1) ITC Classic, ITC's flagship financial services subsidiary, began facing troubles in late 1996 as almost half of ITC's executives were jailed for violations. This damaged ITC's brand and reputation. 2) By 1997, ITC Classic was struggling with negative cash flows, high asset-liability mismatches, and losses that wiped out its net worth. Multiple consultants recommended restructuring but ITC did not act. 3) In 1998, ICICI acquired ITC Classic through a merger, hoping to gain its retail network. ITC also invested funds to cover ITC Classic's losses and liabilities as part of the deal. The merger provided ICICI access to ITC Classic's depositor

1. THE ITC CLASSIC STORY
“ITC is ready to hawk ITC Classic to anyone, for even a rupee.”
- An ITC Classic manager in 1997.
“There is no value in ITC Classic. I wonder how ICICI will benefit from the merger!”
- A stockbroker in 1997.
TROUBLED TIMES
In late 1996, almost half of the executives on board of the tobacco to hotels major ITC Ltd. were
in jail on charges of FERA and excise violations. It was at this point that the downfall of ITC
Classic Finance (Classic), ITC's flagship financial services 49% subsidiary, began.
The scandals in ITC had a massive damaging effect on the ITC brand and corporate image. The
impact got reflected on Classic too and it was inundated with desperate fixed deposit holders
wanting to withdraw their funds. Funds worth over Rs 50 crore were withdrawn within a few
days after the crisis broke out. The continuing uncertainty on fund flows into the company and
the eroded value of its portfolios began scaring off potential investors and foreign partners as
well. International Finance Corporation (IFC), which was to provide a credit of $ 45 million to
Classic, also held back the offer till ‘things cleared up.'
Analysts were quick to raise fingers at Classic's negative cash flows, its huge asset liability mismatch and
the slow process of divestment of stakes held by Classic in the ITC group companies. Like the proverbial
‘final nail in the coffin,'Classic declared a Rs 285 crore loss in June 1997, which almost wiped out its
entire net worth.
Meanwhile, troubles mounted as redemptions kept increasing - from Rs 750 crore in mid 1996,
deposits came down to Rs 550 crore in May 1997. From a peak level of one million depositors,
Classic was left with just six lakh. ITC gave Classic a Rs 75 crore credit line to maintain cash
flow to meet the redemption pressure. There were even reports that Classic had to take inter-
corporate deposits[1] to fund the outflow. The sustained downturn in the capital markets during
1995-96 added to the company's woes and soon, key personnel began leaving the company
Already neck-deep in legal troubles, ITC realized that it would be better off without Classic to
add to its problems. ITC then initiated discussions with Daiwa Securities of Japan and a few
Korean, British and American investment banks for a possible tie-up.
A Business Today report[2] claimed that ITC was desperate not to let Classic go for liquidation,
as that would have reflected badly on its brand power. ITC announced that it was even willing to
infuse more funds to keep Classic afloat. Both GE Capital and the Hinduja Group evinced

2. interest in Classic. Since they laid down very stiff terms for the buy-out and valued Classic much
below ITC's expectations, talks did not proceed further.
Nothing seemed to be working out in favor of Classic as there were no takers for a company with
non-performing assets of over Rs 350 crore and an investment portfolio that was by any
standards an extremely poorly executed one.
At this juncture, ICICI Ltd. stepped in as the ‘knight in the shining armor'to rescue Classic,
taking the corporate world and the media by surprise. All those involved in the issue kept asking
themselves - What did ICICI see in Classic that so many other companies could not?
CLASSIC: THE ITC FOSTERED BABY
Named after ITC's premium cigarette brand ‘Classic,'Classic was incorporated in 1986. Classic
was a non-banking finance company (NBFC) predominantly engaged in hire purchase and
leasing operations. Besides, the company undertook investment operations on a substantial scale.
The company did very well in the initial years and developed a strong network to mobilize retail
deposits. Its fund-based activities such as corporate leasing, bill discounting and equities trading
also grew substantially over the years.
At a compounded annual growth rate of 78% during 1991-96, Classic's annual turnover increased from
Rs 17.3 crore to over Rs 310 crore and net profits from Rs 2.3 crore to Rs 31 crore in the same period. By
June 1996, the company had a deposit portfolio of Rs 800 crore consisting mainly of retail deposits. The
capital market boom of the early 1990s was responsible to a large extent for Classic's impressive
financials. Around 50% of Classic's assets had to be kept in financing and a further 25% was to be held in
liquid funds or cash to handle cash outflows. However, Classic was free to invest the remaining 25% as it
deemed fit - which happened to be in the ‘boom stocks.'When the markets crashed in 1992, Classic had
to face heavy losses.
Like most other finance companies, Classic too saw the 1995-96 stock market downturn taking a
toll on its performance. A sharp increase in cost of funds, weak capital market conditions and the
general liquidity crunch marked the beginning of the company's poor financials. Almost all the
145 scrips in the stock-in-trade list in the company's balance sheet had lost nearly half their value
during 1995-96. While Classic's quoted investments stood at Rs 231.06 crore as on March 31,
1996, the market value as on that day was just Rs 57.40 core. In 1996, ITC had to infuse Rs 60
crore in Classic by buying up group company shares held by it.
Soon after this, troubles began at ITC's headquarters with the Enforcement Directorate (ED)
initiating large-scale investigations against ITC top brass in connection with various issues of
unethical practices. Almost half of the ITC board was arrested and the intensive negative media
coverage significantly harmed the ITC brand equity.
Amidst all this, it seemed as if ITC had given up all hopes of ever being able to find a suitable
partner for Classic.

3. THE CLASSIC POST-MORTEM
Many management consultants remarked that though Classic emerged as a full-scale financial
services company in early 1990s, it never matured from its original status as an asset financing
subsidiary. A majority of Classic's problems stemmed from the structural anomalies like cross
holdings in other group companies. Although consultants McKinsey & Co and Arthur Andersen
(who had been mandated to go into the details of restructuring Classic in the mid 1990s), had
emphasized the need for untangling Classic from the corporate maze of cross holdings in the
group companies, no action was taken to do so.
A Classic source[3] remarked, “McKinsey could not even figure out why some of the financial
services companies existed and why Classic should hold equity in such companies.” McKinsey
wanted to form Classic into a single financial services company by merging various group
companies involved in financial services such as Classic Infrastructure Development Ltd.,
International Travel House Summit, Sage, Pinnacle, ITC Agrotech Finance and a host of other
small companies. McKinsey further recommended that Classic should reduce its investment
banking exposure, concentrate more on asset financing and re-enter niche segments like
automobile finance.
The Arthur Andersen study talked about the need for a leaner organization with strong management.
The consultants identified a complete lack of focus as the most crucial problem faced by Classic.
However, ITC sources brushed aside the recommendations stating that, “Reorganizing the business is
very much on our agenda but our immediate concern is to keep the company liquid.”
After the Rs 285 crore loss was recorded, Classic sold its heavily eroded investments in Morgan
Stanley and Jaiprakash Industries, which helped in covering the losses to a certain extent.
However, its portfolio still comprised shares that had seen heavy erosion in their values. Classic
had to hold large amounts of shares of other ITC group companies like ITC Bhadrachalam and
International Travel House, whose share prices had also taken a beating. The company could not
even sell these shares because of their low prices. Though ITC bought back Rs 69 crore worth of
Bhadrachalam shares, financial analysts remained skeptical of Classic's portfolio. Some of its
investments in group companies like Greenline Construction, Minota Aquatech and ITC
Agrotech Finance etc. were illiquid for all practical purposes and only artificially inflated the
company's net worth and the asset values.
Classic also had a huge asset-liability mismatch. Its asset-financing portfolio was functioning
fine till September 1995, when due to a liquidity crunch it had to miss on installment
repayments. Eventually, the volume of overdue payments reached as high as Rs 300 crore. A
Classic executive said, “Most of our assets are wholesale in nature while our liabilities are retail.
When the market got gripped by a panic, all wanted their funds, but we cannot make our assets
liquid at such short notice.”
In 1995, Classic had entered into a lease and buy-back deal of used electricity meters with the
Rajasthan State Electricity Board (RSEB). Later, RSEB defaulted on lease rentals worth Rs 40
crore, forcing Classic to make provisions to repossess the meters and settle the losses. Classic's
real estate forays also did not prove to be beneficial for the company. Analysts also remarked

4. that the fact that over the years, Classic had become increasingly dependent on public deposits.
Public deposits, deemed to be a rather volatile source of fund, had to be resorted to by Classic
mainly due to the reluctance of banks to fund NBFC operations during that period. This later
resulted in the heavy redemption rush putting a strain on the company's cash reserves.
THE CLASSIC POST-MORTEM contd...
The credit rating agency, Credit Rating Information Serviced Ltd. (CRISIL) downgraded
Classic's rating for its fixed deposit scheme and non-convertible debentures from AA to A+ and
from FAA+ to FAA-, respectively in June 1996 and further to A- and FA, respectively in
December 1996. An internal CRISIL note revealed some other important issues that had led to
Classic's demise. The note stated: “Although the company's asset portfolio remained fairly well-
diversified in terms of the client base/industry spread, the high growth rate, and the inherent risk
in corporate plant and machinery financing had an adverse impact on the company's asset
quality, resulting in difficulty in timely recovery of dues from a number of clients.” The note
further criticized Classic's exposure to the corporate asset financing business in general, and to
the machinery segment in particular, which was inherently deemed to be risky.
Classic was also reported to have made a tactical error by shifting its focus from its primary business of
hire purchase and leasing to secondary market operations. The company was blamed to have entered
the latter arena to ‘get rich quick'by stock market deals, besides to spread the risk associated with asset
financing. In 1995-96, a former Classic director said, “Only about 55% of Classic's business was in hire
purchase and leasing, while the rest was in stock market operations.”
THE MERGER
ITC soon realized that only one of the country's three mega-financial institutions - Industrial
Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), or ICICI
would be in a position to absorb Classic's losses and bad loans. ITC approached IDBI and ICICI
and held extensive discussions with both the FIs. Eventually, a deal was struck with ICICI at a
swap ratio of 1 ICICI share for 15 shares of Classic[4] .
In January 1998, shareholders of Classic approved the company's amalgamation with ICICI with
99.93% of the votes in favor of the resolution. Justifying the merger from ICICI's perspective,
Kamath said, “Our goal is to move towards universal banking with a spectrum of financial
solutions. Any opportunity to move closer to the goal will be capitalized.” However, a section of
ICICI shareholders, holding shares of both ICICI and ITC Classic, opposed the merger resolution
claiming that the merger ratio was unfair and was ‘leaked'to the market.
They said that the price dropped and adjusted to the merger ratio much before the announcement
of the ratio by the company. They also alleged that if the market price of the share was one of the
considerations, then the fall in the price of the share just before the merger was a clear indication
that the swap ratio was already in the market before the announcement. Voices were also raised
against ICICI's decision to retain only those Classic employees whom it found capable after
internal evaluations. However, since the dissenting shareholders were in minority, the resolution
was successfully tabled.

5. ITC and its affiliate companies subscribed to a preferential share issue of Rs 350 crore of ICICI
as part of the merger proposal. The preferential share capital carried a nominal interest of Re 1
for every Rs 1 crore of share capital issued for a period of 20 years. The infusion of funds in
ICICI by ITC was to take care of any future liabilities arising out of the merger. One-fourth of
Classic's asset base of Rs 1,000 crore accounted for investments in subsidiaries that operated in
the stockbroking and mutual funds business. As ICICI was not interested in them, ITC provided
Rs 272 crore to repay secured creditors, and to make up for the losses due to the decline in the
investments made by these subsidiaries.
It was decided to prepay Classic's creditors to reduce its interest burden. ITC also assumed the
liabilities and obligations in relation to all guarantees and indemnities issued by Classic. ICICI
accepted to absorb the Classic personnel as per its requirements and the rest were redeployed by
the ITC group.
THE MERGER POST-MORTEM
Media reports claimed that pressure from FIs coupled with desperation drove ITC to hand
Classic on a platter to ICICI. K.V. Kamat, managing director, ICICI had maintained right from
the beginning that he would consider the deal as long as it did not involve any cash outgo. The
issues of ITC bringing in substantial funds, providing cushion against bad debts and loans and
accepting an ‘unfair'swap ratio kept surfacing in the media. The only silver lining for the
unhappy Classic shareholders'seemed to be the fact that they could hope for a better future with
ICICI.
TABLE I
GAINERS AND LOSERS
ICICI Classic Investors
Risk-free takeover of a Selling off a business it was Acquiring, for every 15
retail network since ITCnot keen on, which enabledshares in a sick company, 1
The Upsides
would pay Rs 622 croreBAT to enter financialICICI share whose value was
for ITC Classic's NPA. services on its own. bound to rise.
ITC Classic's NPAs
A fall in profits in 1997-98, An ICICI share would have
might be larger than
The since it would also have toto rise by 400% if the pre-
projected, and its
Downsides cope with the Rs 800 croremerger ITC Classic share
depositors might cash
excise duty claims. price was to be realized.
out.
Source: Business Today, December 22, 1997.
As far as ICICI was concerned, it seemed to be a clear ‘win'proposition. The biggest benefit for
ICICI was Classic's retail network comprising eight offices, 26 outlets, 700 brokers and a

6. depositor-base of 7 lakh investors. ICICI planned to use this to strengthen the operations of
ICICI Credit (I-Credit), a consumer finance subsidiary that ICICI had floated in April 1997.
Kamath said, “The retail network will help us save two to three years. Our estimate of opening
15-20 branches to reach a million people at the retail level required at least 2-3 years. This offer
came our way, which had the retail network already in place.” An additional benefit for ICICI
was in the form of the Rs 110 crore tax-break because of Classic's losses and the provisions for
bad loans. This was something ICICI badly needed since its net profits of Rs 572 crore during
the first half of 1997-98 had increased by 71.77% per cent.
THE MERGER POST-MORTEM Contd...
While ICICI was happy over getting a large deposit base of about seven lakh, it seemed to have
ignored the fact that the base was built on high interest rates offered by Classic - about 16%.
ICICI was forced to give this promised interest while the going rates were much lower. Also,
deposits aggregating Rs 550 crore were to mature by 1999, threatening to be a cash outflow
burden on ICICI. However, ICICI tried to average out the interest outgo by asking the depositor
coming in for renewals to switch over to ICICI books. This was easy to do as the depositors got
the security of an AAA-rated institution. ICICI soon began the ‘clean-up operation'of Classic's
balance sheet by substituting high-interest liabilities. As 75% of Classic's clients were ICICI
clients as well, ICICI was confident of recovering 8-16% of the outstanding amounts from
various parties. ICICI sources claimed that the Classic merger would not affect the dividend or
the non-performing assets of ICICI. This was supported by his justification that Classic was a
company with an asset base of just Rs 1000 crore, while ICICI's asset base was as large as Rs
41,000 crore.
QUESTIONS FOR DISCUSSION:
1. Analyze the reasons behind Classic's failure. Do you agree that the company's demise was
largely due to ITC's poor handling of the company? Support your answer with reasons.
2. Explain the reasons behind ICICI agreeing to merge with the loss-making Classic. Was the
merger truly a win-win situation for both the parties involved?
3. ‘Classic should have stuck to its leasing and asset financing business rather than entering
secondary market operations.'Critically comment on the above statement