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# CORPORATE VALUATION

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INTRODUCTION

Banking in India originated in the last decades of the 18th century. The oldest bank in existence in India is the State Bank of India, a government-owned bank that traces its origins back to June 1806 and that is the largest commercial bank in the country. Currently, India has 88 scheduled commercial banks (SCBs) - 27 public sector banks, 31 private banks and 38 foreign banks. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong.

Axis bank

Axis Bank was established in 1993 and was the first private sector bank to start operations after the Government of India allowed entry of private banks. Previously called UTI Bank, Axis Bank was promoted by Unit Trust of India (UTI-I), Life Insurance corporation of India (LIC), General Insurance Corporation (GIC) and its four subsidiaries, New India Assurance Company, Oriental Insurance Corporation, National Insurance Company and United Insurance Company. The name of the Bank was changed in 2007 as there was brand confusion because many unrelated shareholder entities such as UTI Securities, UTI Technological Service and UTI Investor Services were also sharing the UTI brand. Moreover, the name was changed to connote stability and solidarity as well as was in line with the bank’s expanding operations across geographical boundaries. Staring with one branch in Ahmedabad in 1994, the bank now has 835 branches including extension networks (31st March 2009) across 30 States and 4 Union Territories. The bank also has overseas offices in Singapore, China, Hongkong and Dubai. The bank's broad products and services include consumer banking, NRI business, retail loans, corporate banking, treasury, capital markets and financial advisory services. It divides its business into five segments viz. large corporates, SMEs, agri-business, channel financing and structured products. The bank's retail assets constituted 23 per cent of total advances at the end of March 2008. Housing loans accounted for 57 per cent of total retail assets. Auto loans constituted 7 per cent of its retail loans The bank divides its advances into three focus areas i.e. agricultural, mid--corporate and SMEs. During 2007--08, the bank's agricultural advances grew by 35 per cent to Rs.5,507 crore. Its advances to SMEs reported a whopping 74 per cent growth to Rs.11,536 crore.

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The bank maintains a healthy asset quality with 81 per cent of its corporate advances having a rating of at least `A' as at the end of March 2008. The bank pruned its net stressed assets consistently from 1.92 per cent in 2002--03 to 0.36 per cent by end of 2007--08.

**Axis Bank Ltd.
**

Subsidiaries Axis Private Equity Ltd. Axis Sales Ltd. Axis Trustee Services Ltd.

Consistent growth: The bank’s net profit has grown by over 30% YoY in 36 out of the last 38 quarters. Also the two quarters in which the profit did not grow was on account of write-off of extraordinary items (G-Sec valued on mark to market basis). The net profit has grown by over 60% YoY in each of the last eight quarters. The important performance indicators such as ROA, CAR, NPA and NIM have remained strong over the last five years. Axis Bank comes very near to HDFC Bank in terms of important efficiency parameters. As can be from the table above, the share of current account saving account deposits in the total deposits (CASA) is higher in case of HDFC Bank. Also HDFC Bank scores higher in terms of margins (NIM). However, looking at the returns generated on networth (ROE) and the growth in advances and deposits, Axis Bank appears to be gearing up well to reduce the gap existing in the margins as well as the total balance sheet size. Expanding footprint, expanding balance sheet: The bank has continued to expand its geographical coverage across the country. Over the last five years, the total number of branches including extension centers of the bank has increased from 339 in FY05 to 835 in FY09 whereas ATMs have increased from 1,599 to 3,595. Also during Q1FY10, the bank added 26 new branches including extension centers and 128 ATMs. This has helped the bank particularly in the acquisition of low cost retail deposits, retail assets, lending to agriculture, SME and midcorporates as also the sale of third-party products. The bank’s balance sheet has increased at a CAGR of 43.65% over the last five years Key Positives

• • • • • •

Market leadership position in the travel card segment Market leader in the prepaid cards segment Second largest merchant acquirer in the country Leadership position in private placement of bonds and debentures till 31st December 2008 High quality of its assets The Bank’s Non-Performing Assets (NPAs) are among the lowest in the industry.

Post its rebranding exercise in 2007 the bank has continued to do well and the change in name has not affected the bank’s business. In fact in FY2008 it saw its customer acquisition grow at a robust rate of 67% over the last year to over 9.9 million customer accounts

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OBJECTIVES

This project was undertaken to perform corporate valuation of Axis Bank. It report focuses on the following objectives

1. To ascertain the price per share of Axis Bank, through the technique of DCF valuation. 2. To ascertain the Firm value of Axis Bank , through DCF valuation 3. To determine the Equity multiples of Axis Bank using Relative valuation approach. 4. To interpret and comment upon the deviation of calculated values from the actual values, if any.

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METHDOLOGY

A. DCF Valuation

The valuation of AXIS Bank is done using the DCF valuation approach. In this approach two separate models were used for calculation of value of equity and Value of firm, using FCFE and FCFF concepts respectively. The DCF valuation was done using the three-stage model. 1. Choice of market proxy: BSE 500 Index:

Bombay Stock Exchange Limited constructed a new index, christened BSE-500, consisting of 500 scrips w.e.f. August 9, 1999. The changing pattern of the economy and that of the market were kept in mind while constructing this index. BSE-500 index represents nearly 93% of the total market capitalization on BSE. BSE-500 covers all 20 major industries of the economy. In line with other BSE indices, effective August 16, 2005 calculation methodology was shifted to the free-float methodology. Base Year Base Index Value Date of Launch Method of calculation 1,February,1999 1000 9,August,1999 Launched on full market capitalization method and effective August 16, 2005, calculation method shifted to free-float market capitalization.

Number of 500 scrips

2. Market returns (Rm): The market returns were calculated by taking the average 365 days index returns of the market proxy, BSE 500, over a period of 8 years. It is calculated by taking the average of the historical market return. 3. Risk free rate (Rf) : Rf = risk free rate of 365 day T-bills The value of 364 day T-bills was ascertained from the RBI website. The value was 4.5%. Source : Reserve bank of India (http://www.rbi.org.in/home.aspx )

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4. Historical Beta : Beta is a relative measure of market risk. Beta of the company reflects the change in returns of the company share viz-a-viz that of the market. Historical beta was calculated using regression on the respective returns of the share of Axis bank and that of BSE 500. The time period was of 5 years, from April 04 to March 09. The 30 days average daily returns were taken for this purpose. 5. Cost of equity (Ke) : Cost of equity reflects cost to the company and the minimum expected returns to the share holders. Ke of the extraordinary growth period is used as the discount rate for calculation of present values. Cost of equity was calculated using the CAPM (capital asset pricing model) Ke = Rf + (Rm – Rf) * B Where, Ke = cost of equity

RM =

market proxy return (average) .The market proxy chosen in this case was BSE 500. β = Levered beta of Axis Bank.

Rf = The expected risk-free return in that market (government bond yield) (RM-Rf) = The risk premium of market assets over risk free assets.

6. Cost of debt (Kd): It reflects the minimum interest rate to be paid for holding that debt. The after tax cost of debt was calculated using the formula: Pretax cost of debt = interest expense / Debt Kd = pretax cost of debt * (1-tax rate) The tax rate used was equal to 33% which is the current rate of corporate tax. 7. Cost of capital (Ko): The cost of capital is an expected return that the provider of capital plans to earn on their investment. The cost of capital was calculated using the WACC method. Ko = We*Ke + Wd*Kd Where, We = equity ratio E / (D+E) Wd = debt ratio D / (D+E) 6

8. Reinvestment rate (RR): It is the rate at which cash flows from fixed-income securities may be reinvested. Equity reinvestment rate = (net capex + change in working capital) * (1-(D/(D+E)) / PAT Capital reinvestment rate = (net capex + change in working capital) / EBIT (1-t) t = 33 % 9. Return on equity ROE : This measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity. ROE shows how well a company uses investment funds to generate earnings growth. ROE= PAT / BV of equity (this value was taken directly from Prowess) Return on capital employed: Return on Capital Employed (ROCE) is used as a measure of the returns that a company is realising from its capital employed. ROCE compares earnings with capital invested in the company. It takes into account sources of financing. ROCE= EBIT (1-t) / capital employed (this value was taken directly from Prowess) 10. Calculation of expected growth rates. The growth was calculated as: Fundamental growth rate: The fundamental growth rate is the sum of growth due to investment and growth due to operational efficiency of the company. FCFE G = equity reinvestment rate * ROE + ((ROEn – ROEn-1)/ROEn-1) FCFF G = capital reinvestment rate * ROCE + ((ROCEn – ROCEn-1)/ROCEn-1) Y-O-Y growth rate: The yoy growth rate was calculated using G= (PAT n+1 –PAT n) / PAT n • Note: Since, there was a considerable difference between the fundamental growth of axis bank and the Y-O-Y growth in PAT, the average of both was taken to arrive at the total growth to be used for calculation purpose.

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11. Free cash flow to equity FCFE : This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment. FCFE = PAT

- (net capex + change in working capital) * (1-(D/ (D+E))

Free cash flow to firm FCFF: This is a measurement of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial health. A positive value would indicate that the firm has cash left after expenses. FCFF = EBIT (1-t) - (net capex + change in working capital) 12. Terminal value TV: This is the value of the free cash flows at the end of the time period consider for valuation. This TV is the value at the end of the transition period when the stable stage of growth begins. TVn = FCFEn+1 / (Kest-Gst) TVn = FCFFn+1/ (Kost – Gst) 13. Three stage model for valuation. The three stage model of DCF valuation was applied because the firm is currently in the extraordinary growth phase. There are following stages in this model : Extraordinary growth Phase: From 2010-2014 The time period for extra ordinary growth was taken to be 5 years because of the following plans of the company: i. Expansion plans: Axis Bank has aggressive plans to expand its branch network and advance its extension counters to branches in South India.

(Source: http://www.rupeetimes.com/news/personal_loan/axis_bank_to_spread_out_its_wings_in_south_i ndia_1951.html ) Axis Bank gets RBI approval for asset management company Axis Bank Ltd has received the Reserve Bank of India’s (RBI) approval to set up an asset management company (AMC) that will allow it to offer products such as mutual funds.The bank is also exploring the options of entering the broking business. (Source: http://www.livemint.com/2008/06/28004557/Axis-Bank-gets-RBI-approval-fo.html ) iii. As part of its strategy of building the organic growth engine, the Bank continued to enlarge its geographical coverage of centers with potential for growth, including district headquarters and other Tier II cities and towns across the country. This has 8 ii.

helped the Bank particularly in the acquisition of low cost retail deposits, retail assets, lending to agriculture, SME and mid-corporates as also the sale of third-party products. During the year, 176 new branches were added to the Bank's network (including 12 extension counters that have been upgraded to branches), taking the total number of branches and ECs to 835 as on 31.3.2009 (against 671 branches and ECs in the previous year). Of the 827 branches, 230 branches are in semi-urban and rural areas. With the opening of these offices, the geographical reach of the Bank now extends to 30 States and 4 Union Territories covering 515 centers. During 2008- 09, the Bank opened 831 ATMs, thereby taking the ATM network of the Bank from 2,764 to 3,595. (Source: annual report – 2009 axis bank ) Transition phase: From 2014 - 2020

In this phase the growth rate gradually declines to reach the stable stage growth rate. Since the firm was in high growth a transition period of 6 years was taken. Stable phase: 2021 and onwards The growth rate for stable stage was taken to be 16 %. This rate was chosen after careful study of the growth rate in GDP of India and the growth rate of Indian banking industry. India GDP 2020 "Our baseline projections for India's potential output growth show that the economy can sustain growth rates of about 8 per cent till 2020, significantly higher than the 5.7 per cent that we projected in our original BRICs paper," Goldman Sachs said in a new economic paper released on Tuesday. Source: rediff news (http://inhome.rediff.com/money/2007/jan/23india.htm) For the stable stage Ke was calculated using debt-equity ratio of 1.45, which is the current D/E ratio of SBI which is considered to be a mature bank, having stable growth rate.

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B. Relative Valuation

Relative valuation is a generic term that refers to the notion of comparing the price of an asset to the market value of similar assets. The most common methodology for individual equities is based on comparing certain financial ratios or multiples, such as the price to book value, price to earnings, etc., of the equity in question to those of its peers. Relative valuation gives the comparable market value of the stock. Steps in relative valuation: 1. Finding comparable assets prices by market (listed) 2. Market price of comparable assets is standardized using a common variable (P/E, P/B, P/S…) 3. Adjusting for differences in the characteristics of comparable companies and companies under valuation. Equity Valuation of AXIS bank: The coefficients were calculated by running regression on the comparable firms in the financial services sector. After filtering, 84 comparable firms were obtained. 1. Calculation of multiples of comparable firms P/E : Price to earnings ratio The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. P/E ratio = Price per share / EPS P/B: Price to BV ratio The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's book value to its current market price. A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal (and/or that the market value of the firm's assets is significantly higher than their accounting value). P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders. P/B ratio = Price per share / BV per share Note: the P/E and P/B multiples values of comparable firms were taken directly from prowess. 10

P/S: Price to sales ratio Price-to-sales ratio is a valuation metric for stocks. It is calculated by dividing the company's market cap by the company's revenue in the most recent fiscal year (or the most recent four fiscal quarters); or, equivalently, divide the per-share stock price by the per-share revenue. P/S = price per share / sales per share Note: the P/S values of comparable firms were calculated using formula P/S = (NPM* (1+g)* (payput ratio)) / (ke-g) Where; NPM = net profit margin 2. Calculation of multiples of AXIS Bank The equity multiples of AXIS Bank were calculated using the following equations: • • • P/E = a + b1 (payout ratio) + b2 (g) + b3 (beta) P/B = a + b1 (payout ratio) + b2 (g) + b3 (beta) + b4 (ROE) P/S = a + b1 (payout ratio) + b2 (g) + b3 (beta) + b4 (NPM) Where; a = intercept b1, b2, b3, b4 are the coefficients whole values were calculated through regression on the values of comparable firms.

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DATA ANALYSIS

1. Beta calculation The beta was calculated = 1.019, for the extraordinary growth period.

Coefficie nts 0.09266 2 1.01958 3 Standa rd Error 0.0585 24 0.1275 29 t Stat P-value 1.5833 0.1187 18 87 7.9949 6.25E36 11

Intercept X Variable 1

Regression Statistics 0.72406 Multiple R 8 0.52427 R Square 4 Adjusted R 0.51607 Square 2 Standard 0.44945 Error 3 Observations 60

beta calculation B (l) = B(u) = new beta B(l) = 1.01958 3 0.4698

old D/E = t=

1.52 0.33

0.994

new D/E = We = Wd =

1.45 0.408 0.592

Note: • Due to unavailability of sufficient information, the new beta for stable stage was calculated assuming that the firm will reach the beta of a mature bank, State Bank of India. • SBI is a mature bank which has been maintaining a D/E ratio of 1.45 (source: Prowess) over the years. • We have assumed that Axis bank will also maintain a similar D/E ratio in the stable stage. 12

2. market returns

year

365 Days Index Returns

2002 2003 2004 2005 2006 2007 2008 2009 Rm Rf =4.5 Rm-Rf = 17.08

2.15 -8 107.38 21.89 65.17 9.81 17.04 -42.77 21.58375

3. Table showing the values of Ke, Kd, Ko For extraordinary period cost of equity (Ke) After tax cost of debt (Kd) Cost of capital (Ko) For stable stage cost of equity (Kest) After tax cost of debt (Kdst) Cost of capital (Kost) Note : • • The tax rate for the stable stage was assumed to increase to 40 %. The market returns Rm and risk free rate Rf were taken at the current rate. values 0.219 0.308 0.273

21.486 27.6 25.10

4. DCF Valuation Free Cash Flow to Equity Growth In Extraordinary Pd Growth in stable stage Equity Reinvestment Rate = = = 0.331336616 0.16 0.9410

Note: • The equity reinvested rate is expected to gradually decline in the transition phase to reach 60 % in the stable stage. • The extraordinary growth rate will also decline gradually in the transition phase to reach 16 % in the stable stage. 13

Value during extraordinary growth period Value during transition period Terminal value PV terminal value Total value of equity Number of Shares outstanding Price per share =

= = = = = =

Rs. 536.11 Rs. 4562.233 Rs. 239128.5054 Rs. 27031.70455 Rs. 32,130.04 crore. 359046415

Rs. 894.87 (as calculated from DCF valuation) = Rs. 917.60 (As on August 28, 2009)

Current Price of AXIS Bank share Source: BSE 5. Free cash flow to firm Growth in Extraordinary Pd Growth in stable stage Reinvestment Rate

= = =

0.3265 0.16 0.5249

Note: • The capital reinvestment rate is assumed to decline gradually in the transition phase to reach 35 % in the stable stage. • The growth rate is also expected to decline gradually from the extraordinary rate to 16 % in the stable stage. Value during extraordinary growth period Value during transition period Terminal value PV Terminal value Value of firm = = = = = Rs. 14,659.52 Rs. 26112.951 Rs. 772834.2349 Rs. 54304.76735 Rs. 95,077.24 Crore.

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6. Relative Valuation Axis Bank Payout Ratio Expected ROE NPM Beta Expected Growth Rate = = = = = 0.232 0.994 0.16 0.1348 0.132745

Regression results of the comparable firms. P/E Intercept payout ratio expected growth Beta 16.66732 24.43401 30.24624 -10.8502 P/B Intercept Beta payout ratio ROE -1.1755 -0.00498 2.230254 14.50742 P/S Intercept payout ratio expected growth Beta NPM Result: P/E = = P/B = = a+b1 (payout ratio) +b2 (g) +b3 (beta) 16.4 a+b1 (payout ratio) +b3 (beta) +b4 (ROE) 1.3 2.245473 2.312498 33.58591 -6.50357 8.128086

Note: In the calculation of P/B ratio, the regression was conducted only on the values of payout ratio, beta and ROE. The growth was discarded from the regression because of the phenomenon of Multicollinearity. Multicollinearity is a statistical phenomenon in which two or more predictor variables in a multiple regression model are highly correlated. In this situation the coefficient estimates may change erratically in response to small changes in the model or the data. Multicollinearity does not reduce the predictive power or reliability of the model as a whole; it only affects calculations regarding individual predictors. P/S = = a+b1 (payout ratio) +b2 (g) +b3 (beta) +b4 (NPM) 2.8

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RESULTS

DCF valuation The results of the DCF valuation show that the share of the Bank is fairly priced. There is some variation of the actual price from the price calculated from the model. The firm value of Axis Bank comes out to be Rs. 95,077.24 Crore.

DCF valuation Price per share Relative valuation P/E P/B P/S

Calculated values Rs. 894.87 16.4 1.3 2.8

Market values (current) Rs. 917.60 18.18 2.94 0.6495

The value of P/E is closer to the actual value.

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CONCLUSION

Knowing what an asset is worth and what determines that value is a prerequisite for intelligent decision making – in choosing investment for a portfolio, in deciding on the appropriate price to pay or receive in a takeover, and in making investment, financing and dividend choices when running a business. From this exercise of corporate valuation of Axis Bank it was found out that the current price of share of Axis Bank is more than what was calculated from the DCF model. The calculated P/E ratio of Axis Bank is lesser than the current market P/E ratio. Both these results show that the share of Axis Bank is over valued.

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BIBLIOGRAPHY

1. Damodaran on valuation By: Aswath Damodaran 2. www.bseindia.com 3. www.finance.yahoo.com 4. www.wikipedia.org 5. www.business-standard.com 6. Prowess database.

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