Five Star Business Finance coming with an IPO to raise Rs 2064.54 crore

Five Star Business Finance

• Five Star Business Finance is coming out with a 100% book building; initial public offering (IPO) of 4,35,55,666 shares in a price band Rs 450-474 per equity share.
• Not more than 50% of the issue will be allocated to Qualified Institutional Buyers (QIBs), including 5% to the mutual funds. Further, not less than 15% of the issue will be available for the non-institutional bidders and the remaining 35% for the retail investors.
• The issue will open for subscription on November 9, 2022 and will close on November 11, 2022.
• The shares will be listed on BSE as well as NSE.
• The face value of the share is Rs 1 and is priced 450 times of its face value on the lower side and 474 times on the higher side.
• Book running lead managers to the issue are ICICI Securities, Edelweiss Financial Services, Kotak Mahindra Capital Company and Nomura Financial Advisory and Securities (India).
• Compliance Officer for the issue is Shalini Baskaran.

Profile of the company

Five Star Business Finance is a Systemically Important Non-Deposit taking Non-Banking Financial Company (NBFC-ND-SI) providing secured business loans to micro-entrepreneurs and self-employed individuals, each of whom are largely excluded by traditional financing institutions. It is headquartered in Chennai, Tamil Nadu with a strong presence in south India and all of its loans are secured by its borrowers’ property, predominantly being SORP. The company has developed a business model that is predicated on arriving at an appropriate risk framework, with the optimal instalment to income ratio to ensure that its customers have the necessary means to repay the loan after meeting their regular obligations and other event-based capital requirements.

The company’s growth is primarily volume led through increasing its customer base while keeping the ATS stable, and it expects this to continue. The interest rates on its loans depend on the underlying tenor (which ranges from two to seven years), with approximately 95% of the loans sanctioned being between the interest rate range of 24% to 26% and between the tenure range of five to seven years. 100% of its leads for customers are sourced in-house without any use of direct selling agents to source leads for it; further, all of its loans are fully secured with more than 95% of the collateral being SORP at the time the loan application is approved.

The company had an extensive network of 311 branches, as of June 30, 2022, spread across approximately 150 districts, eight states and one union territory, with Tamil Nadu, Andhra Pradesh, Telangana and Karnataka being its key states. Such key states collectively accounted for approximately 85% of its branch network by number, as of June 30, 2022. It started operations in Chennai, Tamil Nadu and have increased the scale of its operations through growth in number of branches by adopting a calibrated strategy of contiguous expansion across geographies where there is substantial demand for its offering. Such contiguous expansion is underpinned by utilizing neighboring branches to evaluate local credit environments combined with its focus on hiring local staff with an understanding of the catchment area, strong local personal and professional networks and the market. As of June 30, 2022, approximately 95% of its branches were located in cities and towns with populations up to one million.

Proceed is being used for:

• Carrying out the offer for sale.
  
• Achieving the benefits of listing the equity shares on the stock exchanges.

Industry Overview

The National Sample Survey (NSS) 73rd round dated June 2016 estimated that there are around 63.5 million MSMEs in India. Since then, the number of MSMEs is estimated to have increased further to around 70 million as of fiscal 2022. MSMEs complement large corporates as suppliers or directly cater to end users. The MSME sector contributes to India’s socio-economic development by providing huge employment opportunities in rural and backward areas, reducing regional imbalances, and assuring equitable distribution of national wealth and income. The segment currently contributes to 30% of the GDP, over 40% of exports and creates employment for about 110 million people in the country, thus supporting economic development and growth.

MSME lending market across ticket sizes and various player groups (banks, NBFCs, small finance banks, and other formal lenders) to be around Rs 21 trillion as of March 2022. This market size includes loans taken by MSMEs across various constitution types (sole proprietorships, partnership firms, private and public limited companies, and co-operatives) and the ticket size spectrum, and includes loans extended in the name of the firm/entity/company as well as the individuals in case of micro enterprises or entrepreneurs. Meanwhile, loans to MSMEs have grown at a CAGR of 10% during fiscal 2012 to fiscal 2022, which is similar to the nominal GDP growth in this period. Meanwhile, there is a huge demand supply gap in small business loan segment. With increasing presence of small business loans in smaller cities and rising focus of lenders on underserved target customer segment, loan portfolio is expected to see a strong growth in future. According to RBI, size-wise credit to large industry grew by 5.2% in July 2022, against a contraction of 3.8% a year ago. Medium enterprises recorded a credit growth of 36.8% in July 2022 as compared to 59% last year, while credit growth to micro and small enterprises accelerated to 28.9% in July 2022, from 10.5% during the same period in the last year.

NBFCs in small business lending have, over the years, developed expertise in serving the underserved and niche customer segments by developing customised products (tailored to customer/business needs) and building strong credit appraisal mechanisms to serve their target segment. Moreover, their ability to penetrate deeper into geographies gives them the edge in serving these customers. Some NBFCs have tailor made underwriting processes customised for the target segment they cater to which gives them an edge in understanding and serving the customers as well as in maintaining their portfolio quality. NBFCs have also been leveraging technology to efficiently manage the lending process, which has also helped them reduce the turnaround time.

Pros and strengths

Fastest gross term loans growth: The company has the fastest gross term loans growth among its compared peers (being NBFCs in India) with more than Rs 30,000 million in gross term loans, with a CAGR of 65.0% (Financial Year 2017 to six months ended September 30, 2021), catering to the small business finance needs of unserved and underserved customers. While its gross term loans has grown to Rs 50,670.78 million as of March 31, 2022 from Rs 10,082.58 million as of March 31, 2018, at a CAGR of 49.73% (between March 31, 2018 and March 31, 2022), its growth has primarily been volume led with consistent ATS and steady yields. The ATS of its loans in the three months ended June 30, 2022 and June 30, 2021, and the Financial Years 2022, 2021 and 2020, was Rs 0.29 million, Rs 0.27 million, Rs 0.28 million, Rs 0.26 million and Rs 0.31 million, respectively.

Ability to successfully expand to new underpenetrated geographies: As of March 31, 2022, less than 15% of approximately 70 million MSMEs in India have access to formal credit in any form, and historically, there is a perception of high risk and prohibitive costs of delivering services physically that have constrained traditional institutions’ ability to provide credit to underserved or unserved MSMEs and self-employed individuals. As a result, such borrowers resort to credit from informal sources and as such, this relatively untapped market offers huge growth potential for financial institutions. Since starting as a Chennai based NBFC, the company has demonstrated its ability to grow beyond its local market. The company’s first growth phase was between Financial Year 2010 and Financial Year 2015 where it increased from six branches in Chennai to 39 branches across Tamil Nadu. Between Financial Year 2015 and Financial Year 2018, it started to expand in the states of Andhra Pradesh, Telangana and Karnataka, growing from three branches to 72 branches during this period. Since then, it has further expanded to 165 branches across Andhra Pradesh, Telangana and Karnataka, as of June 30, 2022.

100% in-house sourcing: The company’s 100% in-house sourcing, comprehensive credit assessment and robust risk management and collections framework allows it to identify, monitor and manage risks inherent in its operations. Catering primarily to small business owners and self-employed customers while maintaining asset quality requires a special skillset in absence of traditional income evidence, such that lending to these borrowers is based on an assessment of their income and cash-flows through various methods. First, it ensures all of its loans are sourced in-house, either through its branch-led local marketing efforts (i.e., door-to-door or specific referral marketing), repeat customers or through walk-ins. In-house sourcing allows for complete control over the quality of customer and processes involved to disbursement, which leads to better asset quality, compared to other methods of customer acquisition. Further, as its customers are on-boarded by its own officers and not by third party selling agents who may or may not be working with multiple financial institutions, it experiences a lower churn rate of customers throughout its portfolio.

Access to diversified and cost-effective long-term financing: The company has secured financing from diversified sources of capital, including term loans; proceeds from loans securitized; proceeds from the issuance of NCDs; issuances of principal protected market linked debentures; and proceeds from loans assigned; from banks, financial institutions, mutual funds and other domestic and foreign financial and development finance institutions to meet its capital requirements. The company’s average cost of borrowings on its average total borrowings was 10.53% as of June 30, 2022, 10.68% as of June 30, 2021, 10.51% as of March 31, 2022, 11.48% as of March 31, 2021 and 12.07% as of March 31, 2020. Its cost of incremental borrowings decreased from 11.37% in the Financial Year 2020 to 9.68% in the Financial Year 2021 and to 8.51% in the Financial Year 2022, and was nil and 8.42% in the three months ended June 30, 2021 and 2022.

Risks and concerns 

Substantial portion of its customers are first time borrowers: The company has customers who are first-time borrowers from the formal secured lending ecosystem. As of June 30, 2022, 30.42% of its customers were new to the lending ecosystem. Such customers generally may have higher risk of nonpayment or default due to a number of reasons such as not having the experience of payment of interest and repayment of principal, as well as other reasons applicable to its other customers such as business failure, insolvency, lack of liquidity, loss of employment or personal emergencies such as the death of an income-generating family member, including on account of events such as the COVID-19 pandemic. Of such first-time borrowers, during the three months ended June 30, 2022 and the Financial Years 2022, Rs 123.00 million, or 0.23% of its total Gross Term Loans and Rs 109.92 million, or 0.22% of its total Gross Term Loans experienced default (i.e. were in the 90+ DPD category), respectively.

Geographical constrain: The company’s operations are primarily focused in the states of Tamil Nadu, Andhra Pradesh, Telangana and Karnataka. Such key states collectively account for approximately 85% of its branch network as of June 30, 2022. As of June 30, 2022, Rs 20,172.11 million, or 38.09% of its Gross Term Loans, Rs 15,770.01 million, or 29.77% of its Gross Term Loans, Rs 10,325.80 million, or 19.50% of its Gross Term Loans, and Rs 3,793.47 million, or 7.16% of its Gross Term Loans were attributable to Tamil Nadu, Andhra Pradesh, Telangana and Karnataka, respectively. As of March 31, 2022, Rs 19,676.87 million, or 38.84%, Rs 14,843.29 million, or 29.29% of its Gross Term Loans, Rs 9,734.44 million, or 19.22% of its Gross Term Loans, Rs 3,680.78 million, or 7.26% of its Gross Term Loans were attributable to Tamil Nadu, Andhra Pradesh, Telangana and Karnataka, respectively. Any significant social, political or economic disruption, or natural calamities or civil disruptions in these regions, or changes in the policies of the state or local governments of these regions or the Government of India, could disrupt its business operations, require it to incur significant expenditure and/or change its business strategies. The occurrence of, or its inability to, effectively respond to any such event, could have an adverse effect on its business, cash flows and results of operations.

Requirement of substantial capital: The company’s business and results of operations depend on its ability to raise both, debt and equity from various external sources on suitable terms and in a timely manner. The company’s financing requirements historically have been met from several sources, including term loans and working capital facilities; proceeds from loans securitized; proceeds from the issuance of NCDs; and principal protected market linked debentures from banks, financial institutions, mutual funds, and other domestic and international development financial institutions to meet its capital requirements. The company’s business thus depends on, and will continue to depend on, its ability to continually access these sources of capital and secure low cost funding at rates lower than the interest rates at which it lends to its customers.

Stiff competition: The small business finance industry in India is highly competitive and it competes with unorganized money lenders, friends and family members, certain larger NBFCs and HFCs, NBFCs that also offer loans for business purposes but backed for property (in particular self-occupied residential property (SORP), as well as certain microfinance entities and small finance banks, in geographies in which it operates. Consistent with developments over the years, it may also see the entrance of new competitors. Its competitors may have more resources, a wider branch and distribution network, access to cheaper capital, superior technology and may have a better understanding of and relationships with customers in these markets. This may make it easier for competitors to expand and to achieve economies of scale to a greater extent. In addition, its competitors may be able to rely on the reach of affiliated group companies or other banks. Competition in the industry also depends on, among other things, the evolution of government policies relating to the industry (including interest rate deregulation and other liberalization measures), the entry of new participants, and the extent to which there is a consolidation among banks and financial institutions in India and competition is expected to intensify in the future.

Outlook

Five Star Business Finance is an NBFC-ND-SI providing secured business loans to micro-entrepreneurs and self-employed individuals. The company has an extensive network of 311 branches, as of June 30, 2022, spread across eight states and one union territory and approximately 150 districts across India, with Tamil Nadu, Andhra Pradesh, Telangana and Karnataka being the key states. The company has created a business model based on identifying an appropriate risk framework and the ideal instalment-to-income ratio to make sure that customers have the resources to repay the loan after meeting their regular obligations and other event-based capital requirements. On the concern side, the company’s operations are primarily focused in the states of Tamil Nadu, Andhra Pradesh, Telangana and Karnataka and any adverse developments in these regions could have an adverse effect on its business, cash flows and results of operations. Moreover, the company may face asset-liability mismatches, which could affect its liquidity and consequently may adversely affect its operations, cash flows and profitability.

The issue has been offered in a price band of Rs 450-474 per equity share. The aggregate size of the offer is around Rs 1960.00 crore to Rs 2064.54 crore based on lower and upper price band respectively. On the performance front, the company’s total income increased by 12.74% to Rs 3,390.59 million for the three months ended June 30, 2022 from Rs 3,007.55 million for the three months ended June 30, 2021, primarily due to an increase in revenue from operations. Its profit for the period increased by 37.28% to Rs 1,394.33 million for the three months ended June 30, 2022 from Rs 1,015.71 million for the three months ended June 30, 2021. Going forward, the company is planning to increase its penetration in existing markets through increasing branch staff numbers, increasing its branch network in the existing geographies and diversifying to contiguous markets. Also, the company is planning to continue focusing on small business owners and self-employed individuals and increase its market share.