Corporation Bank: Hold

Recommendation: Hold

S. Vaidya Nathan

SHAREHOLDERS of Corporation Bank could considers staying invested on the heels of a major deal involving the Life Insurance Corporation of India.

The structuring of the deal could impart near-term weakness in the stock price. The possibilities of an open offer and of the interest of strategic investors, which have been among the key factors driving the stock, would have to get priced out and this could account for the weak trends in the near-term.

But the possibility of the good business volumes of LIC being routed to the bank and the generally sound fundamentals of the bank should lead to the improved valuation of the stock over a one-two year period. A key factor would be for the bank to retain its present status as a separate entity and not suffer any detrimental change in the working culture and performance parameters following the now stronger bond with LIC. Thus, it may not be a good idea to cut exposures in the stock at this point of time.

Corporation Bank is the first public sector bank where a sizeable stake in the equity has been picked up by a strategic investor. In this context, it is worth noting that financial sector majors such as the Housing Development Finance Corporation (HDFC) and the Unit Trust of India (UTI) have at various times indicated interest if the government cleared the cobwebs.

But the LIC seems to have emerged as a surprise packet. It picked up close to 13 per cent of Corporation Bank's equity from the secondary market. Now, perhaps, with a view to avoiding an open offer under the SEBI takeover code, the preferential offer route has been conveniently adopted.

This route provides for an exemption from the open offer requirements under the SEBI takeover code. Corporation Bank is to allot 24 million shares to LIC. This would raise the former's equity base to Rs 144 crore and the latter's stake to around 27 per cent.

The deal will place LIC in the driving seat. But whether it would provide for adequate premium for the significant ownership and control change may be a key factor for the stock's valuation. If the price paid by LIC is attractive and carries a substantial premium to the market price (which may have been the case if it had taken the takeover route with an open offer), then it may remove some of the concerns over the deal's structuring.

The benefits of the deal, through a possible routing of LIC business through the bank, may flow over a one-two year period. It could provide a substantial float for the bank. The bank is to be involved in a cash management system for LIC and would also distribute LIC products.

Perhaps a significant aspect of the deal may well be the access to open extension counters and ATMs in LIC offices across the country and the indication that LIC could utilise the bank's facilities for the collection of interest and dividend on securities and the payment of annuity and pension claims.

The former could enhance Corporation's Bank reach and give it a footing in regions other than the south, where its spread is not as good. This could open up business opportunities and risks. The reach factor could come at a fraction of the cost a stand-alone presence would have entailed, and this could neutralise the risk element.

These are essentially long-term positives and are unlikely to lead to a jump in valuation in the near term. For the latter, a lot would hinge on how the LIC hold, and a possible government hand through the LIC, is viewed by the market.

The perception factor may also take time to sink in. One other related factor could be some concern over how the deal places Corporation Bank on the technology front to take on the likes of HDFC Bank and ICICI Bank. In this area, not much may be forthcoming from this deal and the bank may have to work its way up the ladder.

As far as its fundamentals are concerned, the bank continues to be on a fairly sound footing. At 1.98 per cent, it has one of the lowest net NPA levels among PSUs, the cost of deposits are getting lower, the spreads are thinner at the industry level, though they have largely been maintained, and, more importantly, the capital adequacy ratio is comfortable at 13.3 per cent.

The LIC deal would mean the bank could pursue business growth comfortably, without further expansion in the equity base. The decision to focus on core and retail growth over volatile wholesale customers may also help at a time when quality credit opportunities in the corporate sector are shrinking.

But it is a competitive arena and the bank's long and strong presence, especially in the South, could come in handy. The bank posted a 14 per cent growth in revenues to Rs 2,096.6 crore and a 12.7 per cent growth in post-tax earnings at Rs 261.84 crore. The share trades at a price earnings multiple of around seven times its 2000-01 earnings per share of Rs 18.13.