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Institutional EYE

Commentary on Corporate Governance Issues

IDFC Bank finds itself a new suitor

IDFC Bank rested its survival on obtaining a bank licence. Having gotten one, it failed to capitalize on its this and for the past two quarters has scrambled for a fix.

Six months ago, the Shriram group was the placebo, now its Capital First Limited (Capital First). The haste with which IDFC Bank has changed partners, begs the question whether IDFC Banks’ and IDFC’s board have understood the contours of what has been proposed, and asked the managements the right questions.

1. IDFC had a board meeting on 12 January in which this transaction was discussed. Given that this is a material subsidiary, why were the stock-exchanges not informed?

2. I banking license requires IDFC to hold 40% equity in IDFC Bank. The proposed exchange ratio will result in IDFC’s holding in IDFC Bank dropping below 40% to 36.2% (and not 37.6% as has been mentioned, as explained below).

a. Is it correct for IDFC’s board to second guess the regulator and assume that they will get permission to dilute below 40%? Uday Kotak’s experience is that RBI draws a red line which cannot be crossed.

b.The board has assumed that this is what its shareholders want: The Shriram experience suggests this is not so. Could this be why IDFC Limited is not a part of this equation? Will it ask its shareholders to vote on this? It should.

3. If IDFC is diluted below 40%, and then needs to top-up its shareholding, will it do so before or after the merger? In either case, it will be in breach of RBI’s licensing conditions, unless they are able to get a waiver – in which case, Kotak should expect the same.

  • At the exchange ratio announced, IDFC will have to spend ~ Rs 7.67 bn to take its shareholding to 40%.

  • If you factor in ESOPs to V Vaidyanathan, IDFC will have to spend ~ Rs 10.78 bn (including 7.5 mn options outstanding on 31 March 2017 and 1.5 mn options proposed to be granted under CMD Stock option scheme-2017); and

  • if you factor in all stock options (exercisable options on 31 March 2017 and fresh options under ESOS-2017 and CMD stock option scheme-2017, IDFC will need to spend Rs 12.19 bn.

a. Does IDFC have this surplus cash? Is this the best use of borrowed funds? Will the President of India – and other shareholders not prefer to receive this as dividend?

b. The above assumes that the share price will be at current levels. Should it run-up knowing that IDFC has to buy equity on the market to reach 40%, pain will be more.

4. Is this the right time to do a merger? IDFC Banks shares trade at 1.5 times its book value (on 30 September 2017) while Capital First at 3.4 times. Any merger will be detrimental to the interest of IDFC/ IDFC Banks’ shareholders.

5. IDFC Bank shares trade at the lowest Price to book of any ‘new private sector bank’ .This was an obvious first place for the board to start asking questions.

6. Based on the exchange ratio and market price, IDFC Bank is ‘acquiring’ an entity with Rs 24.2 bn. of net worth (on 30 September 2017) for Rs 93.11 bn. Is the Rs. 68.91 bn. premium or the acquisition price justified? Put this another way, IDFC Bank is paying Rs 93.11 bn to acquire assets of Rs 229.74 bn Acquiring a CEO to steer the ship should never be so expensive.

7. The deal economics are expected to kick in after 36 months. A lot can happen in between. The best option was to build the business brick-by-brick. The market provides - and always has, opportunities for those who are well positioned. Bandhan Bank which was licensed at the time of IDFC bank and RBL Bank which saw a new management team move in a bit earlier, both have succeeded ( - see Exhibit 2 and 3: IDFC Bank vs Bandhan Bank Vs RBL Bank).

8. Rajiv Lall spoke of paying a 12.6% premium to acquire the shares of Capital First. But the CEO of Capital First will now be the CEO of IDFC Bank, and Rajiv Lall moves-up to Chair. Make no bones, IDFC Bank has been acquired. Th question is why pay a premium to get acquired?

9. IDFC’s holding in IDFC Bank will fall to 40% (- maybe even lower). Will it allow IDFC Bank to use the IDFC brand given that it is no longer a subsidiary? If so, will it like HDFC charge the bank a royalty fees? This should surely be on the table.

10.Since the bank will no longer be a subsidiary, it’s governance framework and structure will now need an overhaul. Some clarity on this was needed.

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