and employment generation services. So far, about 45 per cent of this fund has already been committed in fresh investments. Some of its recent investments from the fund include Dristhi Eye Care, which delivers eye care services to underserved populations, Rural Shores, a BPO focused on generating rural employment, and Hippocampus Center, a rural markets focused education initiative.

Within its broadened sectors of focus, healthcare has proved to be relatively easier to navigate. “It took us a while to understand both the healthcare and education sectors. Unlike MFIs, the bottom-of-pyramid focus is not immediately apparent in business models,” says Mehta. The education sector, on the primary education front, has recently become cause for a bit of worry on account of the government’s Right to Education Act. According to media reports, an estimated three lakh private budget schools could face closure due to their inability to meet the March 31 deadline for meeting infrastructure requirements under the Act. Still, the firm is currently evaluating a couple of deals in the sector.

As things stand now, about 30-40 per cent of investments from Fund II are currently concentrated in the financial inclusion sector. In January this year, the firm participated in a $3.7 million Series D funding round in Mumbai-based Suryoday Micro Finance. It had entered the company in 2010. Earlier last August, it participated in a $7.2 million Series B round in Bangalore-based Vistaar Financial Services. Another 30 per cent of the fund’s investments are in healthcare. It will also selectively make investments in solar and water companies.

Meanwhile, with order gradually being restored to the microfinance sector and private investors retracing their steps, though cautiously, Mehta doesn’t rule out selective MFI investments in the future as well.

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