Points, counterpoints of the mega $65 bn HDFC-HDFC Bank merger

HDFC Bank and HDFC Ltd, two of the three biggest Indian publicly listed financial services companies—announced a one-of-its-kind mega merger worth over $65 billion on Monday that would result in the creation of a banking major with a market cap of around $160 billion.

The deal, by far the biggest-ever corporate M&A activity in the country, would see the merger of HDFC, the top mortgage lender in the country, with HDFC Bank, the second-biggest bank by assets.

Shareholders of HDFC will get 42 shares of HDFC Bank for every 25 shares they own in HDFC. At the same time, the 25.8% stake held by HDFC in HDFC Bank will get extinguished.

SBI ETF Nifty will be the single-largest shareholder of the combined firm with around 3.6% holding. It will be closely followed by IPO-bound state-owned life insurer LIC with a 3% stake.

Points

The proposed deal, which would await regulatory nod from multiple bodies, would lead to a natural fit between associated group firms.

The biggest gain is being seen for shareholders of HDFC, who would be free of the holding company discount. The stake held by HDFC in HDFC Bank itself is worth Rs 2.3 trillion, or roughly half its existing market value.

The stock markets tend to discount the value of the stake in other subsidiaries and associates.

Indeed, one can still arbitrage in the market. There is a valuation gap of around 3% between the intrinsic value of the HDFC stock as per the amalgamation plan and the share price of HDFC Bank. In simple terms, if you buy 25 shares of HDFC now, you would be sitting on an upside to the value of 42 shares of HDFC Bank. Then again, this is a dynamic value and could change every second, so do keep track of the swap ratio before choosing to punt on it.

At the same time, the larger balance sheet size of the combined firm would give additional heft to HDFC Bank.

The deal will also lead to cost synergies of running operations.

Counterpoints

A merger of this magnitude would lead to allocation and exposure calls for institutional fund managers. Since many of them might be investors in both the firms, they may need to retune their holding to restrict exposure in HDFC Bank eventually. In other words, they may have to sell some HDFC Bank shares.

Given that HDFC has lower profit margins, the merger would bring down overall margins of HDFC Bank after the merger. The onus would be on the company to drive synergies and product push to make up for that.