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ICICI-BoR deal fuels hopes of more M&As
May, 20th 2010

The proposed merger of Bank of Rajasthan (BoR) with ICICI Bank has triggered hopes of mergers and acquisitions slowly gaining pace in the banking segment, prompting investors to take a positive view on mid-cap banking stocks even in a choppy market.

Shares of select banks like South Indian Bank, Federal Bank, City Union Bank and DCB outperformed the broader market on Wednesday, gaining between 0.6% and 4.6% against a 2.8% fall in the Sensex.

According to analysts, BoRs valuation, taking into account the price offered by ICICI, was at a significant premium to the current market price. This could have acted as a trigger for the movement in other stocks.

However, analysts say that investors should not base their decision purely on the merger play but should rather look at specific stocks, particularly those trading at attractive valuations.

Vaibhav Agrawal, V-P-research, banking, Angel Broking, says that the BoR deal sets a very high benchmark valuation for other smaller private banks. However, it would not be advisable to invest in these stocks only based on the M&A theme due to the substantial uncertainties involved.

Harendra Kumar, head, institutional equities & global research at Elara Capital, says, We do not see this valuation to be secular ascribed to other mid-sized banks. Mergers are typically driven by strategic objectives and hence would be wrong benchmarks to be used across-the-board.

They should trade on the fundamentals of their business and at a discount to large private and public sector banks. Most stocks in terms of valuation are closer to fair value.

The price commanded by Bank of Rajasthan was certainly higher than most of the other banks. Stocks such as South Indian Bank, Federal Bank and Karnataka Bank are expected to outperform the markets. However, every deal may not be able to get these kind of valuations due to scattered shareholding in case of other banks unlike BoR, says Ajay Parmar, head, institutional equities, Emkay Global Financial Services.

Some stocks such as Federal Bank and South Indian Bank look quite attractive based on their current fundamentals, says Mr Agrawal. Both are trading at very cheap valuations of less than one times their adjusted book values, as compared to five times of book value at which Bank of Rajasthan has been valued. The M&A possibility can be seen as an added potential catalyst in some stocks, rather than the only positive. Even on fundamentals, such as the substantial low-cost NRI deposits that these banks have, profitable operations among others these banks look attractive.

Apart from listed old generation private sector banks, there are few unlisted banks such as Catholic Syrian Bank, Tamilnad Mercantile Bank and Ratnakar Bank which are also viewed as potential acquisition candidates. Analysts, however, say that the acquisition of these banks is not easy as there is likely to be resistance from stake holders including majority shareholders and employees.

They also said there could be uncertainty in the recent deal till the time the special audit is complete. On most metrics on the liability side, the valuation seems sensible. But, given that the authenticity of Bank of Rajasthans reported numbers are not certain until the special audit is complete, risks remain, says a note from Execution Noble.

Mr Kumar adds that consolidation in banks is never easy given cultural, technological and asset quality differences. It will be premature to herald a consolidation at this moment. Depending on the portfolio strategy, one can take tactical positions in smaller banks.

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