The big bank merger announced by the Centre last week, has not gone down well with investors. Most of the public sector banks proposed to be merged with others, have lost 9-12 per cent on Tuesday.
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This has already eroded the Centre’s holdings in the 12 PSU Banks (forming part of the merger proposal) by over ₹6,500 crore and other public shareholders by about ₹1,800 crore, in a single day. But the worst may not be over yet.
The capital infusion proposed by the Centre at abysmal valuations and shares issued to investors of the amalgamating banks in the main bank (into which bank/banks are merged), would lead to notable dilution in the book value of the merged entity. Interestingly in some of the cases, the amalgamating banks trade at a notable premium to the main bank, which will lead to more shares being issued under the swap arrangement, resulting in further dilution. A back of the envelop calculation - assuming that the swap ratio is determined based on the market price at the time of merger announcement — suggests that the dilution in book value of the merged entity could be a sharp 20-30 per cent. Hence stock prices of these PSU Bank stocks can fall further, hurting investors in the coming months.
Capital infusion
The government, being the largest shareholder, has been infusing capital into public sector banks, year after year. But with most PSU Bank stocks trading below book value, capital infused by the government at abysmal valuations has only eroded value for investors.
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In the recent merger announcement as well, the large capital infusion at some of the banks will lead to significant dilution. For instance, if one were to assume that the Centre infuses the proposed ₹16,000 crore into PNB, (likely before OBC-United Bank merger), then given that the stock trades at a low 0.6 times book value (as of June quarter), the capital infusion (at pre-merger market price) will lead to a dilution of over 12-15 per cent straightaway.
In case of Union Bank, the Centre’s ₹11,700 crore would hurt investors even more, given that the stock trades at a low 0.4 times book. The market capitalisation of Union Bank pre-merger announcement was lower than the proposed capital infused. In other words, number of shares that will have to be issued in exchange for the capital will be more than the bank’s outstanding shares. This could lead to a steep dilution of about 30 per cent.
In case of Indian Bank (0.6 times) and Canara Bank (0.4 times), since the Centre proposes to infuse a lower ₹2,500 crore and ₹6,500 crore respectively, the dilution would be lower at 10-15 per cent.
Merger swap
But the dilution for investors does not end there. The additional shares that would be issued to investors of the amalgamating banks, will lead to further dilution in the book value of the merged entity. We have assumed that swap ratio will most likely be based on the market price at the time of merger announcement - as in the case of BOB, Vijaya and Dena merger.
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In case of OBC (trades at a slight premium to PNB) and United Bank, investors in these banks may be issued 113 shares and 16 shares respectively in PNB for every 100 shares they hold. This, alongside capital infusion could lead to about 20 per cent dilution in the merged entity over the next one-two years.
In case of Union Bank merger, the dilution would be far steeper as both Andhra and Corporation Bank that are proposed to be merged into it, trade at a premium valuation, implying more shares (about 32-34 shares for every 100 shares) to be issued under the swap arrangement. There could be a 30-35 per cent dilution in book value in this case, taking into account the substantial ₹11,700 crore capital infusion as well.
In case of Canara Bank and Indian Bank too, the dilution could be over 15-20 per cent.
LIC loses too
LIC is among the minority shareholders, that holds stakes in these PSU Banks. In PNB for instance, LIC owns 7.3 per cent stake, while in Union Bank it holds 6.4 per cent stake. In Canara Bank and Indian Bank it holds 9.2 per cent and 1.8 per cent respectively. The dilution in book value will impact LIC too. In most of these merged entities, LIC’s stake would come down significantly to 3-4 per cent. The fall in stock prices on Tuesday has already eroded about Rs 500 crore worth of LIC’s holdings in these 12 PSU Banks.