IDFC + Shriram Group. Deal not value accretive. Financial summary (FY17) 17 JUL 2017 Company Report Not Rated. Target Price: NA

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1 Not Rated Target Price: NA CMP Potential Upside : Rs 65 : NA + Shriram Group Deal not value accretive MARKET DATA No. of Shares Market Cap Free Float Avg. daily vol (6mth) 52-w High / Low Bloomberg Promoter holding FII / DII : 3,401 mn : Rs bn : 47.2% : 10.8 mn shares : Rs 83 / Rs 96 : BK IB Equity : 52.8% : 17.8%/6.8% *Note: All the above details refer to Bank Financial summary (FY17) Market CMP PAT EPS BV P/E P/BV R oe R oa Net NPA Cap (Rs b n) (Rs) (Rs mn) (Rs) (Rs) (x) (x) (%) (%) (%) Bank* , Ltd* , NA NA NA SHTF 246 1,087 12, SCUF 165 2,488 5, Source: Company, Axis Capital * Bloomberg

2 Announcing the Mega Merger: + Shriram and Shriram group announced a 90-day exclusivity period to discuss a merger. The plan is to merge Bank with Shriram City Union Finance (SCUF); whereas Shriram Transport Finance (SHTF) and other Shriram group entities (life insurance, general insurance, AMC) will be separate subsidiaries of Ltd. Based on CMP, every shareholder of SCUF is likely to get ~39 shares of Bank and while those of SHTF may get ~18 shares of Ltd or SHTF may get de-listed and shareholders will be compensated. SHTF is not being merged with the bank (it will be a 100% NBFC under Ltd) as (1) there is large burden of SLR/CRR/Agri PSL requirements; (2) cap on inter-bank borrowings and (3) this will lead to significant dilution for group shareholders. The merged Bank will have ~Rs 1.1 trn of advances (7 th largest in private sector) and ~1,070 branches (6 th largest). The merger will create a financial conglomerate with mass retail focus and cater to the under served while providing a full range of financial products. We believe the merger is a negative for shareholders of SCUF (exposure to large infra assets, lower return ratios) and SHTF (holdco discount on Ltd shares) but a positive for Bank shareholders. The Bank will leapfrog into a well-diversified, retail-oriented private bank business but consolidation to take 2+ years. We put SHTF and SCUF under review till the ratios are announced. We do not have coverage on Ltd and Bank. 7th largest private bank in terms of advances (FY17) 6th largest private bank in terms of branches 6,000 5,000 4,000 3,000 2,000 1, ,546 4,642 3,731 1,361 1,323 1,131 1,083 HDFCB ICICIBC AXSB KMB YES IIB Merged Entity 6,000 (Rs bn) 5,000 4,850 4,820 4,000 3,000 2,000 1, ,304 1,369 1,200 1,072 1,000 ICICIBC HDFCB AXSB KMB IIB Merged Entity (nos) YES Source: Company, Axis Capital; Data for combined Bank + SHTF 2

3 Merger structure SCUF under the Bank, rest under Ltd Merged entity, a financial conglomerate Ltd (Holdco) Bank + Shriram City Union Finance Co Shriram Transport Finance Co Shriram Life Insurance Co Shriram General Insurance Co AMC + Shriram AMC - AIF - IDF - IB & Broking Customer life cycle in focus cross sells to a ~10 mn customer base Savings Credit Wealth management Protection 3

4 Approval process to take over 12 months 1 2 Individual company boards RBI & other regulatory bodies Both the groups have signed an exclusivity arrangement for 90 days wherein they will evaluate the merger viability/ valuations and other legal aspects. Post which they will approach the boards for final approval and announce the merger ratios Approvals from all the key regulators will be required - RBI, SEBI, IRDA, NCLT, Competition Commission, Stock exchanges 3 High courts / legislatives The above process is likely to take months to complete and we may see a combined entity only by end FY19, hence a significant amount of management bandwidth and time over the next two years will be invested in creating this large financial services conglomerate 4

5 Positives from the deal.retail Retail...the buzz word The merger will create a large universal bank with a core retail offering which includes key businesses under one umbrella liability & asset products, fee products like life insurance, general insurance, asset management, broking, private equity and investment banking The combined group ( Ltd) will have ~70% of business interests coming from retail segment A large branch network (~2,000 in the group, of which ~1,070 in the merged bank) with an even spread across urban and rural markets will help mine customer data and cross sell to ~10 mn group customers For Bank, PSL requirements ease up significantly with the inclusion of SCUF s retail portfolio focus on MSE lending However, direct agriculture lending targets may be a challenge Blended RoA for Bank improves with the inclusion of SCUF s high yield portfolio The deal structure also offers Shriram Capital shareholders an opportunity to unlock value will be able to use Shriram brand that has a much wider acceptance in many regions, thereby getting some advantage in garnering retail liabilities 5

6 Merger hurdles no easy ride The biggest challenge would be obtaining RBI approval for the current deal structure, which seeks to keep Shriram Transport outside the Bank As per the licensing agreement of Bank, any credit businesses should be under its fold and not under the NOFHC Mr. Ajay Piramal (key shareholder of Shriram group) believes the proposed structure will get regulatory approval Our view remains that even if RBI permits at this juncture (chances look meek), they may not get a window of more than 12/24 months within which they will be required to merge SHTF with Bank Hence, significant dilution for existing Bank shareholders will be an overhang Further, equity stakes of certain large shareholders in the merged entity can be above the regulatory threshold HR & cultural issues are another set of challenges in the entire consolidation process Huge dilution will be required for complete amalgamation (both at Ltd and Bank level) Meeting direct agriculture lending targets (under priority sector lending norms) for Bank can be cumbersome on a larger balance sheet SCUF & SHTF are yet to shift to 90 DPD on NPA recognition norms, which will put additional NPA burden on merged entity Cost/ Income may escalate in the initial years as: Low cost structure of NBFC may need to be realigned with that of the bank Relocation/ refurbishment of existing NBFC branches to suit that of the bank will involve significant costs Training/ retention costs for existing employees Drag from SLR/CRR requirements will pull down the denominator (income) 6

7 Current shareholding to be a challenge Top shareholders of SCUF (% ) % SHRIRAM CAPITAL LTD 33.8 DYNASTY ACQ FPI LTD 20.4 PIRAMAL ENTERPRISES 10.0 EAST BRIDGE 3.9 MATTHEWS 3.6 Top shareholders of SHTF (% ) % SHRIRAM CAPITAL LTD 26.1 PIRAMAL ENTERPRISES 10.0 JPMORGAN CHASE & CO 3.6 CAPITAL GROUP 3.1 SANLAM LIFE INSURANCE 3.0 Top shareholders of Bank (% ) % FIN HDFS LTD 52.9 GOI 7.7 SIPADAN INVSTS MAURITIUS 4.4 COMMONWEALTH BANK OF AUSTRALIA 4.1 PLATINUM INTERNATIONAL 1.7 Top shareholders of Ltd (% ) % GOI 16.4 COMMONWEALTH BANK OF AUSTRALIA 10.9 SIPADAN INVSTS MAURITIUS 9.5 ICICI PRU LIFE AMC 7.3 BIRLA SUN LIFE AMC 5.3 Source: Company, Axis Capital, Bloomberg Shriram Capital s stake falls from 33.8% to 13.5% in Bank; Piramal Enterprises will own 4% directly in Bank Piramal Enterprises will indirectly hold 2.25%, taking its beneficial interest in the bank to 6.25% (will require RBI approval) Ltd (NOFHC) promoter stake falls to ~31.7% (below the minimum promoter threshold of 40% which was a licensing requirement) Note: All calculations based on market cap of the 4 companies as of 7th July

8 Merged Entity ( Bank + SCUF) key parameters FY17 SC UF B SIZE & SCALE Merged Enitity (Rs b n) Total Income (Rs bn) Net Profit (Rs bn) Net Worth (Rs bn) Market Cap (Rs bn) AUM (Rs bn) ,083.0 Total Assets (Rs bn) 245 1,122 1,367.0 R EACH Customers (mn) Branches ,072 Employees 26,783 3,906 30,689 ASSET QUAL ITY GNPA (%) NNPA (%) C APITAL POSITION Tier 1 Cap (%) Total CAR (%) R ETUR N METRICS RoAA (%) RoAE (%) VALUATIONS P/BV (FY17) P/E (FY17) To leap into the league of large private banks with significant share of retail assets. Retail liabilities to still remain a challenge Significant addition to branch and customer network however costs to be involved in upgradation/ training Blended return ratios to improve but liability accretion and customer/ employee transition to be the key Source: Company, Axis Capital, Bloomberg 8

9 Shriram merger Why it makes sense for? Significant reach and presence Low cost client acquisition Management expertise of Shriram Group in retail loans esp unserved and under served segments Ability to cross sell to ~10 mn customers Why it makes sense for Shriram group? s Bank license and associated benefits (incl. low cost funds) Ability to cross sell liability products and make customers stick Management expertise of group in large corporate and infrastructure loans 5th largest employer in private banking sector Profitability still far away asset quality woes persist ('000s) (Rs bn) 16 0 HDFCB ICICIBC AXSB KMB Merged Entity IIB YES 0 HDFCB ICICIBC AXSB KMB YES IIB Merged Entity Source: Company, Axis Capital; Data for combined Bank + SHTF Source: Company, Axis Capital; Data for combined Bank + SHTF 9

10 Bank + SCUF portfolios Business mix Bank - Rs 852 bn (Retail ~2%) Business mix (%) Shriram City Union Finance (Rs 231 bn) Sub-segment Key products Infra Emerging large corporates Project finance Term loan Working Capital Finance 2Wheeler 18 Gold Loans 15 Conglomerates PSUs MNCs Trade Finance - Escrow/ LG/ BG/ Export finance Cash Management Corporates linked finance FX & DCM SME 55 Others 13 ECM & Private equity The merged entity will have a well diversified loan mix: SCUF s 2Wheeler and SME finance book Bank s large corporate and Infra finance book 10

11 Company financials (Standalone) Bank Bank Profit and loss account R s mn Interest Earned 85,327 Other Income 10,131 Total (A) 95, 4 58 Interest expended 65,154 Payments to/provisions for Employees 5,736 Operating Expenses & Administrative Expenses 4,432 Depreciation 1,343 Other Expenses, Provisions & Contingencies 4,083 Provision for Tax (13) Deferred Tax 4,525 Total (B) 85, 261 Adjusted Net Profit (A- B) 10, 197 Equity Dividend (%) 7.5 Dividend Per Share (Rs) 0.8 Earnings Per Share 3.0 Book Value Per Share 43 Balance sheet Rs mn Source of funds Capital 33,990 Reserves 112,780 Equity Application Money 11 Deposits 402,082 Borrowings 502,622 Other Liabilities & Provisions 70,112 TOTAL L IABIL ITIES 1, 121, 597 Ap p lication of funds Cash & Balances with RBI 30,363 Balances with Banks & money at Call 20,657 Investments 504,717 Advances 494,017 Fixed Assets 7,866 Other Assets 63,977 TOTAL ASSETS 1, 121, 597 Source: Capitaline, Company Source: Capitaline, Company 11

12 Company financials (Standalone) - Shriram Transport Finance Shriram Transport Finance Profit & loss (Rs mn) Y/ E March FY16 FY17 FY18E FY19E Interest earned 101, , , ,144 Interest expended (50,579) (51,874) (56,084) (61,844) Net int erest incom e 51,374 54,535 57,070 63,299 Non interest income 982 1,897 1,517 1,669 Net incom e 52,356 56,432 58,588 64,968 Op erat ing exp enses (13,473) (12,750) (13,666) (14,556) Staff expenses (5,891) (5,482) (6,031) (6,513) Other operating expenses (7,582) (7,267) (7,635) (8,043) Op erat ing p rofit 38,882 43,682 44,922 50,413 Provisions & contingencies (21,068) (24,443) (20,560) (22,022) P re- t ax p rofit 17,814 19,239 24,362 28,390 Tax expense (6,032) (6,666) (8,259) (9,624) P rofit aft er t ax 11,782 12,573 16,103 18,766 Extraordinary item Minority interest/associates Adj. P AT 11,782 12,573 16,103 18,766 Balance sheet (Rs mn) Y/ E March FY16 FY17 FY18E FY19E Tot al asset s 679, , , ,050 Cash & Balances with RBI 39,239 44,407 29,390 33,294 Investments 13,562 15,494 17,043 18,747 Advances 618, , , ,351 Fixed assets 1, Other assets 7,038 28,694 32,925 37,782 Tot al l iab il it ies 679, , , ,050 Equity capital 2,269 2,269 2,269 2,269 Preference capital Reserves & surplus 99, , , ,603 Networth 101, , , ,872 Borrowings 497, , , ,704 Deposits Other liabilities & prov. 80,185 99,981 92, ,475 Source: Company, Axis Capital 12

13 Company financials (Standalone) - Shriram Transport Finance Shriram Transport Finance Key ratios (% ) Y/ E March FY16 FY17 FY18E FY19E P er share data FDEPS (Rs.) BV (Rs.) Adj. BV (Rs.) DPS (Rs.) Dividend payout (%) Y iel ds & Margins (% ) Yield on advances Cost of deposit Net interest margin Asset qual ity (% ) Gross NPAs Net NPAs Credit cost Provisioning coverage Cap ital (% ) Tier-I CAR Efficiency (% ) ROA ROE Cost to income CASA Effective tax rate Growth (% ) Net interest income Fee income Source: Operating Company, expenses Axis Capital 20 (5) 7 7 Profit after tax (5) Advances Deposits Total assets Source: Company, Axis Capital 13

14 Company financials (Standalone) - Shriram City Union Finance Shriram City Union Finance Profit & loss (Rs bn) Y/ E March FY16 FY17 FY18E FY19E Interest earned Interest expended (13.8) (15.3) (18.5) (20.9) Net int erest incom e Non interest income Net incom e Op erat ing exp enses (10.5) (11.4) (12.9) (15.7) Staff expenses (5.1) (5.5) (6.2) (7.3) Other operating expenses (5.4) (5.9) (6.7) (8.4) Op erat ing p rofit Provisions & contingencies (6.2) (9.1) (9.9) (10.6) P re- t ax p rofit Tax expense (2.8) (3.0) (3.8) (5.1) P rofit aft er t ax Extraordinary item Minority interest/associates Adj. P AT Balance sheet (Rs bn) Y/ E March FY16 FY17 FY18E FY19E Tot al asset s Cash & Balances with RBI Investments Advances Fixed assets Other assets Tot al l iab il it ies Equity capital Preference capital Reserves & surplus Networth Borrowings Deposits Other liabilities & prov Source: Company, Axis Capital 14

15 Company financials (Standalone) - Shriram City Union Finance Shriram City Union Finance Key ratios (% ) Y/E March FY16 FY17 FY18E FY19E P er share data FDEPS (Rs) BV (Rs) Adj. BV (Rs) DPS (Rs) Dividend payout (%) Y iel ds & Margins (% ) Yield on advances Cost of funds Net interest margin Asset qual ity (% ) Gross NPAs Net NPAs Credit cost Provisioning coverage Cap ital (% ) Tier-I CAR Efficiency (% ) ROA ROE Cost to income CASA Effective tax rate Growth (% ) Net interest income Fee income Source: Operating Company, expenses Axis Capital Profit after tax (5) Advances Deposits Total assets

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17 Disclaimer Shriram City Union Finance DEFINITION OF RATINGS Ratings Expected absolute returns over 12 months BUY More than 10% HOLD Between 10% and -10% Disclaimer: SELL Less than -10% Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to the recipient s specific circumstances. The securities and strategies discussed and opinions expressed, if any, in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This report may not be taken in substitution for the exercise of independent judgment by any recipient. 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