Bank Of Baroda rating ‘Add’: Merger swap ratio close to initial estimates

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January 8, 2019 12:46 AM

BoB Has made an announcement on the swap ratios (every 1,000 shares of each bank) for the merger with Vijaya Bank (402 shares) and Dena Bank (110 shares).

Customers exit a Bank of Baroda (BOB) branch in Mumbai, India, on Saturday, April 21, 2018. Bank of Baroda is scheduled to announce full year earnings on May 18. Photographer: Dhiraj Singh/Bloomberg

BoB Has made an announcement on the swap ratios (every 1,000 shares of each bank) for the merger with Vijaya Bank (402 shares) and Dena Bank (110 shares). The impact on book value combined would be negligible for BoB but this view is contingent on the timing of the pending capital infusion programme and net worth adjustments that can happen prior to the merger. Focus now shifts to actual integration from financials. Maintain Add with fair value unchanged at Rs 130.

Swap ratio announced for the merger; not too different from initial estimates
The three banks (BoB, Dena and Vijaya Bank) announced the swap ratio which is as follows for the respective shareholders: (i) Dena Bank shareholders would get 110 shares of BoB for 1,000 shares held in the bank (ii) Vijaya Bank would get 402 shares of BoB for every 1,000 shares held in the bank. At last Wednesday’s closing price of BoB, the deal would imply that Dena Bank is being valued at Rs 30 bn (current market cap of Rs 41 bn and FY19 KIE net worth estimates of Rs 44 bn) and Vijaya Bank at Rs 63 bn respectively (current market cap of Rs 67 bn and FY19 KIE net worth estimates of Rs 98 bn).

Net worth at the time of merger could be different as compared to today
There are a few challenges in estimating the book value/share of the combined entity for a few reasons: (i) there is still some more time before the deal can be completed and the government could look to infuse capital to meet the regulatory requirements of Dena Bank (a lesser concern for Vijaya Bank), a significant negative for the shareholders of BoB as the incremental capital is happening at a significant discount to reported book value. (ii) write-down of net worth is a common occurrence to normalise accounting norms across banks. The most common areas of write-down would be in employees (retirement costs) and NPLs/coverage ratio. With the swap ratio now having been announced, it would be useful if the incremental capital infusion happens post-merger rather than pre-merger.

Discussion shifting towards more challenging part of integration of businesses
We continue to wade through this relatively uncharted territory as the integration process now takes shape beyond financials. The merger has surprisingly seen far less resistance from employees than what one would had anticipated, which is positive. However, this could resurface in the next stage. The challenges of integration of IT systems, employee satisfaction, branch rationalisation, client experiences at the time of merger are issues that are hard to model.

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No change in fair value for now; introducing combined financials
We introduce the combined financials (starting from FY20) as there has been significant progress of the deal going through assuming the reported swap ratio. We have made adjustments to the net worth of Dena Bank to incorporate some degree of normalisation of coverage ratio and taking a conservative view on the possible integration costs, especially on retirement costs. Consequently, we have marked down the net worth of Dena Bank by 50% in FY19. Net NPLs of Vijaya Bank are on the lower side and adjustment to net worth is not too high. There is no impact on our book value/share that is meaningful. Consequently, the impact on our fair value is negligible.

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