An analysis of ICICI FPO in Economic Times

Investors can consider subscribing to ICICI Bank’s follow-on offer. It offers an attractive entry point for investors, given the discount to market price and the embedded value of its subsidiaries.INVESTMENT RATIONALE: The size of the issue, at around Rs 20,000 crore, has come as a surprise, but we believe it is aimed at avoiding frequent visits to the equity market. This is the third time in four years that the bank has chosen to raise funds. With the current issue, the bank should be comfortably placed to meet its growth requirements, at least for the next three years. This is assuming it’s can grow assets at 30%.Such a huge issuance will have a positive impact on margins. Fresh loans may be funded out of equity, resulting in positive net interest margins. As yields increase and the full impact of interest rate hikes during Q1 FY08 sets in, margins will rise. Moreover, we expect the current capital will be used primarily to fund advances in high-yielding areas like rural and international markets. The spreads in these markets are significantly superior to those earned in other segments, which may lead to positive margins in the long term. This will help ICICI Bank maintain its current growth, notwithstanding a slowdown in retail assets.There is now greater clarity on its subsidiary’s valuation and the proposed listing of the holding company. This will ensure relative independence for subsidiaries as ICICI Bank won’t be required to infuse capital into its subsidiaries. The current round of funding is expected to be fully utilised to support the bank’s balance sheet. In the current year, ICICI Bank sees no major capital infusion, as it expects that money raised via private placement will pay for growth of its insurance arms.Significant value can accrue from the bank’s subsidiaries. Current placement of equity for the insurance (general and life) and MF AMC has a valuation of Rs 44,600 crore — almost half the bank’s total valuation. Near-term gains in the stock will depend on how the valuations of its subsidiaries (especially the insurance business) are factored into the market price. But, the issue will be neutral or marginally dilutive on earnings. The RoE may fall to high single digits. RoEs can normalise at current rates of 13% by FY09. But the company’s experience in leveraging capital effectively for growth lends support to the issue.VALUATIONS : ICICI Bank trades at around 3.37x its FY07 post-issue book. Adjusted for the value of its subsidiary and investments, the banking business is around 1.5x its FY07 post-issue book. We have assumed a subsidiary and investment value of Rs 420 per share. But we will be more comfortable with a lower figure for the holding company’s valuation. Though the current valuation derived from the private placement provides a reliable estimate for the value of the insurance arm, it’s skewed towards the higher end. We assume a 25% discount on valuations to arrive at 1.6x post-issue valuation for the standalone bank. This is extremely attractive compared to its peers, which typically trade at 4-5x FY07 book.RISKS: The recommendation relies heavily on the subsidiary valuations, especially the insurance business. Any slowdown in the life insurance subsidiary, delay or downward revision of the holding company’s valuations in future are key risks