Shriram group merger deal: What it means for investors

Last week, Shriram Transport Finance Corporation (STFC) and Shriram City Union Finance (SCUF), announced their merger with their holding company Shriram capital (SCL) . Post announcement of the proposed merger, the stocks of the listed entities --- STFC and SCUF fell 15.2 and 8.5 per cent, respectively, over the past week. While the management expects to draw synergies out of the merger—through cross-selling and reduced cost of funds for the larger (merged) entity, investors are not fully convinced. Even rating agencies have raised some concerns, given the different risk segments the two listed entities operate in and believe the differing underwriting skills required may not be conducive for the planned synergies.

While STFC’s shareholders may benefit from improving metrics of the merged entity and elimination of business cyclicality, the operational metrics are not so favourable from SCUF’s perspective. For SCUF’s shareholder, merging with a commercial vehicle finance provider may lower the return ratios.

The deal

SCL that currently holds 26 and 33.9 per cent stake in STFC and SCUF respectively, will be merged into STFC – being renamed as Shriram Finance. The unlisted holding company will get a 1:1 swap for its holding in STFC. The new entity will continue to hold 85 per cent stake in Shriram Housing Finance (currently the subsidiary of SCUF) and 44.56 per cent stake in Shriram Automall India (curently an associate of STFC). Other businesses of the holdco (SCL) (Shriram General Insurance, Shriram Life Insurance, Shriram Credit Company, etc), will be demerged as separate unlisted entities. The entire deal is, however, subject to approvals from shareholders, SEBI, IRDA, RBI, CCI, NCLT, RoC , etc and is expected to be completed by October/November 2022.

As per the swap ratio, for every share held in SCUF and SCL, shareholders will be issued 1.55 and 0.097 shares of STFC respectively. . The management expects to incur a cost of acquisition of about Rs 400 crore – including stamp duty, HR costs and branding costs .

Synergies unclear

The management expects the merger to drive a bottom-line growth of 10 per cent immediately and 12 per cent in the subsequent year. However, the synergies envisaged come with challenges aplenty.

One, on an existing asset base of ₹1.5 lakh crore (AUM of merged entity), the management expects cross-sell capabilities to drive further growth. However, given the different target segments in which STFC (commercial vehicle financing) and SCUF (serving retail underbanked segments) currently operate in, cross-sell opportunities with current product offerings may be limited, in our view. However, the management has guided towards adding other product verticals such as supply chain financing, freight discounting, LAP, etc, in due course of time, and it is too early to decide on the fate of these new verticals. With this the management expects to sell at least two products per customer by FY24.

Two, the existing differences in underwriting for the different focus verticals may not be easy to collaborate on. The management also envisages to leverage its tech platform, which is untested in the CV financing space, given its usual dependence on manual underwriting. This could lead to potential risks in asset quality, going ahead . Further, while on one-hand STFC’s business cyclicality could be eliminated post the merger with SCUF, cross-selling retail/ SME loans to existing customers (fleet operators), could intensify the risk of bad loans .

Three, the management also expects an upgrade in its credit rating for the larger merged entity, which in their view could bring down cost of funds by 30-50 basis points (bps). However, this seems contradictory given the asset quality risks and reduction of promoter holding (to just about 20 per cent in the merged entity), which may act as overhangs on the existing credit ratings. For instance, rating agency Fitch in a recent note, highlighted that STFC’s credit ratings benefit from its 30 per cent market share in used-CV financing, which may now be dented with addition of SCUF’s assets (that lacks any significant market share in any of its product segments). Besides, Fitch views the blended asset-quality profile of the merged entity to be weakened, although the pro-forma GNPA numbers appear similar.

Having said that, the management also seeks to benefit from the digital ramp up on retail deposit mobilization and reduction in excess liquidity, which could help fillip the net interest margin to an extent.

Basis the proforma numbers of the merged entity, STFC is expected to benefit from a 40 bps increase in overall return on assets (RoA). From SCUF’s perspective the merged entity’s RoA is 70 bps lower than its existing RoA of 3.1 per cent. Even in terms of capital adequacy and non-performing loans, STFC seems to gain from superior metrics of SCUF (see table). This explains the 13 per cent premium being paid to SCUF’s shareholders (basis swap ratio), considering close price of December 10, 2021.

While near-to medium term operational difficulties remain for the merged entity, the only sure-shot benefit would be its large size. This coupled with the reduced promoter holding could help in acquiring a bank license for the merged entity.

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