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Merger - It's the most talked about term today creating lot of excitement and speculative activity in the markets. But before Mergers & Acquisitions (M&A) activity speeds up, it has to actually pass through a long chain of procedures (both legal and financial), which at times delays the deal. With the liberalization of the Indian economy in 1991, restrictions on Mergers and Acquisitions have been lowered. The numbers of Mergers and Acquisitions have increased many times in the last decade compared to the slack period of 1970-80s when legal hurdles trimmed the M&A growth. To put things in perspective, from 15 mergers in 1998, the number crossed to over 280 in FY01. With a downturn in the capital markets, valuations have come down to historic lows. It's high time that the consolidation game speeds up. In simple terms, a merger means blending of two or more existing undertakings into one, consequent to which each undertaking would lose their separate identity. The most common reasons for mergers are, operating synergies, market expansion, diversification, growth, consolidation of production capacities and tax savings. However, these are just some of the illustrations and not the exhaustive benefits. However, before the idea of Merger and Acquisition crystallizes, the firm needs to understand its own capabilities and industry position. It also needs to know the same about the other firms it seeks to tie up with, to get a real benefit from a merger. Globalization has increased the competitive pressure in the markets. In a highly challenging environment a strong reason for merger and acquisition is a desire 1
to survive. Thus apart from growth, the survival factor has off late, spurred the merger and acquisition activity worldwide. Take retail finance for instance. With corporate banking becoming an unprofitable business for banks due to high risk of asset quality, banks including financial institutions are tapping the retail finance segment. ICICI's acquisition of Anagram Finance from Lalbhai group, HDFC Bank's merger with Times Bank and ICICI Bank's merger with Bank of Madura are some of the latest examples of consolidation in the banking sector. We could see the similar trend perking up in other sectors. The present study gives some insight as to why the banks are going foe merger and acquisition and what are the legal, tax and financial aspects governing them. The study also deals with other aspects such as types of merger, motives, reasons, bank too much on merger, and successful consolidation in merger, recent trend in merger and acquisition activity. Lastly a case study involving the merger of ICICI with ICICI Bank has been taken.
Objective of study: • • • To discuss the form of mergers and acquisitions. To highlight the real motives of merger and acquisitions. To focus on the considerations that are important in the mergers and acquisitions negotiations. • • To find out reason for merger in the banking sector. To understand the implications and evaluation.
2. Mergers and Acquisition
Business combinations which may take forms of merger, acquisitions, amalgamation and takeovers are important features of corporate structural changes. They have played an important role in the financial and economic growth of a firm. Merger is a combination of two or more companies into one company. One or more companies may merge with an existing company or they may merge to form a new company. Laws in India use the term amalgamation for merger. For example, Section 2(1A) of the Income Tax Act, 1961 defines amalgamation as the merger of one or more companies with another company or the merger of two or more companies (called amalgamating company or companies) to form a new company (called amalgamated company) in such a way that all assets and liabilities of the amalgamated company and shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies become shareholders of the amalgamated company. Merger or amalgamation may take two forms: • • Merger through absorption Merger through consolidation
Absorption: In absorption, one company acquires another company. All companies except one lose their identity in merger through absorption.
Consolidation: In a consolidation, two or more companies combine to form a new company. In this form of merger, all companies are legally dissolved and a new entity is created. In consolidation, the acquired company transfers its asset, liabilities and shares to the acquiring company for cash or exchange of shares.
Acquisition: A fundamental charectaristic of merger (either through absorption or consolidation) is that the acquiring company (existing or new) takes over the ownership of other companies and combine their operations with its own operations. In an acquisition two or more companies may remain independent, separate legal entity, but there may be change in control of companies.
Takeover: A takeover may also define as obtaining of control over management of a company by another. Under the Monopolies and Restrictive Trade Practices Act, takeover means acquisition of not less than 25% of the voting power in a company. If a company wants to invest in more than 10% of the subscribe capital of another company, it has to be approved in the shareholders general meeting and also by the central government. The investment in shares of another companies in excess of 10% of the subscribed capital can result into their takeover.
Types of Merger
There are three major types of mergers they can be explain as follows: 1 Horizontal Merger : This is a combination of two or more firms in similar type of production, distribution or area of business.
2 Vertical Merger : This is a combination of two or more firms involved in different stages of production or distribution. Vertical merger may take the form of forward or backward merger. Backward merger: When a company combines with the supplier of material, it is called backward merger. Forward merger: When it combines with the customer, it is known as forward merger.
3 Conglomerate Merger : This is a combination of firms engaged in unrelated lines of business activity. Example is merging of different business like manufacturing of cement products, fertilizers products, electronic products, insurance investment and advertising agencies.
Advantages of Merger and Acquisitions
Maintaining or accelerating a company’s growth. Enhancing profitability, through cost reduction resulting from economies of scale.
Diversifying the risk of company, particularly when it acquires those business whose income streams are not correlated.
Reducing tax liability because of the provision of setting-off accumulated losses and unabsorbed depreciation of one company against the profits of another.
Limiting the severity of competition by increasing the company’s market power.
3. Motives behind the Merger
Motives of merger can be broadly discussed as follows: 1 Growth: One of the fundamental motives that entice mergers is impulsive growth. Organizations that intend to expand need to choose between organic growth or acquisitions driven growth. Since the former is very slow, steady and relatively consumes more time the latter is preferred by firms which are dynamic and ready to capitalize on opportunities.
2 Synergy: Synergy is a phenomenon where 2 + 2 =>5. This translates into the ability of a business combination to be more profitable than the sum of the profits of the individual firms that were combined. It may be in the form of revenue enhancement or cost reduction.
3 Managerial Efficiency: Some acquisitions are motivated by the belief that the acquires management can better manage the target’s resources. In such cases, the value of the target firm will rise under the management control of the acquirer.
4 Strategic: The strategic reasons could differ on a case-to-case basis and a deal to the other. At times, if the two firms have complimentary business interests, mergers may result in consolidating their position in the market. 5 Market entry: Firms that are cash rich use acquisition as a strategy to enter into new market or new territory on which they can build their platform.
6 Tax shields: This plays a significant role in acquisition if the distressed firm has accumulated losses and unclaimed depreciation benefits on their books. Such acquisitions can eliminate the acquiring firm’s liability by benefiting from a merger with these firms.
Benefits of Mergers
1 Limit competition 2 Utilise under-utilised market power 3 Overcome the problem of slow growth and profitability in one’s own industry 4 Achieve diversification 5 Gain economies of scale and increase income with proportionately less investment 6 Establish a transnational bridgehead without excessive start-up costs to gain access to a foreign market. 7 utilize under-utilized resources- human and physical and managerial skills. 8 Displace existing management. 8
9 Circum government regulations. 10 Reap speculative gains attendant upon new security issue or change in P/E ratio. 11 Create an image of aggressiveness and strategic opportunism, empire building and to amass vast economic power of the company.
4. Steps of Merger and Acquisitions
There are three important steps involved in the analysis of merger and acquisitions can be explained as follows: 1 Planning: The most important step in merger and acquisition is planning. The planning of acquisition will require the analysis of industry specific and the firm specific information. The acquiring firm will need industry data on market growth, nature of competition, capital and labour intensity, degree of regulation etc. About the target firm the information needed will include the quality of management, market share, size, capital structure, profit ability, production and marketing capabilities etc,
2 Search and Screening : Search focuses on how and where to look for suitable candidates for acquisition. Screening process short lists a few candidates from many available. Detailed information about each of these candidates is obtained.
Merger objectives may include attaining faster growth, improving profitability, improving managerial effectiveness, gaining market power and leadership, achieving cost reduction etc. These objectives can be achieved in various ways rather than through merger alone. The alternatives to merger include joint venture, strategic alliances, elimination of inefficient operations, cost reduction and productivity improvement, hiring capable manager etc. If merger is considered as the best alternative, the acquiring firm must satisfy itself that it is the best available option in terms of its own screening criteria and economically most attractive. 3 Financial Evaluation : Financial evaluation of a merger is needed to determine the earnings and cash flows, area of risk, the maximum price payable to the target company and the best way to finance the merger. The acquiring firm must pay a fair consideration to the target firm for acquiring its business. In a competitive market situation with capital market efficiency, the current market value is the current market value of its share of the target firm. The target firm will not accept any offer below the current market value of its share. The target firm in fact, expect that merger benefits will accrue to the acquiring firm. A merger is said to be at a premium when the offer price is higher than the target firm’s pre merger market price. The acquiring firm may pay the premium if it thinks that it can increase the target firm’s after merger by improving its operations and due to synergy. It may have to pay premium as an incentive to the target firm’s shareholders to induce them to sell their shares so that the acquiring firm is enabled to obtain the control of the target firm.
5. Reasons for Merger
The reason of merger can be broadly explain as follows: 1 Accelerated Growth: Growth is essential for sustaining the viability, dynamism and value enhancing capability of a firm. Growing operations provide challenges and excitement to the executives as well as opportunities for their job enrichment and rapid career development. This help to increase managerial efficiency. Other things being the same, growth leads to higher profits and increase in the shareholders value. It can be achieve growth in two ways: • • Expanding its existing markets Enhancing in new market A firm may expand and diversify its markets internally or externally. If company cannot grow internally due to lack of physical and managerial 11
resources, it can grow externally by combining its operations with other companies through mergers and acquisitions.
2 Enhanced Profitability : The combination of two or more firm may result in more than the average profitability due to cost reduction and efficient utilization of resources. This may happen because of the following reasons: a) Economies of Scale : When two or more firm combine, certain economies are realized due to the larger volume of operations of the combined entity. These economies arise because of more intensive utilization of production capacities, distribution networks, engineering services, research and development facilities, data processing systems and so on.
b) Operating Economies : In addition to economies of scale, a combination of two or more firm may result into cost reduction due to operating economies. A combined firm may avoid or reduce fuctions and facilities. It can consolidate its management functions such as manufacturing, R & D and reduce operating costs. Foe example, a combined firm may eliminate duplicate channels of distribution or create a centralized training center or introduce an integrated planning and control system.
c) Strategic Benefits :
If a firm has decided to enter or expand in a particular industry, acquisition of a firm engaged in that industry rather than dependence on internal expansion may offer strategic advantages such as less risk and less cost.
d) Complementary Resources : If two firms have complementary resources it may make sense for them to merge. For example, a small firm with an innovative product may need the engineering capability and marketing reach of a big firm. With the merger of the two firms it may be possible to successfully manufacture and market the innovative product. Thus, the two firms, thanks to their complementary resources, are worth more together than they are separately.
e) Tax Shields : When a firm with accumulated losses and unabsorbed tax shelters merges with a profit making firm, tax shields are utilized better. The firm with accumulated losses and unabsorbed tax shelters may not be able to derive tax advantages for a long time. However, when it merges with a profit making firm, its accumulated losses and unabsorbed tax shelters can be set off against the profits of the profit making firm and tax benefits can be quickly realized.
3 Utilisation of surplus funds: A firm in a mature industry may generate a lot of cash but may not have opportunities for profitable investment. Most managements have a tendency to make further investments, even though they may not be profitable. In such a
situation a merger with another firm involving cash compensation often represents a more efficient utilization of surplus fund.
4 Managerial Effectiveness: One of the potential gains of merger is an increase in managerial effectiveness. This may occur if the existing management team, which is performing poorly, is replaced by a more effective management team. Another allied benefit of a merger may be in the form of greater congruence between the interests of managers and the shareholders. A common argument for creating a favourable environment for mergers is that it imposes a certain discipline on the management.
Diversification of Risk: A commonly stated motive for mergers is to achieve risk reduction
through diversification. The extent to which risk is reduced, of course, depends on the correlation between the earnings of the merging entities. While negative correlation brings greater reduction in risk. The positive correlation brings lesser reduction in risk.
Lower Financing Costs: The consequence of large size and greater earnings stability, is to reduce
the cost of borrowing for the merged firm. The reason for this is that the creditors of
the merged firm enjoy better protection than the creditor of the merging firms independently.
6. Legal, Tax and Financial aspects of Merger
Legal Procedures for Merger and Acquisition The following is the procedures for merger or acquisition is fairly long dawn. Normally it involves the following steps: 1 Permission for merger: Two or more firm can amalgamate only when amalgamation is permitted under their memorandum of association. Also, the acquiring firm should have the permission in its object clause to carry on the business of the acquired company. In the absence of these provisions in the memorandum of association, it is necessary to seek the permission of the shareholders, board of directors and the Company Law Board before affecting the merger.
2 Information to the stock exchange: The acquiring and the acquired companies should inform the stock exchange where they are listed about the merger.
3 Approval of board of directors:
The boards of the directors of the individual firm should approve the draft proposal for amalgamation and authorize the managements of companies to further pursue the proposal.
4 Application in the High Court: An application for approving the draft amalgamation proposal duly approved by the board of directors of the individual firm should be made to the High Court. The High Court would convene a meeting of the shareholders and creditors to approve the amalgamation proposal. The notice of meeting should be sent to them at least 21 days in advance.
5 Shareholders and Creditors meetings: The individual firm should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. At least 75% of shareholders and creditors in separate meeting, voting in person or by proxy, must accord their approval to the scheme.
6 Sanction by the High Court: After the approval of shareholders and creditors on the petitions of the companies, the High Court will pass order sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. If it deems so, it can modify the scheme. The date of the court’s hearing will be published in two newspapers and also the Regional Director of the Law Board will be intimated.
7 Filing of the Court order: After the Court order its certified true copies will be filed with the Registrar of Companies.
8 Transfer of asset and liabilities: The asset and liabilities of the acquired firm will be transferred to the acquiring firm in accordance with the approved scheme, with effect from the specified date.
9 Payment by cash or securities: As per the proposal, the acquiring firm will exchange shares and debentures and pay cash for the shares and debentures of the acquired firm. These securities will be listed on the stock exchange.
Tax Aspects of merger and acquisition
The important tax provisions relating to merger and acquisition can be broadly discussed as follows: 1 Depreciation: For tax purposes the depreciation chargeable by the amalgamated firm has to be based on the written down value of the asset before amalgamation. For accounting purposes however the depreciation charge may be based on the consideration paid for the
2 Unabsorbed depreciation and Past losses of amalgamating firm: Unabsorbed depreciation and past losses of the amalgamating firm cannot be carried forward by the amalgamated firm except as provided in section 72A (1) of the Income Tax Act. However enables the amalgamated firm to carry forward accumulated losses and unabsorbed depreciation of the amalgamating firm in certain special cases of amalgamation. The benefit is available when the Central Government is satisfied, on the recommendation of the specified authority that the following conditions are fulfilled. • • The amalgamating firm should not be financially viable. The amalgamation should be in public interest. 18
The amalgamation should facilitate the rehabilitation or revival of the business of the amalgamating company.
The amalgamated firm should get a certificate from the specified authority that adequate steps have been taken for the rehabilitation or revival of the business of the amalgamating firm. In view of the benefit that accrues under section 72A(1) the
concerned firm should check with the specified authority fairly early in the amalgamation process whether the benefit is likely occur. Since the benefit under section 72A(1) is often not easily forthcoming merging firm generally resort to a reverse merger. In a reverse merger, a loss making firm acquires a profit making firm.
3 Amortisation of capital expenses: The amalgamated firm can amortise the expenditure on scientific research the expenditure on acquisition of patent rights or copyrights, preliminary expenses and capital expenditure on promotion of family planning.
4 Investment Allowance, Development Rebate and Development Allowance: Investment allowance, development rebate and development allowance remaining unabsorbed in the hands of the amalgamating firm can be carried forward by the amalgamated firm provided various requirements regarding sale or transfer of asset and creation and utilization of reserves are satisfied by the amalgamated firm.
5 Capital Gain Tax: No capital gain tax is applicable to the amalgamating firm or its shareholders if they get share in the amalgamated firm.
Financial Aspects of Merger
There are many ways in which a merger can result into financial synergy. A merger may help in: • • • • eliminating the financial constraint deploying surplus cash enhancing debt capacity lowering the financial cost. It can be broadly explain as follows: 1 Financial Constraint: A firm may be constrained to grow through internal development due to shortage of fund. The firm can grow externally by acquiring another firm by the exchange of shares and thus, release the financial constraints.
2 Surplus Cash: A firm may be faced by a cash rich firm. It may not have enough internal opportunities to invest its surplus cash. It may either distribute its surplus cash to its shareholders or use it to acquire some other firm. The shareholders may not really benefit much if surplus cash is returned to them since they would have to pay tax at ordinary income tax rate. Their wealth may increase through an increase in the market value of their shares if surplus cash is used to acquire another firm. If they sell their shares they would pay tax at a lower, capital gain tax rate. The company would also be enabled to keep surplus funds and grow through acquisition.
3 Debt capacity: A merger of two firms, with fluctuating, but negatively correlated, cash flows, can bring stability of cash flows of the combined firm. The stability of cash flows reduces the risk of insolvency and enhances the capacity of the new entity to service a larger amount of debt. The increased borrowing allows a higher interest tax shield which adds to the shareholders wealth.
4 Financing cost: Does the enhanced debt capacity of the merged firm reduce its cost of capital? Since the probability of insolvency is reduced due to financial stability and increased protection to lenders, the merged firm should be able to borrow at a lower rate of interest. This advantage may, however be taken off partially or
completely by increase in the shareholders risk on account of providing better protection to lenders. Another aspect of the financing costs is issue costs. A merged firm is able to realize economies of scale in flotation and transaction costs related to an issue of capital. Issue costs are saved when the merged firm makes a larger security issue.
7. Valuations of Merger
Valuations: Any understanding on M&A is incomplete without a discussion
on valuation. During the course of a merger procedure, normally a Chartered Accountant or a category-I Merchant Banker is appointed to work out the value of shares of companies involved in the merger. Based on the values so computed the 22
exchange ratio is worked out. It is the value at which a buyer and seller would make a deal. There are certain basic factors, which determine the value of a company's share. As these are very subjective factors, valuations generally vary from case to case depending on assumptions and future projections. The following steps are involved in the valuation of a merger which can be broadly discussed as follows:
• • • • • •
Identify growth and profitability assumptions and scenarios Project cash flows Estimate the cost of capital Compute NPV (Net Present Value) for each scenario Decide if the acquisition is attractive on the basis of NPV Decide if the acquisition should be financed through cash or exchange of
Evaluate the impact of the merger on EPS (Earning Per Share) and PE (Price-
1 Cash Flow approach: In a merger or acquisition the acquiring firm is buying the business of the target firm rather than a specific asset. Thus merger is a special type of capital budgeting decision. This should include the effect of operating efficiencies and synergy. The acquiring firm should appraise merger as a capital budgeting decision. The acquiring firm incurs a cost (in buying the business of the target firm) in the expectation of a stream of benefits (in the form of cash flows) in the future. The
merger will be advantageous to the acquiring firm if the present value of the target merger is greater than the cost of acquisition. Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. Discounted Cash Flow (DCF) approach is an important tool in analyzing mergers and acquisitions. Earnings are basis for estimating cash flows. Cash flows include adjustments for depreciation, capital expenditure and working capital. Cash Flow = EBIT (1-T) + Depreciation – Changes in Working Capital – Changes in Capital Expenditure 2 Earning Per Share (EPS) and P/E (Price Earning) ratio: In practice, investor attach a lot of importance to the earning per share (EPS) and the price earning (P/E) ratio. The EPS and P/E ratio is the market price per share. In the efficient market, the market price of a share should be equal to the value arrived by the discounted cash flow technique. Thus, in addition to the market price and the discount value of share the merger and acquisitions decisions are also evaluated in terms of EPS, P/E ratio, book value etc.
3 Exchange Ratio: The current market value of the acquiring and the acquired firms may be taken as the basis for exchange of shares.
Exchange Ratio = Share price of the acquired firm/Share price of the acquiring firm (Pb/Pa). The exchange ratio in terms of the market value of shares will keep the position of the shareholders in value terms unchanged after the merger since proportionate wealth would remain at the pre merger level. There is no incentive for the shareholders of the acquired firm, and they would require a premium to be paid by the acquiring company. In the absence of net economic gain, the shareholders of the acquiring firm would become worse off unless the price earning ratio of the acquiring firm remain the same before the merger. The shareholders of the acquiring firm to be better off after the merger without any net economic gain either the price earnings ratio will have to increase sufficiently higher or the share exchange ratio is low, the price earning ratio remaining the same.
8. Banking too much on Mergers
Mergers and acquisitions (M&A) can help banks restructure in a way that gives them superior organizational capabilities, resulting in a sustainable competitive advantage. However, it will be too simplistic to consider merger and acquisition as a recipe for all, or even a majority, of banking sector ills. Generally 25
the merger and acquisition route is contemplated to take advantage of scale of operations. But the problem does not always relate to scale. There are many examples where commendable results have been achieved by breaking profit centers into smaller units. The ability of a bank to meet competition will therefore depend upon the speed, quality and efficiency of its delivery system through a conducive work climate and a responsive workforce. Unless both the management and employees collectively strive for this goal. Banking experts believe that a merger with a ‘right’ bank can help a bank increase its net worth and hence its capital adequacy. This is particularly relevant in the context of the proposed revised rules of the Basle Committee on Banking Supervision aimed at keeping bank capital standards with the increased sophistication in the financial services industry. In the case of private sector banks, where the promoters are required compulsorily to dilute their stake to the stipulated 40%. Merger can be quite useful to take care of the mandatory requirement. This apart, mergers would also expand the business opportunities for both the banks.
Shareholder Value: There is no doubt that bankers in India need to be sensitive to the fast changing economic environment and must constantly and consciously seek to strive to increase shareholders value. To achieve this, the focus must be on ensuring that funds mobilized by banks generate adequate returns in excess of the cost of
capital. Also they should on an on-going basis, endeavour to invest in technology that increases their reach and enhances customer satisfaction.
2 Integrated HR system: Banks the most, apart from lack of professionalism and adequate technology upgradation is the lack of a centralized human resources (HR) strategy. Banks must therefore, urgently evolve an integrated HR system, wherein the trust should be growth with people. Banks will have to build around this concept a performance measurement system a career development path and a remuneration policy. In this policy has to be the realization that: • • In the day to come, there is bound to be greater staff mobility between banks. Staff remuneration has to be based partly on market trends and partly on job requirements and individual banks needs rather than standardized uniform scales for all banks. Complete autonomy needs to be given to banks in this regards. • Promotions must be decided primarily on merit and requirements of the banks concerned, ensuring at the same time that the promotion policy is objective and transparent and does not give rise to widespread frustration. Based on these considerations, banks should evolve a personnel and HRD policy with: • • A comprehensive system of recruitment and training A conscious programme for development of different categories of employees 27
New horizons for employees to grow within the organization itself Greater coordination amongst banks with regard to recruitment, particularly at senior levels to prevent poaching as for as possible.
Growth with people: In this area of knowledge and information, people will inevitably be an organizations most important asset. This calls for a new paradigm business growth through people’s growth. Growth is created not by the entity of the organization but by its talented and knowledge people. The growth of the banking sector in India leading to sustained shareholder value can thus be ensured only through its vast workforce. Banks can respond to the challenge of change and growth only if the potential of their employees is harnessed.
Customer Orientation: Another trusts area for banks in their quest for growth and creating shareholder value is customer service. Research has shown that a customers decision to stay loyal to a particular bank is most often based on how he has been treated by a teller or a staff. Banks must therefore focus on improving the capabilities of such staff to consistently deliver services of expected quality level. This is in turn directly linked to how their organisation has resolved and integrated marketing, operations, finance and HR objectives into a unifying service strategy that is delivered by frontline staff. Mergers generally pose another ticklish problem for the new organisation that is bringing about harmony and a sense of identity when two banks with 28
starkly contrasting corporate cultures are sought to be merged. In such a situation there is bound to be problems of diversity of corporate culture, value and approach. Integrating workforces is always a tough task and any incompatibility could result in gross inefficiencies, defeating thereby the very objective of the merger. Merger and acquisition is therefore no substitute for poor asset quality, lax management, indifference to technology upgradation and lack of an integrated HR strategy. Ti must be remembered that merger is only one of the alternatives in corporate restructuring there could be better and more advantageous to leverage optimum utilization of corporate resources.
M&As: New mantra in banking sector
Corporation Bank is the latest to join the bandwagon of mergers and acquisitions. Following a statement by Finance Minister P Chidambaram last month, calling for a consolidation of the Indian banking industry, there has been a spate of announcements from banks, with M&A on their mind. The board of the directors of Corporation Bank has given in-principal approval for the bank to go forward with its plan to acquire another bank. Earlier, Indian Bank, which has barely wiped out its Rs 1,600 crore loss, also announced its intentions to acquire another bank. The Chennai-based bank feels its will acquire a wider reach through an acquisition.
Bank of Baroda has also joined the fray, basically because being a bank with a strong presence in western India, it requires to spread its wings in the rest of the country. Ditto goes for Vijaya Bank, Central Bank of India, United Bank of India, Punjab & Sind Bank and Punjab National Bank. Union Bank of India, on the other hand, already has a national level presence, but wants to become a global entity and therefore is looking at the acquisition route. The Government’s recent announcements have also created a positive atmosphere for these developments. Minister Prithviraj Chavan recently said, "The Indian Government will soon unveil a policy guideline to encourage mergers and acquisitions in the Indian banking sector." The policy is expected to provide the impetus for growth in the wake of the Government’s decision to retain the public sector character by capping the public holding of capital. Further, he said, the rapid technological advances in the sector also spelt the need for a new breed of regulators and inspectors to keep amateur hackers and professional techno-thieves at bay. The move to formulate such guidelines has been fuelled by the fact that present day banking required a smaller number of very large banks rather than a pack of small banks. There are about 90 scheduled commercial banks, four non-scheduled commercial banks and 196 regional rural banks (RRBs). The State Bank and its seven associates have about 14,000 branches; 19 nationalised banks 34,000 branches; the RRBs 14,700 branches; and foreign banks around 225 branches.
However, only State Bank of India is among the top 200 banks in the world. This fact has probably triggered off the entire process. It is also felt that consolidation of the industry will better help banks raise capital for growth from the financial market without further liquidating the public sector character in ownership and management. On the down side, the sector will have to be prepared for issues arising out of compatibility of technology and human resources. Consolidation and creation of mega banks will also require a clear focus on lending operations and more intensive retail banking. Public sector banks need to catch up on these issues.
9. Benefits of Bank Mergers
Basically a merger involves a marriage of two or more banks. It is generally accepted that mergers promote synergies. The basic idea is that the combined bank will create more value than the individual banks operating independently. Economists refer to the phenomenon of the ‘2+2=5 effect brought about by synergy. The resulting combined entity gains from operating and financial synergies. Operational synergies generally refer to gain in economies of scale. Economies of scale refers to the lower operating cost (per unit) arising from spreading the fixed costs over a wider scale of production and economies of scale 31
refers to the utilization of skill assets employed in the production in order to produce similar production or services. In a combined entity, the skill used to produce results on a wider scale. Additionally financial synergies refers to the effect of a merger on the financial activities of the resulting company. The cash flows arising from the merger are expected to present opportunities in respect of the cost of financing and investment. The argument is that combining two banks give rise to savings in cost, maximization in the use of resources and increase in revenues. Similarly mergers and takeovers also plays a crucial role in efficient allocation of resources. When a bank is not performing as expected others will notice that the assets of the bank are not being put to their most efficient use. This bank will then become a potential target for a takeover for a bank which believes that under its management the asset can be fully utilized to produce better results. To that extent merger and takeovers play a crucial economic role of moving resources from zones of under utilization to zones of better utilization. Poorly run companies are more prone to bring taken over by the powerful and managers have an incentive to ensure that their company is governed properly and resources are used to produce maximum value. Takeovers in the banking sector will ensure that the boards and management of institutions will improve corporate governance to avoid being target in future.
10. Successful Consolidation in the Banking Merger
The concern of bank supervisors that market participants might systematically overestimate the advantages of mergers and acquisitions and underestimates the downside risks associated with the process of restructuring is based on a large body of empirical studies by academic economists and business consultants. These studies attempt to measure either the potential benefit of mergers in general (mainly to identify the prospective economies of scale and scope) or the “success” of a specific merger at some point in time after the deal was completed. In this latter category, various yardsticks are used, including the repositioning of the merged entity in terms of cost and profit efficiency or the development of simple balance sheet ratios or the valuation of the new company in the stock market. In general the result of these studies lead to the conclusion that most mergers fail to add value either in the form of superior stock price performance or in the form of cost and profit advantages of the combined institution. Moreover, especially in the US, most large scale mergers and acquisitions in banking have been resulted in the destruction of shareholder value, as defined in terms of market capitalization. Also it is claimed that economies of scale can be clearly identified on any small and medium size banks only and that there is no numerical evidence on any economies of scale. In sum the empirical results for mergers and acquisitions in the financial industry seem both to contradict the (theoretical) arguments in favor of a restructuring and motivations given by practitioners. 33
During the last few years the Indian Banking system has witnessed some very high profile mergers, such as the merger of ICICI Limited with its banking arm ICICI Bank Ltd. The merger of Global Trust Bank with Oriental Bank of Commerce and more recently the merger of IDBI with its banking arm IDBI Bank Ltd. The Union Finance Minister, P.chidambaram gave an inkling of the government’s stance on mergers in the banking sector when he stated that “The Government would encourage consolidation among banks in order to make them globally competitive. The Government will not force consolidation, but if two banks want to consolidate we would encourage them. We will encourage them if it helps bank’s grow in size, scale and muscle so that they can compete globally. To facilitate such mergers, a small amendment to the Income Tax Act would be made during the budget session of parliament next year. Similarly banks would be encouraged to go to the market to raise resources. The above statement of the Honorable Finance Minister has to be understood in the context of the Basel II Accord which was proposed in June 1999 by the Basel Committee in May 2003 these would be an increase in capital requirements by 12% for banks in developing countries on implementation of the Basel II Accord. Mergers among banks will be one of the ways to increase market power and there by increase the revenue generation of banks which would in turn enable them to access the capital market to raise funds and meet the increased capital requirement. While considering any proposal for merger of banks it will be necessary to evaluate the impact of the merger on the safety and soundness of the banking system. There is a definite need to develop a merger process and to
identify the authority that will be responsible for conducting the merger review process. Besides, for an outside observer it might also be somewhat surprising that bank supervisors are concerned with the “success” or to what extent business leaders in the financial services industry are taking the right decision when they initiate an merger and acquisition at least as long as other concerns relating to the core mission of the supervisory authorities do not come in. Bank supervisors should be concerned whether the current merger and acquisition activity might pose a threat to efficient risk management and supervision and whether ultimately the stability of the financial system itself might be at risk. It might, however be more appropriate to proceed directly to discussing the implications of the current process of financial sector consolidation for risk management and financial sector stability. While the arguments of bank supervisors in this realm cannot be dismissed entirely, they seem however greatly exaggerated and should not provide a valid argument against a further restructuring of the financial industry.
International Bank Merger and Acquisitions
I) Domestic Bank Merger and Acquisitions:
Domestic Bank Merger and Acquisitions can be broadly discussed as follows: • Domestic merger and acquisition mainly occur between smaller Institutions, indicating a mop-up of excess capacity. • Consolidation of smaller institutions has been a phenomenon during the whole period. • Merger and acquisitions of large institutions are increasing both in absolute and relative terms, thereby affecting the market structures in some Member States. • The number of merger and acquisitions was clearly higher in compare with the three previous years and upward shifts in values of Merger and Acquisitions have been observed in a number of countries, indicating a wave of mergers among larger institutions. Information about the value of merger and acquisitions is available to a limited extent only. The possible effect of merger and acquisitions on
domestic market structures has been estimated by relating the asset of the new institution to the total asset of the banking system. A large domestic players, which, when they are involved, will have a large influence on the market structure than small institutions. The effect on regional retail clients may be equally important in case of merger and acquisitions between small regionally specialized institutions but the overall competitive effect on the market will be larger when the size of the institution increases. For domestic merger and acquisitions large values tended to be involved during the period indicating that it is not only the very small institutions that are involved in mergers and acquisitions at least on an aggregate basis. A development of increased values may, therefore have taken place. There are, however large differences among Member States, both at the level of banking assets involved in merger and acquisitions and in the trends towards either increases or declines. Around 30% of banking assets were involved in domestic bank merger and acquisitions in 1998, whereas 20% in 1999 and then percentages were range between 20 percent to 60 percent in French mergers. Lately, all these markets have, thus undergone quite some changes. Clear downward movements in relation to values or numbers have occurred. More than 40% of Swedish banking assets were involved in domestic merger and acquisitions.
International Banks Merger and Acquisitions:
Far fewer international bank merger and acquisitions have taken place than domestic bank merger and acquisitions. 37
Measured by number, international bank merger and acquisitions were mainly outside the European Union area. When comparing the direction of foreign acquisitions, third countries
have, often in the search for markets offering higher margins, been more common targets for European banks over recent years than other countries. European banks have expanded into Latin America, South-East Asia and Central and Eastern Europe. In some cases, they have also expanded into developed markets such as the US.
Development of Financial Conglomerates: Merger and acquisitions leading to the establish of a financial conglomerate are qualitatively different from pure banking merger and acquisitions, since they lead to the creation of a group which is active in different sectors of the financial industry. The largest and leading firm in a conglomerate may be a credit institution, an insurance company a holding company or another financial institution. Financial conglomerates may be created by way of merger and acquisitions or by a financial institution setting up a company in another sector. The creation of a financial conglomerate is not the only way of offering financial services of different character in a jointly organized way. Co-operation agreements between, for instance a bank and an insurance company may achieve similar results. Such co-operation agreements are common in many Member States. They are often found to be precursors for integration involving ownership elements.
Akin to but different from conglomeration is the establishment of jointly owned enterprises offering specialized financial services. In some Member States savings banks and co-operative banks have set up such jointly owned enterprises that provide asset management, stock broking and settlement activities as well as insurance, all of which are sold to or distributed by the member institutions of the sector. An example would be the jointly owned investment management firm of the savings bank sector in a country. In economic terms such jointly owned enterprises provide equal opportunities of marketing and servicing as financial conglomerates. The development of such enterprises as well as cooperation agreements is common.
III) Domestic Conglomeration:
Domestic conglomeration can be broadly discussed as follows: • Throughout the observation period domestic conglomeration was driven by credit institutions. • Credit distributions are mainly expanding into asset management and the business of investment services in general. Furthermore, such conglomerates seem to be the most widespread from of conglomerates. In most countries credit institutions provide most of the asset management and investment services activities. • Conglomeration led by credit institutions (credit institutions acquiring an enterprise or setting one up in another sector) had a share of around 60 transactions per year in 1997, failing to 56 in 1998 and then rising to 81 in 1999. In the first half of 2000 the number was 67 out of 70 transactions. 39
During the period, expansion into another financial services by way of acquisition increased in importance. • Although these general observations can be made in relation to domestic conglomeration there are significant national differences. These differences are both in terms of the number of transactions and the method used (merger and acquisition or setting up) for conglomeration. A total of 438 transactions were carried out in the observation period.
International conglomeration can be broadly discussed as follows:
It seems credit institutions expanding outside the EEA into in particular, the business areas of other financial institutions, initiate that international conglomeration.
The International expansion has occurred by way of setting up new enterprises and through merger and acquisitions in a rather balanced way.
Looking more closely at the breakdown of mergers and acquisitions, acquisitions outnumber mergers.
There is a little international conglomeration activity involving insurance companies. Banks have also been more actively expanding into other sectors on a
cross border basis than other financial service providers have been into banking. The expansion has been mainly into the business area of other investment services and the management of UCITS, as was found also for domestic conglomeration. Mergers and acquisitions have recently gained slightly in importance with 40
acquisitions being chosen as the legal form. It should be noted, however that a number of countries have few transactions to report. In other countries, figures were not available at all. It seems that international conglomeration is carried out equally by way of setting up a new enterprise and through mergers and acquisitions. Credit institutions have tended only to set up other financial institutions abroad, and it is the other foreign financial companies that are setting up domestic credit institutions.
12. Existing Mergers and Acquisitions in Banking Sector
Banking the world over has been experiencing large scale mergers and acquisitions, either between banks or between banks and financial institutions or between banks and major IT companies. All these mergers and acquisitions are driven by motivations like efficiency gains through synergies, economies, cost effectiveness etc. Some times, non economic factors like prestige, market power or market dominance have also influenced merger and acquisition activity. Trade
liberation the concepts of international and global banking, pervasive effect of technology have also influenced bank mergers and acquisitions. This section deals with the merger of Times Bank with HDFC Bank, Bank of Madura with ICICI Bank, besides the aborted merger of Global Trust Bank with UTI Bank. Other cases discussed are the possible consequences of the proposed reverse merger of IDBI and IDBI Bank (which no longer look like a possibility), the proposed merger of ICICI and ICICI Bank. In the international scene, mergers in the European Union (EU) Banking Industry and the concerns for the bank supervisors have been dealt with.
Times Bank Merges with HDFC Bank:
This merger signaled the willingness of the new private banks (the offshoots of new economic reforms and financial sector deregulation) to quickly respond to the imperatives of competition, expansion and product diversification. The merger is between two near equal entities and is driven by the factors like superiority of HDFC Bank technology, its compatibility, the need for higher CAR ratio, cross selling opportunities for the products of HDFC Bank etc. Post merger, HDFC Bank becomes the largest private sector bank. As both the banks have ambitious and young professionally oriented employees, cultural integration did not pose any challenge. While HDFC Bank has its predominant presence in metro areas, Times Bank has its root in urban centres. This way the merger enlarges the reach of the new entity without significant branch overlap. This merger also forces the government to seriously consider the vital question of consolidation among the public sector banks, for survival. 42
Marriage between the old and the new:
While the merger of Times Bank with HDFC Bank is a Marriage between two young and tech savvy bankers we have a marriage between the old and the new when Bank of Madura merged with ICICI Bank. This all stock merger brought cheer to the shareholders and employees of Bank of Madura and discomfort and anxiety to those of ICICI Bank. ICICI bank was able to meet its goal of expanding access base, enhance geographical coverage and client base through the merger. While ICICI Bank has its branches in metros and urban centres, BOM has its 263 enters, mostly in the south. So the merger indeed increased the geographical coverage without branch overlap of significance. While ICICI Bank has superior technology, BOM has low marks on this score. However, analysts say that the two software models have a high degree of compatibility. The greatest challenge this merger faces is the cultural integration between the Tech savvy young employees of ICICI Bank and Traditional and rather aged employees of BOM. While the clientele of the new entity dramatically goes up, their profiles are dissimilar, raising questions about the success of cross selling opportunities. The real benefits of this merger to the economy is a big question mark
Global Trust Bank and UTI Bank:
The merger that did not eventually take place between Global Trust Bank and UTI Bank presents a good study of the disastrous consequences of 43
unprofessional valuation standards, over exposure of banks to equity markets, besides the dangers of banker broker nexus and above all the tragedy of near absence of sound corporate governance in banks. In the first place, the swap ratio of 2.25:1 in favor of GTB has been questioned by analysts on the grounds of due diligence. Ketan Parekh and his associates appeared to have been involved in manipulating the share prices of GTB, which has also generously lent to this group, not necessarily under the name of equity finance. In fact, GTB itself had exposure to stock market, much beyond the prudential levels at the time of the failed merger, in the year 2001. Ramesh Gelli, Chairman, GTB was asked to vacate his seat by RBI. Obviously, the much publicized corporate governance practices in GTB are only hallow claims. D G Prasuna unmasks these starting irregularities and unethical practices in the deal in her article ‘UTI Bank GTB Merger: Whither Due Diligence’. Incidentally the recent report (year 2002) of joint parliamentary committee on the stock scam of 2001, has indicted both UTI Bank and Global Trust Bank for their actions relating to the failed merger.
Merger of ICICI and ICICI Bank: The Big Picture
While the aborted merger between GTB and UTI Bank remains a scar on the face of the Indian banking sector, the proposed merger between ICICI and ICICI Bank unravels very interesting possibilities. This merger creates the first universal bank in India and the new entity becomes a dominant player in the Indian banking scenario. The recent economic slowdown, sluggish progresses in infrastructure development, languishing project finance activities and high cost of funds were the factors that drove ICICI into the merger of statutory pre-emptions 44
and 49% priority sector lending. Parthasarathi Swami and Aloka Majumdar, tells the story of the merger in their article.
IDBI: Merger is not a Universal Truth
While the birth of the first universal bank in the form of the merger of ICICI with ICICI Bank is a foregone conclusion, IDBI has no such luck. IDBI is one of the oldest development financial institutions of India, with assets over Rs.70000 cror and advances over rs.50000 crore. It is plagued with high level of NPAs, very low profits, slow growth, inadequate net worth and insufficient income. IDBI Bank on the other hand is growing, at a slower pace and has adequate provisions for its NPAs. It is presently concentrating on ‘A’ rated customers for lending. IDBI wishes to solve its problems of high cost funds through universal bank route by merging with IDBI Bank. It also has ambitions to diversify into retail lending segment in a big way. This proposed merger is a non starter as the compliance with statutory pre-emptions (SLR and CRR) implies raising of vary huge funds by IDBI Bank, in a short period a giagantic task, beyond its means. Also the burden of NPAs of IDBI cannot be borne by IDBI cannot be borne by IDBI Bank. Hence the merger is not in the interest of either parties. Merger and acquisition activity among banks and financial institutions has sharply increased world wide, recently, some of the mergers have been perceived as failures. Bank regulators express the following concerns about the mergers. The process of consolidation might have a negative impact on the 45
stability of banking and financial system liquidity in the interbank markets might shrink with less number of participants and ever more netting. Most mergers fail to add value either in the form of superior stock price performance or in the form of cost and profit advantages. Economies of scale are available only for small and medium size banks and economies of scope simply do not exist. Some market participants might be tempted to engage in excessive risk taking (in order to make up for declining profits). “Too big to fail institutions” might cause moral hazard problems. Mergers and acquisitions in the financial industry is a matter of concern for bank supervisors, critically addresses all these concerns of the supervisors ( also called regulators) and concedes that most of them do have some element of truth. However he observes that Mergers and acquisitions have long term perspectives and long term advantages. He adds that large institutions will be able to maintain a superior level of risk management. The perceived reduction in market liquidity is attributable to other reasons and not to Mergers and Acquisitions among financial firms market discipline (the control of credit of markets over the financial soundness of borrowers) has to be enhanced through qualitative improvements in transparency and disclosures. He also notes that the supervisory structures need upgradation, consequent to the consolidation process. The central point of his article is that financial regulation should not frustrate the ability of firms to capture the benefits of consolidation. Banks has made very vital observations on Merger and Acquisition activity, in the last article such as ‘Mergers and Acquisitions involving the European union banking industry. The article studies for different types of
mergers and acquisitions domestic and international banks, mergers and acquisitions leading to domestic and international conglomeration. The driving forces include information technology, disintermediation and the international capital markets. Regulators face new challenges for instance when an insurance company and bank merge together forcing them to work together to find cooperative solutions. Financial conglomerates could cause the risk of contagion. Finally mergers and acquisitions are more common than hostile takeovers in the financial services sector. The traditional challenges of cultural differences are very much present. The values involved in mergers and acquisitions are increasing and international bank mergers and acquisitions are more often carried outside the European Economic area. While small bank mergers and acquisitions are mostly carried out for cost efficiency, large bank merger and acquisitions often have an element of strategic re-positioning.
13. Case ICICI and ICICI Bank
ICICI Bank is India’s second largest bank with total assets of over Rs.1 tn and a network of about %40 branches and offices and over 1000 ATMs. ICICI Bank offers a wide range of banking products and financial services to corporate and retail customers through a variety of delivery channels and through its specialized subsidiaries and affiliates in the areas of investment banking life and
non life insurance, venture capital, asset management and information technology. ICICI Bank’s equity shares are listed in major stock exchange in India, national Stock Exchange of India Limited and its American Depositary Receipts (ADRs) are listed on the New York stock Exchange (NYSE). ICICI Bank was originally promoted in 1994 by ICICI Limited, an an Indian Financial institutions, and was its wholly owned subsidiary. ICICI’s shareholding in ICICI Bank was reduced to 46% through a public offering of shares in India in fiscal 1998, an equity offering in the form of ADRs listed on the NYSE in fiscal 2000, ICICI Banks acquisition of Bank of Madura Limited in an all stock
amalgamation in fiscal 2001, and secondary market sales by ICICI to institutional investors in fiscal 2001 and fiscal 2002. ICICI was formed in 1995 at the initiative of the World Bank, the Government of India and representatives of Indian industry. The principal objective was to create a development financial institution for providing medium term and long term project financing to Indian businesses. In the 1990s, ICICI transformed its business from a development financial institution, offering only project finance to a diversified financial services group, offering a wide variety of products and services, both directly and through a number of subsidiaries and affiliates like ICICI Bank. In 1999, ICICI become the first Indian company and the first bank or financial institution from non Japan Asia to be listed on the NYSE. After consideration of various corporate structuring alternatives in the context of the emerging competitive scenario in the Indian banking industry, and the more towards universal banking, the managements of ICICI and ICICU Bank formed the view that the merger of ICICI with ICICI Bank would be the optimal
strategic alternative for both entities, and would create the optimal legal structure for the ICICI group’s universal banking strategy. The merger would enhance value for ICICI shareholders through the merged entity’s access to low cost deposits, greater opportunities for earning fee based income and the ability to participate in the payments system and provide transaction banking services. The merger would enhance value for ICICI Bank shareholders through a large capital base and scale of operations, seamless access to ICICI’s strong corporate relationship built up over five decades, entry into new business segments, higher market share in various business segments, Particularly fee based services and access to the vast talent pool of ICICI and its subsidiaries. In October 2001, the Board of Directors of ICICI and ICICI Bank approved the merger of ICICI and two of its wholly owned retail finance subsidiaries, ICICI Personal Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. The merger was approved by shareholders of ICICI and ICICI Bank in January 2002, by the High Court of Gujrat at Ahmedabad in March 2002, and by the High Court of judicature at Bombay and the Reserve Bank of India in April 2002. Consequent to the merger, the ICICI group’s financing and banking operations both wholesale and retail, have been integrated in a single entity.
Performance of the Bank:
Channels: The merger has led to an increase in the number of branches to 355, extension counters to 34 call centres to 17 and ATM centres to 510 all over the country and thus providing convenience to the customer. Products and Services: 49
‘Business Multiplier’, ‘ICICI select’ and ‘I-fund’ were the new and innovative products introduced during the year. ICICI bank in tie up with Munshikaka.com has extended their services for online filing and advisory of income tax returns. Also, ICICI bank has launched and implemented a new web based portal which provides real tome exchange rates for corporate customers and also puts their forex transactions online. Cards – Credit, Debit and Smart: Bank has a credit card base of 273000 which puts it in the top third slot. All global VISA cards can use any of the bank’s ATMs for their transactions. They have their credit card, debit card and smart card. The debit card is called ‘ICICI Ncash’. Smart cards have been introduced with pilot launches at Infosys Limited in Banglore and in Manipal Higher Education, Manipal. Together, all these three cards strengthen the financial armoury. In all these initiatives, the bank along with the ICICI group, made full use of business application provided by the modern technology to offer its customer facilities of e-commerce. Increasingly systems were web enabled to provide ease of access and operations to customers. Customer Services: It has seen implementation of six sigma exercise in order to improve customer service and bring down the transactions cost.
Employees Stock Option Plan:
The bank has granted 15,80,200 stocks to its employees and the managing director and the chief executive officer. Of these, 6 senior managers of the bank were granted 25000 stock options each. Corporate Governance: The audit risk committee nomination committee and compensation committee work hand in hand to follow the tenets of good corporate governance.
Performance Review – Year ended March 31, 2002:
The combined entity has emerged as the largest private sector bank in the country marking a new era in Indian Banking, adding considerable strength to the Indian financial system. The significant features of the combined entity are: • A highly diversified asset base- with a balance sheet size of over Rs. 104000
crore, it has 34% in cash and government of India securities, short term corporate finance loans of 23%, retail loans of 8% (including operations of ICICI Home Finance Company Limited) and long term project finance loans of 23%. The balance asset consists of investments of 5% and other miscellaneous assets. • the By adopting the purchase method of accounting, based on the fair valuation of loan portfolio by Deloitte Haskins and Sells and marking to market of the
equity and related investment portfolio, ICICI Bank has written down assets of ICICI to the extent of Rs.3780 crore. This amount has been utilized as follows: 1 Marking to market ICICI’s equity and related investments by Rs.925 crore; 2 Creating additional provisions in respect of ICICI’s non performing loans to the extent of Rs.902 crore, increasing the coverage (Provisions and write-off against
NPLs as a percentage of gross NPLs) to 63 percent on ICICI’s NPLs, and reducing the NPL ratio to below 5.0% at 4.7% for the merged entity and 3 Creating additional provisions to the extent of Rs.1953 crore to provide for any future impairment of ICICI’s legacy assets. As a result of this additional cushioning, the general provision against ICICI’s performing loans stands increased to 4.5% against the regulatory requirement of 0.25%. • The Bank has a network of over 400 branches and the largest connected ATM network of over 1000 ATMs in the country offering anytime, anywhere banking. In addition, it has over 120 retail centers across more than 75 geographic locations. • • The Bank has deposit customer accounts of 5.0 million bondholder accounts. The bank continues to enjoy a capital adequacy ratio of 11.44% (Tier-! Of 7.47%) as against the regulatory requirement of 9%. Since October 2001, when the merger decision was taken, the Bank has added about Rs.15000 crore of deposits, which accounts for a market share of 20% in incremental deposits in the banking system, creating a sound base for the future growth of the Bank. As a part of the merger exercise, ICICI Bank initiated the process of selling down its asset, which created a new market for securitized paper in the country.
Earnings: ICICI Bank’s profit after tax as per the audited unconsolidated Indian GAAP increased by 60.2% to Rs.258 crore in FY2002 from Rs.161 crore in the 52
previous year. As the merger has come into effect only on March 30,2002, ICICI Bank’s profit of Rs.258 crore for Fy2002 includes only two days profit of ICICI and its merging subsidiaries, amounting to about Rs.8 crore. The profit of FY2002 for the Bank is therefore largely comparable to FY2001. Net interest income increased 46.7% to Rs.593 crore from Rs.404 crore, and core fee income increased 65.5% to Rs.283 crore from Rs.171 crore. The average cost of deposits declined to 7.3% in FY2002 from 7.8% in FY2001.
Future Plans: ICICI Bank will convert itself into a universal bank with a reverse merger of its parent ICICI. The combined entity will be the second largest player in the Indian banking sector after public sector behemoth State Bank of India.
Analysis of case:
The proposed merger between ICICI and ICICI Bank unravels very interesting possibilities. This merger creates the first universal bank in India and the new entity becomes a dominant player in the Indian banking scenario. When the board of ICICI and ICICI bank met to approve the merger of the financial 53
institution with the bank at a share exchange ratio of one domestic equity share of ICICI Bank for two shares of ICICI. The recent economic slowdown, sluggish progresses in infrastructure development, languishing project finance activities and high cost of funds were the factors that drove ICICI into the merger. The amalgamation will enable them to have a strong financial and operational structure, which is suppose to be capable of greater resources mobilization and ICICI will emerge as one of the largest private sector banks in the country. The ICICI emerged largest customer base will enable the ICICI Bank to offer banking and financial services and products and also facilitates cross selling of products and services of the ICICI group. The merger will enable ICICI to provide ATMs, credit card, debit card and smart cars and financial services and products to a large customer base, with expected savings in cost and operating expenses. The bank network over 400 branches and the largest The Bank has a network of over 400 branches and the largest connected ATM network of over 1000 ATMs in the country offering anytime, anywhere banking. In addition, it has over 120 retail centers across more than 75 geographic locations. Over the past years ICICI has been talking about a migration path to universal banking. The logic of this gradual transformation was understandable: it wanted to take one step at a time both in terms of creating banking assets and liabilities as well as fulfilling the twin reserve requirements of cash reserve ratio (CRR) and statutory liquidity requirements (SLR). ICICI Bank is buying out the assets of ICICI under the purchase method which allows the purchase ( in this case, ICICI Bank) the opportunity to
revalue the purchased asset at fair market value. This accounting practice is a godsent opportunity for ICICI Bank to bring down the level of non performing assets (NPAs) without resorting to write offs. While revaluating assets (i.e. loans) of ICICI, the bank will writedown the NPAs and drastically pare the level of stricky assets in the combined book of the new entity. This is the biggest achievement of the merger of ICICI with ICICI Bank.
14. Recent Mergers and Acquisitions in Banking Sector
HDFC Bank-Centurion Becomes Third Largest Bank; Second Largest In Branches
This is the largest merger in the Indian banking industry, a precursor to the opening up of the sector for foreign banks in 2009. The merger of HDFC Bank with Centurion Bank of Punjab (which will now renamed as HDFC Bank) is worth Rs 9,526 crore ($2.38 billion). The sector has till now seen only smaller Mergers&Acquisitions like Centurion Bank buying up Lord Krishna Bank and Bank of Punjab; or Punjab National Bank snapping up Nedungadi Bank, but this one is a big one. HDFC Bank will give one share for every 29 shares of Centurion held by its sharehloder, and that would have an economic value of close to $2.4 billion. The merged entity will also have the largest physical presence after State Bank of India, with 1,148 branches across the country. India’s second largest bank ICICI Bank will have only 955 branches. In terms of assets, HDFC Bank-Centurion will have about roughly Rs 150,000 crore, and the third largest. This is less than half of ICICI Bank (Rs 3,76, 700 crore) and State Bank Group 55
(Rs 566,565 crore). The deposits of HDFC Bank reaches Rs 120,000 crore, while advances to Rs 85,000 crore. Rana Talwar, the chief promoter of Sabre Capital which owns a controlling stake in CBoP, said that they decided to merge with HDFC Bank since a merged entity is in a better position to capitalise on the high growth Indian market. “I am not cashing out. I am becoming the shareholder of a much bigger HDFC Bank,” Talwar told media after the merger announcement in a press conference in Mumbai. Rana Talwar, who is currently CBOP chairman, will a non-executive director on the Board of the merged entity. CBOP’s Managing Director and CEO Shailendra Bhandari would be an executive director. Analysts negative However, not everyone is gungho about the HDFC Bank’s expensive buy. “I think this is just a merger for the sake of a merger. I don’t see any immediate value addition to HDFC Bank because of this,” Sejal Doshi, CEO at Finquest Securities, has been quoted as saying. Another analyst echoes his view. “I couldn’t really understand why they bought a bank like Centurion, spending a substantial amount of $2.4 billion. There is some concern on that front…Maybe they want to grow bigger before April 2009 so there’s less possibility of becoming a takeover target when foreign banks come in,” according to R K Gupta, Managing Director at Taurus Mutual Fund. Meanwhile, Morgan Stanley said the deal would not significantly alter market share in lending, retail loans and deposits and so it did not see HDFC
Bank worth more than Rs 1,565. Merrill Lynch saw HDFC Bank rising up to Rs 1,800, while Credit Suisse gave a price target of Rs 1,675.
HDFC bank acquire Centurian bank of panjabin all stock deal
HDFC Bank Ltd., India’s third-biggest by market capitalistaion, has agreed to buy another smaller private bank Centurion Bank of Punjab Ltd, in an all stock deal. This is India’s biggest banking deal yet. The boards of both banks will meet on Monday(February 25) to decide the share-swap ratio. “The two Boards have resolved to pursue the merger subject to satisfactory due diligence, a fair share-swap ratio and all the requisite statutory, regulatory and corporate approvals,” a joint statement said. Ernst & Young and Dalal & Shah have been appointed to determine the share swap ratio. Centurion Bank, controlled by Rana Talwar’s Sabre Capital, has a market capitalisation of Rs 10,600 crore ($2.6 billion). What the deal means is that HDFC Bank will become even stronger bank as it will gain 2.5 million customers, mainly in Kerala and Punjab. The merged company will have 1,148 branches (Centurion had 394 branches and HDFC Bank 754 branches), which is more than ICICI Bank’s 955. But in terms of assets, HDFC-Centurion combine would be less than half of ICICI’s, says a Bloomberg report. Ernst & Young and Dalal & Shah have been appointed to determine the share swap ratio, HDFC Bank said in a statement to the stock exchange. Interestingly, both HDFC Bank and Centurion Bank have grown through M&A in some way. HDFC Bank bought Times Bank from the media
group Bennett Coleman & Co in 2000. Centurion has bought Bank of Punjab and Lord Krishna Bank.
ICICI Bank board to take up Sangli Bank merger today
ICICI Bank Ltd, the country's largest private sector bank, is looking to take over ailing Maharashtra based Sangli Bank The board of directors of ICICI Bank will meet on December 9 to consider the proposal for amalgamation of Sangli Bank with itself, said a release from ICICI Bank. Sangli Bank has been in trouble for quite sometime. The bank's capital adequacy ratio plummeted to 1.64 per cent as on March 31, 2006, against 9.30 per cent in the previous year. The minimum requirement mandated by the RBI is 9 per cent. The Tier-I capital of the bank shrunk to 0.82 per cent (6.44 per cent), while Tier-II dived to 0.82 per cent (2.86 per cent) over the same period. It posted a net loss of Rs 29.27 crore (loss of Rs 31.31 crore) as on March 31, 2006. Net non-performing assets of Sangli Bank were at Rs 20.79 crore (Rs 34.82 crore). Sangli Bank, set up by the Raja of Sangli State in 1916, has 192 branches. The bank has a major presence in Maharashtra and thin outfits in Karnataka, Gujarat, Andhra Pradesh, Tamil Nadu, Delhi and Goa.
The proposed merger comes close on the heels of the merger of United Western Bank with IDBI Ltd. ICICI Bank was the first among several suitors to express its intent to acquire United Western Bank. For ICICI Bank, the merger will provide the much-needed expansion in branch network and boost in rural lending. The acquisition of weak banks seems to be the way to getting round the RBI restrictions on opening new branches. ICICI Bank and HDFC Bank and other private sector banks allegedly involved in the IPO scam have found it difficult to secure licences from the RBI, said a banking analyst. With the proposed acquisition, the branch network of ICICI Bank will jump from the current 630 branches to 822 branches. It recently received the RBI's nod for opening new branches and additional off-site ATMs. The bank is also keen on expanding its rural portfolio, which grew by about 70 per cent on a year-on-year basis. It can also expand its priority sector lending, said the analyst. Sangli Bank's deposits stand at Rs 2,004.23 crore (Rs 1,984.90 crore) and advances were Rs 888.29 crore (Rs 811.92 crore) as on March 31, 2006. The bank has a capital base of Rs 23.56 crore (Rs 22.30 crore). The staff strength stood at 1,923 employees as of end March 2005. ICICI Bank's scrip closed at Rs 876.70 on Friday, down from the previous close of Rs 878.20. 59
Merger of State Bank of Saurashtra with State Bank of India
State Bank of India, the country’s largest commercial bank, has kicked off the consolidation process with its associate banks. SBI has decided to merge State Bank of Saurashtra, a wholly owned associate bank, with itself. The boards of both SBI and State Bank of Saurashtra have given an in-principle approval to the merger proposal. SBI will now have to get approvals from both the Government, the majority owner of the bank holding 59.73 per cent stake, and the Reserve Bank of India. The boards of SBI and SBS met in Mumbai and passed resolutions to merge, a step that could be the beginning of the process of consolidation among public sector banks. The merger of SBI’s associate banks with itself was being considered for the past several years, but could not get through because of political opposition to mergers among public sector banks. The reason to merge State Bank of Saurashtra first is because it offers common advantages. Firstly, it is the smallest of the associate banks, which would mean the merger would be very smooth. Secondly, it is 100 per cent owned by SBI, so no outside shareholders' approval is required. Third, the bank is operating mostly in Saurashtra, where (SBI’s) network is not large, which means the new branches will be complementary and not competitive to SBI's. After the merger of all the seven subsidiary banks, SBI’s net worth would rise to about Rs 43,000 crore. ICICI Bank's net worth has doubled to over Rs 40,000 crore after its follow-on public offer, SBI and SBS would now have to complete the formality of seeking approvals from the government and the Reserve Bank of India 60
(RBI). The merger would benefit over 7,000 employees of SBS as their pay scales would rise and they would also be entitled to the third retirement benefit of pension, in addition to provident fund and gratuity overtaking SBI’s over Rs 31,000 crore. State Bank of Indore could be the next bank on the radar in the consolidation process as it is the smallest bank after State Bank of Saurashtra.
Merger and acquisition the most talked about term today creating lot of excitement and speculative activity in the markets. However, before the idea of M&A crystallizes, the firm needs to understand its own capabilities and industry position. It also needs to know the same about the other firms it seeks to tie up with, to get a real benefit from a merger. A mergers and Acquisitions activity is that the divesting firm moves from diversifying strategy to concentrate on core activities in order to improve and increase competitiveness. Globalization has increased the competitive pressure in the markets. In a highly challenging environment a strong reason for M&A is a desire to survive. Thus apart from growth, the survival factor has off late, spurred the M&A activity worldwide. Some such factors are listed below:
The company's business prospects and nature of its business The prospects for industry in which the company operates 61
• • • • • • • • • •
Management reputation Goodwill and brand value Marketing network Technology level Efficiency level in terms of employees Financial performance Future earnings The legal implications Government policy in general and in particular for that industry Current valuations of shares in stock markets The M&A game in the Indian context has already made a healthy start.
However, the structural and legal problems are adversely affecting the growth rates. Although, the government has realized this fact, it is yet to become proactive. With the entry of multinationals into the Indian markets, consolidation would be the best way to survive and to gain market share. Finally mergers and acquisitions are more common than hostile takeovers in the financial services sector. The traditional challenges of cultural differences are very much present. The values involved in mergers and acquisitions are increasing and international bank mergers and acquisitions are more often carried outside the European Economic area. While small bank mergers and acquisitions are mostly carried out for cost efficiency, large bank merger and acquisitions often have an element of strategic re-positioning.
Mergers and Acquisitions Banking Strategy Banking Financial Management Financial Management : ICFAI Book : ICFAI Book : ICFAI Book : Prasanna Chandra : I.M.Pandey
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