Valuation for a For Profit MFI: Understanding the Outside in Valuation Model 1.0

Publication Date: 2007
Published by: Microfinancecapital.com
Document Type: Toolkit

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This presentation and attached Excel model is a tool to value MFIs.

A critical bottleneck to the growth of the microfinance industry is the unavailability of commercial sources of capital. MFIs are increasingly looking towards external equity as a source of funding. However, before they tap this market, it is imperative to value them.

This presentation and the attached Excel model is a tool to value MFIs. MFI valuation involves three critical problems, which this model takes into account while valuation:

• Uncertainty in assessing future growth rates:
• Solution: The model considers three growth scenarios - best case, base case and worst case. The value of the MFI is then determined under the three scenarios.

• Unavailability of industry benchmarks:
• Solution: The value of a company is determined by future growth, profitability and risk. The model assumes three different growth and profitability scenarios. Based on the parameters of growth and profitability, the model assigns a PE ratio for a typical bank with similar growth and profitability. Based on the three scenarios, the model assigns three PE ratios and values the MFI. The risk, which is determined by the cost of equity, is assumed to be constant.

• Lack of company level transparency:
• Solution: The model is based on a standardized income statement for an MFI. The valuer needs to plug in the current year financials and the model will automatically calculate the net income in three scenarios.

The presentation describes how to use the model. It involves a simple three-step process:

• Once the valuer inputs the relevant figures to calculate the net income, the model assigns a relevant PE ratio.
• The value of the MFI is determined along a "valuation line".
• The valuation line is made using all possible combinations of PE ratios and net income. It is expected that the value of the MFI will lie on this line.

Finally, the document concludes with the limitations of the model:

• It gives a very approximate value and might not be exactly equal to the intrinsic value if the MFI;
• The output is as good or as bad as the inputs used to build the scenarios;
• It assumes that all MFIs will have the same cost of equity (risk), which might not be true.

[Adapted from the author]