September 28, 2006

DCB - Aggressively Priced

Well, an issue that throws more surprises than ever!

A company that has
  • a criminal case pending on fraudulent deposits
  • an increasing losses in its income statement and negative cash flows for the past three years
  • huge write offs because of its poor portfolio
  • to now give existing shareholders fresh equity at a lower cost, a discount of 63% over its previous issue which happened in February this year
  • been bordering on Capital Adequacy Ratio (CAR) at 9% and is compulsory lending lower amounts to maintain this margin
  • currently wants to create a niche in banking by being in selected cities only!! What is the use of it is beyond comprehension!


Issue Details

No of share : 7.15 crore shares
Issue Size : 157.3 crores on the lower side and 185.9 crores on the higher side.
Date of the IPO : September 29, 2006 - October 6, 2006
Price : Rs. 22- 26
Post Equity Issue Dilution : 48.43% will be the free float for this bank
Lead Runners : JM Morgan Stanley and ENAM Financial
Net NPA Details : Currently down from 4.5% to 4.05% in three months
Gross NPA : around 14% of advances


Objectives of the Issue and the mission of the bank
  • To raise capital for funding and meeting their Capital Adequacy Ratio
  • To focus on improving low cost funds through acquisition of CASA accounts
  • To grow fee based income
  • Build a based call center and enhance retail presence
  • Focus on a few states and build a strong sales team


Company Overview

It was setup as a new private sector bank. The company has 72 branches. Of which 26 are located in Mumbai. It has presence in Maharashtra, Gujarat and Andhra Pradesh. AKFED are its in-principal promoters and not from India. They established this bank after two consolidation in the banking history of theirs. They have a significant stake of approximately 60% which they intend to reduce it to 30% by the end of this issue. The bank is predominantly an SME bank. They focus on customers with less than 10 crores of business. They have a fairly large aggressive retail division that is contributing to their bottomline.The management is something to cheer about. It is headed by some strong people today. Mr Vijay Kelkar is in their board too. Most of them are non-executive directors.


Positives

  • While the company is saddled with NPA's, since 2003 the company has done well wrt to NPA's as it has reduced to .75% net. It has burdened itself with current net NPA's at 4.05% or 78 crores.
  • A professional board with immense experience of Dr. Vijay Kelkar, Anuroop Singh from ANZ etc which will help the bank in strong regulatory mechanisms.
  • Setting up a call center will enhance the delivery model for the bank as it will be cheaper to solve a customers problem and creates an alternate sales channel.
  • Customers are in the mid segment and the possibility of charging higher prices is probable. Hence, given the focus on low cost deposits, this can translate to higher net spreads from the current 3%.
  • The bank in view of poor performance has taken amends to reduce its losses. It has reduced salary, stationary, postage charges, directors and auditors fees.
  • The bank has a strong tax-shield with its accumulated losses. It has around Rs.50 of losses currently. Profits on this can be adjusted for the same. At 30% tax rate, this will give the shareholder of Rs.16 as a tax protection. Assuming this comes in the next ten years in an incremental basis there is still about Rs.6 on NPV basis.

Negatives
  • The branch network of the bank is extremely weak. Of the 72 branches that the bank has 26 are located in Mumbai. 51 branches are located in three states constituting risk in raising money. Also, these three states, Maharashtra, Andhra Pradesh and Gujarat has strong network of banks.
  • The banks internal controls on group exposure is at risk. One group has an exposure to 38% of its total capital!
  • The gross NPA that the bank has shown does not give much information. 3 of the five sectors are growing well. I do not have much information on the chemicals, dyes and for the engineering segment. While there is much potential in this segment, however, considering the fact that one does not know the financial of these companies, it would be unfair to comment on the same.
  • Foreign Investors in this bank have an exposure upto 68% before this issue.
  • Cost of funds is 5.73%. SBI is currently at 4.73%. Most of the banks are at these levels.
  • The focus is only building branches, focusing on key areas for business banking.
  • The SME segment has a lot of focus with ICICI, HDFC and all MNCs giving a lot of importance. Nationalised banks and others were always there in this segment.
Financials of the company
The banks networth is near collapsing with around 170-200 crores erosion year after year.
The bank has really a very poor performance and unless they have their plans in place, this bank is headed for disaster. Their P/L shows increasing losses from 2003. Before this, they had an average profits mainly because of their revaluation of their assets. Their core income has been constantly reducing (30% in 6 years) and income from investments has reduced by 50% in the same time. Most of the other income barring lease rentals has remained or marginally increased in the past 6 years. Its interest outgo has also seen a corresponding decrease. But the employee cost and lease rentals has shot up the roof by more than 50%-60% in the same time.
There is an increase in the other expenses to the tune of 200 crores on a year to year basis with little explanation.


Capital Structure
This is probably the first time that I am seeing that the cost of the promoters capital is more than the issue price. The promoters are locking their shares for a period of one year. Also, AKFED, which has a share of 58% will have to dilute to less than 10%. There was a RBI circulation on foreign holding on a bank in India till 2009. The promoteres holding after this IPO will fall to 30%.ESOPs have been provided but its largely ineffective till the price reaches Rs. 40 and not in the next two years.


Interesting Facts
  • The bank has strong exposure with some select few companies. 5 industries, according to their classification has exposure of more than 30% of their funded exposure. Its top borrower has control of more than 19% of the capital. If I am to understand the banking laws, unless this is in infrastructure this just cant happen.
  • The bank has a customer base of only 6 Lakhs of which 5.95 Lakhs are in the retail segment.
  • There has been a sticker sent to all existing shareholders stating that the promoters will have their shares locked-in for a period of one year!
  • The bank has gross NPA at 14%, no wonder it is loss making.
  • The promoters company are not profit making and though it should not impact the bank, but such request for dividend declaration would be hard to resist.
  • Changing auditors rarely happen in a company, but this bank has changed its auditors thrice in five years. How come?
  • One can read the litigation section to have some pass-time in the entire section of the prospectus.

The pricing of this issue:

Comparing it on earnings would be unfair as the bank is loss making and only one quarter of profits is available. So I have taken the book value for comparison and have assumed the following. I have used a two stage relative valuation based on the book value for the company. The following are the key assumptions made

ROE: 14% for the future considering that it is a bank and the leverage is high

Cost of Equity at 12% (CAPM method : Risk Free at 7%, Beta: 1.1 Risk Premium : 5% will give 12.5% as cost of Equity)
Growth during the first 5 years will be 20% and the rest will be at 4%
Payout Ratio : 10% for the first five years and 40% from then onwards.
Based on the above assumptions the price to book value can be 1.02 times.

At the current bookprice of Rs.18, this will work out to Rs. 18.36, making it expensive by about 25%. However, if one adds the loss in the books and the benefits that it would derive out of it, this will translate to another Rs.6. giving a total of Rs.24 to the shareholder.



Summary:

I like the management as it is impressive. The bank may be a loss making company but they seem to be committed in improving it. The portfolio is straddled with poor assets which they seem to be determined to improve. The incremental NPA this year has been only 0.5% which is heartening to hear. I would be suspect of the profit that they are making today as they were clear on the coming IPO. The bank has a strong focus on a segment where the revenue generation is higher. Though the competition is heating up in this segment, I am still happy with the margins that can be charged. Given that the cost of borrowing is on the higher side, this is offset with a higher cost of lending. The bank has not lost on non-fee based income and has done well on that front. Given that these are non-funded incomes, the capital requirements would be lesser.

The issue has been fairly priced and if it does get subscribed to less than Rs. 22-23 it would be a good one. It is a good IPO and can be applied for the banks possible future performance.

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