HDFC and HDFC Bank have been in the news for some time now in relation to their merger into HDFC Bank which is slated to take place in June-July. However, the deal that was expected to bring about financial prosperity seems to be having a hiccup this week.
The Morgan Stanley Capital International (MSCI), an American financial services company, has announced that it will use an adjustment factor of 0.5x to compute the weight of the merged entity in its MSCI India Index after the HDFC and HDFC Bank merger. What does this mean?
It means that the combined weight and importance of the original companies that the merged entity was supposed to have in the index is likely to be lost. The weight of HDFC in the MSCI India Index is currently 6.74, but post-announcement, it is likely that the weight of the merged entity will be around 6.5. This is especially shocking because the expectation was that MSCI will allow the weights of the two companies to combine and become double – but now it seems to be even less than before.
In other words, the merger was expected to bring an inflow of about $3 billion. But now some people expect that the current conditions might erode around the $150 million market weight of HDFC Bank and they are, therefore, apprehensive about the HDFC share price tanking.
A large part of the MSCI weightage comes from how much foreign room (or proportion of shares open for foreign investors) there is in a company. A company needs at least 15% foreign room for inclusion in the MSCI Index – but post-merger, the new entity will have slightly above 15% only. This is because HDFC Bank does not have any foreign room currently (and hence, is not a part of the index yet).
This creates a risk that the foreign room may go down below 15% due to volatile flows in the near future which, in turn, may require sharp adjustment to the index in the form of removal of the merged entity. In order to prepare for this beforehand, MSCI decided to reduce the weightage early on to minimise any future impact.
Last year in November, there was speculation that the combined weightage figure of the merged entity would be adjusted by the factor of entire 1x – the stock prices of both the shares had received much boost at the time. However, the announcement of the adjusting factor as 0.5x has dampened the mood.
Fig.1: The stock price trajectory of HDFC. Notice the gap down from about Rs 2860 to less than Rs. 2715 on 5th May 2023.
As a result of the MSCI announcement, the HDFC twins have seen a major dip in share prices since Friday morning – by 11:30 am, both the stock prices plunged by more than 5%. This dip comes at the end of a strong bull run that both stocks had been enjoying since mid-March.
Fig.2: Notice the bull run that HDFC Bank (and also HDFC) had been having since mid-March and even in early May. Also, notice the drop in its share price on 5th May 2023.
Some may consider this dip to be temporary – they think over time the stock price will bounce back. They might be true – a merger of financial operations between two of the largest players in their fields can create impregnable fundamentals for the future.
Another thing to note here is that MSCI is an American financial services company which provides investment data and analysis to a variety of stakeholders such as mutual funds, ETFs and retail investors. Stock prices in India thus seem to be affected, not only by FII cash flows from the US, but also the financial actions of private companies from the same.
Now whether the MSCI negative news for HDFC Bank and HDFC will have a lasting impact on the stock prices is debatable. Only time will tell, whether the financial giants can overcome such hurdles or not.
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Disclaimer: This article has been written exclusively for educational purposes. The securities quoted are only examples and not recommendations.
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