The Hindu Business Line : Yes Bank: Invest at Rs 45

YES BANK is making losses, and as at end-March 2005 its low-cost deposits were a mere Rs 10 crore. It is, however, asking investors to pay a multiple of 2.25 times the post-offer book value. It plans to debut in the capital market with a capitalisation of Rs 1,200 crore, which is higher than that of many old private sector banks with decades of existence. The pricing and the aspirations of the promoters seem to reflect the potential embedded in the financial services business. There is much potential for branded banking entities to gain by tapping into the expected growth in India and capturing the market-share of less brand intensive outfits.

Thus, investing in the initial public offer of Yes Bank at Rs 45 makes sense. The pricing largely precludes the possibility of large post-listing gains. But the risk involved is also high.

There is the possibility of the bank expanding and gaining market share even as profitability continues to remain under stress. Still there exists, however small the probability, potential for big gains over the next three years.

Also, the success of the initial public offer at the higher end of the price band appears good. In this backdrop, investment at Rs 45 is recommended.

Rationale for investment

Yes Bank is capitalised at about Rs 215 crore; not counting the public offer. The offer of seven crore shares at Rs 45 apiece would enhance the capital to about Rs 530 crore.

If one assumes a return on net worth of 15 per cent on this capital, it works out to an EPS (earnings per share) of about Rs 3. The derived PE multiple of 15 is attractive considering that a young bank such as this can grow at 15 per cent for another 3-4 years. Is the assumption of a return on net worth of 15 per cent realistic? For major brand-driven private sector banks such as ICICI Bank and HDFC Bank it is about 19 per cent. Kotak Mahindra, one of the younger banks, has a return on net worth of about 14 per cent.

ICICI Bank and HDFC Bank are much larger banks and benchmarking against their returns on net worth may not be appropriate.

Comparison with Kotak Mahindra would be more appropriate though it has been in the financial services business for close to two decades. In 2005, Kotak's return on net worth was dragged down by losses from insurance business and treasury operations as well as lower returns from the primary dealer and NBFC businesses. Thus, the expected return on net worth from a pure commercial bank in the initial years of business could well be pegged higher.

Yes Bank, however, has to face intense competition from established peers which will pull down profitability. The bank's strategy, which seems to have factored in the effect of competition, also does not lend itself to expectations of higher return on net worth.

Focussed approach

Yes Bank is focussing its energies on a particular region, the North and the National Capital Territory of Delhi, and on specific industries — food and agriculture, life-sciences, technology, retail and engineering.

The focus on the North appears to be well thought out. Of the four regions, the urban sectors in the West and the South are `over banked' and are choc-a-bloc with both private and foreign banks. This approach also seems perfect for a bank trying to make a mark in intermediation in the food and agriculture sector.

But the urban areas in in the North, too, are over-banked. Any increase in industrial and agricultural growth here will activate the competitive energies of not only the large number of public sector banks but also the larger private banks hungry for business and with a lot of unused capital on hand. So, expecting returns of more than 15 per cent do not appear realistic.

The bank has sought to recruit people with impressive performance track record mainly from the private sector and foreign bank space. Though this increases the probability of success, it does not come cheap. The bank has also opted for the lower capital consuming, but higher cost, strategy of technology outsourcing. These factors, too, militate against the assumption of higher returns.

A return on net worth of 15 per cent, however, appears achievable even with below industry average profitability margin. Even at a normal return of 15 per cent, the offer price is attractive.

Strong credentials

Expectations of a 15 per cent return are not farfetched. A team with years of experience in international and local banking, intent on building a large bank from scratch, has promoted the bank. Rabobank International Holding, Ashok Kapur and Rana Kapoor are the founders of the bank. Both Ashok Kapur and Rana Kapoor have been involved in the international and Indian operations of foreign banks.

The bank has also attracted investments from high profile venture capitalists such as Citicorp and ChrysCapital.

Rabobank is a Netherlands-based outfit with a strong focus on rural banking and has a presence in 37 countries. It also has a non-banking finance company Rabo India in which Ashok Kapur was managing director earlier. Rabo India focuses on corporate and structured finance for the Indian market. The offer document has, however, not identified Rabobank as a promoter although it would hold 20 per cent of the post-offer capital.

Despite the high risk involved, the record of the bank's investors and that of Rabo Bank should inspire confidence. If growth in the Indian financial services market pans out as expected, then investors with a long-term outlook can expect reasonable returns from this offer. And with some luck, such investors can even hope for high returns.

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