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IDBI: Post merger scenario

Jan 22, 2005

A swap ratio of 1.42:1 for the merger of IDBI Bank with IDBI accentuates the synergies of the impending merger in numerical terms. Although the shareholders of IDBI Bank largely stand out to be the true beneficiaries, we reinstate our earlier view that the shareholders of the merged entity will be entitled to better valuations in the coming quarters. Post merger, IDBI will be the fifth largest banking entity in the country, with an asset size of Rs 780 bn and an employee base of over 4,000.

The key drivers
Bailout package: IDBI has been systematically preparing itself for the merger for which it has reduced its non-performing assets by creating a Rs 90 bn ‘Stressed Assets Stabilisation Fund (SASF)'. This bailout package was a `cash neutral assistance' flowing from the Union Government to SASF, and not a cash grant by the government. The package has not yet been fully utilised and will continue to aid the merged entity in purging the NPA legacy of IDBI.

Merger synergy: A scrutiny of the fundamentals of the two merging entities (read IDBI and IDBI Bank), suggests that the merger will be a win-win situation for both the entities. Although given its clean assets and impressive 3QFY05 results (54% YoY jump in bottomline), IDBI bank will offer valuable growth prospects, access to low cost deposits and extended reach will enable the erstwhile FI to seek a better spread on its infrastructure funding. The merged entity will also be rationalizing its manpower size and posting better efficiency ratios in the coming quarters. At present, IDBI has a book value per share (BVPS) of Rs 89, while IDBI Bank has a BVPS of Rs 32. Following is an estimation of the BVPS of the merged entity.

(In millions) IDBI IDBI Bank
No. of shares outstanding 652.8 214.2
Shares held by IDBI in IDBI Bank   120.0
No. of shares to be extinguished   117.0
No. of shares of IDBI Bank to be swapped   97.20
No. of shares added to IDBI (1.42:1) 138.0  
Total shares O/S in IDBI post merger 790.8  
Book value of merged entity 64,173.0  
Book value per share (Rs m) 81.15  

The Damodaran factor: The fact that government will continue to hold 51% stake in the merged entity lends it a PSU bank status and at the same time IDBI Bank's expertise in private banking sector divorces it from all inefficiencies envisioned in a PSU bank. Given Mr. Damodaran's expertise in turning around sick entities (remember UTI), there is a good likelihood that the remnants of the bailout package will also be put to good use. This coupled with his focused supervision of IDBI's growth (Mr. Damodaran having given up his UTI position), is sure to lend the bank strong credentials in the time to come.

Key player in the consolidation story: With the anticipated reforms expected to set the stage for consolidation of the PSU banks, IDBI is ideally positioned to take advantage of the same. Given Mr. Damodaran's view of making IDBI a banking behemoth, strong enough to compete with ICICI and SBI, IDBI is likely to be a key player in the consolidation drive.

What to expect?
At the current price of Rs 72 per share IDBI Bank is trading at a price to book value of 2.25 times while IDBI is trading 1.3 times its book value. Being a private banking entity, IDBI Bank is accorded a price band of 1.5x to 2.25x, while given the arduous task of wiping off bad assets from its books IDBI was given a band of 0.75x to 1.25x.

We expect that given its potential of emerging as one of the most premier banks in the country, thereby giving competitors like SBI and ICICI a run for their money and also taking into account its PSU status, the merged entity should at least be accorded a P/BV band of 1.5x to 2x. At these valuations, we conservatively estimate the price of the merged entity to dwell around Rs 121 per share post merger (at P/BV of 1.5x).

This makes it amply clear that the shareholders of both the entities will be better off not reacting to the market movements in the short term, but should continue to hold their stakes to benefit from the long-term synergies of the merged entity.

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