Shriram Group and IDFC Bank recently announced that they have commenced talks to assess the possibility of merging the two entities.
IDFC Bank Ltd is part of the IDFC group, which was recently awarded a universal banking licence by the Reserve Bank of India (RBI). The bank started operations in 2015.
The back story
The Shriram Group, founded by R Thyagarajan as a chit fund 40 years back, is now a ₹50,000-crore non-banking financial institution (NBFC) powerhouse. The holding company, Shriram Capital, has two primary operating companies listed on the stock exchanges — the used truck financing business organised under Shriram Transport Finance Company Ltd (STFC), and the consumer and small enterprise finance firm, Shriram City Union Finance Ltd (SCUF).
Having grown enormously in the last four decades, the Shriram group has been struggling with the succession issue. The question on everyone’s mind was who, after Thyagarajan?’. He was instrumental in growing a company that is highly trusted, and strong on ethics.
This forced Thyagarajan to bring in Ajay Piramal and the Piramal group, which steadily increased its shareholding in the Shriram Group. There were a number of reasons for this — Ajay Piramal’s status as one of the most shrewd deal makers in the country; his standing as a philanthropist impacting the country on a large scale, as well as a meeting of minds given his value systems.
Currently, the Piramals hold 20 per cent of the equity in Shriram Capital, of which Ajay Piramal is the Chairman. Other shareholders are an employee-focused ownership trust that holds 45 per cent; Sanlam (the South African Insurance company) holding 26 per cent, and TPG capital, a private equity investor holding 9 per cent.
The Piramals
Piramal Enterprises Ltd, flagship company of the Piramal group, is into pharmaceuticals, healthcare, financial services and information management. Its financial services business has been growing very aggressively over the last few years, significantly beating industry benchmarks.
Both the Shriram Group and the Piramals have an ambitious goal of makingtheir NBFCs universal banks, which is a natural progression.
The merger
While there are a number of ways in which the merger structure could evolve, one thing is clear: whichever way it goes, it is bound to be complicated! At this point in time, Piramals’ financial services business is not part of the Shriram group-IDFC merger scheme.
The proposal will most likely be to merge the consumer arm of Shriram Group, that is SCUF, with IDFC bank to form a merged commercial bank. The former’s transport financing businesses, primarily the STFC, will likely become a wholly owned subsidiary of the merged bank and continue to remain as an NBFC. The life and general insurance businesses of the Shriram group may likely be bunched under STFC.
For Shriram Group
This merger will serve three basic objectives for the Shriram Group.
~ First, moving the company from an NBFC status to a universal bank is the ideal way forward for a growing company. With the Piramals more or less running the company with a 20 per cent shareholding, they would like to see aggressive growth in the medium to long term.
~ Second, in the short term, SCUF’s retail and small customer base is expected to complement IDFC’s large corporate clientèle, primarily wholesale, thereby positioning the bank across diverse segments, and giving it adequate opportunities to cross-sell financial products and services, and to tap into the various cost-saving synergies.
~ Third, this also meets the aspirations of the Piramal Group, whose NBFC business, which serves large customer accounts, can be absorbed into the IDFC-SCUF operations. However, Ajay Piramal is of the opinion that it does not make sense to integrate this business right away, as cultural differences could weigh down the possibilities of achieving the targeted aggressive growth in the short term.
Of course, such integration may become inevitable in the longer run, subject to regulatory restrictions.
For IDFC
For IDFC Bank, this could provide instantaneous scale and bring into its fold the largest NBFC company in country, along with its small and retail clientèle accounts, spread across second-tier and third-tier cities. It will also bring with it the associated loan book —something IDFC will value highly, given its early years of operations.
Since the banking penetration in the country is quite low, the next three to five years is likely to see significant growth. Today, with around 150 commercial banks, and around 1.1 lakh branches, the population served per branch in India is still close to around 12,000, which is grossly inadequate to meet the people’s social and financial aspirations, and deepen financial inclusion. Which means a large part of the population still remains under-banked, or unbanked.
Such opportunities lay the ground for this merger. Shareholders of both companies see quite a bit of unlocked value, and will go all out for the merger. At the same time, the deal seems extremely complicated and difficult to understand.
The complications
Given the proposed structure of the merger, agreeing on the valuations and the swap ratio can be daunting, and achieving the same without compromising the interests of the minority shareholders will be challenging.
Since the Shriram Group has some unlisted entities, the structure and valuations could become more cumbersome and difficult to understand.
More importantly, the Piramals want to run the transport finance operations of STFC, an NBFC, in parallel with the merged banking operations of IDFC and SCUF. They too have a vision of merging their own financial services business into the bank, albeit at a later stage. This could pose some challenges, especially from the regulator’s viewpoint.
Culturally, a number of issues are prominent. IDFC Bank only recently transformed from a infrastructure financer to a commercial bank. Shriram is now changing from an NBFC to a commercial bank as a part of this merger. Bringing both the groups together will throw up a number of cultural contradictions that need to be systematically ironed out, while at the same time, seamlessly running the day-to-day operations.
Regulatory restrictions
In the past, although the RBI has given out a few licences for universal banks, payment banks and small finance banks, it has largely kept large corporate groups away from such banking licences. Corporate groups cannot own more than 10 per cent, either directly or indirectly.
Given such regulatory restrictions, Piramal has indicated that it is open to regulatory suggestions and will play by the book, with the single sole objective being the synergies this transaction brings to the shareholders of both Shriram Group as well as IDFC. The discussions have now commenced, but the deal eventually needs RBI approval.
Since the merger announcement, the share prices of both STFC and SCUF have dropped significantly. Given the complexities, the managements of both IDFC and Shriram Group need to clearly communicate to the market and to the regulators, the virtues of the merger and show precisely how the minority shareholders will stand to benefit. Designing a merger structure and shareholding pattern in line with the RBI regulations is also equally important.