Download - Accounting for Amalgamations
CONTEMPORARY ISSUE ON SEMINAR
A STUDY ON
”AMALGAMATION”
MBA
Presented at
Submitted By: Submitted To:
Shilpa Sharma Dr. Pramod Gupta
MBA II Sem.
Alwar Institute of Management & Technology
M.I.A., Alwar (Raj.)
2011-2012
Acknowledgement
I express my sincere thanks to my project guide Dr. Pramod Gupta,
Department of management studies, AIET Alwar, for guiding me right from
the inception till the successful completion of the project. I sincerely
acknowledge her for extending their valuable guidance, support for
literature, critical reviews of project and the report and above all the moral
support they had provided to me with all stages of this project.
I would also like to thanks Dr. Pramod Gupta and supporting staff faculty
members of Department of Management Studies, AIET, Alwar for their help
and cooperation throughout our project.
Shilpa Sharma
Accounting for Amalgamations
Contents
1.Introduction
2.Definitions
3.Explanation
4.Types of Amalgamations
5.Methods of Accounting for Amalgamations
-The Pooling of Interests Method
-The Purchase Method
6.Consideration
7.Treatment of Reserves on Amalgamation
8.Treatment of Goodwill Arising on Amalgamation
9.Balance of Profit and Loss Account
10.Treatment of Reserves Specified in A Scheme of Amalgamation
11.Disclosure
12.Amalgamation after the Balance Sheet Date
13.Accounting Standard
14.Common Procedures
Case Study:-
-Introduction to ICICI Bank
-Introduction to Madura Bank
- Merger of ICICI Bank with Bank of Madura
Accounting for Amalgamations
The following is the text of Accounting Standard (AS) 14, ‘Accounting for
Amalgamations’, issued by the Council of the Institute of Chartered Accountants of
India.
This standard will come into effect in respect of accounting periods commencing on or
after 1.4.1995 and will be mandatory in nature.2 The Guidance Note on Accounting
Treatment of Reserves in Amalgamations issued by the Institute in 1983 will stand
withdrawn from the aforesaid date.
Introduction
This statement deals with accounting for amalgamations and the treatment of any
resultant goodwill or reserves. This statement is directed principally to companies
although some of its requirements also apply to financial statements of other
enterprises.
This statement does not deal with cases of acquisitions which arise when there is a
purchase by one company (referred to as the acquiring company) of the whole or part of
the shares, or the whole or part of the assets, of another company (referred to as the
acquired company) in consideration for payment in cash or by issue of shares or other
securities in the acquiring company or partly in one form and partly in the other. The
distinguishing feature of an acquisition is that the acquired company is not dissolved
and its separate entity continues to exist.
Definitions
The following terms are used in this statement with the meanings specified:
(a) Amalgamation means an amalgamation pursuant to the provisions of the
Companies Act, 1956 or any other statute which may be applicable to companies.
(b) Transferor company means the company which is amalgamated into another
company.
(c) Transferee company means the company into which a transferor company is
amalgamated.
(d) Reserve means the portion of earnings, receipts or other surplus of an enterprise
(whether capital or revenue) appropriated by the management for a general or a specific
purpose other than a provision for depreciation or diminution in the value of assets or
for a known liability.
(e) Amalgamation in the nature of merger is an amalgamation which satisfies all the
following conditions:-
(i) All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
(ii) Shareholders holding not less than 90%of the face value of the equity shares of
the transferor company (other than the equity shares already held therein, immediately
before the amalgamation, by the transferee company or its subsidiaries or their
nominees) become equity shareholders of the transferee company by virtue of the
amalgamation.
(iii) The consideration for the amalgamation receivable by those equity
shareholders of the transferor company who agree to become equity shareholders of
the transferee company is discharged by the transferee company wholly by the issue of
equity shares in the transferee company, except that cash may be paid in respect of any
fractional shares.
(iv) The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the assets and
liabilities of the transferor company when they are incorporated in the financial
statements of the transferee company except to ensure uniformity of accounting
policies.
(f) Amalgamation in the nature of purchase is an amalgamation which does not satisfy
any one or more of the conditions specified in sub-paragraph (e) above.
(g) Consideration for the amalgamation means the aggregate of the shares and other
securities issued and the payment made in the form of cash or other assets by the
transferee company to the shareholders of the transferor company.
(h) Fair value is the amount for which an asset could be exchanged between a
knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length
transaction.
(i) Pooling of interests is a method of accounting for amalgamations the object of which
is to account for the amalgamation as if the separate businesses of the amalgamating
companies were intended to be continued by the transferee company. Accordingly, only
minimal changes are made in aggregating the individual financial statements of the
amalgamating companies.
Types of Amalgamations
Generally speaking, amalgamations fall into two broad categories. In the first
category are those amalgamations where there is a genuine pooling not merely of the
assets and liabilities of the amalgamating companies but also of the shareholders’
interests and of the businesses of these companies. Such amalgamations are
amalgamations which are in the nature of ‘merger’ and the accounting treatment of such
amalgamations should ensure that the resultant figures of assets, liabilities, capital and
reserves more or less represent the sum of the relevant figures of the amalgamating
companies. In the second category are those amalgamations which are in effect a mode
by which one company acquires another company and, as a consequence, the
shareholders of the company which is acquired normally do not continue to have a
proportionate share in the equity of the combined company, or the business of the
company which is acquired is not intended to be continued. Such amalgamations are
amalgamations in the nature of ‘purchase’.
An amalgamation is classified as an ‘amalgamation in the nature of merger’ when all
the conditions listed in paragraph (e) are satisfied. There are, however, differing views
regarding the nature of any further conditions that may apply. Some believe that, in
addition to an exchange of equity shares, it is necessary that the shareholders of the
transferor company obtain a substantial share in the transferee company even to the
extent that it should not be possible to identify any one party as dominant therein. This
belief is based in part on the view that the exchange of control of one company for an
insignificant share in a larger company does not amount to a mutual sharing of risks and
benefits.
Others believe that the substance of an amalgamation in the nature of merger is
evidenced by meeting certain criteria regarding the relationship of the parties, such as
the former independence of the amalgamating companies, the manner of their
amalgamation, the absence of planned transactions that would undermine the effect of
the amalgamation, and the continuing participation by the management of the transferor
company in the management of the transferee company after the amalgamation.
Methods of Accounting for Amalgamations
There are two main methods of accounting for amalgamations:
(a) the pooling of interests method; and
(b) the purchase method.
The use of the pooling of interests method is confined to circumstances which meet
the criteria referred to in paragraph 3(e) for an amalgamation in the nature of merger.
The object of the purchase method is to account for the amalgamation by applying
the same principles as are applied in the normal purchase of assets. This method is
used in accounting for amalgamations in the nature of purchase.
The Pooling of Interests Method
Under the pooling of interests method, the assets, liabilities and reserves of the
transferor company are recorded by the transferee company at their existing carrying
amounts.
If, at the time of the amalgamation, the transferor and the transferee companies
have conflicting accounting policies, a uniform set of accounting policies is adopted
following the amalgamation. The effects on the financial statements of any changes in
accounting policies are reported in accordance with Accounting Standard (AS) 5, ‘Prior
Period and Extraordinary Items and Changes in Accounting Policies’.3
The Purchase Method
Under the purchase method, the transferee company accounts for the
amalgamation either by incorporating the assets and liabilities at their existing carrying
amounts or by allocating the consideration to individual identifiable assets and liabilities
of the transferor company on the basis of their fair values at the date of amalgamation.
The identifiable assets and liabilities may include assets and liabilities not recorded in
the financial statements of the transferor company.
Consideration
The consideration for the amalgamation may consist of securities, cash or other
assets. In determining the value of the consideration, an assessment is made of the fair
value of its elements. A variety of techniques is applied in arriving at fair value. For
example, when the consideration includes securities, the value fixed by the statutory
authorities may be taken to be the fair value. In case of other assets, the fair value may
be determined by reference to the market value of the assets given up. Where the
market value of the assets given up cannot be reliably assessed, such assets may be
valued at their respective net book values.
Many amalgamations recognise that adjustments may have to be made to the
consideration in the light of one or more future events. When the additional payment is
probable and can reasonably be estimated at the date of amalgamation, it is included in
the calculation of the consideration. In all other cases, the adjustment is recognised as
soon as the amount is determinable [see Accounting Standard (AS) 4, Contingencies
and Events Occurring After the Balance Sheet Date].
Treatment of Reserves on Amalgamation
If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the
reserves is preserved and they appear in the financial statements of the transferee
company in the same form in which they appeared in the financial statements of the
transferor company. Thus, for
example, the General Reserve of the transferor company becomes the General
Reserve of the transferee company, the Capital Reserve of the transferor company
becomes the Capital Reserve of the transferee company and the Revaluation Reserve
of the transferor company becomes the Revaluation Reserve of the transferee
company. As a result of preserving the identity, reserves which are available for
distribution as dividend before the amalgamation would also be available for distribution
as dividend after the amalgamation. The difference between the amount recorded as
share capital issued (plus any additional consideration in the form of cash or other
assets) and the amount of share capital of the transferor company is adjusted in
reserves in the financial statements of the transferee company.
If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of
the reserves, other than the statutory reserves dealt with in is not preserved. The
amount of the consideration is deducted from the value of the net assets of the
transferor company acquired by the transferee company. If the result of the computation
is negative, the difference is debited to goodwill arising on amalgamation. If the result of
the computation is positive, the difference is credited to Capital Reserve.
Certain reserves may have been created by the transferor company pursuant to the
requirements of, or to avail of the benefits under, the Income tax Act, 1961; for example,
Development Allowance Reserve, or Investment Allowance Reserve. The Act requires
that the identity of the reserves should be preserved for a specified period. Likewise,
certain other reserves may have been created in the financial statements of the
transferor company in terms of the requirements of other statutes. Though, normally, in
an amalgamation in the nature of purchase, the identity of reserves is not preserved, an
exception is made in respect of reserves of the aforesaid nature (referred to hereinafter
as ‘statutory reserves’) and such reserves retain their identity in the financial statements
of the transferee company in the same form in which they appeared in the financial
statements of the transferor company, so long as their identity is required to be
maintained to comply with the relevant statute. This exception is made only in those
amalgamations where the requirements of the relevant statute for recording the
statutory reserves in the books of the transferee company are complied with. In such
cases the statutory reserves are recorded in the financial statements of the transferee
company by a corresponding debit to a suitable account head (e.g., ‘Amalgamation
Adjustment Account’) which is disclosed as a part of ‘miscellaneous expenditure’ or
other similar category in the balance sheet. When the identity of the statutory reserves
is no longer required to be maintained, both the reserves and the aforesaid account are
reversed.
Treatment of Goodwill Arising on Amalgamation
Goodwill arising on amalgamation represents a payment made in anticipation of
future income and it is appropriate to treat it as an asset to be amortised to income on a
systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult
to estimate its useful life with reasonable certainty. Such estimation is, therefore, made
on a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a
period not exceeding five years unless a somewhat longer period can be justified.
Factors which may be considered in estimating the useful life of goodwill arising on
amalgamation include:
• the foreseeable life of the business or industry;
• the effects of product obsolescence, changes in demand and other economic
factors;
• the service life expectancies of key individuals or groups of employees;
• expected actions by competitors or potential competitors; and
• legal, regulatory or contractual provisions affecting the useful life.
Balance of Profit and Loss Account
In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit
and Loss Account appearing in the financial statements of the transferor company is
aggregated with the corresponding balance appearing in the financial statements of the
transferee company. Alternatively, it is transferred to the General Reserve, if any.
In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit
and Loss Account appearing in the financial statements of the transferor company,
whether debit or credit, loses its identity.
Treatment of Reserves Specified in A Scheme of
Amalgamation
The scheme of amalgamation sanctioned under the provisions of the Companies
Act, 1956 or any other statute may prescribe the treatment to be given to the reserves
of the transferor company after its amalgamation. Where the treatment is so prescribed,
the same is followed. In some cases, the scheme of amalgamation sanctioned under a
statute may prescribe a different treatment to be given to the reserves of the transferor
company after amalgamation as compared to the requirements of this Statement that
would have been followed had no treatment been prescribed by the scheme. In such
cases, the following disclosures are made in the first financial statements following the
amalgamation:
(a) A description of the accounting treatment given to the reserves and the reasons
for following the treatment different from that prescribed in this Statement.
(b) Deviations in the accounting treatment given to the reserves as
prescribed by the scheme of amalgamation sanctioned under the statute as compared
to the requirements of this Statement that would have been followed had no treatment
been prescribed by the scheme.
(c) The financial effect, if any, arising due to such deviation.
Disclosure
For all amalgamations, the following disclosures are considered appropriate in the
first financial statements following the amalgamation:
(a) names and general nature of business of the amalgamating companies;
(b) effective date of amalgamation for accounting purposes;
(c) the method of accounting used to reflect the amalgamation; and
(d) particulars of the scheme sanctioned under a statute.
For amalgamations accounted for under the pooling of interests method, the
following additional disclosures are considered appropriate in the first financial
statements following the amalgamation:
(a) description and number of shares issued, together with the percentage of each
company’s equity shares exchanged to effect the amalgamation;
(b) the amount of any difference between the consideration and the value of net
identifiable assets acquired, and the treatment thereof.
For amalgamations accounted for under the purchase method, the following
additional disclosures are considered appropriate in the first financial statements
following the amalgamation:
(a) consideration for the amalgamation and a description of the
consideration paid or contingently payable; and
(b) the amount of any difference between the consideration and the value of net
identifiable assets acquired, and the treatment thereof including the period of
amortisation of any goodwill arising on amalgamation.
Amalgamation after the Balance Sheet Date
When an amalgamation is effected after the balance sheet date but before the
issuance of the financial statements of either party to the amalgamation, disclosure is
made in accordance with AS 4 ‘Contingencies and Events Occurring After the Balance
Sheet Date’, but the amalgamation is not incorporated in the financial statements. In
certain circumstances, the amalgamation may also provide additional information
affecting the financial statements themselves, for instance, by allowing the going
concern assumption to be maintained.
Accounting Standard
An amalgamation may be either –
(a) an amalgamation in the nature of merger, or
(b) an amalgamation in the nature of purchase.
An amalgamation should be considered to be an amalgamation in the nature of merger
when all the following conditions are satisfied:
(i) All the assets and liabilities of the transferor company become, after amalgamation,
the assets and liabilities of the transferee company.
(ii) Shareholders holding not less than 90% of the face value of the equity shares of
the transferor company (other than the equity shares already held therein, immediately
before the amalgamation, by the transferee company or its subsidiaries or their
nominees) become equity shareholders of the transferee company by virtue of the
amalgamation.
(iii) The consideration for the amalgamation receivable by those equity shareholders of
the transferor company who agree to become equity shareholders of the transferee
company is discharged by the transferee company wholly by the issue of equity shares
in the transferee company, except that cash may be paid in respect of any fractional
shares.
(iv) The business of the transferor company is intended to be carried on, after the
amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the assets and liabilities
of the transferor company when they are incorporated in the financial statements of the
transferee company except to ensure uniformity of accounting policies.
An amalgamation should be considered to be an amalgamation in the nature of
purchase, when any one or more of the conditions specified in above paragraph is not
satisfied.
Case study:- Mergers in the Banking Sector
ICICI Bank
INTRODUCTION
ICICI Bank (formerly Industrial Credit and Investment Corporation of India) is
India' s l a r g e s t p r i v a t e b a n k . I C I C I B a n k h a s t o t a l a s s e t s
o f a b o u t Rs.20.05bn (end-Mar 2005), a network of over 550 branches and offices,
and about 1900
atms. I C I C I B a n k o f f e r s a w i d e r a n g e o f b a n k i n g p r o d u c t s a n d
f i n a n c i a l services to corporate and retail customers through a variety of
delivery channels and through its specialized subsidiaries and affiliates in the
areas of investment banking, life and non-life insurance, venture capital
and asset management.
ICICIB a n k ' s e q u i t y s h a r e s a r e l i s t e d i n I n d i a o n s t o c k
e x c h a n g e s a t Kolkata and Vadodara, the Stock Exchange, Mumbai and the
National Stock Exchange of India Limited and its adrs are listed on the New
York Stock Exchange (NYSE). During the year 2005 IC ICI bank was invo lved
as a de fendant in cases o f a l leged c r im ina l practices in its debt
collection operations and alleged fraudulent tactics to sell its products.
The industrial Credit and Investment Corporation of India Limited now known as ICICI
Ltd. Was founded b the World bank, the Government of India and representatives of
private industry on January 5, 1955.
The objective was to encourage and assist industrial development and investment
in India. Over the years, ICICI has evolved into a diversified financial institution. ICICI’s
principal business activities include:
Project Finance
Infrastructure Finance
Corporate Finance
Securitization
Leasing
Deferred Credit
Consultancy services
Custodial services
T h e I C I C I G r o u p s d r a w s i t s s t r e n g t h f r o m t h e c o r e
c o m p e t e n c i e s o f i t s ind iv idua l compan ies . Today , top Ind ian
Corpora te look towers IC ICI as a bus iness partner for providing
solutions to their varied financial requirements. The Group also offers a gamut
of personal finance solutions to individuals. To lead the financial services into the new
millennium, the Group is now truly positioned as a Virtual Universal Bank. The
liberalization of the Indian economy in the 1990s offered ICICI an opportunity
to provide a wide range of financial services. For regulatory and strategic reasons, ICICI
setup specialized subsidiaries in the areas of commercial banking, investment banking,
non- banking finance, investor servicing brooking, venture capital financing
and state level infrastructure financing.
IC ICI p lans to focus on i t s re ta i l f i nance bus iness and expec t the
same to contribute upto 15-20 % of its turnover in the next five years. It is
trying to change the perception that it is a corporate oriented bank. The bank hard
selling its image as a retail segment bank has fo r the f i r s t t ime come up
w i th an adver t i sement tha t addresses i t s products at the individual. This is to
drive home the point that the bank has product and services catering to all
individuals. For this purpose the network of ICICI Bank shall come into use.
The parent plants to sell its products and also raise retail funds through the banking
subsidiary.
THE ICICI GROUP COMPRISES OF:
ICICI Bank Limited,
ICICI Securities and Finance Company Limited (ICICI Securities),
ICICI Credit Corporation Limited ( ICICI Credit),
ICICI Investors Services Limited (ICICI Services),
ICICI Venture Funds Management Limited (ICICI Venture),
ICICI international Limited,
ICICI -KINFRA Limited (I-KIN),
Mr. K.V. Kamath, CEO of ICICI Limited, has recently voiced the intentions
of ICICI Limited towards banking and ICICI Bank. ICICI Limited is endeavoring to forge
a closer relationship with ICICI bank. Mr. K V Kamath recently quoted in a leading daily
“Bank ing i s dead . Un iversa l bank ing i s in o f fe r ing w i th a who le range
o f f i nanc ia l products and services. The basic idea is for banks to do
business along with “banking”. Bankers will have to emerge as businessmen.”
ICICI Bank is a focused banking company coping with the changing times of
the bank ing indus t ry . So i t can be a luc ra t i ve ta rge t fo r o ther p layer
in the same l ine o f operations. However, when merged with ICICI Limited the
attraction is reduced manifold considering the magnitude of operations of the
ICICI limited.
Of course, one would still need a bank to open letters of credit, offer
guarantees, hand le documenta t ion , and ma in ta in cur ren t accoun t
fac i l i t i es e tc . So banks w i l l no t superfluous. But nobody needs so many
of them anymore.
Second ly , bes ides c red i t , a cus tomer may a lso want f rom a bank
e f f i c ien t cash management, advisory services and market research on his product.
Thus the importance of fee based is increasing in comparison with the fund-based
income.
The pre--merger status of ICICI Bank is as follows: it had liabilities of Rs.12,073 crore,
equity market capitalization of Rs.2,466 crore and equity volatility of 0.748.
Working through options reasoning, we find that this share price and volatility are
consistent with assets worth Rs.13,249 crore with volatility 0.15. Thus, ICICI bank had
assets which are9.7% ahead of liabilities, which is roughly consistent with the spirit of
the Basle Accord, and has leverage of 5.37 times.
History of ICICI Bank
The World bank the Government of India and representatives of Indian industry form
ICICI Limited as a development finance institution to provide medium-term
and long-term project financing to Indian businesses in 1955
.
•1994 ICICI establishes ICICI Bank as a subsidiary.
•1999 IC ICI becomes the f i r s t Ind ian company and the f i r s t bank o r
f i nanc ia l institution from non-Japan Asia to list on the NYSE.
• 2001 ICICI acquired Bank of Madura (est. 1943). Bank of Madura was a
Chettiar bank, and had acquired Chettinad Mercantile Bank (est.1933) a n d
Illanji Bank (established 1904) in the1960s.
• 2002The Boards o f D i rec to rs o f IC ICI and IC ICI Bank approve the
merger o f ICICI, IC ICI Persona l F inanc ia l Serv ices L im i ted and ICICI
Capital Services Limited, w i th IC ICI Bank . A f te r rece iv ing a l l necessary
regu la to ry approva ls , ICICI integrates the group's financing and banking
operations, both wholesale and retail, into a single
INTRODUCTION OF BANK OF MADURA
T h e p r e - - m e r g e r s t a t u s o f B a n k o f M a d u r a i s a s f o l l o w s : i t h a d
l i a b i l i t i e s o f Rs.4,444 crore, equity market capitalization of Rs.100 crore and
equity volatility of 0.69.Working through options reasoning, we may say that the
stock market thinks that its assets are worth Rs.4, 095 crore with a volatility
of 0.02. Hence, bom is bankrupt (with assets which are Rs.350 crore behind
liabilities) and has a leverage of 41 times. If we needed to bring bom up to a
point where its assets were 10% ahead of liabilities, which is broadly consistent with the
Basle Accord, this would require an infusion of Rs.800 crore of equity capital.
How do we combine these to th ink o f the merged en t i t y? Asse ts and
l i ab i l i t i es a re additive, so the total assets of the merged entity would prove
to be roughly Rs.17,345 crore and the liabilities would prove to be Rs.16,517
crore. The merged entity would hence need roughly Rs.800 crore of fresh
equity capital in order to come up to a point where assets were at least 10%
ahead of liabilities.
How can we estimate the market capitalization of the merged entity? The value
of equity is the value of a call option on the assets of the merged entity.
Pricing the call requires an estimate of the volatility of the merged assets, i.e.
It requires knowledge of the extent to which the assets of the two banks are
uncorrelated. We find that using values of the cor re la t ion coe f f i c ien t rang ing
f rom 80% to 95%, the vo la t i l i t y o f asse ts o f the merged entity proves to be
around 0.12. In this case, the valuation of the call option, i.e. An es t imate o f the
marke t cap i ta l i za t ion o f the merged en t i t y , p roves to be
rough lyRs.2,500 crore.
This number is not far from the pre--merger market capitalization of ICICI
Bank, which was Rs.2,466 crore. Hence, we can say that on purely financial
arguments, the merger i s rough ly neu t ra l to IC ICI Bank shareho lders i f
BOM was merged in to IC ICI Bank for free. Indeed, if banking regulators
took their jobs more seriously, They would force the shareholders of bom to walk
into such a merger at a zero share price as a way of reducing
T h e n u m b e r o f b a n k r u p t b a n k s i n I n d i a b y o n e . S u c h a f o r c e d -
m e r g e r w o u l d b e a politically easier alternative for the RBI when compared with
closing down BOM.
The shareholders of ICICI Bank have paid a non-zero fee for bom. This
reflects a hope that the products and processes of ICICI Bank will rapidly
improve the value of assets of bom in order to compensate. In addition, the merged
entity will have to rapidly raise roughly Rs.800 crore of equity capital to obtain a
10% buffer between assets and liabilities.
H e n c e , t h i s p r o p o s e d m e r g e r i s a g o d s e n d f o r b o m , w h i c h w a s
o t h e r w i s e a bankrupt entity which was headed for closure given the low
probability that it would manage to raise Rs.800 crore of equity on a base of Rs.100
crore of market capitalization. I t i s u s e f u l t o o b s e r v e t h a t b o m p r o b a b l y
d i d n o t s e e t h i n g s i n t h i s w a y , g i v e n
t h e wi l l i ngness o f Ind ia ' s bank ing regu la to rs to in te rminab ly to le ra te
the ex is tence o f bankrupt banks. Closure of bom would normally involve pain for
bom's shareholders and workers ; ins tead bo th g roups w i l l ge t an
ex t reme ly p leasan t r ide i f the merger goes through.
The proposed merger is a daunting problem for ICICI Bank. It will need to rapidly f i nd
rough ly Rs .800 c ro re in equ i t y . I f Ind ia ' s bank ing regu la to rs were
ser ious abou t capital adequacy, ICICI Bank should have to pay roughly
zero to merge with bom (it is doing a favour to bom and to India's banking
system); instead ICICI Bank has paid a positive price for bom. The key question
that will be answered in the next two/three years is: Will ICICI Bank's superior
knowledge of products and processes revitalize the assets and employees of bom, and
generate shareholder value in the merged entity? ICICI's top management clearly
thinks so, and it would be a very happy outcome if this did indeed happen.
The proposed merger is a good thing for India's economy, since the
headcount of bankrupt banks will go down by one, and there is a possibility of
obtaining higher value added out of the poorly utilized assets and employees of bom. If
the merger goes through, then it will reduce the say of the management team of bom in
India's resource allocation, which is a good thing.
Merger of ICICI Bank with Bank of Madura
T h e p r o p o s e d m e r g e r b e t w e e n I C I C I B a n k a n d B a n k o f M a d u r a
( b o m ) i s a remarkab le one . The p re - -merger marke t cap i ta l i za t ion o f
IC ICI Bank was rough lyRs.2500 crore while bom was at roughly Rs.100
crore. Bom is known to have a poor asset portfolio. What will the merged entity be
worth?
The key rationale underlying every merger is the question of synergy. Can
ICICI Bank's products and technology bring new life to the 263 branches of
bom? Will ICICI Bank (which has 1,700 employees) be able to overcome the
2,600 employees that bomcarries, given that Indian labour law makes it
troublesome and expensive to sack workers?
In applying these ideas to ICICI Bank and to bom, we need to believe that the
stock market effectively processes information to produce estimates of the price and
volatility of the shares of both these banks. This assumption is suspect,
because both securities have poor stock market liquidity. i n te rp re t ing the
numbers shown here . There a re many o ther aspec ts in wh ich th is
reason ing leans on models, which are innately imperfect depictions of
reality. However, these models are powerful tools for understanding the basic
factors at work, and they probably convey the broad picture quite effectively.
The s tock o f IC ICI Bank may be in the l ime l igh t on the back o f the
p roposed acquisition of Bank of Madura.
Though the stock has gained sharply in the last two months after hitting a
recent low of Rs 110, some upside may be left as the bank could get re-rated
on account of the merger. Existing shareholders could hold their exposures in ICICI
Bank while investors with an appetite for risk could contemplate exposures despite the
impressive gains of the past few months. ICICI Bank continues to be one of the
better options in the banking sector at the moment and the possible merger with
ICICI may well be on the backburner.
The merger would pitchfork ICICI Bank as the leading private sector bank.
The merger may be v iewed favorab ly s ince Bank o f Madura has
focused s t reng ths and a reasonably good quality balance sheet. The board of
directors is to meet on December 11to consider the merger.
It is quite likely that the swap ratio may be fixed in a manner that holds out a good deal
for the shareholders of Bank of Madura. This may also be influenced by the fact that the
Bank of Madura stock has gained sharply by around 70 per cent in the past fortnight in
the homestretch to the deal.
As the acquisition is to be financed by issuance of stock, the rise in the
market capitalization of Bank of Madura may mean a higher degree of equity issuance
by ICICI Bank. But the price may well be worth paying as this is the only way
that ICICI Bank may be able to get control over banks with reasonable quality
balance sheets that could make a difference in the medium to long-term.
Bank of Madura has assets of Rs 3,988 crore and deposits of Rs 3,395 crore
asof M a r c h 2 0 0 0 . T h e f a c t t h a t t h e b a n k h a s a c a p i t a l
a d e q u a c y o f 1 5 . 8 p e r c e n t w i t h shareholder funds of Rs 263 crore may
mean that ICICI Bank (post-merger phase) will have more leeway to
pursue growth without expanding the equity base (other than paying for the acquisition).
S t rong cap i ta l adequacy , a s t rong beachhead on the In te rne t a rena ,
a revamped ITa r c h i t e c t u r e , a g r o w i n g r e t a i l c l i e n t b a s e t h r o u g h
a b r i c k - a n d - c l i c k s t r a t e g y , a n d improving asset quality and earnings growth
are positive features as far as ICICI Bank is concerned.
Despite these factors, the share had been on a downtrend from after touching a high of
Rs 271, eight months ago. The uptrend then was on the back of the announcement
of its ADR issue and new technology initiatives. The subsequent downtrend was
triggered by the possibility of the merger with its parent. There is continuing
concern on asset qua l i t y o f IC ICI . I t has been a s ta ted goa l o f the
IC ICI g roup to go in fo r un ive rsa l banking. It is clear that once regulatory
hurdles are removed, such a possibility becomes distinctly feasible.
But Given the battering that bank stock took, ICICI may now hesitate to
pursue this path. A lso IC ICI Bank i s the mos t v i s ib le inves to r - f r iend ly
face fo r the g roup in te rms o f r e t u r n s t o s h a r e h o l d e r s a n d i t m a y
w e l l b e m a i n t a i n e d a s a s e p a r a t e e n t i t y . I n t h i s backdrop, the stock
may hold scope for improvement in the valuation of the stock.
Financial standing of ICICI Bank & Bank of Madura
Parameters ICICI Bank Bank of Madura
1998-1999 1999-2000 1998-1999 1999-2000
Net worth 308.33 1129.90 211.32 247.83
Total deposit 6072.94 9866.02 3013.00 3631.00
Advances 3377.60 5030.96 1393.92 1665.42
Net profit 63.75 105.43 30.13 45.58
Share capital 165.07 196.81 11.08 11.08
Capital
adequacy ratio
11.06% 19.64% 18.83% 14.25%
Gross
advances
4.72% 2.54% 8.13% 11.09%
Net advances 2.88% 1.53% 4.66% 6.23%
Source
Complied from Annual Report (March 2000) of ICICI Bank & Bank
of Madura
Crucial Parameters: - How they stand
Name of the bank Bank of Madura ICICI Bank
Book value of bank on the
day of merger
announcement
183.00 58.00
Market price on the day of
merger announcement
183.00 169.90
Earning per share
Dividend paid (in %)
P/E Ratio
38
55%
1.73
5.4
15%
78.3
REFERENCES
1.www.google.com
2.www.wikipedia.com
3.www.icai.org
4.www.icicibank.com