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High bank borrowing rates and entrepreneurship

01 Jul 2014 - {{hitsCtrl.values.hits}}

t was with lot of interest I went through the recently issued IPO prospectus of Lucky Lanka Milk Processing Company Ltd (“Lucky Lanka”).
My interest in this company was not only because I am a consumer of Lucky Lanka products, but because this company is often referred to as an entrepreneurial success story and as a Private Equity manager any sort of entrepreneurial success stories interest me.
After going through the IPO prospectus, I could not help writing this brief note putting down some observations which reiterate some points I have highlighted in through many research articles before.

I did not expect to see such high cost of borrowing among companies with solid business models, and I did not expect to see such high cost of borrowings in companies matured enough to come to the stock market.

Under-funding and high debt levels

Many of us would think a company producing popular milk products consumed by people from all walks of life throughout the country to be managing its finances very comfortably. But if we examine Lucky Lanka’s financials, we can easily see the level of difficulty the company has managed its finances.
It is yet another entrepreneurial venture struggled with under-funding and high levels of debt. Moreover, the company’s cost of borrowing appear to be over 22 percent (for latest year) when the comparable market rates are much lower.

Although I have seen many private companies struggling with both accesses to finance as well as high cost of finance, I did not expect to see such high cost of borrowing among companies with solid business models, and I did not expect to see such high cost of borrowings in companies matured enough to come to the stock market.

What is important is that we must ask ourselves “can manufacturing companies competing with imports, grow - or even be sustainable at interest rates as high as 22 percent?”

Fortunately Lucky Lanka has managed not only survive such high interest rates, but also to reach great success. What could have been the result if Lucky Lanka was availed other forms of funding or even able to borrow at much lower cost from early on? For example, if they had credit at 16 percent during last three year, company could have saved around more than Rs.47 million compared total of Rs.43 million profits made during the same period! I do not wish to speculate on the potential equity value upside resulting in such interest cost saving, but we can only speculate that Lucky Lanka’s growth could have been negatively impacted by unavailability of suitable funding.

.Reflection of the reality

In my view, Lucky Lanka’s case is probably not an isolated case, but a reflection of the reality faced by many budding local entrepreneurs. There may be many businesses like Lucky Lanka which are not only faced with difficulty in accessing finance, but also faced with unreasonable cost of credit.
There may be so many entrepreneurs with innovative business ideas and plans, but with no lender willing to consider giving them funding.
High cost of borrowing makes businesses uncompetitive, curtails growth and also increases risk of bankruptcy which in turn increases risk of entire financial system. The fact that a larger share of Lucky Lanka’s borrowings are not from the large lending institutions also explains the important role played by the small financial institutors in supporting SMEs, and also raises the question of the effectiveness of various SME lending programs of large lenders.

Currently Sri Lanka’s credit growth has reduced to a very low level despite low interest rates. There is a policy push to promote more private sector credit.

In such an environment, examples like Lucky Lanka only suggests that ground realities could be much different than what we assume or expect for a credit growth to take place. Unless serious measures are taken to promote alternative sources of funding like venture capital and private equity, some local industrialists many not only find it difficult to compete in the market, but also to survive.

(Indika Hettiarachchi is the Managing Director Jupiter Capital Partners. He is a graduate of University of Wisconsin, USA, completed a MA degree at University of Colombo and also qualified as a CFA charter holder. He founded Jupiter Capital Partners (“JCP”) in 2012 with the aim of developing a platform to channel equity funding for SMEs. JCP’s efforts to bring attention to Sri Lanka among global investors, and the SME sector helped JCP being awarded the Frontier Markets Private Equity firm of the year in Asia region in 2013 (beating other two nominees - global investment giant Kohlberg, Kravis and Roberts, and Vietnam’s Mekong Capital). He was also named as one of the 40 important business leaders in Sri Lanka under age of 40 by Echelon magazine. Before founding JCP he was a Principal at a leading global emerging markets Private Equity firm. Email: [email protected])

Features

High bank borrowing rates and entrepreneurship

I did not expect to see such high cost of borrowing among companies with solid business models, and I did not expect to see such high cost of borrowings in companies matured enough to come to the stock market.

Under-funding and high debt levels

.Reflection of the reality

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