COMMENT: Kotak & Axis - good together or better alone?
Kotak Mahindra Bank, in a recent intimation to the stock exchange, has informed the investors that the bank has received communication from Reserve Bank of India to bring down its promoters shareholding to 30 percent by June 2017, 20 percent by December 2018 and 15 percent by March 2020.
Kotak Mahindra Bank, in a recent intimation to the stock exchange, has informed the investors that the bank has received communication from Reserve Bank of India to bring down its promoters' shareholding to 30 percent by June 2017, 20 percent by December 2018 and 15 percent by March 2020. Promoter shareholding currently stands at 33.6 percent. While this is unlikely to be the driving force for an acquisition, a reduction in stake would be a useful side-effect of any deal.
The Street has been abuzz with rumours of Kotak Mahindra Bank and Axis Bank coming together. The gains in terms of size is obvious: It catapults the entity to the position of Number 3 by size and perhaps only next to the most valuable bank by market capitalisation. If we assume the deal at 15 percent premium to the current market price (3.5X our calculated adjusted book), the stake of Kotak Bank’s promoter will stand reduced to 17.4 percent, killing a second bird with the same stone.
The last big merger in the private sector banking space in 2014 between Kotak Bank and ING had a few very obvious synergistic gains for Kotak Bank – access to geographies where Kotak had relatively less presence (South), ready network and hence reduced time to market, access to ING’s SME business and the modest valuation of the acquisition did justice to the relatively inferior quality of book that was inherited.
The rumoured union now is vastly different. As the exhibit shows, Axis is 2.8X in assets, 2.5x in deposits and has 2.7x loan book. It has enviable pan-India touch points – in terms of branches Axis is 2.4x of Kotak and has 6.7X the number of ATMs. With an enviable CASA (current and savings account) ratio of 48 percent, this is a franchise that anyone would like to own. But in terms of geographical complementarity, it has nothing much to offer to Kotak as both the banks are now pan India players with a similar distribution of branches. Kotak is predominantly in urban areas whereas Axis’ is a bit more entrenched in Tier II & Tier III towns.
The bigger challenge for this entity comes from the asset side. While Kotak's loan book is tilted more towards retail/ SME (72 percent of the book) and exhibits pristine quality, Axis, albeit its steady reorientation towards retail, has a sizeable corporate book (46 percent) which is under stress. The deterioration in asset quality has been a concern for Axis shareholders for a while.
However, for a potential buyer, the bigger risk would emanate from the possible future surprises in the book that is considered ‘standard’ as of now. Theoretically, it is still possible to conduct stricter due diligence of the loan book and take provisioning for the same, and the result of this exercise would be critical in determining the “valuation of the deal” and the relative gains/losses for the shareholders of the two entities.
Our analysis suggests that at the current market price, while Axis prima facie quotes at 2.5X trailing adjusted book (Kotak 3.8x), if we factor in the assets under 5/25, SDR and even a part of the restructured pool, there is a substantial erosion in the reported book.
The wide gap between the two could turn out to be the deal-breaker. At the current price, the valuation works out to 3X our calculated adjusted book, compared to the reported valuation of 2.1X book (similar to the valuation of ING deal).Finally, for any match-making to work, the softer issues are more relevant than the hard numbers. Culturally integrating workforce that is larger than its own is not an easy task for Kotak. In an age where technology, products etc. are key differentiators in the banking business, does size really matter?