Profit of combined entity will start looking up 36 months from now, says Rajiv Lall
Mumbai: After the failed attempt to merge Shriram group with itself, Rajiv Lall of IDFC Ltd is now looking to merge Warburg Pincus backed non-banking finance company Capital First with IDFC Bank. Private equity fund Warburg Pincus will pare its shareholding to a little over 10% from 36%, and V. Vaidyanathan, managing director and chief executive of Capital First will reduce his stake to around 3.5%. With this deal, Lall hopes to leverage on Capital First’s customer base of 3 million customers and grow a profitable retail business over the next few years. Edited excerpts from an interview:
How much time would you require for all the regulatory processes to be in place?
This is an 8-9 month process. We would require regulatory approvals from Reserve Bank of India (RBI), Securities & Exchange Board of India (Sebi), Competition Commission of India (CCI). Then have to navigate it past National Company Law Tribunal.
When did the conversation with Capital First begin?
It got done in two months. It’s not very complicated. I had looked at it a year ago. At that time, it was not feasible because the promoter of Capital First owns such a large share of it that any post merger or acquisition of ownership shares would have been way in excess of what the RBI stipulated maximum ownership should be. Coincidentally as it happened, Warburg Pincus sold a considerable chunk of ownership in Capital First in October. Whenever exclusivity period with Shriram expired, this was a natural thing for me to do. So, I reached out to them.
This deal with Capital First is much simpler and less complex?
The valuations are such that all the regulatory requirements are met. So, we need to take regulatory dispensation from RBI. We have been looking for a retail head for a long time. We have hit all the right buttons.
Wouldn’t it have been better to hire more people to head the retail business?
The other consideration is that by October this year, IDFC would have had to reduce its ownership in IDFC Bank from 54% to 40%. How would one achieve that? If IDFC were to sell 14% in the market, we would have created an overhang in the market. It would have been terrible for shareholders. The stock is unlikely to be re-rated in eight months to a valuation where we could raise money. Timing-wise, this was perfect way of dealing with that obligation in a manner that was conducive for IDFC. Strategically, it’s a good fit.
What is the final shareholding of the merged entity?
IDFC Bank shareholders will come down to 72% and this is also an important point for people to appreciate. When you make an acquisition, there is a control premium. What’s happened is that promoters of Capital First have relinquished their control. Any promoter would ask for a huge premium. In this case, if you take the three-month average price to January 2018, we have saved a 10% premium, which is why the dilution to IDFC Bank shareholder is not that significant. Just by comparison, Kotak Bank when they bought Vysya, they paid a control premium of 21.5%. we were in conversation with other entities, the control premium they wanted was absurd, say 40-50% on an average valuation. Look at the control premium paid by IndusInd bank to Bharat Financial Inclusion Ltd, higher than 10%. It’s a much more narrow business. We have done two extremely good deals. Grama Vidiyal was a compelling valuation.
But Capital First is largely focussed on SME lending. How would you look at expanding your liabilities book?
They are very diversified. There are MSME, consumer durable financing, secured and unsecured lending. This is similar to Shriram City Union Finance (SCUF). Vaidyanathan and Capital First have reached out to a customer base that banks have had difficulty getting to. This was very attractive about SCUF. Same thing is equally attractive about this business.
RBI had given the licence to IDFC Bank and you as the MD and CEO. Will they be okay with the new management?
Banking licence is given to an institution, which is more important than a person. That said, all these appointments are subject to RBI approval. Vaidyanathan is a seasoned banker before he the NBFC. He was a star at ICICI.
Vaidyanathan is known to be an aggressive banker. How will you marry that with IDFC’s approach towards retail lending?
We all learn from our experiences. Vaidyanathan is turning out to be a matured leader. For him to be backed by a shrewd and successful and savvy investor like Warburg says a lot. Look at the track record of 6-7 years.
Why do u think Warburg decided to exit Capital First?
Warburg is a perfect investor. They have made a successful investment. They walked in at a fragile time. Vaidyanathan took over management of Future Capital, which had a hugely impaired book. Warburg had a huge bet that they will be able to turn this around. Now, it’s the stated strategy that in the long term, they want to become a universal bank.
Why did you give a premium to Capital First?
They are merging with us. Warburg has acceded control and it’s a modest premium.
What will be your strategy for growing the deposit base?
Our corporate franchise will continue to drive CA (current accounts) very aggressively. To build SA (savings accounts) is a marathon and an expensive proposition. It requires huge distribution network. In our quarterly results, you will see the traction we have made in CASA. That will continue and will only accelerate. What will happen is that we will add 70 branches and 3 million customers. We will be able to cross-sell to our customers.
Our retail physical presence will become much wider. We will have greater profit to reinvest in faster pace of rollout of branch network. You are able to reach a large customer base that has a reasonable income. And that’s the nice thing about Capital First customer base which is different from the customer base of Grama Vidiyal. Grama Vidiyal customer base does not have a rich liability to offer. But Capital First’s customer base has a much richer liability base. So if you have a great brand loyalty and connect with a customer base that has liability to offer, then that will significantly increase the expansion of our casa base.
Will this merger help solve the problem of high borrowing costs?
That will take 24-36 months; no short cut for that. Again, if you look at Capital First’s balance sheet, their cost of borrowing is not much lower than ours. It’s 120 bps higher. So one of the important synergies is that for them their cost of funds will come down. Even with their high cost of funds, their profitability is high. So, we are buying very significant profitability. 36 months from now, when our cost of funds will come down, we would have significantly built up CASA franchise, the profit from combined entity will start looking up.
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