A none too exciting merger
Corporate chiefs like to flaunt mergers and acquisitions as great triumphs of the imagination. The markets tend to greet mergers with whoops of delight — the share prices of the two companies often rise in response to such announcements.
This flies in the face of the fact that a large number of bank mergers, perhaps the majority, fail to enhance total shareholder value, that is, they do not enhance the aggregate value of the shareholders of both the companies involved. That has not stopped CEOs from trying.
Mergers, like marriage, represent the triumph of hope over experience: Every CEO hopes that he will belong to the minority that succeeds. While touted as great strategic coups, they are, in fact, confessions of failure, the failure to grow on an organic basis. This tells you that a merger makes sense mostly when organic growth cannot deliver adequate returns.
In the proposed merger of the IDFC group with the Shriram Group of companies, there is not even the initial euphoria. The shares of listed entities in both the groups fell in the days following the announcement of discussions on the subject.
IDFC was in the business of financing infrastructure, an area that will remain forbidding for some time. So it set up a banking operation as a subsidiary. It has not made much headway with corporate lending. It tried to focus on financial inclusion with its ‘Bharat Banking’ initiative. For any bank, however, financial inclusion can only be the icing on the cake. The cake is retail and corporate assets.
To acquire that, a bank needs competitive pricing. That comes from having a ratio of current and savings accounts (Casa) to total deposits of at least 30 per cent. IDFC Bank’s Casa is 5.2 per cent of its deposits. It has 74 branches. To raise its Casa, IDFC Bank would need to have at least 500 branches. The CEO of IDFC Bank, Rajiv Lall, has confessed that organic growth is not a realistic option for his bank. But that does not make any merger sensible.
IDFC Bank will merge with Shriram City Union Finance (SCUF), to start with. Shriram Transport Finance Corporation (STFC) will be kept out of the merger initially. IDFC Bank has assets of around ~50,000 crore. SCUF has assets of ~20,000 crore. Even absorbing SCUF will be a challenge.
The challenge is to raise deposits to fund SCUF’s assets. IDFC Bank hopes to cross-sell saving deposits to SCUF’s retail customers. This is not something that is accomplished overnight. To start with, IDFC Bank will have to fund SCUF assets mostly with “bulk deposits”, that is, deposits that are at rates higher than the “card” rates for normal retail deposits.
Bulk deposits are typically corporate surpluses parked with banks for short periods (90 days or so). Over 90 per cent of SCUF’s assets (such as small business loans, two-wheelers and car loans) have a tenure of two to three years. Financing medium-term fixed assets with short-term deposits is fraught with interest rate risk.
What is in it for the Shriram Group shareholders? With its small asset base, SCUF should have no problem growing organically. Its net interest margin (NIM) of 13 per cent and its return on assets of 2.4 per cent would make bankers turn green with envy. Banks are thrilled with a NIM of 4 per cent and a return on assets of 1 per cent. STFC has an asset base of ~80,000 crore. But it too has plenty of potential for organic growth, given is unique focus on used commercial vehicles.
It‘s all too readily assumed that Non-Banking Financial Companies (NBFCs) stand to gain by converting themselves into banks because then they can access low-cost deposits. For well-managed NBFCs that focus on niches that banks are not good at (second hand vehicles, financing against gold), this is simply not true. Their higher cost of funding is more than taken care of by high-yield assets.
As analysts have noted, for the Shriram Group, the merger is motivated more by succession issues. Its founder, R Thiagarajan, felt that none of the professionals in the group had the necessary entrepreneurial flair. So he brought in Ajay Piramal as a strategic investor. Mr Piramal found the business too hot to handle. Now, the two have decided to entrust the business to the IDFC group.
There is a clash of cultures inherent in the merger. This has to do not just with the North South divide. Integrating a banking business with an NBFC business is not easy. The Shriram Group’s businesses are cash-intensive, require the processing of thousands of cheques and relate to a clientele that is vastly different in character from that of IDFC Bank. If the proposed merger goes through, investors in the two groups must keep their fingers crossed.