After the MD & CEO of Axis Bank Shikha Sharma asked the board to cut short her tenure, it could be the right moment for Uday Kotak promoted and led-Kotak Mahindra Bank to make a bid for the private lender.
Nomura Securities’ research analysts say that with a very short time left in Sharma’s term, RBI’s pressure on Axis Bank’s management, and with an asset quality clean-up exercise, this is the best opportunity for Kotak Mahindra Bank.
“We believe this presents a great opportunity for Kotak Mahindra Bank to acquire one of the largest liability/retail asset franchises,” Nomura analysts Adarsh Parasrampuria, Amit Nanavati and Riddhi Jain say in an April 10 note – Kotak’s best chance to merge Axis Bank.
“In case of M&A, the deal would be highly earning per share (EPS)/book value per share (BPS) accretive for Kotak Mahindra Bank even after paying meaningful premium to Axis Bank shareholders,” they add.
For Axis Bank, there would be limited pushback for any merger, given the loss of confidence that the regulator has expressed by not approving the renewal of the CEO’s term and a vacuum in top management, the analysts say. As for Kotak Mahindra, it is a good time, as Axis Bank has ramped on the NPA recognition process.
“We believe the majority of the bad news is now known,” Nomura says. “Since the time of the last merger talks,” Kotak Mahindra Bank’s stock has outperformed Axis Bank’s by nearly 30%, making the acquisition more reasonable.”
This would be a win-win for Kotak Mahindra Bank on multiple grounds. While the Axis Bank’s possible merger would gain liability and retail asset size enough to rub shoulders with HDFC Bank, even from the promoter’s perspective, the Nomura analysts believe that this should aid in diluting the promoter’s stake down to RBI’s requirements.
Prime facie, a merger would make Kotak + Axis Bank combined a close second largest private bank after HDFC Bank in terms of advances and also absolute current account and savings account (CASA), and largest in terms of number of branches. As of December 20178, compared to 4,860 and 4,734 branches each of ICICI Bank and HDFC Bank, a possible merger of Axis Bank (with 3,589 branches) and Kotak Mahindra Bank (with 2,171 branches) would add the total number of branches up to 5,760.
Similarly, the low cost CASA tally could also change substantially.
Currently, HDFC Bank is the leader in the private banks’ space with CASA worth over Rs 3.07 lakh crore, as of December 2017. In event of the merger, the bigger entity would command CASA worth over Rs 2.86 lakh crore (Axis Bank: Rs 2.02 lakh crore and Kotak Mahindra Bank: Rs 84,386 crore).
This would put ICICI Bank at the number three slot.
The Nomura analysts also point out that qualitatively, while Axis Bank’s loan book will require some clean-up related provisioning, the recent capital raise by Axis Bank and excess capital levels at Kotak Mahindra Bank would aid the clean-up.
“A combination of franchise/reach of Axis Bank and underwriting/leadership of Kotak Mahindra Bank would make it one of the largest and best private banks,” the trio point out.
The Nomura analysts’ projections on the financials around a possible merger, estimate that in FY2020 (year of normalised credit costs for Axis Bank), the combined entity would generate return on assets (ROAs) of 1.7% and return on equity (ROEs) of 15.5-16%. At current prices, the trio estimate that the deal would be +40% accretive to the earnings per share and book value per share of Kotak Mahindra Bank. “This should make it possible for Kotak Mahindra Bank to offer some premium to
Axis Bank shareholders to make the deal attractive to Axis Bank minority shareholders,” the Nomura analysts note. “The deal would be +25% accretive for Kotak Mahindra Bank even after paying a 10-30% premium for Axis Bank.”
Separately, Nilanjan Karfa and Harshit Toshniwal, both Mumbai-based equity analysts with broking firm Jefferies point out that the Axis Bank board will have to find a replacement soon.
“We hope the new person is an outsider, allowing fresh thoughts and strategy and to reestablish old links and rebuild credibility with investors,” the duo noted. “We are positive on the bank’s improving fundamentals and believe this event is an additional catalyst.”
The Jefferies’ analysts believe that one of the first challenges, among others, for the new CEO will be to re-establish credibility with investors. “Across our investor meetings for the past few years the one thing that was common was that large percentage of investors were a little hesitant to be optimistic on Axis Bank versus banks of similar characteristics - the inherent fear was that NPL ratios could increase sharply,”they said.
However, Jefferies continues to be optimistic about Axis Bank with a positive outlook for the stock.
The duo points out that the stock has corrected 11% in the last three months compared to nearly 3% correction in the NIFTY 50. The duo also believes that this captures a fair amount of bad news in the Mar’18 quarter (to be reported on 26 April). “If indeed the bank undertakes a clean-up exercise, we believe the H2FY2019 outlook and beyond should improve dramatically,” they add.
Clearly, an Axis Bank shareholder could remain invested in order to gain in the coming time. And, a merger with Kotak Mahindra Bank could just be icing on the cake.
