While the acquisition may look expensive, it will lead to gains in the medium term.
Bank of Rajasthan (BoR) shareholders are literally laughing their way to the bank after news of the proposed take-over by ICICI Bank broke. In two trading sessions, BoR’s stock zoomed 40 per cent. Interestingly, given its current price of Rs 119.40 and the swap ratio of 1:4.72, which gives results of Rs 180-190 in terms of per share value, there is a clear scope for the stock to rise further.
In contrast, ICICI Bank’s stock fell by over seven per cent on Tuesday — a clear reflection that the market perceives the deal to be expensive. At three times its 2009-10 estimated book-value, BoR’s stock looks expensive compared to its more bigger and profitable peers like Axis Bank and YES Bank, which are trading at similar valuations. BoR beats even smaller banks like South Indian Bank, Federal Bank and Karur Vysya Bank, which are trading at lower valuations.
But, a look beyond the valuations suggests the merger is positive for ICICI Bank in many ways.
Deal saves on time, scope
The deal values each of BoR’s 466 branches at Rs 6.5 crore. While it typically costs about Rs 3 crore to set up a new branch and over 12-15 months for a branch to break even, BoR’s acquisition would immediately increase ICICI’s branch tally (about 2,000 prior to the deal) by 23 per cent. It will also save ICICI Bank about two years (if it had to set up a similar number of branches on its own).
Given BoR’s deposit base of Rs 15,000 crore, it would add 7.5 per cent to ICICI’s deposits, while adding around 4.5 per cent to ICICI’s advances. BoR’s asset quality also looks healthy with gross non-performing assets (NPAs) at 2.8 per cent for the nine months to December 2009. Nevertheless, even if these turn out to be higher, it should not make a material difference to ICICI Bank’s balance sheet.
Positively, there is scope for ICICI Bank to improve the operating metrics of BoR in the medium term. BoR, which reported a loss of Rs 45 crore in the December 2009 quarter, has seen its cost-to-income ratio deteriorate from 49 per cent in 2007-08 to over 60 per cent in the December 2009 quarter. If ICICI Bank can improve this ratio to its own level of about 38 per cent and leverage its strengths to drive revenues, BoR’s operations should turn profitable sooner than later.
Secondly, its ability to improve BoR’s low-cost deposit share (Current Accounts-Savings Accounts, or CASA, ratio) from 28 per cent to over 40 per cent (in case of ICICI) will also help improve margins.
The road ahead
Over the past two years, ICICI Bank has curtailed its expenses and shifted focus towards improving loan book quality, which has lowered its net NPAs to 1.87 per cent. It intends to increase its loan book by 15-20 per cent in 2010-11, in contrast to the contraction in the loan book in 2009-10.
A focus on costs and better loan book growth should, hence, help ICICI Bank drive growth and profitability in 2010-11. For now, although the acquisition of BoR at seemingly higher valuations might be an overhang on the stock in the short term, investors with a long-term outlook can consider the stock.
