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HDFC Bank–CBOP merger: Our view - Views on News from Equitymaster
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HDFC Bank–CBOP merger: Our view
Feb 25, 2008

Kick-starting the much awaited consolidation process in the Indian private sector banking space, one of the best private sector banks in the country, HDFC Bank has decided to merge another small but upcoming private sector bank, Centurion Bank of Punjab (CBoP) with itself. This event is on the eve of a fiscal that will mark the compliance of some Indian banks with Basel II and several such consolidations that will signal the preparedness of Indian banks for the RBI’s 2009 roadmap for foreign banks. The union
The union of HDFC Bank and CBoP will make the merged entity the seventh largest banking entity in the country with the largest branch franchise amongst private sector banks. The similarity in the composition of assets of both the banks, with a high proportion of retail assets makes the synergies more attractive.

FY08 HDFC Bank CBoP Merged entity ICICI Bank
Balance sheet size (Rs bn) 1,106 414 1,520 4,233
Advances (Rs bn) 600 260 860 2,540
% of retail assets 65.0% 64.0% 64.7% 64.0%
Deposits (Rs bn) 820 360 1,180 2,950
% of CASA 58.0% 32.0% 50.1% 22.0%
% NIMs 4.5% 4.2%   2.6%
Net NPA / advances (%) 0.3% 1.0% 0.5% 1.1%
Employees (nos.) 25,770 7,500 33,270 39,600
Branches (nos.) 754 394 1,148 979
Adj. BV (FY08) 318 11    
Ratio 1 29    
Source: Equitymaster Research

The positives for HDFC Bank…
The time and cost of setting up branches that HDFC Bank has managed to save with the merger is certainly something that will stand in good stead for the bank in the longer term. With its conservative approach towards growth and the necessity of acquiring size and scale prior to FY09, this is one of the best options that the bank could have opted for. Further, the diversification in asset profile and franchise will be very favourable for the bank in the medium to long term.

…and the negatives
HDFC Bank holds the distinction of having sustained one of the highest proportions of low cost deposits (CASA-current and savings accounts) for several fiscals. The lower proportion of the same in CBoP book will marginally dilute the ratio for the merger entity, albeit temporarily. The same holds true for the net interest margin (NIMs). We see both these concerns getting ironed out in the longer term. What, however, is to be examined is whether HDFC Bank can sustain the best asset quality that it has maintained so far even after the merger. This is notwithstanding the fact that the net NPAs of the merged entity will be less than 1%, thus not being very significant.

What it means for the shareholders?
Considering the swap ratio of 29:1 (i.e., 1 share of HDFC Bank to be issued for every 29 shares of CBoP to the latter’s shareholders), we arrive at a March 2010 target price of Rs 1,597 for the merged entity (HDFC Bank) on applying an adjusted book value multiple of 3.5 times on our FY10 estimated numbers.

  Pre-merger Post-merger with CBoP
  HDFC Bank CBoP HDFC Bank
No. of shares 354 1,872 419
FY10E Adj. Networth* (Rs bn) 155 36 191
Multiple to ABV 3.5 3.0 3.5
FY10E target price (Rs) - - 1,597
Source: Equitymaster Research
* Adjusted networth is arrived at after reducing the net NPAs from the networth
For shareholder of CBoP  
No. of shares in HDFC Bank (nos) 1
Cost of each share of HDFC Bank (Rs)** 1,450
Upside (% CAGR) until March 2010 5.0%
   
For shareholder of HDFC Bank  
Current cost of each share of HDFC Bank (Rs) 1,400
Upside (% CAGR) until March 2010 6.8%
Source: Equitymaster research
**Cost of each share of HDFC Bank for CBOP shareholders is arrived
at by multiplying the current price of each share of CBoP with 29

The target price arrived by us is without factoring in any further dilution in the merged entity and without considering the preferential allotment to be made to HDFC. We shall therefore have to revise the target price on receipt of further details, if necessary. Meanwhile, the merged HDFC Bank stock offers upsides (CAGR) of 5% and 6.8% respectively to CBoP and HDFC Bank shareholders from the current levels.

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