HDFC Stock May Witness Huge Selling Pressure, Say Brokerages

Having received most regulatory nods, the proposed HDFC Bank Ltd.-HDFC Ltd. merger will go to their respective shareholders for approval next month. If cleared, the deal will trigger a rebalancing on stock indexes.

India's largest private sector lender will take over HDFC in the biggest corporate merger valued at $40 billion. It will create a behemoth with a combined balance sheet of Rs 17.87 lakh crore and net worth of Rs 3.3 lakh crore.

The National Company Law Tribunal permitted both the companies to hold shareholders' meeting, seeking approval for the proposed merger on Nov. 25. The companies have already received the nod from stock exchanges, the Reserve Bank of India and the Competition Commission of India.

Dubbed as the 'penultimate step' in the merger process, the approval will trigger the Nifty rebalance, consequently leading to exclusion of the target company—HDFC.

As HDFC is part of all the Nifty indices, the stock could see major selling from passive trackers of the Nifty 50 Index, according to a note by Nuvama Alternative and Quantitative Research.

Investec pegged these outflows at $2.4 billion (about Rs 19,700 crore at current exchange rate) via 88 million (8.8 crore) shares from ETFs and index funds tracking the underlying indices as of December 2022.

Emkay Global Financial Services estimates outflows of $1.25 billion (about Rs 10,200 crore), citing its current weight in the Nifty 50 at 5.63%.

Exclusion of the HDFC stock will make way for another stock in the Nifty 50 index. Likely contenders include Pidilite Industries Ltd. and Ambuja Cements Ltd., which may bring inflows of nearly $140-170 million, Investec said in a note.

Apart from these, according to Nuvama Alternative and Quantitative Research's note, Tata Power Co. and SRF Ltd. are the other likely additions.

"All the next possible contenders are quite close in terms of free-float market cap for the period under consideration. The next few months will be crucial in determining which stocks holds a best chance," it said.

Emkay Global Financial Services also ranked Pidilite Industries as the top candidate for inclusion in the Nifty 50 followed by Ambuja Cements. "Each would have around 0.45-0.50% weightage in Nifty 50 which would entail an inflow of $110-140 million," it said.

Based on past rebalances in the index, analysts expect HDFC to be excluded at the end of December or at the end of January.

Unlike Nifty, shareholder approval plays no role in exclusion of the stock from the S&P BSE indices. It will take place only closer to the effective date of the merger.

Going by the current pace of approvals, HDFC will continue to be a member of the BSE index till the entire process is over, around the first quarter of FY24, Investec said.

Global Indices, such as MSCI and FSTE, too, will only take any action around the effective date.

Knee-Jerk Reaction

Following the announcement of shareholders' meeting, analysts expect the merger arbitration ratio may expand.

The strategy refers to making a profit by capturing the spread between the current market price of the target company and the proposed acquisition terms.

Selling pressure in HDFC will result in expansion of merger arbitrage spread from the current 3.2% to up to 6%, with a 3% decline in the price of HDFC, according to Emkay Global Financial Services.

As news of HDFC's exclusion from the Nifty 50 spreads, the price of December 2022 month futures would decrease, thereby shrinking the roll cost. Hence, it is advisable to short roll now, it said.

Investec pegged HDFC's discount to HDFC Bank spread to contract from 3% to 1.5%, but eventually due to the impending selling pressure on HDFC that should expand up to 5-5.5% by end-December, it said.