kotak - ing vysya - and the winner is...

The merger of ING Vysya Bank with Kotak Mahindra Bank was announced on 20 November 2014. The next day the stock price of both the banks rallied suggesting that the market liked the deal.

On 21 Nov, ING Vysya closed at 7.83% higher than 19 Nov price:

 And Kotak closed at 11.59% higher:

It looks like the market liked Kotak better than ING Vysya. Is that fair? Do ING Vysya shareholders feel let down?

At the time of my analysis the market data was as follows:

Based on the market information Kotak would have had to issue 133.91 M shares to acquire ING Vysya, and swap ratio would have been 0.704 Kotak shares for each of ING Vysya shares. The actual swap ratio is 0.725:1; Not too far off. Again, is this a fair deal?

Kotak is retaining almost all of its income:

While earnings per share of both the banks have increased at a similar rate (about 14%) in the last four years, Kotak has not been that generous in terms of dividends payout, which implies that it is considering high growth potential for its business.

In order to check whether this deal is value accretive to the shareholders of both the banks we have to value each of them on a stand-alone basis first, and then on a combined basis.

With an expected annual growth rate (10-year) of about 15%+ for Kotak and about 11%+ for ING Vysya, we can value individual banks independently based on dividend-discount-model. Both banks are expected to have stable payout ratio, return on equity and growth rate after ten years.

Caution: Since I have used dividend-discount model for valuation, regulatory capital requirements are not separately considered. Probably, it makes sense to do another valuation based on capital adequacy required to achieve the target growth rate, although capital adequacy and Tier 1 capital ratio at present are at comfortable levels for both the banks.

Based on the valuation, both Kotak and ING Vysya appear to be highly over-priced by the market. That is, Kotak is using its expensive currency (high stock price) to buy another expensive currency. Since the actual swap ratio is close to the market-swap ratio, the first impression is that Kotak shareholders are benefiting more from this deal.

Even without considering any benefits from synergy, I reckon the swap ratio should have been about 0.879 Kotak shares for each of ING Vysya shares. Kotak should have issued 167.36 M shares assuming that market prices would correct to their rational (lower) levels in time to reflect the true fundamentals. Alas, market prices are higher, and as noted above, based on those prices Kotak should have issued 133.91 M shares. The actual swap ratio is much lower.

But then as talked about in every acquisition, there are synergy benefits.

If there are any synergy benefits from this merger, surely Kotak shareholders must have an upper hand over ING Vysya shareholders. The actual swap ratio of 0.725 Kotak shares to each of ING Vysya shares is much lower, and hence value-accretive to Kotak shareholders. 

Based on the terms of the deal, the implied numbers are as follows:

The implied value of this deal is Rs.159 B, and the implied price of the stock of ING Vysya bank is Rs.838.86 per share. There is hardly any premium on acquisition; sounds so unfamiliar, doesn't it?

Why is ING Groep, the largest shareholder in ING Vysya, letting this happen to itself? Is it because it is in need of cash? If so, what about the minority shareholders?

it's apple again - on sale, or wishy-washy

I did not plan to keep talking about Apple; but then, there is so much going on these days, I can't help it. I wrote about large cash Apple has been piling up; I also had my own advice on its use of cash. Heck, there is more advice too. Carl Icahn is not an ordinary guy of course, although he has been likened to a four-year old and to a six-year old. Icahn's history speaks of his capabilities as a successful investor what with billions in net worth. Not surprisingly, the subject matter is Apple again. 

I had argued in October 2012 that innovation was imperative for Apple to continue to be in the growth territory. At that time Apple stock was trading at about $600 per share (pre-split) giving its entire equity a market value of $570 b. Today it is $639 b. 

Optimism in 2012 
I had also supplied some contrasting opinions about where Apple might be headed. One of the arguments was that it would trade at $1650 per share (pre-split) by 2015; that is, its equity would be worth $1.5 trillion. Well, that argument was supported by robust revenues and margins that Apple would be able to sustain due to its ability to innovate and maintain its superior technology. The numbers looked like this:

iTV was estimated to be a $100 b business by 2015, and the argument went further: Apple would be a $610 b revenue company by 2015 as all its key markets start to experience hyper growth.

Whether these estimates will actually come to fruition is something that only time will tell. Nevertheless, $1500 b market value is huge, really unheard of.

By the way, Apple's revenues for 2014 reached $182.79 b. For it to clock $610 b revenues in 2015, they would have to grow by....well...you get the point.

$1 trillion as of October 2014
How about a little less optimistic, say, $1000 b market value? Carl Icahn is at it again; he is arguing that Apple stock which is trading currently at $109 per share, is actually worth $203 per share. He is supplying his estimates which look like this:

Icahn's estimates might appear to be much lower, but, in the context of Apple's recent performance they too seem to be far-stretched. While he is estimating large investments in research & development, he is also giving simplistic arguments that net earnings equal free cash flows available to equity shareholders. This assumes that depreciation equals capital spending and working capital requirements in future which may not be realistic.

Historical performance
Apple's revenues for 2014 reached $182.79 b, and the growth rate for the year was 6.95%.

Going by its history, it looks like the law of large numbers is showing up, and growth rate is coming down.

If we assume that Apple's revenues will increase by 6.95% (2014 growth rate) annually in the next 10 years, they would be $358 b by 2024. If they grow by 9.20% (2013 growth rate) annually they would be $440 b, but not until 2024.

For revenues to reach $610 b in 2024 (not 2015), they would have to grow by 12.81% annually in the next 10 years.

Icahn believes that Apple is dramatically undervalued; and accordingly, is pushing the CEO to use cash for large stock buybacks with the promise that he will not tender any of his 53 million shares (worth nearly $6 b). At least he wants to eat is own cooking; let's give him that credit.

I had a different idea, didn't I? Tim Cook won't listen to me though.

What is it
Is Apple really on sale, or all this is wishy-washy?