The ordeal of ITC Classic Finance is finally over. Industrial Credit and Investment Corporation of India (ICICI) has announced plans to amalgamate the beleaguered Calcutta-based finance company. Many suitors had come come a-calling before, but none returned after conducting the customary due diligence exercises on the books of ITC Classic.
ICICI should have pretty strong reasons for taking the plunge. Public opinion is biased against ITC Classic for largely subjective reasons. Firstly, its spectacular losses. For the year ended March 31, 1997, ITC Classic reported a net loss of Rs 284.99 crore, thereby wiping out its net worth. Secondly, the 18-month delay in finding a willing buyer for the company has also gone to reinforce the doubt in the public mind that the companys financials still hide more than they reveal. As per the latest financials, ITC Classic provided a total of Rs 181.59 crore towards provisions and write offs. Of this, Rs 60 crore went towards bad debts; depreciation in value of investments in subsidiaries claimed another Rs 82 crore; and Rs 39.74 crore was applied towards fall in market value of other investments. While the latter two are justified on account of depressed markets, what is however cause for concern is the absolute value of non-performing assets (NPAs). Estimates range between Rs 350-Rs 400 crore. Though ITC
Classic has said that it has provided for more than what RBI regulations require, the absolute value of NPAs is an open question.
Unless ICICI can satisfy the markets that the deal means well for its shareholders, the stock could come in for severe hammering. The price of acquisition the share swap ratio will be decided on December 1.
However, analysts are circumspect about ICICIs possible motives. No doubt, the deal marks ICICIs retail thrust into the eastern sector which has been virgin territory. Thanks to the collapse of Prudential Capital and the run on deposits of ITC Classic in the recent past, vast tracts of money are waiting to be tapped. ICICI has said that the deal gives them access to a retail depositor base of some 7 lakh, 10 branches and 12 franchisees. Six of the branches are in areas where ICICI did not have a presence earlier; so also, 11 of the 12 franchisees bring in new territory for ICICI. So far, so good. But in the ultimate analysis, what ICICI is taking over is a mailing list of depositors.
The point about 12 franchisees seems to be rather stretched because it could have been possible to buy them out individually, perhaps with much lesser payout. ICICI has recently set up its own non banking finance company (NBFC), I-Credit the idea being that the costs of developing the retail depositor network would be borne by the NBFC, especially because NBFCs have much greater freedom in paying commissions and in pricing the deposits than the parent company would have had. Agreed that tapping the retail market has been high on the ICICIs agenda, the issue then is of timing. Given that raising retail deposits is not going to be much of a problem in the next two years, I-Credit had that much lead time in building a retail network from scratch.
It is also difficult to agree to the official ICICI line that servicing a retail depositor base necessarily means having a physical presence in the area. Indeed, ICICI has been a strong votary of technology driven client servicing systems. And in any case, ICICI is handling its own equity investor base through centralised servicing systems. The point about being close to the retail depositor seems to be misplaced; it is open to question whether retail deposits could still end out to be cheaper than wholesale deposits if the establishment costs of all these servicing units are taken into consideration.
What is also important is that ICICIs requirement of funds is not expected to be more than Rs 15,000 crore in the next couple of years; the retail component at the moment is small but at most it can be expected to expand to 50 per cent in two years time. Whether this should merit ICICIs immediate heavy retail thrust is again a question of policy.
As of March 31, 1997, ITC Classic had retail borrowings of Rs 664.05 crore. This is after the company paid off early redemptions of Rs 107 crore. It has promised redemption of another Rs 70 crore in the current financial year. One issue that must be considered is whether ICICI stands to add to this stock of deposits after the amalgamation or whether the redemption pressures will revive, not that the company is in a position to meet these demands. Assuming for arguments sake that ICICI is left with Rs 500 crore after all the early redemption pressures have been met, does the economics of the merger still look good? Does buying out a company for the promise of Rs 500 crore of deposits make sense?
The answer to that lies in the price of acquisition. From the details available at the moment, ICICI has got a good deal. For one, ITC the 49 per cent shareholder in ITC Classic is putting in almost Rs 600 crore to clean up the ITC Classic balance sheet. Of this, Rs 350 crore is by way of 20-year preference shares, which are at almost zero cost to ICICI. But what is more important is that ITC will pay for the disengagement of ITC Classics subsidiaries ITC Classic Home Finance, Classic Credit, and Classic Share and Stock Broking Services. Though ICICI sources say that ITC may either purchase these assets outright or arrange for their disengagement, the fact of the matter is that a sum of almost Rs 250 crore will come into ITC Classics books (and thereby into ICICIs books).
Assuming that out of the officially acknowledged NPAs of Rs 360 crore as of March 1997 of which Rs 60 crore has already been provided for the entire amount is a dead loss, ICICI still is realising Rs 250 crore in cash on other assets. Seen that way, ICICI is buying out a squeaky clean company.
ICICI sources suggest that they have had a long and close business association with the companies which figure on ITC Classics NPA list. We have done a company-by-company valuation of the assets, a top ICICI official said, suggesting that the problem with NPAs may not be as acute as made out in the numbers. It, of course, goes without saying that ICICI is in a better position to realise sticky assets from errant clients than perhaps any ordinary corporate or multinational NBFC could have.
But the cream of the deal, analysts with brokerage houses said, was in the tax break that would accrue to ICICI as a result of the merger. One analyst, on condition of anonymity, said ICICI has been almost paranoid about tax payments and is seeking to minimise outflows. For the year ended March 1997, ICICI paid out a tax of Rs 104 crore on profit before tax of Rs 857 crore: that is only a 11.5 per cent tax payout.
This year, ICICI has had strong profits. Profit before tax surged 54 per cent in the first half of the current year to Rs 622 crore from Rs 405 crore in the corresponding period last year. Of this, Rs 84 crore came out of capital gains on the sale of its stake in ICICI Bank (which went public recently). It could use a tax break, analysts say, noting that the accumulated losses of ITC Classic present a ready made opportunity. One analyst has ventured that the tax break could be as much as Rs 90 crore, in which case, he says, ICICI has acquired ITC Classic for free.
Indeed, he says, that explains why ICICI did not merge Classic with its own finance company, I-Credit, but opted for the parent company. Further, ICICI may have some deferred tax liability coming up which has not been disclosed. The merger makes no sense except in this light, the analyst argues.
ICICI is getting a reasonably clean company but with suspect long term benefits. But as another analyst put it: ICICI may even make a killing on the deal...As an investment decision, return to shareholders may compensate for the equity dilution. But whether ICICI has latched itself onto a good business policy (of merging companies) remains suspect.No doubt, the deal marks ICICIs retail thrust into the eastern sector which has been virgin territory till now. But in the ultimate analysis, what ICICI is taking over is a mailing list of depositors.
