It May Be A Win For IDFC Bank But Is The Mega Deal A Win For Shriram Group Companies?
Will a merger of IDFC and Shriram Group entities may not be a win-win for all shareholders?
In a complex, multilayered deal IDFC Ltd. and IDFC Bank Ltd. hope to combine with the three Shriram Group companies in order to put under one umbrella a financial conglomerate that covers banking, infrastructure lending, transport finance, consumer finance, insurance and asset management.
But will this strength in numbers and size be advantageous for all the shareholder groups involved?
Unlikely, says Edelweiss Securities in a report published on July 9.
Some part of this may be attributed to the complex manner in which the deal is being designed, mostly in order to meet regulatory requirements.
- Shriram Capital Ltd., the unlisted holding company of the Shriram Group and parent company of Shriram City Union Finance Ltd. and Shriram Transport Finance Company Ltd. - will merge with listed IDFC Ltd., the promoter company of IDFC Bank Ltd., also in the business of infrastructure lending and asset management.
- Shriram City Union Finance Ltd., the listed consumer finance company, will merge with listed IDFC Bank Ltd.
- IDFC Ltd. will hold the listed Shriram Transport Finance as an unlisted subsidiary. This will entail a delisting process.
It’s important to note that Ajay Piramal-promoted Piramal Enterprises Ltd. owns a 20 percent stake in Shriram Capital as also a 10 percent stake directly in each of its two subsidiaries.
Why Won't Shriram Transport Be Merged With IDFC?
There are two reasons for this as explained by the managements of both groups.
- As per the terms of its banking license IDFC needs to hold a minimum 40 percent stake in IDFC Bank until October 2018. Given Shriram Transport's size and market capitalisation, its merger with IDFC Bank would have brought IDFC's shareholding to below that required threshold.
- Also the merger structure needs to ensure that Piramal Enterprises' resulting stake in IDFC Bank remains below 10 percent ( in 5 percent tranches). The Reserve Bank of India does not permit any individual shareholder of a bank to exceed that limit.
The merger of Shriram Transport with IDFC Bank would have also required the bank to set aside substantially more capital to meet RBI's Credit Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements.
Will This Structure Hurt Shriram Transport Shareholders?
It's well accepted that holding companies tend to trade at a discount, of between 15 to 40 percent.
If the final deal does indeed require Shriram Transport to become an unlisted, subsidiary of IDFC, that will involve shareholders of Shriram Transport getting shares of IDFC in exchange. Thereby exposing them to a potential holding company discount.
On the flip side, they will get access to a mix of businesses including infrastructure financing, asset management and insurance.
Also, the delisting of Shriram Transport may take place under one comprehensive merger scheme and not under the reverse book built delisting process, thereby denying its public shareholders better price discovery.
Will Shriram City Union Shareholders Benefit?
The merger of Shriram City Union into IDFC Bank can to a certain extent resolve the bank's priority sector lending obligations and give it access to a large retail customer base and the Shriram branch network.
But Shriram City Union's gold loan and consumer lending businesses boast of higher growth rates than at IDFC Bank.
The Shriram company also enjoys a much higher valuation with a Price to Book Value Ratio of 3.16 versus IDFC Bank’s 1.50.
Ofcourse in the short run the merger swap ratio is expected to price in the difference in valuation. But the slow growing and higher risk infrastructure and project loans business of the bank would continue to suffer low valuations after the merger as well leading to a lower price to book multiple for the consolidated entity versus the current valuation Shriram City Union commands.
Edelwiess Research indicates that the return ratios of the combined entity would be weaker too.
For instance the Return on Equity for the combined entity amounts to 8 percent versus Shriram City Union's current 11.7 percent.
Do Shriram Group Companies' Shareholders Stand To Lose?
It's tough to conclude decisively this early. The two groups have signed a 90 day exclusivity agreement to take merger talks forward. What eventually emerges is unclear, in terms of merger structure, swap ratios and cross ownership.
Strategically, the merger is in a right direction given IDFC Bank was struggling with execution and growth and Shriram group, with the current retail asset base of more than Rs 1 lakh crore, had long term structural growth concern in absence of stable low cost liability franchise. However, there could be near term challenges with respect to execution, regulatory approvals, capital allocations, holding company discount etc. that can weigh on stock price performance.Edelweiss Securities (July 9 report)
Some market experts told BloombergQuint that the proposed deal does not seem very positive for any stock but IDFC bank.
They expect shares of Shriram Transport, Shriram City Union Finance and IDFC to be under pressure in Monday’s session.
Piramal Enterprises too, by virtue of being a large shareholder in the two Shriram companies, could see its share price hurt.
An earlier version of this story was amended to clarify that RBI permits non-promoters to own up to 10 percent in a bank, in 5 percent tranches. That is, the investor needs RBI permission to exceed 5 percent.