Axis Bank investors frown at Enam buy

Axis Bank took the world of finance by surprise, announcing its decision to acquire Enam Securities investment banking and capital market transactions’ business. It will pay about Rs 2,067 crore in stock to Enam’s owners -Vallabh Bhansali, Jagdish Master, Nemish Shah and Manish Chokhani- in a cashless acquisition, structured as a merger.

This is Axis Bank’s first major acquisition after Shikha Sharma took over as the MD&CEO. One of the newer private sector banks, it has grown steadily over the years, focusing on the retail market, following the footsteps of older private sector banks such as HDFC Bank and ICICI Bank.

The acquisition will take Axis Bank closer to resembling a universal bank, plugging in crucial gaps in its portfolio. It also alters its risk profile a tad, as the investment banking and capital market businesses are strongly correlated to financial markets, bringing along the inherent volatility of this sector.

Deal Structure:
Axis will demerge its investment banking business to a wholly-owned subsidiary Axis Securities and Sales. Enam too will demerge its investment banking, capital markets -including equities, debt, stock broking, IPO, distribution- and related businesses to this company.

The scheme of arrangement envisages the issue of 1.38 crore shares of Axis Bank to Enam’s shareholders in return for the transfer of these businsses. They will end up owning a 3.3% stake in Axis Bank. That may seem small, but is significant considering that the RBI cap on any single private entity’s shareholding in banks is 5%.

Enam will move to Axis, along with its team. Axis can use the Enam brand for about 2 years. That will ensure a smooth transition both of the business and the brand association, from Enam to Axis. Enam’s Mr Chokhani will head of the new business. Mr Bhansali will be an independent director on Axis Bank’s board.

Enam is projecting this transaction as a merger and not a takeover. That appears to be partly correct, as it is Enam’s team which will be running the business. And, Enam’s promoters are being paid in stock and not in cash. So their interests will be aligned. But it is an acquisition indeed, as the business and intellectual capital represented by the employees now belong to Axis Bank.

Valuation Blues:
Axis Bank’s stock was down by about 3% on November 18, a day after the announcement, and is down by 1.6% today, at the time of posting, indicating continuing concerns on the valuation and equity dilution. Enam’s revenues between April and end-October were Rs 182 crore and its profit before tax was Rs 77 crore.

Assuming a tax rate of 30.9%, its PAT works out to Rs 54 crore, or about Rs 95 crore. Axis Bank is issuing 1.38 crore shares for this PAT stream, which translates to an earnings per share of Rs 69. Now, Axis Bank’s consensus per share earnings estimate for fiscal 2010 is about Rs 80 a share.

Now, that means the new business is going to bring that EPS down a bit. Given that Axis Bank’s projected net profit is over Rs 3,000 crore, compared to the acquired business’ Rs 95 crore, the dilution fear seems overdone.

But has Axis overpaid? The company is paying about 6-7 times 2010-11 revenues, which does seem on the higher side. To justify that, Axis will have to quickly manage the post-acquisition integration, ensure the planned synergies work out, and be able to demonstrate the business is growing faster post-merger, and profitability has either sustained or is increasing.

Axis Bank will not be running the business as it is and will seek to exploit synergies between the two. This acquisition will help provide what banks call life-cycle banking or offering a client a full suite of products and services. In the case of a corporate, it can start with a banking relationship, extending to corporate finance, mergers & acquisitions, and cross-border expansion.

It could even be to handhold a company that moves from being a small business to a mid-sized one to eventually becoming a large-sized business. In the retail side, it again starts with a savings account, moves on to lending and investment management. Private wealth management has become the new buzz word among banks, as they scramble to offer to their clients a complete suite of products.

The key risk to this acquisition is whether the two cultures can co-exist or even meld. A retail bank can be aggressive in its approach but it still functions within the rules laid down by the RBI. Now, Enam’s different activities do come under Sebi’s ambit but these are for specific tasks and investment banking itself does operate under any regulation specific to how it must conduct its business.

That frees investment bankers to go about their business, setting their own ground rules, and when it comes to a transaction -broking, IPO or loan syndication- the respective rules will be followed. That is different from a bank’s culture where the RBI plays a larger than life role. And, Enam’s claims that attrition is very low, means that the people who come to Axis will be soaked in the Enam culture.

Key Issues:
A few critical issues will determine if this merger really succeeds. Will the current promoters succeed in bringing all their important client relations along with them? Will they be motivated enough to continue growing the business? Will they seek to sell their stake in the near term or hold on to it, becoming long term partners?

The answer to this could mean if the promoters adopt a hands off approach in the transition period, or play a key role in the integration process. Will the employees of Enam have the same loyalty and passion they had in their earlier company? Will Axis Bank be able to give this business the freedom to operate even as it tries to combine strengths with its own business?

And, how will it handle the volatility that comes with this line of business, and the risk of some transaction going wrong, bringing embarrassment to the company? A private company can stay away from the glare of public scrutiny but a listed company has no such protection.

The SKS Microfinance case is one example of that. Most mergers take time to show their effect, 1-2 years at the least, but Axis Bank will have a shorter time-frame in which it can prove that the acquisition was not an expensive mistake but one that put it on the path to become an universal bank.

Comments are closed.