While Gruh earns a near 30 per cent return on equity (ROE) and was valued at between 14 to 16 times book value, Bandhan earns a ROE of around 20 per cent and was valued between 8 to 10 times book value. Both have good quality of loans.
Gruh has fantastic parentage and a very long history. The nature of business of Gruh carries far lower risk than Bandhan Bank’s business does.
0.6 Shares of Bandhan Bank buys one share of Gruh. The reported book values as at March 31, 2018 were approximately Rs 23 per share for Gruh and Rs 79 per share for Bandhan.
If we go by book value alone, the ratio should have been around 0.3 share of Bandhan for every share of Gruh. If we take in to account the fact that Gruh has an ROE which is one and a half times Bandhan Bank, we could push the swap higher to nearly 0.45 shares of Bandhan for every share of Gruh. The actual ratio is another third higher.
The higher ROE of Gruh is possible because of a parentage that helps gets funds at low cost and keeping a small size helps it to remain focused on its profitability. It is able to find a large enough market with attractive growth, without giving up on profitability, in terms of ROE. Clearly a brilliant business has been built. On the other hand, Bandhan Bank will now see its ROE falling as it keeps increasing its risk profile. It would also have a cost of borrowing higher than what Gruh could enjoy with the support of HDFC association.
Gruh will now become the housing loan portfolio of a commercial bank. Clearly, the shareholders of Gruh will be now shareholders in a less attractive business and will not enjoy the premium valuation that Gruh shares used to enjoy. Gruh shareholders enjoyed a valuation that was clearly out of whack.
Bandhan Bank also enjoys a premium valuation, based on its promoter quality and its track record in the microfinance business. It has some way to go before establishing itself as a commercial bank of quality. Given the promoter background, there is expectation that after Kotak Bank, we have another bank of High Quality. Bandhan Bank promoter has also created a clever ownership structure which ensures that the rewards will go to the employees.
All the staff have been made the shareholders, through a “Trust” structure. I am not sure how it would work and what would be the implications of this. Bandhan Bank also has the issue of a not so well known second line. Gruh was always looked at as an HDFC child and now the challenge for an independent CEO or a business manager will be debated.
Deepak Parekh made a comment about a ‘cultural’ fit. As far as I can see, it seems to be a good marriage and the cultures seem to be well aligned. Staff have no reason to be unhappy. The fact is that two legal entities will become one. Some duplication would have to be culled.
If I were a shareholder in either, I wish I had sold off my positions just before the merger. Not being in the know, many of us have a call to make. Not many of us own both the shares. If I were to be an owner of Gruh, my concerns would be to decide whether to own a specialised well run housing finance bank or a young bank that has the potential to be a great bank. If I was a shareholder in Gruh since a long time, the only thing I was counting was the dividends and the ownership continuing unchanged. Now, there will be more worry points when the combined entity is created.
On a pure qualitative basis, I will perhaps be happy to exit both and buy in to an established one like HDFC Bank or Kotak Bank. For a Bandhan Bank shareholder, there is an immediate gain as a new growth area takes care of size to a great extent. I am not sure that Bandhan Bank will be able to raise resources as easily as Gruh or even at a cost that is comparable.
On the whole, the entity will earn a ROE that is lower than that of Gruh. And possibly will protect the ROE of Bandhan Bank, going forward. It is clear that the Bandhan Bank’s focus is the MSME segment that provides a higher return. Risk management and culture holds the key.
Let me also be clear that I do not have a view on the prices of the shares of the firms I have mentioned. My focus is purely on the quality and some aspects of business, going forward. So please do not take this as a buy/sell on any of the shares mentioned above.
(The writer is a veteran investment advisor. He can be contacted at balakrishnanr@gmail.com)
