Investors will be better off with Bharat Fin than IndusInd Bank

The recent market correction has made IndusInd Bank attractive. But investors in Bharat Financial Inclusion stand to gain more than their IndusInd counterparts from the merger of the two, at the current prices.

As per the merger agreement — both are scheduled to unite in the next three months — BFI investors would get 639 shares of the bank for every 1,000 shares held. But their current share price factors in only 619 shares, thus offering a chance to gain 20 more shares or 3 per cent more. So investors keen on buying IndusInd Bank shares would be better off buying BFI shares instead.

The 3 per cent gap between the announced swap ratio and the current price ratio also offers a good arbitrage opportunity. As per calculations (assuming 12 per cent interest cost on margin and 0.05 per cent rollover cost — brokerage + transaction tax), traders can make money if the merger happens within three months. Profits may vary depending on the interest costs on the margins and the timing of the merger (the earlier the better).

However, the risk is the delay in the merger, which could result in higher costs, mainly the interest cost on the margin money and transaction costs due to more rollovers required in the futures positions. A merger after three months will not result in any meaningful gain for those seeking to benefit from the difference.

Merger synergies
There will be some immediate synergies while some will be realized over the medium term. Immediate synergies include lower cost of funds (around 3 per cent less) for BFI after the merger. According to analysts, about 60 per cent of BFI’s loan portfolio of Rs 10,570 crore can be sold to other banks to earn a fee. Further, BFI, being a pure microfinance company had to maintain cash on its balance sheet (12.7 per cent of total assets). After the merger, this can be brought down and additional leverage can be created on BFI’s equity, thus boosting margins and return on equity.

In the medium term, the merger will help IndusInd expand its rural distribution, while allowing cross-selling and liability collections. Some microfinance customers would be worthy of relationship banking. Over the next two years, analysts expect retail assets to exceed 60 per cent of IndusInd Bank’s total asset under management (AUM). Currently, it is 50 per cent.

IndusInd and peers
IndusInd has the highest growth and lowest NPA in the industry. In the June quarter, its gross NPA fell to 1.15 per cent and net profit growth was at 27 per cent.

HDFC Bank’s gross NPA for that quarter was 1.33 per cent, net profit growth at 18 per cent. For Kotak Mahindra Bank, it was 2.17 per cent gross NPA and 12 per cent net profit growth.

Despite better numbers, on the valuation front, IndusInd remains cheaper. Its shares are trading at price to book multiple of 4.2 as compared to 4.8 in case of HDFC Bank and 4.3 in case of Kotak Mahindra Bank.