Bitter merger pill for Bank of Baroda investors, stock falls over 16%

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Knee-jerk or not, investors’ initial reaction is a thumbs-down to the proposed merger of Dena Bank and Vijaya Bank with Bank of Baroda (BoB). The latter’s stock price took a steep 16-plus per cent hit on Tuesday, the highest such loss under P S Jayakumar’s leadership.

A number of brokerages view the merger as a negative furing the medium term for the bank and have downgraded their rating on the stock. Three key immediate concerns outweigh the possible gains from the merger.

First, the merger has been announced when BoB shows signs of a turnaround and is improving its provision coverage, laying the foundation for growth. “Such a large-scale merger will present its own set of challenges in the near term, particularly as the non-performing assets cycle is in the early stages of recovery,” analysts at Motilal Oswal Financial Services highlight as they review the brokerage’s earlier recommendation on BoB.

Second, with the merger consuming much of the management attention and energy, analysts fear the bank might be unable to pursue its charted growth trajectory in the near term. Suresh Ganapathy of Macquarie feels BoB's return to double-digit return ratios could get delayed by a couple of more years. This is also why Deutsche Bank has downgraded BoB’s shares from ‘buy’ to ‘hold’.

The third worry is who will get how much from the merger. Vijaya Bank and Dena Bank constitute 28 per cent and 16 per cent of BoB’s loan book, based on June financials. Therefore, their probable impact on the merged entity’s loan loss is unlikely to be severe. The question is of the capital infusion and swap ratios. At 8.8 per cent of common equity tier-1 capital, Dena Bank is already under the Reserve Bank’s 'Prompt Corrective Action (PCA) watch. While it is only the second smallest bank under PCA, its current negative net worth situation could be an interim drain on BoB.

On asset quality and profit, Vijaya Bank is a few shades ahead of BoB, while its balance sheet is much smaller. Analysts at PhillipCapital say if the deal is sweetened for Vijaya to not take a huge cut in its adjusted book value, this will have an adverse impact on BoB. “In the best case possibility, we see 20-25 per cent (share price) correction in BoB and Vijaya, assuming a swap of 21:1 for Dena Bank and BoB and 1.75:1 for Vijaya Bank and BoB,” the brokerage says.

Credit Suisse has slashed its target price for BoB’s stock by a little over 50 per cent, apart from lowering its rating by two notches to ‘underperform’. It says synergy benefits would be tough to exact with any merger of government-owned companies.

However, Siddhart Purohit of SMC Global feels Tuesday’s sell-off in the BoB counter was overdone. “While I don’t rule out further correction in the near term, for long-term investors the correction presents a good buying opportunity,” he states. For him, Dena Bank’s selection eases the overhang of merger and eliminates the probability of a weaker franchise being thrusted on BoB.

The development also brought weakness to stronger shares in the segment, Union Bank and Canara Bank, which lost seven to nine per cent in Tuesday’s trade. Uncertainty on the swap ratio dragged down Vijaya Bank’s stock by about six per cent.

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