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Brilliant Move

Murali Iyer

In a recent ad for TimesBank, the question was raised: "How could you be at two places at the same time?" And the answer to the conundrum was: "Clone yourself, or come to TimesBank!"

Reflecting on the events of the past week, one can confidently say that more customers are going to throng TimesBank in future, though in a different avatar. But the fact remains that the management understood that the bank itself was a clone of HDFC Bank under various parameters. And the result has been a merger of these two well-known, new, private-sector banks. This merger has created a behemoth within the banking industry and the leader -- State Bank of India (SBI) -- will now have to constantly keep looking over its shoulders to see the progress being made by this newly merged entity.

Genesis

At the beginning of the current calendar year, the Jains of Bennett, Coleman & Co. Ltd. -- promoters of TimesBank -- had started to look out for suitors and were seriously considering exiting the banking business. Though HDFC Bank and ICICI Bank had evinced an interest then, nothing concrete emerged from the discussions, for the correct valuation of the yet unlisted TimesBank was not available. Once the IPO got over in July 1999, the market price became a benchmark for valuing the business. And this time around, HDFC Bank came better prepared.

Assisted by IndOcean Chase Capital Advisors -- a strategic investor in HDFC Bank -- the merger became a reality in late November. In the final analysis, HDFC Bank's shareholding will undergo a metamorphosis as can be seen from the following pie charts:

The Deal

As per the merger proposal announced last week, shareholders of TimesBank will get one share of HDFC Bank for every 5.75 shares held by them. The merger deal is a brilliant move by HDFC Bank and significantly enhances the underlying value in the stock. The stock swap ration in itself is beneficial to minority shareholders. The preferential allotment of shares being done to HDFC and IndOcean Chase (at the then market price of Rs 94 to maintain their holdings in the merged company at existing levels) will add substantially to the earnings and book value, relative to the increase in equity.

In one swift operation, HDFC Bank has managed to increase its lead (by market capitalisation) over other banks and close in on SBI. The merged bank will become the second largest in India by market capitalisation. HDFC Bank had been looking for growth and this deal fitted in like a glove. Both banks are essentially technology driven, with great emphasis on service orientation. More importantly, both have a strong retail franchise and customer base.

Size-wise, HDFC Bank has nearly doubled, with no impact on capital adequacy -- which will actually improve dramatically after the fresh pumping-in of equity. TimesBank's focus was on the middle-market companies and a strong presence in the retail segment. On the other hand, HDFC Bank's focus has remained on the top 200 blue-chip corporates. But it has more products to sell and is already hawking HDFC's housing loan schemes, debit cards, etc. The merger will now help it cross-sell its product offerings over a wider client base. Avenues for cost rationalisation on promotional spends (as the TimesBank brand will be killed for all practical purposes) and technology investments will also open up once the merger goes through.

Profile

TimesBank is a typical new-generation, private-sector bank operating through three divisions -- Corporate Banking, Retail Banking and Treasury. At the end of March 1999, it had a network of 35 branches and an asset base of Rs 32.745 billion. It also had 200,000 customers (in terms of retail banking and demat accounts) and an employee strength of 592.

By merging TimesBank with it, HDFC Bank will be taking its branch strength to 92 and adding the customer base to its existing base of 450,000 (assuming that there are no accounts that overlap). Organic growth couldn't have taken HDFC Bank to the position it has reached overnight through inorganic growth. Thus, branch rationalisation is not visualised. Even employee rationalisation is not expected to come about, except in the higher echelons of the bank, as further organic growth would absorb all employees. The bank management is also not ruling out further acquisitions, and well-trained employees will be definite assets in such times.

Financials

As mentioned earlier, HDFC Bank has nearly doubled in size overnight with this acquisition. This should see its Tier-I capital adequacy improve from the additional funds being pumped in via the preferential allotment to HDFC and IndOcean Chase. Tier-I capital adequacy is likely to go up from an estimated 7.2% for March 2000 to 9.3%, post-merger and allotment. This should be reason enough for HDFC Bank to postpone its decision to tap the capital markets for additional funds. The network enhancement will also enable a higher exposure to its top rung clients, and help it sell its retail products.

	Times Bank			HDFC Bank			Merged entity
	1997-98	1998-99	Var (%)	1997-98	1998-99	Var (%)	1998-99
Net Interest Income	367	544	48.2	1033	1469	42.2	2013
Other Income	454	406	-10.6	620	681	9.8	1087
Operating Income	387	385	-0.5	1026	1262	23	1647
Net Profit	248	280	12.9	632	824	30.4	1104
Equity	1000	1350*	35	2000	2000	0	2235
Net Worth	1437	1708	18.9	2851	3389	18.9	6212
Deposits	22144	30112	36	21917	29151	33	59263
Advances	10589	13120	23.9	8420	14006	66.3	27125
Total Assets	24308	32745	34.7	28300	43500	53.7	76244
All figures in Rs. Crores * Fully-diluted equity post July 1999 IPO
Branches	30	35		37	57		92
Employees	545	592		827	660		1252
Capital Adequacy	11.3	12		13.9	11.9		11.9
Net Interest Margin (%)	2	2		5.1	4.6		3.5
Net NPA Level	1.2	2.4		1.2	0.7		1.4
RoE	18.8	17.8		23.9	26.4		22.2
RoA	1.3	1		2.7	2.3		1.7

Based on the balance-sheet sizes of both banks as of September 1999 (six months ended), the deposit base of the merged entity is expected to grow from Rs 39 billion to Rs 69 billion, while the asset base is expected to move to Rs 90 billion. Post-merger and allotment, employees of the company are expected to be given ESOPs worth Rs 100 million. All this will see the equity move up to Rs 2.53 billion. A financial profile of the merged entity has been provided below for details.

Benefits

The leveraging potential of the retail banking side is the key driver for the merger, whereby HDFC Bank would be able to cross-sell its portfolio of products (auto loans, demat accounts, niche services, debit cards, housing loans, personal loans, et al) to a wider range of customers. HDFC Bank stands to benefit greatly, since, with its stock acting as the acquisition currency, it has got tremendous value out of the deal. It has managed to grow and gained tremendous market share by buying a bank that does not carry too much baggage. While there are no apparent cost benefits, as is normally expected out of an M&A transaction, the leveraging potential on the retail asset size is tremendous.

The integration of systems and technology should lead to savings on the operational and administrative fronts. On asset size, the quality (the net NPA level of Times Bank is 2.4% on customer assets as compared with HDFC Bank's 0.7% for the year ended March 1999) though relatively poor, does not compare too badly with peers. There would be some rationalisation of the asset portfolio and one-time provisioning to clean up the accounts. Once the businesses are integrated, spreads should improve due to the availability of TimesBank's asset base and HDFC Bank's low funding costs. And so should earnings potential from the non-fund business front. This should drive valuations upwards.

Branch and employee rationalisation will be nil or kept to the bare minimum. The merger should see HDFC Bank gaining a presence in seven or eight more cities. As mentioned earlier, the increased retail base will provide a ready market for its capital market products and a leveraging upside for its increasingly aggressive foray into various consumer products. This would have taken months to build up otherwise. TimesBank's operating cost ratios are comparable to those of HDFC Bank. Additionally, the merger will provide opportunities to rationalise costs on promotional spends, additionally technology investments and other administrative heads. In short, the HDFC Bank management seems to be well poised to gain higher profitability from the incremental assets. Financially, earnings and book value (even on an adjusted basis) will increase significantly, relative to the equity dilution. Additionally, the inherent business model, with the strong focus on capital markets, will enable HDFC Bank to lower the average cost of funds, which is more than 150 basis points higher for Times Bank.

Stock Trends

The merger ratio of 1:5.75 has been apparently, and rightly so, weighted in favour of the stock valuations accorded to both banks on the stock markets. HDFC Bank's premium valuations (on traditional parameters) are justified by its unique business model, management track record, superior earnings quality, and profitability. In this context, the ratio is fair to TimesBank shareholders, since it has enabled an unlocking of value in the stock. The HDFC Group and IndOcean Chase retain the first right of refusal in case of Bennett, Coleman & Co want to sell off their stake in the merged entity. This would ensure that the price remains stable.

Predictably, the stock market has given a big thumbs-up to HDFC Bank on the merger. Its stock has shot through the roof from Rs 94 on the day of the announcement of the merger to above Rs 150. Initially, both scrips were expected to move in tandem to the stock swap ratio. But with TimesBank's scrip lagging behind in this stock derby, it seems to be a very good bet for investment. Technically too, the TimesBank scrip looks good to follow in the footsteps of big brother HDFC Bank. Though there is not much to glean from the chart as it has got listed only recently, the general movement and the sharp upswing in HDFC Bank's price should be a good indicator for things to come.

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