Recently the expected merged talks between the two banks (Axis, Kotak Mahindra Bank) had hit the news headlines. Consolidation theme has been quite popular in the Indian financial services context, especially in last few years. This has been primarily driven by economic reasons with investors (especially foreign) trying to make good especially with the stunted growth & relatively somber economic mood overall.
In this analysis of ours, we will be looking into a few basic parameters to understand the rational behind this merger talks.
Scale of the banks
Business Figures: (FY16 in crores). Axis is nearly 2.5-3X times KMBNetwork Figures: (FY16 October).
- It is clearly evident that the retail network of Axis (Branch & ATM distribution) is quite large compared to KMB. Axis footprint, both in branches & ATM are significantly high.
- Also Axis not only has a very strong POS network, its debit card & credit card volume also highlights the significantly much higher customer/ account base in comparison to Kotak bank. (POS & Card distribution)
- Kotak has a higher concentration of branches in Metro compared to Axis which has a predominance in semi-urban (Branch distribution)
Operating Performance as of date
- Axis, despite a higher base, has seen better growth rate in operating revenue compared to KMB(Revenue/ Expense: FY12-16).
- Axis performs better in managing its operating expense, which is reflected in a much better Cost to Income ratio for Axis Bank (Cost to Income Comparison).
- The usage by volume & value of debit & credit cards by both Axis & KMB customers looks quite comparable though Axis fares slightly better than KMB in average transaction value & per card transactions for its credit card portfolio (Card Transaction Comparison)
- Kotak bank initially was much more retail focused but slowly it started to create a strong corporate portfolio as well. Currently the portfolios of both the banks are quite similar footing though Kotak shows a higher corporate portfolio (SME for KMB may be distributed between corporate & retail)
- Axis has a much higher CASA (47%) compared to Kotak bank (38%). The impact is reflected in the lower ‘cost of funds’ for Axis bank.
What is driving the merger?
The primary reason may be lack of organic growth. As evident in the graph below, Axis is struggling to keep up the growth momentum. Operating revenue growth has been quite muted with 22% in FY13 to 16% in FY16 (Growth Comparison: Last 4 Years)
Operating profit growth is better off but that also reflects the constraint of how much you can squeeze of your cost to keep improving your bottom line (Axis cost to income has steadily come down from 45% in FY12 to 39% in FY16). This is also a reflection of the banking system confidence on the Indian economy.
There is perhaps a growing realization that the opportunity for organic growth will be more & more challenging while a merger/ consolidation can provide an opportunity for the merged entity to derive efficiency from operational synergy and deliver a much stronger growth in operating profit.
Kotak bank performance has been mostly worse in terms of growth in revenue & profit (ignoring FY16 as ING Vysya bank got merged that year). Kotak bank has been trying to increase its retail footprint for last few years (high savings account rate etc) but it has not been as successful as they would have liked it.
Moreover RBI regulations stipulated banks with significant promoter holding to reduce it to 10% (or 15%? Which is the guideline for the new banks). RBI in its earlier directive to KMB had asked it to reduced promoter shareholding to 30% by Dec 16 (it had 33.67% by 31st Mar 2016, 2014 directive) and ultimately to 10%/ as applicable by 2018 (2012 directive).
With stunted growth, limited opportunities, it may make sense for KMB to have a minority investor stake in the merged entity. It will not only get it off the hook on the promoter equity but also provide the promoter to maximize its shareholding value with an expected better performance of the much bigger merged bank.
Most possibly Uday Kotak/ existing promoter group will retain a minority investment in the merged entity and play a role of an active shareholder/ investor leaving Axis to run the bank.
The challenge though exists in terms of higher NPA (& bad loans, >4% compared to ~2.5% GNPA of KMB) of Axis. Its loan book looks much worse than KMB. That may reduce KMB promoters interest in getting merged with Axis.
How the merged entity fare compared to the 2 biggies? (ICICI & HDFC Bank)
Surely it would give a run for money to the 2 biggies. It will be difficult to predict how the merged entity P&L will end up but we can do a simple comparison just for the sake of providing some idea. We would be basically merging the P&L of the Axis bank & KMB for FY16 and compare it with ICICI & HDFC for the same FY. The chart below gives a glimpse the kind of competition we may be witnessing, if the merger really goes through!
But the actuals may look different considering:
- The merged entity will look to have a cost to income which is better than current of Axis (lower than current KMB). Only that will justify the synergy related operational efficiency to accrue to the merged entity. This would positively impact the operating profit (compared to above representation)
- There will be customers/ accounts who may not take well the merger and may decide to shift to other banks. The success of the merger will lie in not only retaining the current portfolio but also augment it. Any loss will negatively impact the operating revenue
- There are always merger challenges, operational cost of merger, cultural challenges leading to inefficiency/ failure, pangs of consolidation of operations, front line sales and other functions. Remember mergers are always tricky and many fails due to reason stated above.
- Axis & Kotak Mahindra Bank annual reports/ investor presentations: FY12 to FY16, accessed from individual bank’s website