ICICI Bank Ltd is acquiring Bank of Rajasthan Ltd for around Rs3,000 crore in a share swap transaction. Interestingly, its market capitalization has fallen by around Rs7,200 crore, around 2.3 times the acquisition amount.

That’s a big thumbs-down from the market. Of course, it must be noted here that the broad markets fell by around 3% on Wednesday, and ICICI shares would have lost around Rs3,000 crore in value even if they only mimicked the drop in the markets.

Even so, investors have demonstrated that they are highly disappointed with the deal, and especially the valuation. Bank of Rajasthan had an adjusted book value worth Rs559 crore at the end of December, so the acquisition price works out to 5.5 times book value. Other old private sector banks such as Karur Vysya Bank Ltd, Federal Bank Ltd and South Indian Bank Ltd trade between one and two times their book value. What’s more, Bank of Rajasthan is running losses and banks such as Axis Bank Ltd and Yes Bank Ltd which have high profit margins trade at much lower price-book multiples.

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Besides, as analysts at Credit Suisse point out in a note quoted by Reuters, “At a swap ratio of 1:4.7, the acquisition is expensive, at 5 times book or a $680 million (Rs3,128 crore) cost to acquire 466 branches. This is surprisingly high, as it had organically added 400-plus branches last year at a fraction of this cost."

Based on the share-swap ratio, ICICI Bank will be paying Bank of Rajasthan shareholders Rs188 per share. (After the drop in the share price of ICICI Bank, the valuation has come down to Rs175 per share.)

This is more than double the prevailing value of Bank of Rajasthan shares, which traded at Rs83 a day before the deal was announced.

According to ICICI, the valuation is in line with the market capitalization per branch of old private sector banks, and it also compares favourably with relevant precedent transactions. A report by Anand Rathi Research states that the per branch valuation of Rs6.5 crore represents a 9% premium to that of old private sector banks. It also points out that the cost-income ratio of Bank of Rajasthan branches are poor at close to 90% and, hence, there is significant potential for improvement by ICICI.

But investors are far from convinced about the deal, which is reflected in the sharp fall in ICICI’s shares. As IIFL Cap puts it in its report, “While some old private sector banks may have been acquired in the past at high price-book valuations, we firmly believe that such high acquisition premiums are no more justified given that branch licensing is no more a constraint for private or government banks."

Some of Bank of Rajasthan’s bonds had been downgraded by ICRA Ltd in February this year, owing to “deterioration in the quality of the bank’s advances portfolio which had reported higher than expected restructuring, bank’s relatively higher exposure to sensitive sector like real estate and textile, low net profitability over the last few quarters".

In sum, ICICI is acquiring a poor asset at an exorbitant price. Thankfully, for investors, the size of the acquisition is very small relative to ICICI’s size and, hence, the damage will be limited.

Graphic by Naveen Kumar Saini/Mint