Why the worst may not be over yet for investors of Equitas Holding

Shareholders are vulnerable to deep 'Holding company' discount, risk of further stake dilution and possible moderation in return ratios

One of the risk factors mentioned in the April 2016 dated IPO document of Equitas Holding was of listing its wholly-owned small finance bank (SFB) three years from commencing lending operations. Back then, since the mood was different and there was much euphoria on a new sub-segment being created in banking space, many investors chose to sidestep this risk factor. There was also hope that since SFBs cater to the financial inclusion theme, the Reserve Bank of India (RBI) could probably go soft on listing requirements. Come 2019, these narratives have totally changed.

“Time and again what the RBI has taught investors is that if there is a rule to be followed, it will be followed,” says Abhinesh Vijayaraj of Spark Capital. Few days ago the RBI imposed penalty on Equitas Holding for not listing its SFB within the slated deadline of September 4, 2019. Among others, Equitas SFB cannot open new branches, which analysts at Kotak Institutional Equities say isn’t very detrimental for the business. “As the bank has already slowed branch expansion and has been focusing on improving productivity, we see this development less concerning,” they say. Issues around listing the SFB is the larger overhang and explains why Equitas Holding stock fell by 6.4 per cent on Monday.

While the company awaits approval from Securities Exchange Board of India (SEBI) on a certain scheme of arrangement that has been proposed by Equitas SFB, the possibility of listing shares of the SFB through an IPO also exists. A few weeks back, Ujjivan Financial Services proposed to list its SFB through IPO.

For investors of Equitas Holding and Ujjivan Financial, the risk of listing the SFB is that they not only become vulnerable to a huge ‘holding company’ discount but also face the threat of further stake dilution as the holding companies have to reduce their stake in the SFBs to 40 per cent within five years from start of operations. For Equitas, analysts expect this discount to be 50–80 per cent given that the SFB is its only key subsidiary. The Street typically assigns a discount to the real value of a business, if held indirectly through subsidiaries.

Analysts also point out that as Equitas SFB is well-capitalised (over 22 per cent capital adequacy ratio in March 2019) an IPO to comply with regulatory requirements could be detrimental to shareholder’s return profile.

Therefore, in the coming days, while details on listing Equitas SFB could bring clarity to investors, they may still be stuck with a value depletive investment. Equitas Holding stock trades at nearly 20 per cent discount to its listing price and has corrected 15 per cent since October 25 last year, when the SFB listing issue first surfaced.