RealMoney Silver - Huge Indian Banking Merger Could Mean Bucks for Investors

Huge Indian Banking Merger Could Mean Bucks for Investors
By Jay Somaney
RealMoney.com Contributor
3/3/2008 1:24 PM EST

I am appalled at the relative lack of coverage/interest/debate in our media and television after news of one of India's largest privately owned (as opposed to government-controlled) banks, HDFC Bank (HDB) "merging" with Centurion Bank Of Punjab broke late last week. The two banks will "merge" in an all-share deal worth about $2.5 billion. HDB will issue one its own shares for every 29 that shareholders of Centurion Bank of Punjab hold. This deal also marks the largest takeover ever in Indian banking sector history, which is an event worth taking note of in itself.

The deal is actually a takeover, but the management teams of both banks enjoy an extremely cordial personal relationship, so it's being termed a merger rather than a takeover. However, make no mistake; HDB is taking over Centurion Bank of Punjab.

This merger makes HDB the largest private-sector bank in India, in terms of branches, allowing it to overtake key rival ICICI Bank (IBN) on that front. IBN still has a bigger market capitalization and is also bigger in terms of asset size.

With this move, HDB's pan-Indian branch network increases to 1148 branches from 754 at present. HDB has also received prior approval from the RBI (India's central bank) to open 250 more branches this year, so by calendar-year-end, the number of branches across India should number almost 1400, which is formidable indeed.

One of the central reasons for this move by HDB is the fact that the government of India has decided to allow global banks to move into India freely beginning April 1, 2009 (without current restraints on numbers of branches and other competition-hindering regulations), and in order for these Indian banks to survive, they have to scale up to fend off takeover attempts, hostile or not. This would force the foreign banks to go into India with a build-it-can't-buy-it philosophy, allowing Indian banks further time to increase the competitive distance between themselves and the newly arrived global banking giants.

Both banks, HDFC Bank and Centurion Bank of Punjab, have most of their management teams comprised of ex-Citicorp (C) bankers, which should make the integration process between the two a relative breeze, given the commonality in management styles and thinking.

On the flip side, HDFC Bank is more efficient than Centurion Bank of Punjab in almost every metric, including cost of deposits, non-performing assets, return on assets, net-interest income margins, return on equity, etc., but Centurion Bank was the best choice for HDB as far as its inorganic growth choices were concerned.

Other alternatives would have been more expensive, and the integration process could also have been far more tedious, unless HDB was lucky enough to find another bank with a management team also mostly comprised of ex-Citibank bankers.

In addition, banking experts in India say that HDB will need to bring Centurion Bank branches to a mere 60%-65% of its own efficiency level to make the deal earnings-per-share accretive immediately. I do not think it will take HDB too long to bring it up to that level of operational efficiency.

Admittedly, the acquisition is dilutive in the near-term on earnings and book value, however, gaining scale is more important from a long-term-survival-issue point of view than a temporary short-term slight hiccup to earnings.

So, if one can look past the short-term dilution to earnings, HDB is worthy to be a core holding in your long-term portfolio.

Until the next time, happy investing.