IDFC, Shriram group enter merger talks. What do brokerages say?

Shriram group and IDFC unveiled their intent, on Saturday, to merge the two entities and have entered into an agreement to evaluate the proposal for 90-days. 

As per the proposed plan, IDFC Ltd will be the holding company of the merged entity. Shriram City Union Finance will be merged with IDFC Bank and Shriram Transport Finance will be a fully owned subsidiary of IDFC, which will also own 75% of the life and general insurance arms of Shriram Capital.

Reacting to the development, shares of IDFC and IDFC Bank jumped around 8% and 4% to Rs 64 and Rs 68 levels, respectively in pre-opening trade. On the other hand, Shriram Transport Finance and Shriram City Union Finance rallied 9% and 2.5% respectively to Rs 1,100 and Rs 2,550 levels respectively. By comparison, the Nifty 50 traded flat at 9,665 levels, up 8 points, or 0.1%.

Though the finer details of terms and conditions of the proposed merger haven’t been made public, here’s what leading research houses and brokerages think of the deal:

MACQUARIE

If I am a Shriram Transport Finance shareholder, I will land up getting shares in IDFC Ltd, which will have all other businesses – banking, life, general insurance etc which I don’t want. Plus the structure is inefficient as it would entail a holding company discount. Unless the shareholders of SHTF are compensated in terms of a huge premium, the deal should be opposed by them. As per IDFC management, they have already taken Sanlam – one of the large investors in Shriram Group on board with respect to this merger.

As per the universal banking license guidelines issued, all lending related businesses under the holding company structure should be held in a bank. So we are surprised that IDFC can have IDFC Bank and Shriram Transport separately. IDFC management feels that its doable and they have made necessary consultations with experts and will approach RBI.

It is going to be a very time consuming process as it is a very complex merger. The merger approval process itself could take 12 months and another 2 years for integration. Technology and cultural integration will be a huge challenge. Business could suffer during this period. There could be brand confusion – both the brands will coexist. There could be exits of some important staff members of Shriram group in our view.

JEFFERIES

Proposed merger of IDFC and Shriram group companies, could create a large diversified financial conglomerate. IDFC may get access to Shriram's customer base, but given divergent businesses, limited synergy / cross sell potential, deal rationale for SHTF is limited, in our view. With Shriram Transport likely to be de-listed post deal, swap ratio would have to be favorable for Shriram Transport's shareholders, given SHTF may represent 40% of proforma loan book and 50% of proforma profits.

HSBC

A three-way merger has never been attempted in the Indian financial space, coupled with the size, which would be the largest to date. We see at least three-five years in the integration process along with significant execution risks. Business models of all three entities are quite different so integrating them under one roof would be challenging. While segments and customers are not overlapping, synergies appear almost non-existent; most of Shriram Transport Finance and Shriram City Union Finance customers belong to the economically backward segment. So this will not only make IDFCB’s business more risky, profitability and scaling up will be difficult. 

Apart from the technical difficulties, our analysis shows that a merger would not be value accretive. With significant drag of regulatory ratios on Shriram Transport Finance and Shriram City Union Finance balance sheet, their return on assets (ROA) could decline from ~1.8-2% to ~1%, similar to where IDFC Bank is currently. So, a potential merger is not likely to boost IDFC Bank’s profitability either, in our view.

EDELWEISS RESEARCH

Strategically, the merger is in a right direction given IDFC Bank was struggling with execution and growth and Shriram group, with the current retail asset base of over Rs 1-lakh crore, had long term structural growth concern in absence of stable low cost liability franchise. However, there could be near-term challenges with respect to execution, regulatory approvals, capital allocations, holding company discount etc. that can weigh on stock price performance. We believe IDFC Bank would be relatively better placed while Shriram Group would be in a compromising position. However, a lot would depend on swap ratios finally agreed upon between both the groups.