IDFC and Shriram group have entered into an agreement to evaluate a potential combination of all businesses in both groups and the proposed structure will lead to:
(i) Shriram City Union Finance (SCUF) being merged with IDFC Bank; and (ii) all financial businesses of Shriram group, including Shriram Transport Finance (STFC), and its insurance businesses being absorbed by IDFC Ltd.
IDFC and Shriram group —contours of a merger
(i) SCUF will be merged with IDFC Bank;
(ii) STFC will remain a standalone NBFC (non-banking financial company) and become a subsidiary of IDFC Ltd; and (iii) Shriram group’s life and general business (76% stake in both businesses) will also become a subsidiary of IDFC Ltd.
As per the proposed structure, there will remain two companies after the merger: (i) IDFC Bank – which will be a combination of the current IDFC Bank and SCUF; and (ii) IDFC Ltd – which will have SHTF (100% subsidiary), Shriram’s life and general business (76% stake) and existing asset management, private/project equity and infrastructure fund businesses of the current IDFC Ltd.
IDFC Bank – SCUF being absorbed in the bank
Strategic: There are limited overlaps between IDFC Bank and SCUF’s businesses and loan book. It does provide the merged entity with a high yielding PSL (priority sector lending) compliant loan book and possibility of reducing cost of funds, but does not take away the challenges of building on the CASA/fee franchise on a large balance sheet now. Leadership/employees/technology challenges will be high.
Regulatory implications: Meets most shareholding requirements but the RBI could have objections with IDFC holding STFC as a standalone NBFC.
Valuations and our view: Assuming current prices, the deal will be 20% book-dilutive and earnings-neutral for IDFC Bank. IDFC Bank will trade at 1.6x FY19F P/B and 15x FY19F EPS. Upsides will depend on the ability to deliver on CASA/fees franchises better than the standalone IDFC Bank.
IDFC Ltd+ – What’s in it for STFC’s investors?
IDFC Ltd will transform from being a holding company of IDFC Bank and businesses such as IDFC group’s AMC/PE business to a larger company. This could possibly mean that holding discount of IDFC Ltd reduces. Shriram employee trust, Piramal group and Sanlam group, who are currently large shareholders of Shriram Capital, could become the largest holders in IDFC Ltd and drive the business in future. STFC’s investors could possibly hold a stake in IDFC Ltd vs. holding a stake in a focused used CV financier. This is a compromise for STFC’s investors and they should be compensated with a higher value through the merger swap ratio, in our view.
SCUF being absorbed in the bank
Constraints: The proposed merger structure envisages merging SCUF into IDFC Bank, while STFC will continue to operate as a separate NBFC. Assuming the merger happens at current prices, IDFC Financial Holding’s stake in IDFC Bank will drop from 52.9% to 30.3% and Shriram Capital will hold a 14.4% stake. Since the whole of Shriram Capital is planned to be absorbed within IDFC Ltd, the combined shareholding of IDFC Financial Holding in IDFC Bank will be 44.7%.
Promoter holding: New bank licensing required the holding company to hold a minimum 40% stake in the bank – with the proposed merger, we don’t see that as an issue as IDFC Financial Holding could hold 44.7% stake in IDFC Bank after merger.
Single shareholding: Single shareholders, apart from the holding company, cannot hold more than 10% stake – apart from the promoters, Piramal group (10% stake) and Apax Partners (+20% stake) have concentrated holding in SCUF. On merger, Piramal group would hold 4.3% stake and Apax Partners would hold 8.7% stake in the bank and, hence, this condition is also not breached.
NBFC within group will be a key regulatory hurdle: Bank licensing agreement has a condition that “no financial services entity held under the holding company can engage in an activity that is permitted by the bank” – given that the merger proposes STFC as a standalone NBFC within IDFC Ltd, there could be a regulatory breach here and could be one of the key constraints in the merger structure. We note that STFC will be held by the promoter (IDFC Ltd) of the holding company (IDFC Financial holding) and not directly by the holding company and this could possibly provide an explanation.