Ujjivan Small Finance: 18% Guaranteed Return, but No Takers. Why?

Introduction

Since March this year, their stock prices have surged by nearly 2.5 times, driven by the impending merger of the two companies. Under the swap ratio announced in October last year, a UFS shareholder is entitled to receive 11.6 shares of USFB. However, despite the apparent arbitrage opportunity, there seems to be a surprising lack of enthusiasm among investors. Why is this the case? Let’s delve into the intricacies of this financial puzzle.

The Growing Gap

Until the first week of September, the share prices of UFS and USFB moved in sync, reflecting the merger anticipation. However, in the past month, a significant gap has emerged, with UFS shares outpacing USFB shares by 15-18 percent. As of the latest data, UFS shares closed at Rs 581, while USFB shares settled at Rs 59. Given the merger ratio of 1:11.6, the arithmetic suggests that either UFS should be valued at Rs 684 or USFB should be priced at Rs 50.

On the surface, it appears that investors holding UFS shares stand to gain an effortless 18 percent return once the merger is finalized. This situation has left traders scratching their heads, as the arbitrage opportunity seems too good to pass up. However, the persistence of this gap raises several intriguing questions.

The Puzzle Unraveled

1. Delayed Merger Concerns

One plausible explanation for the hesitancy among investors is the fear that the merger process might not proceed as swiftly as anticipated. Despite the merger ratio being announced in October the previous year, the Extraordinary General Meeting (EGM) for shareholder approval is still a month away. If investors perceive a potential delay, the allure of an 18 percent return may lose its shine. After all, traders always seek opportunities where their capital can be deployed for better returns in a shorter time frame.

2. Valuation Uncertainty

Another critical factor influencing investor sentiment is the perceived valuation of USFB in the post-merger landscape. As it stands, USFB is valued at nearly three times the trailing 12-month book value, significantly higher than peers like IDFC First Bank (less than 2.5 times) and Karur Vysya Bank (less than two times). The market’s assessment of USFB’s future prospects will play a pivotal role in whether the stock continues to soar or faces a correction.

Clarification: No Meaningful Dilution

It’s worth noting that the merger will not result in any significant dilution. The holding company’s stake in USFB, held by UFS, will get canceled in the new structure. A previous version of this report erroneously mentioned a 65 percent dilution, which was calculated incorrectly. We apologize for any confusion this may have caused.

Conclusion

In the complex world of financial markets, the case of Ujjivan Small Finance Bank and Ujjivan Financial Services presents an intriguing conundrum. While the prospect of an 18 percent guaranteed return appears enticing on the surface, there are valid reasons behind the hesitancy among investors. The uncertainty surrounding the merger timeline, valuation expectations, and market volatility all contribute to this perplexing scenario. As the merger date approaches, it will be interesting to see how investors navigate this financial puzzle and whether the gap between UFS and USFB shares finally closes.

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