PFC-REC merger: What shareholders need to know and what UBS says

Post-merger, PFC will continue to remain as a 'government company'.

The board approval for the merger of PFC and REC came after an announcement made in this regard in the Budget on Sunday.

Earlier, pursuant to 'In Principle' approval of the Cabinet Committee on Economic Affairs (CCEA), PFC acquired 52.63% of the government's holding in REC Limited (REC) for ₹14,500 crore in March 2019.

Accordingly, REC has been operating as a subsidiary company of state-owned PFC.

"The Board of Directors of PFC took note of the Budget announcement and accorded its in-principle approval for restructuring in the form of a merger of PFC and REC, while ensuring that, post-merger, PFC continues to remain as a 'Government Company' under the Companies Act, 2013, and other applicable laws," according to the regulatory filing.

Finance Minister Nirmala Sitharaman, in her Budget speech on Sunday, had said, "The vision for NBFCs for Viksit Bharat has been outlined with clear targets for credit disbursement and technology adoption.

In order to achieve scale and improve efficiency in the public sector NBFCs, as a first step, it is proposed to restructure the Power Finance Corporation and Rural Electrification Corporation.

What UBS says on the PFC-REC merger

Analysts at UBS, in their latest note dated February 9, highlighted that PFC and REC have confirmed that they will start the merger process post announcement of restructuring by the Finance Minister in the Union Budget.

PFC already owns 52.6% in REC and, in turn, is 56% owned by the Central Government. REC is expected to be merged into PFC, where PFC would issue new shares to REC holders.

The merger would be under the Companies Act, and an independent valuation should decide on the swap ratio.

At the current price (LTP), for every nine shares of REC, eight shares of PFC would be offered.

At CMP of REC, "we estimate PFC shares count to increase by 34%; we estimate FY27 BVPS of ₹474 without assuming any benefits of merger and the government stake to fall to 42%," UBS said.

BVPS stands for book value per share.

"We believe post-merger the entity could see better pricing power given the large overlap in customer base, likely higher growth, and the elimination of the holding company discount that exists in the current structure," UBS said.

This could possibly drive re-rating, which at the current price implies 0.88 FY27P/B. For REC holders, the swap ratio is the key in the near term. "We remain constructive and await more clarity on the merger," it added.

Core synergy would be dominant within

In terms of loan book size, PFC would become comparable to some big banks with a combined loan book of ₹11.5 trillion (US$125bn). The mix between the two companies is now largely similar, and there is a large overlap in customer base.

Post-merger conventional generation would still be 29%, 40% distribution and transmission, and 14% renewables.

This should lead to better margins and RoA, eliminating competition for the same set of customers.

Additionally, given the government's focus on building scale through mergers, there could be increased growth momentum across renewables and infra funding.

Government stake could come down to 42%, says UBS

Post the merger, at the current price of PFC and REC, UBS estimates that the government share would fall to 42% vs 56% in PFC today.

Given that PFC and REC depend on implicit government support for the cost of funds, continued government support will be critical.

On the single borrower limit, a solution may be required, given that the earlier merger was called off because of the issue.

"We see the merger being positive for growth and RoA and await more clarity on the process," UBS added.

How shares are performing on Monday

Shares of Power Finance Corporation were trading around half a percent lower at ₹417.20 apiece on the NSE in the noon deals, while REC shares were down 3% at ₹361.40 apiece.