Merged HDFC entity could have double the weight in MSCI, says Macquarie

After the completion of HDFC and HDFC Bank's union, the weight of the merged entity could be double that of HDFC Limited in MSCI, according to a sales note by global financial services group Macquarie.

HDFC is part of MSCI indices whereas HDFC Bank is not. MSCI requires the proportion of shares available to foreign investors relative to the maximum allowed to be at least 15 percent and HDFC Bank fails to meet this criterion.

Despite the heavy FII selling earlier this year, HDFC Bank's "foreign room" as of September end stood at 11 percent, as per the Macquarie dealer.

So, what has changed?

MSCI's new rule says, "When there is a corporate event affecting index constituents, non-index constituents that are involved in the event are considered for immediate inclusion in the MSCI Global Investable Market Indexes."

The non-index constituent will be treated as a continuation of index constituents, it added. This means that HDFC Bank, which is a non-index constituent, will be treated as an extension of HDFC Limited.

How this removes the technical overhang

The merged entity has a foreign room of 17.3 percent as of September-end, which is above MSCI's 15 percent threshold, but a key technical overhang was the 0.5x adjustment factor.

"If a security's foreign room is less than 25 percent and equal to or higher than 15 percent, MSCI will use an adjustment factor of 0.5 to reflect the actual level of foreign room," according to the firm's website.

As per Macquarie's calculations, the adjustment factor of 0.5x would have resulted in free float-adjusted market capitalization of $63.1 billion.

But now since HDFC Bank will be considered an extension of HDFC Limited, the adjustment factor applicable will be 1x and not 0.5x. This implies free float-adjusted market capitalisation of $126.3 billion for the merged entity.

This is more than twice of HDFC Limited's current free float-adjusted market capitalisation of $55.9 billion, said the Macquarie note.

How does the weight go up?

Free float-adjusted market capitalisation is used to derive the weight of the stock in the index. Thus, HDFC Limited's 5.78 percent weight in MSCI could now go up to 13 percent of the merged entity.

Anjali Sinha, who has penned the Macquarie note, concludes, "My understanding is that post the merger, HDFC Ltd stock is replaced by HDFC Bank and the weight goes up. It's time to load up."

At 2.30 pm, both the stocks were trading 6 higher in trade and were the top index gainers. HDFC was quoting at Rs 2,661 on the National Stock Exchange and HDFC Bank was trading at Rs 1,617.