2022 may be the year of Mergers & Acquisition (M&A) if the amalgamation activities continue at the same pace. On the Monday of 5th April, the investor community woke up to a blissfully surprising announcement – the merger of HDFC Ltd. (NBFC) and HDFC Bank Ltd. (private lender).
In the last week of March, two merger activities took place, Axis Bank’s acquisition of Citi Bank’s consumer business and PVR – Inox from the entertainment space. We have covered these two mergers in detail in our investors’ education initiative “Informed InvestoRR”. To get insights into these mergers, long-term investments and more subscribe to the 5 in 5 Wealth Creation Strategy.
In this article, we explore the World’s largest Banking Deal in the last 15 years and the biggest merger in Indian corporate history.
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Marriage of two equals
In the words of HDFC Chair Deepak Parekh, the merger between HDFC and HDFC Bank is a merger of two equals and comes at the right time as the Reserve Bank of India (RBI) regulations have slimmed the operational arbitrage for non-banking entities. Arbitrage is the practice of taking advantage of differences in prices in two or more markets.
Moreover, he highlighted that the regulatory amendments for NBFCs and banks over the last few years eased the merger. The lenders were in talks for the last three weeks for the merger.
RBI issued a series of guidelines to harmonize regulations between Banks and NBFCs in the last three years. In our opinion, the marriage of two equals makes sense as RBI has been urging large non-banking financial corporations to become banks for better regulations and applying the same banking laws to them.
The amalgamation will involve HDFC and its two wholly-owned subsidiaries – HDFC Holdings and HDFC Investments.
Benefits on the cards
According to HDFC Bank CEO Sashidhar Jagdishan, “The biggest motivation for the deal is creating demand in the housing market as our penetration in this segment is very low”. The proposed merger will enable HDFC Bank to bolster its housing loan portfolio. This in turn will inflate the balance sheet of the merged entity enabling it to underwrite large ticket size loans.
For HDFC, the primary gain will be quick and easy access to well-diversified low-cost funding and a huge customer base of HDFC Bank. Following the merger, HDFC will hold 41% of transactions in the bank.
The proposed entity will complete a product suite with HDFC Life, HDFC MF, etc., coming under one roof. This will help the leadership strengthen the distribution and cross-selling of a complete suite of products.
In addition to the merging entities, the Indian economy is expected to benefit from the merger too. According to Parekh, the pressing need for the Indian economy is access to credit. The merged entity will enable a greater flow of credit into priority sectors like agriculture.
Treat to shareholders
Currently, HDFC is the promoter of HDFC Bank with a 21% stake. However, following the merger HDFC bank will own all the subsidiaries and associate companies of HDFC Ltd, eliminating HDFCs shareholding in the bank.
Post-merger, the public shareholders will own 100% of HDFC Bank and existing shareholders of HDFC will own 41% of the bank. A treat to shareholders is, that HDFC shareholders will receive shares in the ratio of 1:1.68. Meaning if you hold 25 shares of HDFC you will receive 42 shares of HDFC Bank.
2nd Largest Company by Market Cap
The merger announcement of the two financial giants pleased the traders and investors. On 5th April, HDFC rose ~14% achieving a market cap of Rs. 5,05,725.10 crore and HDFC Bank jumped ~10% to top the market cap of Rs. 9,16,927.47 crore. The sum of the market capitalization of the twin came to Rs. 14,22,652.57 crore.
If we put this into context, the market cap of the second-largest company TCS was Rs. 13, 73, 882.31 crore. The merged entity has the potential to become the second-largest company by market cap in India. Moreover, if the merger falls in place, HDFC Bank will be the world’s fifth most valued bank and the 63rd most valued company with a combined valuation of $190 Bn.
Headroom for FPIs
Currently, the HDFC Bank is not included in the MSCI index, a gauge for foreign fund managers to compare Indian equities with other emerging market peers. That’s because Foreign Portfolio Investors (FPIs) have less room to raise their stakes in the bank.
Following the mega-merger, the FPI holding in the amalgamated entity would be 66%. This means foreign investors will have additional 10% headroom in the merged entity. A stock requires a 15% stake scope for foreign investors to be part of the MSCI index.
Inclusion in the MSCI index is expected to bring $5 Billion dollars for the counter with over 10% weight. Counter means stock in investing parlance.
Will the merger be a smooth sail?
The simple answer to this is No. Although RBI has issued a host of guidelines to ease the process of acquiring a Banking license for large NBFCs, the merger will not as smooth as expected for HDFC and HDFC Bank.
RBI wants banks to limit ownership stake in insurance companies. HDFC Bank’s acquisition of HDFC will not only boost the bank’s balance sheets but also bring in the insurance business. HDFC Life and HDFC Ergo are among top private players in the life and general insurance players. Analysts say the RBI will not be comfortable with the insurance exposure the bank will get from the deal.
Nonetheless, the bank’s management has asked RBI for clarity on complying with the rules.
Win-win situation for all
While there may be hurdles in the way of the merger, the $40 Billion deal is a win-win situation for all. HDFC which has helped many buy their homes finds a home of its own in the family company.
The bank gets to spread its wings in the housing market. Priority sectors like agriculture in the Indian economy is expected to receive greater credit flow.
The merged entity will emerge as the most profitable finance company in the country. HDFC shareholders will receive additional HDFC Bank shares at no additional cost.
All in all, the merger, once it falls in place will be a win-win situation for each stakeholder involved. However, we will have to wait and watch how things turn out for everyone.
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