IIB has announced a swap ratio for merging with Bharat Financials at 0.639x, implying a 10% premium to the current price for BHAFIN. The MFI (micro finance) business is completely different to mainstream banking, but IIB has demonstrated its ability to run successfully an NBFC independently within the bank as well. In our opinion, the SLR/CRR regulatory impact on BHAFIN’s book will be more than netted off by funding costs and PSL benefits on BHAFIN’s book. While the acquisition of an MFI business at +5x FY17 book is not cheap on an absolute basis, the finalised swap ratio will not be dilutive for IIB either on a FY19F EPS or a book basis. We remain positive on IIB and keep our TP of Rs 1,850, implying 3.6x Sep-19F book of Rs 509. Contours of the merger: IIB has fixed the swap ratio for BHAFIN at 0.639x, implying Rs 1,118/share for BHAFIN, an 11% premium to current valuations. IIB signed an exclusivity arrangement with BHAFIN for a possible merger in Sep-17. In the past, Indusind had also been expected to evaluate a merger possibility at similar valuations, but we think with the asset quality cycle behind us for the MFI business the merger at similar valuations makes much more economic sense, given the underlying risks are better identified and managed now. IIB will issue warrants to its promoters to get their stake back to 15% levels: this will lead to 1.8-2% dilution.
MFI business is much more attractive in a bank if managed well: IIB had always been positive on MFI businesses; it has an Rs 29 billion MFI portfolio which it guided to ramp-up to Rs 100 billion in 3-4 years. IIB partnered with ~11 Bcs (business correspondents) and had a ~25% share of MFI loans sourced through BCs. If a merger took place, we calculate MFI loans would be 9-10% of any merged entity’s loan book, vs 3% currently. Merger synergies: In its earnings call, IIB management highlighted the benefits from this merger. (i) IIB thinks the largest benefit is on the funding cost side, where MFI funding costs are 300bps higher than bank funding costs, and a merger would lead to an immediate reduction in costs. (ii) It is also RORWA-accretive, as RWA for MFI book in an MFI is 100%, whereas it is 75% in a bank. The entire MFI portfolio is PSLcompliant; IIB is already fully PSL-compliant, hence this will offer IIB an opportunity to tap into the PSL certificate market where the fee rate is 1.5-2%. (iii) Rural network reach, which would give IIB an opportunity to build a strong liability base. The merged entity will have 3,600+ touch points, with ~1,400 BHAFIN branches, ~1,200 IIB branches and ~1,000 Ashok Leyland branches.