Ujjivan Small Finance: 18% guaranteed return, but no takers. Why?

On Tuesday, UFS shares closed at Rs 581 and USFB at Rs 59. Considering the merger ratio of 1:11.6, either UFS should be at Rs 684 or USFB at Rs 50.

The term Ujjivan means revival and both Ujjivan Small Finance Bank (USFB) and Ujjivan Financial Services (UFS) appear to be living up to their name. The stocks have risen close to 2.5 times since March this year, ahead of the impending merger of the two companies. Under the swap ratio announced in October last year, a shareholder in UFS will get 11.6 shares of USFB.

Till the first week of September, the share prices moved in tandem, factoring in the eventual merger. But over the last one month, UFS shares have been rising at a much faster rate. So much so that there has been a gap of between 15-18 percent. On Tuesday, UFS shares closed at Rs 581 and USFB at Rs 59. Considering the merger ratio of 1:11.6, either UFS should be at Rs 684 or USFB at Rs 50.

Simply put, investors holding shares of UFS stand to make an easy 18 percent once the merger goes through, or so it seems. This is puzzling to traders who have been buying UFS to benefit from the arbitrage. The anomaly is there for all to see and ideally, the gap should have immediately closed. But it remains. That means some smart players are giving the opportunity a pass. One of the reasons could be a concern that the merger process may take longer to go through than expected. Remember, the merger cleared the ratio announced in October last year, and the EGM for shareholder approval is still another month away. If the delay is the worry, then the 18 percent may not seem attractive, as traders can deploy their money elsewhere for a better return.

Secondly, much depends on how the market perceives USFB's valuation in the months ahead, considering that it will be the surviving entity post-merger.

At Tuesday’s closing price, USFB is valued nearly three times the trailing 12-month book value, higher than IDFC First Bank which is quoting at less than 2.5 times the book, and way above Karur Vysya Bank which is quoting at less than two times the book.

Related stories

Santosh Nair

Executive Editor, Special Projects|Moneycontrol

• 
  Spotting the next Bajaj Fin and Chola in NBFC space, according to Green Edge’s Haria
• 
  Investors over-bullish on PFC, REC; risk-reward not impressive: Green Edge’s Digant Haria
• 
  With politics out of the way, it is now back to basics for the stock market

Can USFB continue to further re-rate from these levels till the record date?

There has been a significant improvement in the asset quality and profits, but the market has already rewarded the stock for it. Should the outlook for the banking sector sour, USFB shares will most likely take a knock given the steep run-up of late. And if that happens, UFS shares will correct lockstep.

Clarification: The merger will not result in any meaningful dilution because the holding company’s –UFS’s stake—in USFB will get cancelled in the new structure. The previous version of the copy mentioned that there will be a 65 percent version dilution, because of a wrong calculation. We apologise for the error.