The Four Reasons Behind Mergers Finance Essay

In simple terms, a merger means blending of two or more existing undertakings into one, consequent to which each undertaking would lose their separate identity. The most common reasons for mergers are, operating synergies, market expansion, diversification, growth, consolidation of production capacities and tax savings. However, these are just some of the illustrations and not the exhaustive benefits.

However, before the idea of Merger and Acquisition crystallizes, the firm needs to understand its own capabilities and industry position. It also needs to know the same about the other firms it seeks to tie up with, to get a real benefit from a merger. Globalization has increased the competitive pressure in the markets. In a highly challenging environment a strong reason for merger and acquisition is a desire to survive. Thus apart from growth, the survival factor has off late, spurred the merger and acquisition activity worldwide.

Take retail finance for instance. With corporate banking becoming an unprofitable business for banks due to high risk of asset quality, banks including financial institutions are tapping the retail finance segment. ICICI's acquisition of Anagram Finance from Lalbhai group, HDFC Bank's merger with Centurion Bank of Punjab and ICICI Bank's merger with Bank of Madura are some of the latest examples of consolidation in the banking sector. We could see the similar trend perking up in other sectors.

The present study gives some insight as to why the banks are going for merger and acquisition and what are the legal, taxes and financial aspects governing them. The study also deals with other aspects such as types of merger, motives, and reasons, bank too much on merger, and successful consolidation in merger, recent trend in merger and acquisition activity.

Purpose

The purpose of this assessment is to examine the merger process that was done on 25 February 2008 between HDFC Bank and Centurion bank of Punjab. The basic purpose of merger is to achieve faster growth of the corporate business. Faster growth may be had through product improvement and competitive position. The whole point of this process is to show how the change management works. The study also focuses on how the technology and superior margins with support from low-cost deposits will ensure profitable growth in the future.

OBJECTIVE

There are four main paths that explain the reasons behind the merger activity. These four paths are related to:

(1) Creating economies of scales

(2) Expanding geographically

(3) Increasing the combined capital base (size) and product offerings

(4) Gaining market power

(5) Identify benefits and barriers of the change management process and provide recommendations for future activities

INTRODUCTION

Housing Development Finance Corporation Limited (HDFC) Bank

The Housing Development Finance Corporation Limited (HDFC) was amongst the first to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in the private sector, as part of the RBI's liberalization of the Indian Banking Industry in 1994. The bank was incorporated in August 1994 in the name of 'HDFC Bank Limited', with its registered office in Mumbai, India. HDFC Bank commenced operations as a Scheduled Commercial Bank in January 1995.

Housing Development Finance Corporation (HDFC), India's leading housing finance company, HDFC Bank is one of India's premier banks providing a wide range of financial products and services to its over 11 million customers across over three hundred cities using multiple distribution channels including a pan-India network of branches, ATMs, phone banking, net banking and mobile banking. Within a relatively short span of time, the bank has emerged as a leading player in retail banking, wholesale banking, and treasury operations, its three principal business segments.

The bank's competitive strength clearly lies in the use of technology and the ability to deliver world-class service with rapid response time. Over the last 13 years, the bank has successfully gained market share in its target customer franchises while maintaining healthy profitability and asset quality. As on December 31, 2007, the Bank had a network of 754 branches and 1,906 ATMs in 327 cities.

Centurion Bank of Punjab

Centurion Bank of Punjab is one of the leading new generation private sector banks in India. The bank serves individual consumers, small and medium businesses and large corporations with a full range of financial products and services for investing, lending and advice on financial planning. The bank offers its customers a wide range of wealth management products such as mutual funds, life and general insurance and has established a leadership 'position'. The bank is also a strong player in foreign exchange services, personal loans, mortgages and agricultural loans. Additionally the bank offers a full suite of NRI banking products to overseas Indians.

Centurion Bank of Punjab now operates on a strong nationwide franchise of 394 branches and 452 ATMs in 180 locations across the country, supported by employee base of over 7,500 employees. In addition to being listed on the major Indian stock exchanges, the Bank's shares are also listed on the Luxembourg Stock Exchange.

MERGER

HDFC Bank and Centurion Bank of Punjab merger at share swap ratio of 1:29 The Boards of HDFC Bank and Centurion Bank of Punjab met on 25 February, 2008 and approved, subject to due diligence, the share swap ratio for the proposed merger of Centurion Bank of Punjab with HDFC Bank. The Scheme of Amalgamation envisages a share exchange ratio of one share of HDFC Bank for twenty-nine shares of Centurion Bank of Punjab. The combined entity would have a nationwide network of 1,148 branches (the largest amongst private sector Banks) a strong deposit base of around Rs.1200 billion and net advances of around Rs.850billion. The balance sheet size of the combined entity would be over Rs. 1,500 billion.

HDFC Bank was looking for an appropriate merger opportunity that would add scale, geography and experienced staff to its franchise. This opportunity arose and we thought it is an attractive route to supplement HDFC Bank's organic growth.

Commenting on the proposed merger, Mr. Deepak Parekh, Chairman, HDFC said, "We were amongst the first to get a banking license, the first to do a merger in the private sector with Times Bank in 1999, and now if this deal happens, it would be the largest merger in the private sector banking space in India. We believe that Centurion Bank of Punjab would be the right fit in terms of culture, strategic intent and approach to business." Mr. Aditya Puri, Managing Director, HDFC Bank said, "These are exciting times for the Indian banking industry. The proposed merger will position the combined entity to significantly exploit opportunities in a market globally recognized as one of the fastest growing. I'm particularly bullish about the potential of business synergies and cultural fit between the two organizations. The combined entity will be an even greater force in the market

RESEARCH QUESTIONS

Q1. What is the effect after merger and accusation on the financial performance of the organization?

The merger added around 400 branches to HDFC Banks' branch strength of 760 along with a 15-20 per cent increase in the asset base to more than Rs.1.7lakh crore. While the merger has helped increase the size of HDFC Bank, it has also led to some pressure on key ratios for the combined entity; Centurion Bank of Punjab ratios were lower than that of HDFC Bank.

Q2. How does it affect the cultural changes inside the organization?

All the employees of Centurion Bank of Punjab have been assigned their new roles in the merged entity and the training processes are underway to bring them at par with HFDC Bank standards. All systems integrated with HDFC Bank platform, i.e. flex cube Treasury is still already integrated with the same, while both wholesale banking and retail banking is fully integrated and working.

The merger positioned the combined entity to significantly exploit opportunities in a market globally recognized as one of the fastest growing. The potential of business synergies and cultural fit between the two organizations. The combined entity emerged to be a greater force in the market.

Q3. Study on the growth process after the merger and acquisition of bank.

HDFC Banks' net revenues have grown at a compound annual growth rate (CAGR) of 44.5 per cent in the last five years on the back of net interest income (NII) and other income growing by 43 per cent and 47.7 per cent, respectively. Net profits grew by 33 per cent; the lower pace is due to the bank's prudent policy of higher provisioning (last three years).

HDFC Bank has been going slow on the retail loans and even CBoP's non-issuance of fresh loans (since December 2007) to the two-wheeler and personal loan segments, has ensured comfortable NPA (non-performing assets) levels for the combined entity. HDFC Bank, after the merger, provided higher provisions to the combined entity in line with its own superior provision coverage of around 67 per cent (CBOP's at 55 per cent). Although, it added pressure on the profitability in the near term but it will help avoiding slippages in asset quality in the future.

The advances haven't slowed and this is indicated from the credit-deposit ratio rising from 63 per cent last year to around 75 per cent current year. The recent Cash Reserve Ratio (CRR) cut has released additional funds of around Rs.4500crore that could be used for further loan disbursements and provide support to (NIM) Net Interest Margin's. The higher yield on advances and investments in conjunction with high interest rates has meant that NIM is still comfortable at 4.2 per cent.

Q4. How did the market share and capitalization of HDFC bank get affected after merger?

The bank's competitive strength clearly lies in the use of technology and the ability to deliver world-class service with rapid response time. The bank has successfully gained market share in its target customer franchises while maintaining healthy profitability and asset quality.

As of June 30, 2009, the Bank had a distribution network with 1,416 branches and 3,382 ATMs in 550 cities.

For the quarter ended June 30, 2009, the Bank earned total income of INR 51.36 billion as against INR 42.15 billion in the corresponding period of the previous year. Net revenues for the quarter ended June 30, 2009 were INR 28.99 billion, up by 25.1% over INR 23.16 billion for the quarter ended June 30, 2008. Net Profit for the quarter ended June 30, 2009 was INR 6.06 billion (Rs.606.1crore), up by 30.5% over the corresponding quarter ended June 30, 2008.

The Bank's total balance sheet size increased by 10.38% from INR 1685.98 billion as of June 30, 2008 to INR 1861.15 billion as of June 30, 2009. Total deposits were INR 1457.32 billion , an increase of 11.31% from June 30, 2008.

Total income for the year ended March 31, 2009 grew by 58.2% to INR 196.22 billion (Rs19622.9crore) over the corresponding year ended March 31, 2008.

Leading Indian and international publications have recognized the bank for its performance and quality.

MEHTODOLOGY

HYPOTHISES

H1: Merger and Acquisition process has direct relation with the financial performance of the organization.

H2: Mergers & acquisition is directly related to the cultural changes inside the organization.

H3: Mergers and Acquisition process is inversely related to the growth process of an organization.

H4. There is a positive Relation b/w the market share and merger.

Research Philosophy

The researcher follows a positivism approach which shows that the study is based on some scientific statements. The study includes the testing of hypotheses, which enable in the assessment of various laws.

Positivistic approach seeks to identify measure and evaluate any phenomena and to provide rational explanations for it. This explanation will attempt to establish causal links and relationships between the different elements (or variables) of the subject and relate them to a particular theory or practice.

Advantages of Positivism Approach

The following are the advantages of this approach:-

The research can be structured in a better way.

It ensures that the data that is collected is valid and holds true in all means.

The hypothesis can be tested much easily.

Disadvantages of Positivism Approach

The following are the disadvantages of this approach:-

It is very difficult to arrive at a proper sample size.

It is very time consuming.

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Sources of Data

The data that is to be collected must be logical. The quality of the conclusion is highly dependent on the data that is being collected. Hence one must ensure that accurate and reliable data are collected.

Primary Sources

The research is in the form of interview and survey obtains these data from individuals. They are generally true facts.

Secondary Sources

These include that information pertaining to company, latest journals and academic papers, online reliable resources that would provide the latest development in the field. Secondary sources are those data that are already obtained by others.

Research Design

Research Design basically shows how all the major components of the research project - samples, measures, and treatments work together to address the central research questions.

A Cross-sectional study is undertaken as the time for the research is short. The facts are collected from employees of different age groups. It involves the data collection at a particular point of time. The research includes finding out the variables that are responsible for the problem identified. Such study is termed as Correlation study. This kind of a study takes place in a natural environment and where there is very little interference by the researcher.

CONCLUSION

Merger and acquisition the most talked about term today creating lot of excitement and speculative activity in the markets. However, before the idea of M&A crystallizes, the firm needs to understand its own capabilities and industry position. It also needs to know the same about the other firms it seeks to tie up with, to get a real benefit from a merger. A mergers and Acquisitions activity is that the divesting firm moves from diversifying strategy to concentrate on core activities in order to improve and increase competitiveness. Globalization has increased the competitive pressure in the markets. In a highly challenging environment a strong reason for M&A is a desire to survive. Thus apart from growth, the survival factor has off late, spurred the M&A activity worldwide

Some such factors are listed below:

A¢â‚¬A¢ The Company's business prospects and nature of its business

A¢â‚¬A¢ The prospects for industry in which the company operates

A¢â‚¬A¢ Management reputation

A¢â‚¬A¢ Goodwill and brand value

A¢â‚¬A¢ Marketing network

A¢â‚¬A¢ Technology level

A¢â‚¬A¢ Efficiency level in terms of employees

A¢â‚¬A¢ Financial performance

A¢â‚¬A¢ Future earnings

A¢â‚¬A¢ The legal implications

A¢â‚¬A¢ Government policy in general and in particular for that industry

A¢â‚¬A¢ Current valuations of shares in stock markets

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