Finshots Special Edition: SBI Cards IPO

At Finshots, we take our IPOs very seriously. And today we have a special edition newsletter where we cover one of the hottest issues likely to hit the market this season — SBI Cards,

Point of Interest: SBI Cards is a separate legal entity (not SBI) that’s responsible for issuing SBI branded credit cards in India. They do pay SBI a royalty fee of 17 Crores for this privilege. But it’s not that big of a deal since they are largely owned by SBI. What is a big deal, however, is that they are trying to go public by offering about 14% of the company to people like you.

The Story

Now before we get to the nitty-gritty, a small note on the psychology of spending.

There’s a very good reason why banks shove credit cards down your throat even when you don’t want one. Because unlike standard payment methods, where the cash outgo is instantaneous, credit cards require you to pay your bills at the end of a monthly cycle. And when you decouple this process of paying for a purchase and the actual cash outgo, you mitigate some of the pain associated with spending. In fact, this allows people to focus on the benefits of the purchase instead of the price tag. So in summary, when you have a credit card, you’ll most likely spend more money than you would otherwise. And the more money you spend, the better the money-making opportunity (for credit card companies, of course).

Where is my Interest Rate?

You see, credit card companies make most of their money when you fail to pay back your dues within the window you’re expected to pay them. Beyond this, they’ll charge you an interest rate that could vary anywhere between 25% to 40% annually (depending on your creditworthiness). Yes, you heard that right. 25–40%. That's a lot of money and they can charge this because credit card debt isn’t like other debt. It’s not like a home loan or an auto loan. In the event, you default on your payment obligations, credit card companies have little recourse to retrieve their money because there’s no collateral here. Yes, they will hound you with calls and make your life miserable. But they’ll have to spend a considerable sum of money in the process, especially if they are hell-bent on retrieving their dues. And this introduces a certain kind of uncertainty you simply don’t see with home and auto loans.

Also, banks have no real say on how you use this extra credit. You could spend it on groceries, gamble away the money or try and buy little teddy bears. There’s no way to know for sure if all of this money will be channeled into productive avenues that’ll help you pay back your dues. So credit card companies try to compensate for this added risk by charging a higher interest rate. For instance, 51% of all SBI cards revenue could be attributed to interest income last year (FY19). And all of this has culminated in rather remarkable fashion. I mean, look at these numbers for god’s sake. They’ve got a money minting machine here at SBI Cards.

And in a country like India where people are only now beginning to access the power of credit, the opportunities are boundless. But that also means something else. The industry is rife with competition.

Coming out on top

I mean, ask yourself this. What’s separating my credit from yours? Its money after all and if there’s a company out there making it more accessible, you’d likely to string along with them, no questions asked. And as a consequence, SBI Cards spends a bulk of its revenue on promotional and sales activities — Free movie tickets, reward points, gift cards, discounts, lollypops, a hug, it's all on the table. In fact, SBI Cards has over 33,000 sales personnel operating out of 133 cities spread across most of India’s territory. Hell, they spent over 24% of their revenue last year (FY19) trying to cover for this and that’s the defining feature here i.e. if you’ve got the right distribution channels and marketing personnel, you are more likely to come out on top.

Another defining feature of the credit card business is that it can be pretty hard to assess an individual's creditworthiness. Because while interest income offers money-making opportunities, it’s also presenting to you a potential defaulter. We are talking about individuals who don’t pay back their dues. And as on September 2019, the company had about 538 crores in bad unpaid loans  (GNPA) i.e. about 2.33% of all outstanding dues on that date. Not bad by any stretch of the imagination. But in the pursuit of growth, companies can be led astray into making decisions that might not necessarily be prudent i.e. offer credit to people who shouldn’t exactly be on a credit card in the first place. So it’s important to keep track of this number and see if the company continues to remain prudent.

Thankfully interest isn’t the only source of income for SBI cards and before we delve into what’s bringing in all the remaining moolah, we dance.

The Credit Card Tango

When you go to your favourite Big Bazaar store and the cashier swipes your SBI credit card, it puts into motion an elaborate Tango that begins with the POS machine — the small box where you enter your credit card pin. Now bear in mind each POS machine is linked to a bank account (In this case, Big Bazaar’s (BB) bank account). So BBs bank receives the transaction information and then forwards it to SBI Cards (the bank that issued the credit card in question) using a payment network operated by Visa or Mastercard. SBI Cards, in turn, verifies to see if the customer has a valid credit line and they make the payment if everything checks out. This information is then relayed to BB’s bank via the payment network and the money is finally credited once every intermediary in this chain has taken their cut.

SBI Cards for its part, charges what you call an interchange fee for facilitating this transaction. Which means each time you make a transaction SBI Cards makes money. The more you spend, the more money SBI Cards makes in the process. Which is why they have every incentive to make you spend as much money as possible so long as they believe you’ll pay up. Unfortunately. this also poses a very interesting challenge. It’s subject to regulatory change. Very recently, the finance ministry abolished interchange fee (through MDR) on all RuPay debit cards. It doesn’t take a genius to figure out that the move would have been detrimental if it had been applied to credit cards as well.

Fortunately for SBI cards, they also charge joining fee, annual fee, late fee, currency markup fee, cash advance fee, over-limit fee, reward redemption fee, bad hair cut fee and these aren’t necessarily subject to wild swings borne out of regulatory changes. In fact, 44% of all the company’s revenue comes from this sort of stuff (FY19). So it’s not all bad. Not one bit.

Also, they don’t really charge a bad haircut fee. I made it up. So don’t worry if you have a bad haircut. You’re still good :)

All aboard the hype train

But who are we kidding? You and I both know that none of this stuff will matter come March 2nd, 2020. Because subscribing to an IPO is much like going to the movies. It doesn’t really matter if the movie is absolute crap, so long as the hype machine can churn out enough promo material. And right now there’s so much hype I don’t even know where to begin. My dad wants a piece of this stuff. Our intern wants to get in on the act. I overheard a couple talking about SBI Cards IPO when I was eating my vadapav this morning and at this rate, my favourite milkman down the street will also open a Zerodha Account and subscribe to the IPO issue.

So you know what. The story ends here. Until next time ….

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For all the valuation people: Assuming SBI cards posts similar EPS performance next quarter as they did in the past 3 quarters and we consider the upper price band of 755, the company will be valued at a P/E of 44. Make of this what you will :)