Sonal, a wonderful synopsis of IDFC First Bank. Two things seem missing / ignored. Could you elaborate a bit on the IDFC vs IDFC FIRST ?? and no comment on a relatively disruptive credit card foray…
excellent , incisive analysis … thanks for the share Sonal
Re Slide 22: If your holding period is 3 years then its a no brainer between IDFC and IDFCB. The probability that the holding structure will be uwound in that time and the AMC sold, leading to an eventual reverse merger, is very high in my opinion.
Look at the risk reward; if the upside scenario plays out (which is 90% prob in that timeframe) your 3.5x return estimate could potentially be 7-8x; if it doesn’t (10% prob) and the 55-60% holdco discount that is currently there persists you stilll make atleast 3.5x!
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Hi puch, can you please outline why you think so? What is the math for this calculation?
Which part? The upside/downside probabilities or the return calculations? I think the return calculations are pretty straight forward; regarding the probabilities I have assumed those are my personal opinion and are based on the work one has done on the IDFC situation. The intentions of both the management and the RBI are quite clear and this is reflected in both the recent management commentary and the recommendations of the RBI IWG. It’s more a question of when rather then if the reverse merger will happen and when you extend the holding time period to three years you significantly increase the odds in your favour.
For argument sake let’s assume it’s a coin toss or a 50-50% chance that the reverse merger goes through; what is better in that case IDFC or IDFCB? 50% of the time you make 3.5x and the other 50% of the time you make 7x. Say the odds are only 5% in favour of the reverse merger; even in that case IDFC is a better bet!
Holding IDFC gives you a free optionality to the IDFCB story and at the current level of holdco discount the risk reward over a long time frame is heavily in your favour.
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This is the part i am struggling with. Just wanted to see your calculations, if you dont mind sharing 
That quite simple Sahil; Sonal has assumed an entry price of Rs 50 for IDFCB and an exit price of Rs 175. Extrapolating this to IDFC assume that the entry price is Rs 40 - 45, now IDFC holds around 1.42x shares of IDFCB shares for every IDFC share. This means at the exit price we get shares worth Rs 245 of the bank for every IDFC share. For the AMC we have another growing asset that just grew PAT by around 80% to Rs 145cr. Annunalize the most recent quarters numbers and you have a FY22 PAT of Rs 200-220cr. At a 20-25x exit multiple on the FY23 numbers you get roughly after tax Rs 30 a share for IDFC. Together this works out to roughly 7x your original investment ; now there might be certain reverse merger costs that we can’t predict at this point but the basic point being that the return profile of an investment in IDFC is far superior to IDFCB.
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Hi @Puch this calculation is reasonably well known.
It’s also discussed in this thread
But why isn’t the idfc price reflecting this scenario. If the probability of the merger is high over a three year period then the idfc price should quote significantly higher.
Any thoughts on What’s the trigger the market is waiting for?
Similarly @voldemortdevil has shared a deck on idfc first bank and he represents a sebi registered adviser.
If this is such a no brainer Why would a professional advisory firm not advise buying idfc?
Regards
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I have around 68% of my portfolio concentrated in IDFC Ltd, which was bought purely on the
expected IDFC First bank merger special situation.
The probability of this event happening is tough to quantify. But, once we step back and look at facts.
Best Case
- IDFC Ltd is holding IDFC First Bank share in the ratio of 1:1.43
- IDFC Ltd has become a pureplay holding company of IDFC First Bank and IDFC AMC.
- RBI in their Nov 2020 IWG circular proposed option for collapsing holding structure for NOFHCs.
- IDFC Ltd, Ujjivan,Equitas have been lobbying RBI to do this for quite some time and wrote to RBI on their inputs.
- IDFC Ltd Management have shown their intent
- Seriously evaluated almost all options to unlock value, took analyst, legal feedback.
- Informed in concall that they will sell off the IDFC AMC for reverse merging with IDFC First bank[Infact they mentioned 2500 indexed cost in the sale event thereby hardly some 300cr tax outgo on 3500cr sale]
- Became serious about value creation for their shareholders & prioritizing value unlocking.
- Mentioned timelines of 12Months from the process start date [regulations are out]
- Super confident on RBI has no reasons to reject this proposal.
- Proposed selling IDFC First bank shares to reward IDFC Ltd shareholders in an extreme case.
- On another hand for IDFC First Bank,
- Shareholders, Management will not want someone who is holding 37% of the company to go on a selling spree in the market.
- Have aggressive growth plans which needs capital infusion every 2 years.
- IDFC Ltd post MF business sale will be left with 3000+cr as capital which can be infused into IDFC First bank at 2-3x book value.
- If IDFC Ltd agrees for a 2-5% haircut in the swap ratio, existing book value/share for IDFC First bank shareholders will increase by
((Discount Rate)(.37)(IDFC First BankNetworth) / #Postmerger shares outstanding. Which is a win for IDFC & IDFC First Bank shareholders. Adding to this, 3000cr infusion will also add more to book value over night.
so, in a nutshell, there is Management Intent, Shareholder pressure, Regulator Intent.
Worst Case
on the other hand, consider if the regulator denies this proposal - the merger will not happen.
In that case,
Look at IDFC Ltd as an entity.
- They have an AMC Business with 1.2 lak cr in AUM with a 40% ROE and PAT growth at 80% over the past 1 year and at a 160cr PAT run-rate last quarter.
Ascribing a 30x multiple[Non-fire sale valuation] will give a 5kcr valuation. Maybe growth deserves more than 30x. - If IDFC Ltd sells at least 10% of IDFC First Bank[Which they intended] they’ll can give a 3.5kcr payout i.e some 40rs dividend per share- dividend tax payable in the hands of shareholder.
the downside is fairly protected with underlying value.
Reason Why Holding discount should not be applicable for IDFC in this case?
This holding discount should not be compared with a Grasim,bajaj holdings or tata investments- Unlike other companies where promoters-typically families use the holding struture to control companies without having 50% effective shareholding.
There the holding structure is formed with an intent to have control, in IDFC Ltd’s case IDFC is not promoter-led, No interest in running a Bank business or even board representation & everything is at arm’s length.
Honestly, Special situations are quite rewarding but require a lot of patience. These assumptions are as good as any investment thesis.
We projecting & valuing IDFC First bank at 25% AUM growth for making an investment case is as good as an IDFC Ltd shareholder predicting a merger. odds are it may happen or it may not happen, whatever is the outcome, it depends on our ability to comprehend and model risk-reward in our investment thesis.
In this case, I have an extreme bull case for IDFC First Bank in the short-run due to 14+% ROE and 1.5% ROA rerating thereby 3x + P/B Multiple.
Bullcase:
1x in IDFC First Bank gives 2x+ for IDFC Ltd shareholders
2x in IDFC First Bank gives 4.5x for IDFC Ltd shareholders
3x in IDFC First Bank gives 7x for IDFC shareholders
Bear case:
1x in IDFC First Bank gives 27kcr liquidatable networth +(160cr, 30+%ROE ,Growth business-These numbers will increase in upcoming years) for a current 8.5kcr IDFC Ltd
2x in IDFC First Bank gives 40kcr liquidatable networth +(160cr, 30+%ROE ,Growth business- These numbers will increase in upcoming years) for a current 8.5kcr IDFC Ltd
3x IDFC First Bank gives 54kcr liquidatable networth +(160cr, 30+%ROE ,Growth business- These numbers will increase in upcoming years) for a current 8.5kcr IDFC Ltd
- A management who wants to deliver value.
You’ll have a cash machine that will probably have less upside than IDFC First Bank- but, one can always exit after RBI decision with some haircut in bear case if they seek growth.
Risk-Adjusted returns make sense for me now so, swapped IDFC First Bank for IDFC Ltd and doubled down. for others, it may not make sense.
One can also enter IDFC once regulations are out, in that case, one will end up buying IDFC at a less discount than today(40% Discount).
Trigger will be RBI releasing the final guidelines- google search by
“extant ownership guidelines and corporate structure for indian private sector banks”. The Moment an update appears in RBI site on this topic, there will be a wild swing in the stock price.
This is an uncertainity which is priced at 40% discount for now, when it is certain[RBI regulations out] market will price it accordingly.
How do special situation investors make money if everything is priced before the event occurance 
If something is not written it doesn’t mean it’s wrong, everyone will have their own thesis and risk apetite.
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Your reply is very detailed and extensive. Thanks for writing it out and sharing with all of us. It needs lot of patience and thought to get that level of clarity and understanding.
I read through the guidelines of the rbi iwg group.
Quoting from the rbi report relevant to idfc
"
11. Banks currently under NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold. "
This means that the trigger for idfc to get rerated is when they confirm a deal for idfc mutual fund.
Now here’s what I had heard on one of the conference calls of idfc or read somewhere ( not sure)
Blackstone pe fund has expressed interest for buyout of L&T mutual fund.
This request is pending with sebi for some time. ( Many many months now)
Reason: they are yet to determine if that pe fund passes the “sponsor criteria”
This similar issue was raised when oaktree capital was bidding for DHFL . There were AIF structure complications there too
This is important because the pe fund will want to exit after few years. So then who will be in charge if the promoter is selling and going away. This is important because mutual funds manage public money and someone needs to be held accountable.
In case if oaktree sebi had not accepted an aif structure proposed by oaktree.
Incidentally, there are now many new aspirants like Helios , RJ groww , who have applied for an MF license approval. This process might be faster and easier.
This clearly means two things.
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Foreign PE Funds which are usually aggressive buyers will not play in this mf buyout market. They like speed and transparency.
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With it possibly becoming easier to get a new license as compared to buying out an existing one , many participants may chose to apply rather than buy. This means that mf company valuations will go lower unless someone is really willing to pay for an existing AUM book.
I think lot of players are awaiting clarity on this specific event.
Once there is a decision on the L&T case. The stock will move
Regards
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Think @manikya_saiteja_gund has already done a great job laying out the basic thesis and answering your questions.
Block quote
If this is such a no brainer Why would a professional advisory firm not advise buying idfc?
Can’t speak for @voldemortdevil but there are enough savvy allocators who have bought into the story, recent examples I can remember are RJ buying 12mn shares as per this https://twitter.com/krunal39923264/status/1397438365696348160?s=19 and Banyan Capital presenting it as an idea at the Asian Investing Summit 2021 https://moiglobal.com/vp-rajesh-202104/, they had a great presentation on the idea.
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I don’t see RJ name in the twitter link you provided.
Can you please let me know where was it in screen shot
Thanks @manikya_saiteja_gund for details & efforts. I have IDFC as 31% in my PF on the same thesis. Happy to see someone having greater conviction in the story.
My 2 cents :
-
Can someone file a RTI with RBI inquiring the status on IWG’s recommendations ?
Disc. am a NRI, hence bit complicated -
I do calculate IDFC’s discount post considering 3500 cr as valuation for AMC (which we shall get one way or other. Hence current discount of IDFC over IDFC F Bank works out to be 50%.
Disc. Invested from low levels, largest holding
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This is a top 100 shareholders list as of 21 may. RJ might have bought it earlier at any point in time. Will have to look at idfc bulk deals data to get that
There are some other interesting names. Quick list after scanning
Akash bhanshali
Manish chokhani and family
Eastbridge fund
Plutus wealth( which bought big at around 51)
Guys, on IDFC vs IDFC first: I would love to see the merger through. But basis what I understand:
-
The merger is easier for Equitas and Ujjivan as the managements for the two entities are the same. In case of IDFC and IDFC F the two managements are different. Hence there is an extra loop of convincing the IDFC F management to allow IDFC to merge with it.
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Secondly, based on what I understand, the IDFC AMC business is not as great as it use to be. So, I don’t know who is keen to buy that and at a price that the management wants.
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Per me, IDFC will sell its stake in IDFC F and then pay the proceeds as dividend. This is highly tax inefficient.
On the credit card business, too early. I am not factoring anything in. I know the prudence of CF has gone up post merger. Counting on it.
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Hi Sonal,
Yes I tend to agree. Idfc mf is primarily a debt house. Equity AUM is a small portion. So the prospective buyers are most likely going to be financial institutions who are interested in having debt in their AAUM. I have already highlighted the “sponsors” problem for foreign financial institutions earlier in the thread. This limits the number of buyers interested in idfc mf
Lower equity AUM also means that the valuation js not going to be as high as many are estimating.
In addition there is going to be capital gains on idfc mf sale which my estimate is approx. 500 crores ( mentioned in some idfc concall)
Yes, not sure if many Investors are budgeting for this. Dividending sale proceeds of MF sub means that the marginal tax in the hands of the individual investor could be 35 percent or higher depending on one’s income slab.
That is serious drag on margin of safety on the idfc price.
@voldemortdevil can you share thoughts on why idfc first may not be keen on reverse merger ? What could their objections be against idfc.
Why?
As a growing bank, won’t it make sense for them to use that money and further boost the capital reserves? Vaidyanathan is a conservative guy!
Their shareholding and control gets diluted by 40%. The big institutional investors in IDFCF might not like dilution. I don’t think there is anything for IDFCF management in this reverse merger. What do they get?
How there would be dilution? No new shares would be issued by IDFC first bank.
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- Growth capital in the form of whatever money amc selloff can fetch
- If idfc sells off in open market, that actually causes more heart burn for idfc bank because they are unable to raise growth equity capital at good Valuations (if buyers know that lot of supply is coming, why would price ever appreciate).
The reverse merger kills 2 birds with 1 stone.
I will still stay away from it because imo it is important to not get greedy in a bull market. That additional 50-60% return comes at the cost of some probability of the reverse merger failing (however small it is). Not worth disturbing the compounding story, incurring ltcg and stcg and then the uncertainty of regulatory landscape.
Will look to learn from this special situation to better prepare myself for the next one.
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