IDFC-Shriram merger: What it means for various stakeholders?

How does it benefit IDFC Bank?
Ever since its conversion to a bank, IDFC Bank has been candid in its aspiration to grow the retail book and shed the tag of an infrastructure lender. As of now, only 24% of the assets are retail. The Bank had acquired a small micro finance company Grama Vidiyal Micro Finance in the past. A merger with SCUF, a lender catering to mostly small borrowers in rural and semi-urban areas with products ranging from SME lending, two-wheeler financing, lending against gold and small ticket housing finance should help expanding its retail footprint.

However, the liability picture would worsen as the book size gets bloated with the merger. IDFC Bank’s proportion of deposits to total liabilities is only 18% and the share of CASA (current and savings account) is 5.2%. Inability to build up deposit base matching the asset book will impact margins as SCUF will also have to comply with regulatory requirements (SLR and CRR).

Moreover, IDFC Bank with a legacy of corporate financing professionals and the recent hires from peer private sector banks, is culturally a very different entity compared to the small-ticket southern India focused lender like Shriram City Union. While an integration on paper looks simple, the reality might pinch for several years.

The Piramal angle
Finally, RBI’s stance on the merger is critical for Piramals to own a stake beyond 5% in IDFC Bank. But such a restriction will put a valuation cap on Shriram City Union which wouldn’t go down well with the shareholders.
Incidentally, Piramal Enterprises owns 20% in Shriram Capital and close to 10% in shriram Transport Finance and SCUF. Since Shriram Capital has 33.77% stake in SCUF, Piramal’s overall stake in SCUF stands at 16.7%. As this analysis suggests, the upside for SCUF shareholders is limited.

If the deal takes place at a valuation less than 3.5X FY17 book of SCUF, the shareholders of SCUF stand to lose. For the existing shareholders of IDFC Bank, the short run the upside is contingent on the price paid for merging SCUF. In the long-term, however, once the integration issues and the asset liability mismatch are tackled, it can expect to gradually command a valuation of retail lenders.

In the table below we have assumed the deal to happen at a slight premium to the current market price (3.5X SCUF book, current valuation 3.3X book) of SCUF and the entity to migrate to non-performing asset recognition on a 90-day past due basis from the current 120-day.

For the shareholders of Shriram Transport, with is marquee institutional ownership, de-listing will come about only at a significant premium. Given the relatively large book size, a merger with IDFC Bank is unlikely in the near future unless dictated by the regulator.

Is there any stakeholder who benefits?

Of the four listed entities, while we definitely do not see upside for shareholders of SCUF, Shriram Transport shareholders can still expect some respite from premium on de-listing. For IDFC Bank, short-term gains are contingent on valuation paid to merge SCUF whereas long-term gains can only accrue if the myriad integration challenges are overcome within a reasonable period.

For IDFC Ltd shareholders it is a clear big play in the holding company umbrella (despite the valuation discount that comes with it). The non-financing businesses of Shriram Capital are likely to come under the holding company IDFC Ltd.

While Shriram Life with 0.5% market share and Shriram General with 1.44% market share are relatively smaller entities in the respective businesses, it will nevertheless create a conglomerate with presence across the entire spectrum of financial services. IDFC has been an underperformer and as our analysis suggests, there is still a lot of value if the wheel is steered in the right direction.

While lot more details will emerge in the coming three-months, Shriram group’s shareholders should brace for turbulence as Piramals enter banking through a complex merger with IDFC.