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Shriram + IDFC: Is it more than the sum of parts?

Companies and Sectors | Published on Jul 17th 2017 | Comment(s) 0
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A week after the announcement of the two-way merger of IDFC Bank and Shriram Capital, there is still a lot of speculation on the core purpose behind the merger. The clarification by Mr. Ajay Piramal that “the merger was not an attempt to enter banking through the back door” probably summed up the narrative that was going to hog the headlines in the entire deal. Of course, the deal is far from done. There is a 90-days time frame by which the two parties will have to seek necessary approvals and work out the final contours of the merger deal. The approval from the National Company Law Tribunal (this has replaced the court approval) and the Competitive Commission of India (CCI) will also have to be completed. Since Shriram has an insurance business and IDFC is a bank, the deal will also require the approval of the RBI, SEBI and the IRDA. But first, what exactly is the proposed structure of the deal?

How the IDFC – Shriram deal will be structured?

Under the terms of the deal there are two key companies of the Shriram Group which will be involved in the deal. Shriram City Union Finance (SCUF), which is into consumer financing, will merge entirely into IDFC Bank. Therefore SCUF will cease to exist as a distinct listed entity and will also get delisted from the bourses. Shriram Transport, which has a much bigger asset base compared to SCUF, will not be merged into IDFC Bank as that will led to a substantial dilution of capital and impede the long term ability to create wealth. Instead, Shriram Transport will become a 100% subsidiary of IDFC Ltd, the parent holding company. Merging Shriram Transport with IDFC is also ruled out as it would result in diluting the stake of IDFC in IDFC Bank below the RBI prescribed threshold of 40%, which is not statutorily permissible. In fact, the loan book of the Shriram group is larger than the loan book of IDFC and hence a full merger would become a case of the tail wagging the dog.

What are the synergies from the IDFC / Shriram merger?

When we talk of the synergies we come back to the statement made by Mr. Ajay Piramal regarding the entry into banking through the back door. Remember, Piramal group owns a stake in Shriram Capital as well as a direct stake in Shriram Transport and SCUF. For Piramal, it provides an exposure to banking, which would not have been normally possible considering that the RBI is slightly averse to giving banking licenses to large industrial groups to avoid conflict of interest. For Shriram the big synergy will be that it automatically converts its NBFC operation into a banking operation. Shriram was always one of the contenders for a banking license, although the fact that Shriram Chits owning a stake in the banking entity will be a matter of concern for the RBI. The big positive for the Shriram group is that it gives them access to a large institutional balance sheet that can be a major blessing in turbulent times.

From the perspective of IDFC Bank, it gives them access to a readymade market that is predominantly strong in the Southern part of India. Currently, Shriram Transport and SCUF put together can offer a unique active client base of 1 crore customers. That is the kind of straight access for IDFC Bank that will take years to create organically. With banking becoming increasingly technology-driven, the value of an active client gets magnified as the cost of client acquisition and maintenance comes down substantially. The synergies, therefore, exist both ways.

So, will the IDFC – Shriram merger be a smooth affair…?

Not exactly, as there could be some key impediments along the way! Firstly, most of the customers of Shriram Transport and SCUF are essentially small-value customers. Expecting them to contributing to the CASA deposits base of IDFC Bank in a big way would be a tad ambitious. Secondly, there is likely to be a clash of cultures. While IDFC is more of a professional banking culture, the Shriram Group is more of semi-urban culture, considering its client base. As we have seen in the past, this kind of cultural differences can impose a huge cost. Thirdly, IDFC and IDFC Bank put together have a loan book of Rs.60,000 crore while Shriram Transport and SCUF put together has a loan book of Rs.105,000 crore. It needs to be seen if IDFC Bank has the bandwidth to manage this kind of an inorganically larger loan book without faltering on discipline. Additionally, both the IDFC and Shriram groups have NPAs in excess of 7-8% and handling the combined entity will quite a task. Lastly, there could be regulatory hurdles along the way. RBI is likely to be uncomfortable with the Piramal Group holding stakes in IDFC Bank on the strength of its current holdings in the Shriram Group. IRDA is also likely to have objections as both Shriram Life and Shriram General Insurance will now become subsidiaries of IDFC Bank. IRDA will have to be convinced of the strength of the balance sheet of IDFC Bank before approving this structure.

Finally, will the whole be more than the sum of parts?

In the short run there are likely to be both technical and practical hurdles to the merger. Benefits of the merger are likely to be largely back-ended for both the parties to the merger. But more importantly, it could set a template for the merger of two financial powerhouses and could be the trigger for many more to come. But first, the IDFC and Shriram management will have to ensure that the deal sails through the regulatory hurdles. The next 90 days could be critical.

 




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