- July 29, 2022
- Posted by: Ramkumar
- Category: Posts
HDFC Merger With HDFC Bank
The merger between HDFC Bank and HDFC Bank has generated positive sentiments among the investor community. 𝐇𝐨𝐰𝐞𝐯𝐞𝐫, 𝐢 𝐚𝐦 𝐧𝐨𝐭 𝐬𝐮𝐫𝐞 𝐰𝐡𝐨 𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬 𝐟𝐫𝐨𝐦 𝐭𝐡𝐢𝐬 𝐝𝐞𝐚𝐥? 𝐀𝐫𝐞 𝐭𝐡𝐞 𝐛𝐞𝐧𝐞𝐟𝐢𝐜𝐢𝐚𝐫𝐢𝐞𝐬 𝐇𝐃𝐅𝐂 𝐛𝐚𝐧𝐤 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬, 𝐇𝐃𝐅𝐂 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬, 𝐨𝐫 𝐜𝐮𝐬𝐭𝐨𝐦𝐞𝐫𝐬 𝐨𝐟 𝐭𝐡𝐞𝐬𝐞 𝐛𝐚𝐧𝐤𝐬?
In my view, 𝐜𝐮𝐬𝐭𝐨𝐦𝐞𝐫𝐬 𝐨𝐟 𝐇𝐃𝐅𝐂 𝐰𝐢𝐥𝐥 𝐛𝐞 𝐭𝐡𝐞 𝐛𝐞𝐧𝐞𝐟𝐢𝐜𝐢𝐚𝐫𝐢𝐞𝐬, 𝐟𝐨𝐥𝐥𝐨𝐰𝐞𝐝 𝐛𝐲 𝐭𝐡𝐞 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐨𝐟 𝐇𝐃𝐅𝐂. 𝐓𝐡𝐞 𝐇𝐃𝐅𝐂 𝐛𝐚𝐧𝐤 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐰𝐢𝐥𝐥 𝐬𝐞𝐞 𝐭𝐡𝐞𝐢𝐫 𝐫𝐞𝐭𝐮𝐫𝐧𝐬 𝐝𝐢𝐦𝐢𝐧𝐢𝐬𝐡𝐞𝐝 𝐟𝐫𝐨𝐦 𝐭𝐡𝐢𝐬 𝐝𝐞𝐚𝐥.
To substantiate my hypotheses, I valued HDFC to evaluate its value. I prefer the Dividend discount valuation method to value banks as it is simple. It is challenging to differentiate debt for banks as debt is a raw material against financing tool for banking firms. As this is a merger, i used the 𝐞𝐱𝐜𝐞𝐬𝐬 𝐫𝐞𝐭𝐮𝐫𝐧𝐬 𝐯𝐚𝐥𝐮𝐚𝐭𝐢𝐨𝐧 𝐦𝐨𝐝𝐞𝐥 to determine how long HDFC would generate excess returns against its cost of equity.
I assumed the following:
1)With a larger balance sheet and at the current cost of capital due to lower interest rates, I assume that ROE for the next five years for HDFC will rise to 25%
2)Then, the ROE will converge towards its cost of equity at year ten, after which it will generate zero excess returns.
As I arrive at the equity value, i dont worry about cross-holdings.
I arrive at the value/share for 𝐇𝐃𝐅𝐂 = 𝐑𝐬—2,042 𝐚𝐬 𝐨𝐟 𝐭𝐨𝐝𝐚𝐲.
Thus, in my view, even though it is a 𝐬𝐡𝐚𝐫𝐞 𝐬𝐰𝐚𝐩 𝐝𝐞𝐚𝐥 𝐚𝐧𝐝 𝐭𝐡𝐞 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐨𝐟 𝐇𝐃𝐅𝐂 𝐚𝐧𝐝 𝐇𝐃𝐅𝐂 𝐛𝐚𝐧𝐤 𝐬𝐡𝐚𝐫𝐞 𝐭𝐡𝐞 𝐫𝐢𝐬𝐤𝐬, 𝐢 𝐭𝐡𝐢𝐧𝐤 𝐭𝐡𝐞 𝐇𝐃𝐅𝐂 𝐛𝐚𝐧𝐤 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐚𝐬𝐬𝐮𝐦𝐞 𝐚 𝐡𝐢𝐠𝐡𝐞𝐫 𝐫𝐢𝐬𝐤 𝐭𝐡𝐚𝐧 𝐇𝐃𝐅𝐂.
From a business viewpoint, this merger signals the following:
1)Consolidation in Financial services will be a reality with the influx of Fintech firms.
2)As NBFC regulations converge towards banks, HDFC bank needs to raise higher capital for #CRR and #SLR. Thus, if interest rates rise, HDFC bank will struggle to raise money at current borrowing rates, impacting its ROE.
3)Integration issues can derail potential synergies as two banks cater to different customers. Thus, the priority for sales training is essential to cross-sell and upsell effectively; otherwise, customers are at risk of moving to SBI and ICICI.
Thus, in my view, the 𝐛𝐚𝐧𝐤𝐢𝐧𝐠 𝐜𝐮𝐬𝐭𝐨𝐦𝐞𝐫𝐬 𝐚𝐫𝐞 𝐭𝐡𝐞 𝐰𝐢𝐧𝐧𝐞𝐫𝐬 𝐨𝐟 𝐭𝐡𝐢𝐬 𝐝𝐞𝐚𝐥. However, this deal can compress the 𝐨𝐯𝐞𝐫𝐚𝐥𝐥 𝐩𝐫𝐨𝐟𝐢𝐭𝐚𝐛𝐢𝐥𝐢𝐭𝐲 𝐨𝐟 𝐭𝐡𝐞 𝐛𝐚𝐧𝐤𝐢𝐧𝐠 𝐬𝐞𝐜𝐭𝐨𝐫 𝐚𝐬 𝐜𝐮𝐬𝐭𝐨𝐦𝐞𝐫 𝐫𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐛𝐞𝐜𝐨𝐦𝐞𝐬 𝐚 𝐩𝐫𝐢𝐨𝐫𝐢𝐭𝐲 𝐟𝐨𝐫 𝐛𝐚𝐧𝐤𝐬 𝐚𝐭 𝐭𝐡𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞 𝐨𝐟 𝐩𝐫𝐨𝐟𝐢𝐭𝐚𝐛𝐢𝐥𝐢𝐭𝐲.