1. Micro Finance & Valuations
“Valuation approaches & challenges
in Micro Finance”
Taco Lens
19 June 2013

2. Introduction
“Exploratory thesis” with a practical impact
• Explore existing theoretical frameworks
• How can they be applied within Triodos Investment Management –
Emerging Markets, Micro Finance Investments
• Directly apply the findings and conclusions of the thesis in daily practice
• Result: New valuation policy including tools and databases is being
developed and made ready for implementation.
2

3. Problem Definition
Overall Problem Definition:
• Which valuation methodology(s) could be applied when valuing MFIs and
what are the challenges?
Sub questions:
• How to define MFIs?
• Which valuation methodology(s) exist when valuing “conventional”
banks?
• How do MFIs differ from banks from a valuation perspective?
• Which valuation methodologies could be applied in practice when valuing
MFIs?
• Which challenges arise when valuing MFIs?
3

4. 4
How to define MFI’s?
• Organizations active within inclusive finance; active in emerging markets
• The activities of these organizations are aimed at supplying financial
services to segments which are not served by the conventional banking
sector; i.e. the low to middle income populations as well as micro and
small – enterprises (SME).
• While often the initial focus is on supplying credit, more and more MFIs
have started to diversify their offering and their income streams by
offering savings, insurance and payment products & services.
• Look at valuations and transactions from a private equity investment
point of view.

5. 5
Which valuation methodology(s) exist when valuing
“conventional” banks?
“Conventional” Bank Valuation:
• Free Cash Flow to Equity method (FCFE)
• Residual Income Method
• Multiple Based (P/E and P/BV)

6. 6
How do MFIs differ from banks from a valuation
perspective? (1)
• Initially MFIs are performing activities which banks also perform, such as
attracting deposits and providing loans
• The differences occur for a large part from the incorporation of
sustainability in the overall strategy & business model by MFIs and their
focus on providing financial products & services to the real economy and
using their capital to support that strategy.
• These differences will become apparent via the different patterns and
ratios in the forecast of the P&L and balance sheet.
• To be able to identify and structure the key drivers of value the value
driver tree concept can (also) be applied for MFIs.

7. 7
How do MFIs differ from banks from a valuation
perspective? (2)
• The most important difference: Life Cycle Development Framework
Life Cycle Development Framework MFIs
Early Stage
Loans
(Majority Interest
income & minority
fee income)
Savings
(Interest
income)
Payments
Services &
Insurance
Products
(Fee income)
Product Offering &
Income Sources High Growth Maturing
+
+
Time & Development

8. 8
How do MFIs differ from banks from a valuation
perspective? + Challenges (3)
Challenges:
• Emerging Markets
- Country risk / Cost of equity
• Non-traded organizations
- Cost of equity / Beta generation
• High growth
- Cost of equity/ Terminal value
Additional Valuation Method to mitigate the challenges:
• Venture Capital Approach
Many banks can be positioned
in the maturing phase and are
quoted on a stock exchange

9. 9
How do MFIs differ from banks from a valuation
perspective? + Challenges (4)
Challenges: Emerging Markets; Country risk / Cost of Equity
• Methods:
- Incorporate the specific risks in the cash flows
- Apply a specific adjustment in the discount factor; Country Risk
Premium
- Combination of both methods where company specific elements are
considered in the cash flow and country specific elements in the
discount rate.

10. 10
How do MFIs differ from banks from a valuation
perspective? + Challenges (5)
Challenges: High Growth & Non-Traded
• In general, when an organization is in a high growth phase the discount
rate should be higher and when the organization is in a more
mature/stable phase the discount rate should have decreased.
• This implies that the cost of capital should be adjusted during the
forecasted period for the changes in risk profile over time when this is
justifiable.
• Gordon Growth: Key for determining the terminal value the organization
needs to have reached a stable state at the end of the forecast period.
• For high growth companies which are also non-traded it is a challenge to
derive the beta since no objective model exists at the moment which
derives the beta of a fast growth non-traded organization. Challenge to
apply CAPM model to derive the cost of equity at the start of the life cycle
development model.

11. 11
Which valuation methodologies could be applied in
practice when valuing MFIs? (1)
• General banking valuation methods, both cash flow driven methods and
multiple driven methods, are a good starting point to value Micro Finance
Institutions (MFIs): MFIs show similarity in their operating model when
compared to banks and know the same challenges when defining debt,
working capital and reinvestments.
• However.....
• Following the life cycle development framework, the stage in which an
MFI finds itself is a key element to consider when selecting valuation
methodologies and when performing a valuation. Depending on the stage
of development, start-up, high growth phase or a maturing phase
different valuation techniques can be applied.

12. 12
Which valuation methodologies could be applied in
practice when valuing MFIs? (2)
Valuation Methodologies & Life Cycle Development Framework MFIs:
Valuation
Methods:
Venture Capital
Approach
FCFE FCFE
Multiples (P/E +
P/BV)
Venture Capital
Approach
Residual Income
Method
Residual Income
Method
Multiples (P/E +
P/BV)
Multiples (P/E +
P/BV)
Early Stage High Growth Maturing

13. 13
Valuation
Method
Pro’s Con’s Challenges
FCFE Can treat excess returns as free
cash flow to equity holders
Detailed method
Complex; sensitive to
assumptions
Sensitivity towards the
Terminal Value and discount
rate
Cost of Equity; Beta
determination
Projecting Future Cash
Flows & Terminal Value
Venture
Capital
Approach
Applicable to start/up & high
growth companies
Terminal Value less impact
Use IRR instead of cost of
equity
Discount rate based upon
“broad” target
Blend of a DCF valuation
method and a relative method
Select appropriate multiple
from peer group
Residual
Value
Method
Conceptually a sound method
Applicable to high growth
companies; based upon book
value
Terminal Value less impact
when compared to
FCFE/Venture Capital Approach
Discount rate & future net
income growth rate
Not applicable when capital
structure changes significantly
(e.g. equity raise, IPO)
Projecting Future Cash
Flows & Terminal Value
Multiples:
P/BV Meaningful for MFIs being a
financial institution
Ease of use and understand
ability
No view on future earnings
Less applicable to start ups &
fast growth MFIs
Peer group selection; lack
of listed companies and in
different stages of
development
Foreign exchange
exposure
P/E Widely used/recognized
Meaningful for a margin based
industry like microfinance
Ease of use and understand
ability
Comparability of peers
Volatility of earnings / can be
negative
Peer group selection; lack
of listed companies

14. Case Study
14
• A “real-life” case was selected to test the identified valuation approaches
• The case example was positioned in the life cycle development model on
the edge of the high growth/maturing phase and therefore all valuation
techniques could be applied
• The findings confirmed the findings from the theoretical framework; such
as:
• In general, significant impact of the terminal value; challenging to
apply Gordon Growth appropriately and to create a highly
comparable peer group for multiples due to information restrictions
• Significant difference in valuation outcome between cash flow driven
methods versus multiple methods; possible due to “significant
optimism” within the forecast and/or market circumstances
influencing trading multiples versus transaction multiples

15. Limitations
15
Current theoretical frameworks;
• How to derive cost of equity (estimation of beta) of an organization not
yet in stable growth stage
• Challenging to complete a detailed multi stage or longer period forecast
Limited availability of public data;
• Compilation of comparable peer groups

16. Recommendations - Theoretical
16
• Further empirical research of the applied valuation methodologies; to
further understand the application & impact of the methodologies in the
MFI market. A preferred approach can potentially be identified or
developed.
• Further research regarding the estimation of the cost of equity when
extending the forecast period and/or when applying multi stage
forecasting. Emphasis should be put on the theoretical framework
regarding the beta estimation in the early stage and growth phase to be
able to complete a multi stage forecasting approach.
• Further research the topic of discounts & premiums specifically for the
MFI segment.

17. Recommendations - Practical
17
• Develop a structured valuation template, which contains all of the
identified valuation methods; the outcomes should be captured in a
database and compared. These insights and conclusions can provide
input to come to a preferred valuation approach.
• Develop (further) a peer group benchmark for traded organizations,
which is sufficiently comparable when investing in the MFI market, which
is comparable to own circumstances and characteristics.
• To be of higher statistical meaning it is recommended to perform more
case studies and compare the outcomes.