Is AU Small Finance Bank being aggressive?

AU Small Finance Bank recently announced the acquisition of Fincare SFB in an all-stock deal at a valuation of Rs 5,100 crore. The bank's strategic move to expand its presence in southern India and venture into microfinance lending may be a sound strategy. However, the question is whether the acquisition is made at a fair price or if management has overpaid for it.

The acquisition of Fincare SFB by AU Small Finance Bank has been executed at a valuation of Rs 5,100 crore! While the bank's move to strategically expand its presence in South India and to venture into microfinance lending may be a sound strategy, is it fairly valued or overpriced ?

We decided to explore.

Price and valuation
Let's start with the numbers.

Fincare's acquisition price reflects a price-to-book (P/B) ratio of 3.9 times.

When we probed deeper into the company's fundamentals, we found out that Fincare has relatively higher non-performing assets (NPAs) and lower return on assets (ROA) compared to its peers.

Further, their P/B ratio notably surpasses the industry median P/B ratio of 2.3 times, potentially signifying an overvaluation.

In other words, the fundamentals might not be extraordinary, but the acquisition price certainly is, which might be concerning to investors.

Product mix
The composition of Fincare SFB's loan book has a significant 60 per cent allocation towards microfinance - a segment known for its inherent risks. While it presents an opportunity for AU Small Finance Bank to expand into microfinance lending, it also amplifies the risk profile of the combined entity because microfinance borrowing is inherently a risky and volatile segment.

Key takeaway
Acquisitions, often celebrated for their synergistic potential, must pass the litmus test of value addition. As an investor, it is critical for you to scrutinise the true value and potential of such transactions.

AU Small Finance Bank's acquisition of Fincare SFB appears to have sound strategic objectives. Still, the high valuation and relative underperformance of Fincare against its peers certainly warrant a closer look.

The history of corporate acquisitions serves as a reminder that strategic alignment without financial justification may not always culminate in value creation. Synergy-based acquisitions have not yielded great results because of the high valuation at which the company was bought.

Will this happen to AU and Fincare? Only time can tell. But we must remember that no matter how good an acquisition looks, it will not add value if not for good valuation.

Also read: Is your stock priced right?