ValuePickr Forum

Infrastructure Development Finance corporation - IDFC

As we know IDFC has got banking licence and is going to launch IDFC Bank in October 2015.

As per the management, if you are an IDFC shareholder, for every share you own, you will get a share in the bank. IDFC will have 51 per cent stake in the bank and the rest will be held by existing shareholders.

All fund based activity will be transferred to the bank and AMC, PE, Broking & Investment Banking businesses will be retained as separate subsidiaries of IDFC holding company.

I have attempted to value the resultant two companies below:

Assumption IDFC is fairly valued at current price
# of Shares issued & paid ‘n’ = 159.3 Crores
CMP = 152.60 Rs/ Share
Dividend FY15 = 2.6 Rs/ Share Ex date 23 Jul 2015
BV = 102.9 Rs/ Share
Mcap = 24,309 Rs Crores
Price / Book Value= 1.48
Valuation of Banking/ Financing ‘a’ =18,232 Rs Crores 75% of present IDFC (assumed*)
Valuation of Remaining Biz ‘b’ = 6,077 Rs Crore 25%
IDFC Holding’s Stake in IDFC Bank = 53%
IDFC Holding Value from IDFC Bank (53% of ‘a’ )= 9,663 Rs Crore
Post 20% Holding Co discount ‘c’= 7,730 Rs Crore
Total Value of IDFC Holding ( ‘b’ +‘c’ )= 13808 Rs Crore
Share Price of IDFC Holding on listing= 87 Rs/ Share
# of Shares issued & paid ‘n2’ = 338.4 Crores
Valuation of Banking/ Financing ‘a’ / ‘n2’ 54 Rs/ Share

Total value post listing of IDFC Bank=143 Rs/ Share Including dividend
Upside over Current Price -6% (by end Sept 2015)

Scenario 2:
If no holding company discount is applied, Valuation of IDFC Parent will be Rs 99 / share.
Total value post listing of IDFC Bank=155 Rs/ Share Including dividend
Upside over Current Price +2% (by end Sept 2015)

  • based on own estimates. One can run different scenarios.

This is pure mathematics. No change in value of IDFC or its businesses is assumed or implied.

Would like to have comments from other Valuepickrs.

Disclaimer: As on date of writing this I own this scrip and may trade, get in or out anytime. I am not making any recommendation to buy or sell this stock.

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Alternative valuation on demerger:

IDFC Parent Book Value = Rs 64 per share
Applying the current P/BV of 1.5 of IDFC
Listing price of IDFC Parent = Rs 95 per share

IDFC Bank Book Value = Rs 41 per share
Applying the current P/BV of 1.5 of IDFC
Listing price of IDFC Bank = Rs 61 per share

Total value = 95 +61 = Rs 155

You have missed the disclosure of your holding in the company. This is a must for strating a new thread on any company.

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Manish, thanks for pointing this out. Have added the disclaimer in the first post.

Hi All, Even I am following this stock since it got bank license. It is very difficult to get a fair value. I have read few research report which stated 220 as fair value and some others as 130. It all depends how the bank starts operating in next 3 to 5 years

Now my question is after the demerger, is it advisable to sell, IDFC and buy IDFC Bank shares. Though there will initial hiccups, I feel idfc bank will be better propisition. Others, please let me know your views.

Disc: invested.

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Your disclosures are non-conducive. You need to mention whether you hold that stock as on the date of starting the thread. Please edit and make clear disclosure.

@shailmundra
This is not the way of disclosure. Either you hold the stock or not if yes than at what price?
Similar view you have mentioned about Sourashtra cement. Please update this

First,a disclosure. IDFC constitutes approx 10% of my portfolio. Since my portfolio is highly(too) diverse with >2% in approx 30 stocks, it remains a large bet in my portfolio. My average purchase price is around 125, bought between Sep 2013 and Sep 2014.

Second Disclosure: My investment horizon is 10 years+, and my return expectation is a CAGR in the high teens. This is something I decided apriori, not something which I have discovered after the tepid rise in the stock price.

First the negatives:

a) IDFC is a primarily infrastructure lending organization. This means that growth has been tepid to zero in the last 2 years. This contrasts with the 15-20% growth of other NBFCs during the last 2 periods.

In addition to low growth, there are also problems in its loan book. Approx 3% is lent to Gas Based Power Plants, and we all know that this may have to be written off. (Though they do have some provisions against that). In general, you cannot have been lending to power and roads and not have problems.

b) Once they convert to a Bank, the profits will almost certainly fall, as all costs related to the Bank (CRR, SLR, extra employees, IT costs, Branch Costs), will be immediately applicable, while the bank will take its time to increase NII and revenue.

c) IDFC has made a horrendeous bet on Gsecs, trying to play the interest rate cycle. This bet is going to mean a big profit downturn in the last quarter results.

d) Lots of people think of HDFC Bank when they think of IDFC becoming a bank. However, in a straight sense the scenario is quite different. When Kotak, HDFC, IndusInd, Axis, and ICICI became banks in the 1990’s their primary competition was PSU Banks, which were run in an abysmal fashion. Today, when IDFC Bank needs to get market and mind share, it is by competing against these new banks, rather than the PSU banks. This is a much more difficult task. So the going is not going to be easy at all.

e) Post the demerger, IDFC Ltd will be left with its IDF, AMC and PE Fund. No one can predict the holding company discount on the Bank’s share, but since DDT is 18%, it is fair to assume that it will be at least that much. In addition, there will never be additional FII investment in the holding company, since they will be pretty much at the limit.

Now the investment thesis:

a) The price: Current price of IDFC is < 1.5 times book. This compares very favorably with other Private sector banks with similar management quality.

b) FII Holdings: In the demerged bank entity, FII investment will be 25%, and this can increase to 49%, It stands to reason that this will get filled up quickly.

c) The Opportunity: I think this is the single biggest reason to invest. While it is true that Private sector banks today are very well run and have large CASA and network moats, it is also true that technology is upending the entire banking business model. The need for an elaborate branch network, the need for lots of employees, the need for elaborate relationship models, is fast evaporating. The use of mobile banking, banking correspondents, payment banks, and the overall influx of technology means that banks which are saddled by legacy branches and employees can be seriously affected by a bank which remains technology invested, but has no investments in a branch network or does not require anyone to visit a bank, ever. It is true of PSU Banks for sure, but is also true of a lot of Private sector Banks. Everything I have read or heard of from IDFC management in their public comments makes me reasonably certain that they understand this, and this is the business model they intend to follow.

Now, it may be that they are early, that the market is not ready for a technology oriented bank, and that it will take a while for customer awareness and adoption. In which case, IDFC Bank will remain a has been. But even in that case, the price provides excellent margin of safety.

In summary, an investment in IDFC remains an investment in the future of technology enabled banking. It is clearly not a short term play, but in the short term, the low price does provide a margin of safety. But you must weigh it against the opportunity cost of waiting for the price to reflect improved performance in the future. It seems good for a passive investor like me, who would like to buy something and then only occassionally reflect on whether the investment thesis is playing out.

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Very sensible analysis Samir. Agree for each and every point. :smile:

Disc: I have been investing in this stock for last 6 months at around 150

Samir, excellent analysis.

I agree about your point about changing competitive landscape for new private banks. So history may not repeat itself. I want to add that currently PSU banks are saddled with high NPAs and lack enough capital to grow. So private banks are likely to grow their market share. How much IDFC can encash is a question.

I am a firm believer of “omni-channel” strategy (mix of online and offline channels serve customers).

It’s good to know that exposure to gas based power project is only 3% of loan book. That was a concern.

Any idea at what yield they took a bet on Gsecs? It may turnout to be a good bet in 2-3 quarters time ( as WPI is consistently negative and CPI is coming down, RBI is likely to ease interest rates further). Although it may lead volatility Qtr on Qtr.

My idea was to just show the impact of demerger. Who knows what is the right valuation in the short term.

As Buffett said, " In the short term, market is a voting machine; in the long term it’s a weighing machine".

I have no idea what yield they invested in the Gsecs in. What I do know is that they increased their GSec exposure from some 10000 crores to 17000 crores over the last 2-3 quarters. This is on a loan book of 55000 crores, some of which is exempt from SLR requirements. So they do not require so much GSEC exposure, even if they were a bank. The management admitted as much in the last quarter con call. So clearly it was a bet on falling interest rates. While real rates have fallen some 40-50 bps, Gsec yields have actually increased over the last 2 quarters, and if my own exposure on gsec funds in any criterion, the GSec exposure would have resulted in flat to negative returns in the last quarter. Of course, this depends on a lot on the maturity profile and the trading pattern, but the macro scenario cannot be ignored.

Regards
Samir

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It is valued at 1.5 times book for a good reason.

It is into infra lending - the most risky form of lending. Last when I checked it had a infra lending book of 60,000 crores.

Banks typically diversify their lending across corporate, SME, auto, home, infra, etc etc. In my opinion, a bank should not have more than 10% exposure to infra lending.

For IDFC Bank to reach a state, where it has only 10% exposure to infra lending, it has two options

  • Increase the loan book to a size of 6 lakh crores from current 60 thousand crores (this is clearly impossible for the next 5 years)
  • Sell off a large part of its infra loan book (difficulty with this is that there would be hardly any private / PSU bank who is keen to buy any sort of infra loan book in today’s environment…)

So, IDFC Bank will remain an infra lender for a long time to come… and expecting a huge re-rating by the market may not be realistic, just because it has become a bank.

Disc. Not invested

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IDFC Bank will not be saddled with a lot of legacy systems, processes, policies, and organizational inertia that HDFC, Kotak, etc are saddled with…

So, I think IDFC has some advantages, which it might be able to exploit. I think one of the reasons RBI gave a license to IDFC is because they proposed a very unique/differentiated/novel banking model.

However, the big concern is that IDFC has so far been an Investment Banker doing deals of size of 500 crore or more. IIRC, they have 4 fancy offices in each of the metros, from where they do these big deals. They have no clue about operating on the ground, in urban/semi-urban/rural areas. They will have to completely rejig their culture, thinking, operations, etc and get their hands and feet dirty on the ground. The background couldn’t be any worse mismatched than this case - clearly the worst background fit possible. For this reason alone - I would think the chances of success are low. They will remain primarily a wholesale bank, with hardly any impact on the retail scene.

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Is this the right calculation?

FIIs will get direct shareholding of 25% of the Bank + indirect shareholding of 25% of the Bank (as they will be holding 50% of the Parent).

I am not sure if this is the right calculation. I remember that HDFC Bank had a similar problem which was raised with RBI - whether FII shareholding is calculated based on direct + indirect (through parent HDFC). Or is it only direct shareholding that is counted against FII limit. Any idea what was decided in that case?

I am pretty sure that what I mentioned is right. If the holding company is less than 50%, I think it is counted as an Indian company

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@PP1
"
For IDFC Bank to reach a state, where it has only 10% exposure to infra lending, it has two options

Increase the loan book to a size of 6 lakh crores from current 60 thousand crores (this is clearly impossible for the next 5 years)
Sell off a large part of its infra loan book (difficulty with this is that there would be hardly any private / PSU bank who is keen to buy any sort of infra loan book in today’s environment…)"

You are right and you are not. Most of the existing loans have a maturity profile <5 years. In 5 years, if they were not to increase their book, but simply lend repayments to “other than infra” borrowers, they will have infra lending of 0.

@PP1 and remember, their capital adequacy ratio at the moment is something like 25%. So they double their loan book without recourse to any fresh capital. CAR for NBFC’s is much higher than for a bank. So their ability to bring down the percent of infra on the loan side is very high

Their CAR is high, because they have not been doing any infra financing since they got the bank license around 1.5 years ago.

But, waiting for 5 years to get their infra exposure down is a helluva time for a stock investor… The P/B re-rating can happen in pace with the diversification of assets - I would not be willing to wait 3 - 5 years for that… But, if you are a very long term investor - then it might make sense…

I did indeed suggest this stock to a relative - because he is a very long term buy-and-hold investor… It also helped that the stock was valued at 0.9 P/B at that time (stock was trading at below 90 Rs). He continues to be invested - and will hopefully reap rich rewards in 5 years time.

Yeah, this logic makes sense…