Merger and Acquisitions: A Case Study of ICICI Bank - Bank of Rajasthan

This case study analyzes the merger of ICICI Bank and Bank of Rajasthan, focusing on the rationale behind M&A, sources of funds, financial impact, and enhancement of shareholder value. It also examines the financing of the merger and the financial performance pre and post-merger acquisitions. The study uses financial ratios and common size financial statements to justify the analysis.

Accounting
Assignment

1
ACCOUNTING & FINANCE ASSIGNMENT
Case studY
Name of the Student :
Date : 07th October,2018
Administrator
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Background
Our Study is intended to focus the rationale behind one of the most commonly found practice in
the business world that is Merger& Acquisitions (M&A) along with the identification of the
possible sources of Funds to finance the process. It also makes a deep- rooted analysis of the
financial impact of the entire process by making a comparison of pre and post merger financial
figures and finally whether it succeeds in enhancement of the shareholder’s value or not. In order
to serve our purpose we have selected one of the largest Tech merger of ICICI Bank - Bank of
Rajasthan. The analysis explains the merger that has took place in the last 10 years and what are
the parameters and performance metrics that are seen while doing the merger. Since this is one of
the financial news, it is always expected that it would trigger the stock market when the news is
made public. In the given case as well, the reaction of the stock market and the prospective
investors has been captured in the report towards the end.
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Contents
Cover Page………………………………………………………………………………………1
Background……………………………………………………………………………………...2
Introduction……………………………………………………………………………………..4
Justification for the choice of the Company and Sector………………………………………..5
Rationale & Theory of Merger and acquisitions……………………………………………….6
Examination of the Financing of the Merger and acquisitions…………………………………7
Financial Performance pre and post merger acquisitions………………………………………8
Impact of Financing announcement…………………………………………………………….9
Conclusion……………………………………………………………………………………10
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Introduction
The practice of consolidation of companies is known as Merger and acquisition, that consists of
two words, first being merger, means combining two companies to form as one and single
company, whereas acquisition refers to the taking over of one company (Vendor company) by
another company (Purchasing Company). The basic objective behind our study is to cover the
various aspects of M&A such rationale behind M&A, how the justification for the M&A should
be provided after making a thorough analysis of pre and post merger effect, what are the various
sources of Funds to facilitate the process and finally how the final outcome of the entire process
results into the overall enhancement of shareholder’s value. In order to justify our study we have
selected the case study approach along with the questionnaire method by referring the merger of
ICICI Bank - Bank of Rajasthan. In this modern era of Banking Industry evidencing the dynamic
change in the financial world perhaps can provide the best evidence to justify the process of
acquisition.
In order to facilitate our study the major sources of financial data gathered are Annual reports of
both of the banks, website of the banks along with the relevant publications of the News journals.
The methodology selected here is the use of various financial ratios and common size financial
statements have been used to justify our study. All the relevant financial figures presented are the
parts of the secondary data collection.
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The ICICI Bank, acquirer was formed in the year 1955 with the initiatives taken by the
government of India, representatives of the Industries along with the World Bank collaboration
in order to serve the long and medium term project Financing to the Indian Business. A major
transformation was noticed in the year 1990 when it converted itself into a developmental
financial institution by offering services directly as well as through its various subsidiaries.
The major reason behind selecting the merger of ICICI Bank - Bank of Rajasthan is nothing but
to bring out the Instance of compulsory merger option exercised by the various regulatory
authorities on the promoters of the Bank of Rajasthan since 2009 as there were lot of evidences
showing severe noncompliance by the Bank of Rajasthan. Because of which no option left for
the promoters other than to restructure the same. This case study is also an indication towards the
fact that Indian Banking Industry still have a strong enough regulatory system for its future
survival.
Justification for the choice of the Company and Sector
The major reason behind choosing the merger of ICICI Bank- Bank of Rajasathan to prove its
worth for our study is enumerated as follows.
1. This merger is the best evidence to establish the power of regulatory intervention in
the Indian Banking Industry to strengthen the Indian Banking system
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2. It is the best example of the strategic move taken by the ICICI bank to establish itself
to be a market leader (Kusnadi & Wei, 2017).
3. This merger evidences the recapitalization of the weaker bank as per Basel II norms.
It is because of this reason that the approval of the board on the merger could be
aviailed quickly (Kang, Yu, & Lee, 2016).
4. This study further showed that how the policy of liberalization adopted by the
government of India and Reserve Bank of India helped to increase the profitability of
the ICICI Bank.
5. This also shows that how the Bank can target the local population for enlarging its
local customer database. The ICICI bank planned to increase the number investors in
the local region and also to increase the level of comfort for local community and the
number of branches and the linking of bank accounts was made easy through this.
The number of facilities that could be given to the potential as well as existing
customers was increased (Johan, 2018).
6. It provides the guidance to investors, strategy and policy makers to make relevant
decision in M & A Cases (Charles H, Giovanna, Dennis M, & Robin W, 2015).
Rationale & Theory of Merger and acquisitions
The major theories of takeover applicable in the case of acquisition of Mindmeld by
CISCO are enumerated hereunder:
1. Efficiency Theory
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2. Market Power Theory
3. Bankruptcy Avoidance Theory
1. Efficiency Theory
The efficiency theory of takeover is again of two types, i.e. differential efficiency
theory and inefficiency management theory. In the case of Bank of Rajasthan’s
acquisition by ICICI Bank is based on inefficient management theory (Svahn,
Mathiassen, & Lindgren, 2017) . The reason behind this is that ICICI Bank in the
given case is a strong market player, but the Bank of Rajasthan was blamed for lot of
non compliances by the various regulatory authorities and consequently the promoters
of the Bank sold majority of their stake, there was great risk from operations
associated with the Bank of Rajasthan. Hence assigning the leadership in the hands of
ICICI Bank would lead to ensure the smooth operation by the merged group.From the
various non compliances like decrease in the shareholdings of the promoters of the
bank and various penalties imposed by the SEBI on the BOR it was quite evident that
the inefficiency in performance of BOR was made public as in the same
circumsatnces its acquirer was performing much better. At the same time this deal
offered the benefit of synergy to the ICICI which simply aimed at combining the best
elements of both of the banks and removing the worst part associated with
them.Synergy is achieved only when the merged valuation of the firm goes higher in
comparison to their individual valuation that happened in this case by increase in the
valuation of shares post merger (Egelund-Mu¨ller, Elsman, Henglein, & Ross, 2017).
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In this case the inefficiency of the BOR was replaced by the addition of employees by
the ICICI with a view to providing much better delivery of products and services.
Because of which the ICICI also got a scope to serve the rural customer.
Again the ICICI raised the level of corporate culture in the BOR through the
implementation of CASA principles.
2. Market Power Theory
Market power theory ensures the control of quality, price and supply of the products
services in the market to be achieved through the acquisition process. The benefit
through merger is the benefit of synergy in operations thereby increasing the
operational performance of the ICICI bank by way of reducing the operation cost. In
the given case the new customer base and raise in the amount of deposit together with
the better outreach to a large group of customer helped the ICICI to gain the market
leadership. due to which not only the profitability of the Bank increased but also the
barrier to enter the rural market was also removed (Ghofiqi, 2018).It could be
evidence from its past history that for gaining the market power it made a number of
M&A in past too.
3. Bankruptcy Avoidance Theory
As BOR had been facing huge allegations from various regulatory authorities hence
there was a possibility that a time might come to these authorities to declare it an
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insolvent one, but before this the decision to merge it with ICICI Bank made a
miracle.Generally merging a weaker Bank has also a lot of positive and negative
effect. Because there will be very few amount of bidder who would like to bid for
it.Hence in this case merger was seen as an alternative to Bankruptcy.ICICI though
paid 90% Premium on the share of BOR as the Bank didn’t have to search for its
target, but BOR had to merge with icici as a result of regulatory provision (Grundy,
Held, & Bero, 2017).
4.
Unique reason which necessitated the merger of ICICI Bank- Bank of Rajasthan
The major reasons why the merger of ICICI Bank -Bank of Rajasthan are as follows:
i) The growing instances of non compliances made by Bank of Rajasthan made it an
instance of compulsory merger for which the best leader in form of ICICI Bank
was chosen (Iggers, 2018).
ii) This merger indicates towards the possible reasons for the weakness in the Indian
Banking sector that makes it a target of the strong Bank.
iii) The smart strategic move of a bank in industry to strengthen its position by
correctly identifying the target bank to be merged has become evident from the
initiative taken by ICICI Bank through its expansion plan (Kaufmann, 2017).
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iv) ICICI wants its presence in the northern part of India serving the rural customer as
a part of its strategy that was fulfilled by this merger.
v) The ICICI bank planned to increase the number investors in the local region and
also to increase the level of comfort for local community and the number of
branches and the linking of bank accounts was made easy through this. The
number of facilities that could be given to the potential as well as existing
customers was increased (Hansen, Otley, & Stede, 2003).
Examination of the Financing of the Merger and acquisitions
The Bod of directors of both of the banks approved the scheme of merger as on 18 th
May,2010 on the basis of an all stock plan. The merger of ICICI Bank-Bank of Rajasthan was
approved by the Board of directors of the second largest private sector Bank of India,i.e. the
ICICI Bank was approved to be a non cash deal involving the equity that was swap option in the
ration of 1: 4.72 resulting into the allotment of 25 shares by the ICICI for every 118 shares of the
Bank of Rajasthan. This is how the purchase consideration of the company was decided and
being paid off (Kusolpalalert, 2018).
In terms of Purchase consideration to be paid to BoR was valued for Rs.30.41 billion, for which
each of its share was valued at Rs.189/- plus an amount of Rs.90/- per share ((approx.) as
premium.
At the time of merger the total number of outstanding shares of ICICI was 111 crores, whereas
for BoR it was 16 crores only and the market capitalization of the former was Rs.99221/-crores,
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whereas for later it was Rs.1597/- crores (Webster, 2017). Thus, it can be said that the entire
purchase consideration was being settled off in terms of equity arrangements and debt was not
required. In the financials of ICICI bank post merger, it was shown as equity financing as the
balance of equity increased rather than det. So it qualifies as on all equity deal. In the given case,
working capital finance was not required as by ICICI bank as the entire thing as being paid off in
the form of equity shares.
Financial Performance pre and post merger acquisitions
The following figures also provide major indication towards the fact that the said merger
didn’t bring any major changes in the overall financial performance of the Bank, instead
it has affected the financial performance in terms of profitability of the ICICI Bank. All
the major ratios have been computed for ICICI bank post merger to show the impact of it
on the overall business. This was one of the instrumental mergers and brought ICICI
bank into one of the top banks in the country with a huge addition in the list of customers
served.
Pre and Post Merger analysis through the Profitability Ratio
ICICI Bank(Pre merger)
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Particulars March 2008 March 2009 March 2010
Return on Assets 417.64 444.9 463.01
Return on Net Worth 8.94 7.58 7.79
Return on Investment 62.34 56.72 44.72
Interest Spread 3.51 3.66 5.66
Net Profit Margin 10.51 9.74 12.17
Operating exp/Total Income 26 26.22 29.05
Interest spent/Interest earned 76.28 73.09 68.44
Other Income/Total Income .17 .86 .92
BOR( Pre Merger)
Particulars March 2008 March 2009 March 2010
Return on Assets 69.81 64.8 58.04
(including revaluation)
Return on Net Worth 21.75 18.29 -18.86
Return on Investment 173 185.5 177.5
Interest Spread 5.53 7.03 4.65
Net Profit Margin 9.75 7.81 -6.85
Operating exp/Total Income 21.18 21.12 36.34
Interest spent/Interest earned 70.09 72.16 75.36
Other Income/Total Income 5.99 3.25 4.06
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Post Merger
Particulars Post Merger
Return on Assets 478.31
Return on Net Worth 9.35
Return on Investment 42.97
Interest Spread 4.01
Net Profit Margin 15.91
Operating exp/Total Income 24.81
Interest spent/Interest earned 65.29
Other Income/Total Income .02
From the analysis of the above it is quite evident that before merger the net profit ratio of
BOR was 10.04% and that of ICICI Bank was 12.17% that reached to a new height of
15.91% after merger. It is the depiction of monopoly gained by ICICI and the goodwill
earned by the ICICI that contributed towards increasing the post merger net profit ratio.
Similarly the ROI of BOR was 177.48% and that of ICICI was 44.72% but that reached
to a level down to 42.97% after the deal of merger. After the merger net worth of BOR
increased by 9.35%.
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There are many other ratios which should be noted like the return on assets or how good
the assets of the company were being utilized. It shows the efficiency of the company’s
assets and the same increased from 417.64 to 478.31% which indicates the increase in
efficiency of the operations and how the assets are being used to generate revenue. From
the perspective of the bank, the interest spread and the interest spent / interest earned ratio
matters a lot and here in this deal, both of them has increased and improved significantly
(Yadao, 2018). The interest spread improved from 3.51% before merger to 4.01% post
merger which clearly indicates the increase in profitability through reduction in the
operating expenses. The interest spent / interest earned was 76.28% before merger and
the same decreased to 65.29% post merger and this can be counted as one of the major
improvements in the company from the perspective of the profitability. Thus, it can be
well said that the company improved not only in terms of profitability but also in terms of
liquidity as well as on operations front.
Common Size Financial Statement Analysis
Common size P& L Account of ICICI Bank
Particulars Pre
merger
period
Post
Merger
Period
March08 March09 March
10
March
11
March
2012
Revenue
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Interest earned 78% 79% 78% 79% 81%
Other Income 22% 21% 22% 21% 19%
Total Revenue 100% 100% 100% 100% 100%
Expenditure
Interest Spent 59% 58% 53% 51% 55%
Employee Exp 5% 5% 6% 9% 8%
Selling &
distribution
15% 15% 18% 11% 7%
depreciation 1% 2% 2% 2% 1%
Misc Exp 9% 10% 8% 12% 13%
Operating exp 27% 28% 31% 26% 21%
Provisions &
Contigencies
3% 5% 4% 7% 8%
Total Exp 90% 90% 88% 84% 84%
Net profit 10% 10% 12% 16% 16%
Previous year
profit
3% 6% 9% 10% 12%
Total 13% 16% 21% 26% 28%
Apportionment
Transfer to
Statutory
Reserve
3% 5% 6% 5% 6%
Tr. To other
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Reserves
Proposed
dividend/Tr.to
Govt
3% 4% 5% 5% 5%
Balance C/F to
Balancesheet
6% 7% 10% 15% 17%
Total 13% 16% 21% 26% 28%
Given above is the common size income statement of the entity pre merger and post
merger where each of the line items of the profit and loss account has been compared
with respect to the overall receipts and it shows how that proportion has changed over the
period of time (Covaleski, Evans, Luft, & Shields, 2003). From the above mentioned
trend analysis, we can see that the proportion of the interest expenses has declined
considerably from 59% to 51% and also the selling and the distribution expenses have
come down from 15% to 11% which was a major boost to the bottomline of the company
and that helped the company in lowering down the percentage of the overall operating
expenses. As a result of this efficiencies and synergies, the profit of the company has
improved from 3% to 10% within the year and that further swelled to 12% by the end of
12%. All this was instrumental in proving that the merger of the banks was the correct
decision overall (Coate & Mitschow, 2017).
Besides all the above financial parameters, there were many other non financial
parameters in which the company has improved. The increase in number of branch
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networking post merger could not substantially help the ICICI to increase its profit, the
major reason for which was identified as the burden of loss in form of securitized pool of
assets and consequential decrease on the return from its advances made (Borit & Olsen,
2012). The Bank failed to earn sufficient return on its advances because of the high
amount of retail unsecured loan advances were made by it. During the post merger period
the Reserve Bank of India raised the CRR twice once in February 2010 by 75 basis points
and again from April 2010 by further 25 basis points. Due to which the ICICI could not
earn any return on these CRR Balances and it impacted negatively the return on yield
earning assets in the year 2011. At the same time the various investments made by the
bank in corporate bonds, debentures and certificate of deposits brought an increase on its
return on investment.
The other income in 2011 of the Bank decreased due to the decrease noticed in treasury
related activities (Boghossian, 2017).The increase in income by way of dividends and Fee
was noticed in 2011,whereas the trend of decline in realized and unrealized profits made
through its equity investments was noted in the same year due to the volatile market trend
in the same year.
The Net profit after tax of the Bank showed an increase of 28%, that resulted from the
huge decrease of 47.9% in the amount of provision in respect of provision for
contingencies. The major reason behind the declining trend in the amount of provision
and contingencies are less amount of provision on retail non performing assets, because
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there was a decrease in the amount of loan provided to the retail unsecured loans. There
was an increase by 11.1% noticed in the net interest income from 2010 fiscal year.
During the year 2011 employee cost substantially increased though other administrative
expenses showed a declining trend.The major reasons behind increasing the employee
costs were employing new employees for BOR Branches, increase in employee base,
increase in the annual amount of salary and performance linked bonuses etc (Belton,
2017).
Impact of the Financing announcement
Consequent to the announcement made for the merger of ICICI and Bank of Rajasthan
the change in the share prices along with the shift of wealth base from the hands of BOR
to ICICI could easily be noticed though this change was much more favorable for the
shareholders of the BOR as their gaining percentage was around 90% between the dates
of starting the negotiation for the merger on 7th May,2010 to the date of final approval of
the scheme on 23rd May,2010. This can be further elaborated through the following table:
Particulars Share price a day
before the
Share price on the
date of
Share price a day
after the
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Announcement of
the Merger deal
Announcement of
the Merger deal
Announcement of
the Merger deal
BoR Rs.82.85 Rs.99.45 Rs. 119.35
ICICI Rs. 901.10 Rs. 809.20 Rs. 824.45
The premium per share of Rs.90/-(approximate) paid by the ICICI to BoR was based on
the BOR’s closing price of the share for Rs.99.50/- per share on Bombay stock exchange
on the date of announcement whereas ICICI’s closing price on the same day was
Rs.889.35/- per share that was reflected through the swap ratio of 25:118. From the
figures shown in the above table it seemed quite clear that during the period when the
negotiation process for the merger was going on during that period no major vulnerability
was noticed but once after the announcement was made then the share price of BOR was
adjusted against that of ICICI.
In the above table share price of BOR just one day before the announcement of the deal it has to
face serious allegations from regulatory authorities like RBI during which its value increased by
20.9% that came to Rs. 84.7 per share on 6th May,2010 which was closed on Rs.61.8 as on 26th
February,2010.
But on the period of negotiation there was no noticing effect on the share prices of the Banks
(Abdullah & Said, 2017).
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But after the announcement of the deal the share price of the BOR stated picking up that could be
seen from its jump from Rs.99.45/- per share on 17th May which closed at Rs. Rs.162.3/- per
share on 24th June,2010.
Conclusion
From the above analysis and study it can be seen that the poor corporate governance of BOR
finally made it a target company for the ICICI Bank which acquired it through the process of
regulatory intervention made by RBI and other regulatory Authorities. Before merger ICICI was
following the strong principle of CASA that is Cost, quality, credit and capital for its future
growth as a part of its governance policy. Product focus was one of the most important strategy
lying in the minds of the Bank.The major benefits that accrued to ICICI were getting new
customer base, increase in the amount of deposit, improvement in operational efficiency, cross
selling of its products to the customers of BOR etc.After the merger the growth rate of the
dividend to the shareholders too noticed a sustainable increase. The major developments noticed
during our study are because of the liberalized policy adoption by the government of India the
merger deal brought the expansion of the ICICI Bank. The deal also increased the overall cash
ratio from .281 times to .557 times. This deal also makes us aware that Bank should consider the
post merger legal battles too as after merger even non compliances of the provision of Income
Tax Act,1961 can attract the tax .At the same time it is to be kept in mind that always merger
cannot bring the overall positive things to the acquirer. Some compromises are required to be
made by both of the parties.
The overall details of the merger are present in the following URL.
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http://www.business-standard.com/article/finance/bank-of-rajasthan-to-merge-with-icici- bank-
110051900028_1.html http://www.dnaindia.com/money/1384635/report-bank-of-rajasthan-to-
merge-with-icici- bank
www.marketobservation.com www.icicibank.com http://
articles.economictimes.indiatimes.com/2002-07-02/news/27364631_1_icici-bank-largest-
private-sector-bank-branch
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