HDFC Bank Update: HDFC Bank and CBoP To Merge

HDFC Bank and CBOP Merger: Long-term Positive For Both, Current Price Of CBOP Reflects Takeover Premium

HDFC Bank and CBOP boards have given an in-principle approval for merger between the two banks. The merger between the two banks would be long-term positive for both the banks. At current market price, merger appears to be more beneficial to CBOP’s shareholders than HDFC Bank.

HDFC Bank and CBOP boards met on Saturday, 23 February 2008, and have given an inprinciple approval for a merger between the two banks. We believe a merger between the two banks would be long-term positive for both the banks. At current price (Rs. 56 for CBOP and Rs. 1,475 for HDFC Bank), the merger would be more in favour of CBOP’s shareholders than HDFC Bank, given CBOP’s stretched valuation v/s its fundamentals. CBOP’s current price already reflects a takeover premium and we therefore believe that HDFC Bank should not be merging this bank at higher than the current price (25% premium to our fair value estimate). At current price the merger ratio will be one share of HDFC Bank for 28 shares of CBOP.

Valuation of CBOP is expensive relative to its fundamentals. CBOP and HDFC Bank, both trade at similar valuations of 4X PBR FY2009E. However, HDFC Bank generates higher RoE on a consistent basis of 18-20%, whereas this has been a low 10-12% for CBOP. Even on a PER basis, CBOP trades at 34X EPS FY2009E v/s HDFC Bank 24X. At our fair value estimate for CBOP of Rs. 45 the merger ratio should be 35 shares of CBOP for one share of HDFC Bank (note CBOP per share face value is Rs. 1). However, we believe that in such a merger the acquirer will likely need to pay a premium and the deal is unlikely to happen at a price lower than the market price.

What would HDFC Bank get? HDFC Bank’s advances and deposits will both increase by 20%. However, the bank would see an increase of 52% in its branch network to 1,148. We believe HDFC Bank has a far superior brand name and would be in a position to increase CBOPs CASA ratio from 25% (HDFC Bank has CASA ratio in excess of 50%) and shift its deposit profile to retail (we estimate 50% of CBOP’s term deposits are non-retail).

Why is CBOP considering a merger? We believe the premium valuation at CBOP is likely driven by expectations of a sale to a foreign bank. In our view, this scenario is unlikely to materialize for another 5-7 years and CBOP’s valuations could thus carry risk of downside in case the May 2009 election do not result in a pro-reform party at the centre. Sale of CBOP to a bank like HDFC Bank at current valuations therefore makes sense. The only clear advantage to HDFC Bank is the large branch network of CBOP. Since the current price already reflects a takeover premium, we believe that the transaction should not be done at higher than the current price.

Comparison between HDFC Bank and CBOP across key variables