Merchant Banking

MERCHANT BANKING

Reshma Sonawane

Ranjit Shetty

Mamta Bist

Richapriya

Shamila Saldanha

Concept & Definitions Dictionary of Banking and Finance

(American)

fee based activity - arrange finance - trade in

shares - help launch new stock issuances

American

fund based activity - invest - monitor - sell -

different from proprietary trading

Definitions

English

fee based activity - market securities -

services as a capital market intermediary

Indian

fee based activity - market securities -

additional responsibilities

MERCHANT

BANKING SERVICES

Merchant Banker’s Core Business Portfolio

1. Issue Management

2. Private Placements

3. Underwriting

4. Mergers & Acquisitions

5. Syndicated loans

6. Portfolio Management

7. Offshore finance

8. Financial Restructuring

9. Factoring & Forfaiting

10.Hire Purchase & Leasing

11. Buyback & Delisting

12.Project Counselling

13.Corporate Restructuring

Issue Management

Introduction

Number - Price - Timing of release

Files all the paperwork

Markets the new stock

Indian MB: Prospectus, disclosures, statutory

compliance

Lead manager and co-lead managers

Role of a Merchant Banker in Issue Management An expert advisor to the issuing

management

Co-ordinator to ensure timely completion

Watchdog for statutory compliance

Protector of investor interests

Interface b/w Issuer and SEBI

Functions of a Merchant Banker in Main areas of Issue management

1. Appointment, MoU and inter-se allocation of

responsibilities

2. Issue Structuring and Pricing

3. Due diligence

4. Preparing and filing the offer document

5. Underwriting and pre issue compliance

Functions of a Merchant Banker in Main areas of Issue management

6. Liaison with SEBI and the Stock Exchanges

7. Co-ordination with other functionaries

8. Issue marketing

9. Functions during the issue

10. Post-issue compliance

Pricing of IPOs SEBI allows issuers to freely price IPOs

Proper price - successful issue - good

investor returns - subsequent issues

Merchant banker’s task: trade off between

immediate gains and long term returns with

market realities

Valuation versus Pricing Finding the intrinsic

value of the company

Consideration for giving up the right to accrue future cash flows

Setting an offer price

Diluting stake to earn a smaller share of a bigger pie

Entry price to gain a right to accrue future cash flows

IPO pricing is a combination of various parameters in addition to valuation

The Price Band

Financial Year 04-05 05-06 06-07

Earnings Per Share 7.10 4.59 2.68

Weighted Avg. EPS

= (3 × 7.10) + (2 × 4.59) + (1 × 2.68) / 6

= 5.52

The Price Band

Taking an Average Industry P/E of 8.6,

we arrive at the most conservative price or the

lower end of the price band

5.52 × 8.6 = Rs. 47.47

The Price BandConsidering the company has an upper P/E range of 10 to 12, the upper end of the price

band is calculated as:

Highest EPS for the given period x Highest P/E

=7.10 × 12

=Rs. 85.20

Thus, the price band is Rs. 47 to Rs. 85

The Overpriced Jet IPOFinancial Year 1 2 3

EPS (5.34) (17.84) 19.44

Weighted Avg. EPS = Rs. 2.88

Avg. Industry P/E = 24

Ideal Price = Rs. 69.12

Cut-off price = Rs. 1,100

Times oversubscribed = 16 (80% @ Rs. 1,125)

Learnings

Strong market conditions, strong brand,

market share

Over priced shares eventually cannot support

their offer price

Qualitative justifications without financial

performance cannot sustain over-priced

shares

The Underpriced TechMahindra IPOFinancial Year 1 2 3

EPS 6.17 8.97 18.32



Ideal Price = Rs. 395.40

Offer price = Rs. 365

Times oversubscribed = 75 (QIB Portion)

Trading Price = Rs. 1500

Learnings

Under priced shares results in under selling

of the company. This can be verified if the

share climbs significantly post listing and

stays there in the long term

Rights issues Company has to provide better returns on

price because it is asking the same people

some more money a second time.

Major considerations: EPS, BV of share,

industry P/E, and most imp current co P/E

FPOs include new investors as well, so can

be slightly overpriced

Pricing a Rights Issue

For X Ltd.



Ideal Price = Rs. 105

Offer price = Rs. 60 (10 + 50)

Trading Price = Rs. 75

Pricing a Rights IssueWeighted Avg. EPS = Rs. 7.50

Company P/E = 5 to 6

Price band = Rs. 37.5 to Rs. 45 (Assume Rs. 40)

Market Price < Offer Price

Investor friendly move to get an encouraging

response (discount of 47 % to Rs. 75 )

Cut-off price Retail / Institutional & HNI bid prices

Allocations to I, NI, Retail Investors

Choosing valid bids

Allotments to highest bidders (max % allowed

per category) as per the DIP guidelines

Lowest price at which last share is allotted is

cut-off price

Cut-off price

Final fixed offer price in a book built issue

It is decided after the subscription lists are

closed and the valid bids received &

evaluated

Co aims at getting the highest bid from all

categories while remaining within the

guidelines

Book-Built Offers

Prices ↔ fundamentals & market mood

Floor price

Cut-off price and floor price

Final capital and issue structure

emerges after cut-off price is arrived at

Post-Issue Capital Structure

Proposed Issue Size

Promoter's Cotribution

Offer through Offer document

Reservations

NPO

Offer to Indian Public

Firm allotments

Determining Capital Structure

Marketability and Desirable position

Fixed price offer:

Fund requirement / Offer price = Issue size

Book built offer:

Fund requirement or Least dilution of

shareholder’s stakes / Issue size or Floor price

Biocon Ltd.

Adani Power IPO

PRIVATE PLACEMENTS

Objective OfPrivate Placement

FundRaising

StrategicObjective

Advantages Of Private Placements

From Issuers’ Perspective

Faster access to funds

Less market uncertainties

Cost efficiency

Less paperwork

Advantages Of Private Placements

From Investors Perspective

Less Transparency

Interaction with Issuer Co.s’ mgmt.

Liquidity & price validation on a continuous basis

Private Placement Of Equity

Venture Capital (VC)

PrivateEquity (PE)

QIBs &Non-Institutional

Investors

Venture Capital

“Financing Of Innovation”

“High Risk – High Return”

E.g. Apple Computer, Yahoo, E-bay, Cisco Systems

Private Equity

“Later stage Financing”

Good Investment Opportunities in well performing Cos.

Large deal sizes

Moderate return expectations

QIBs & Non-Institutional Investors QIBs

(Mutual Funds, FIIs, Banks, Insurance Cos.)

Non-Institutional Investors

(Family sources/Assosiates of Promoters, Angel Investors, Stock Broking Cos., Non-Residents, etc.)

Merchant Bankers Role In Private Placements Business Advisory Formulation of the Transaction Valuation Deal Structuring Offer Literature Transaction Advisory

UNDERWRITING

What Is Underwriting Evolution Contingent Obligation Nature Of Underwriting Sub Underwriting Underwriting Commission Underwriting Commission Devolvement

MERGERS & AQUISITIONS

Strategic Objectives relating to M&A

SYNDICATED LOAN

Types of Syndication

1. Under written deal

2. Best-efforts Syndication

3. Club deal

Types of Syndicated Loans

Loan for

Greenfield Projects

Expansion

Investment in Corporate Securities

Consortium Loan Rediscounting Loan

Role of Merchant Bank in Syndication Process

Case Study-

Jaguar-Land Rover Acquisition

PORTFOLIO MANAGEMENT

Types of Portfolio Aggressive Portfolio

Dividend Yield Portfolio

Deep Value Portfolio

The Focused Portfolio

Index (Nifty), Arbitrage (Future)

Diversified portfolio

Function OF Merchant Banker in Portfolio Mgt

Risk Diversification

Efficient Portfolio

Asset Allocation

Beta Estimation

Rebalancing Portfolios

OFF SHORE FINANCE

Services Provided by Merchant Bankers

Long Term Foreign Currency Loan

Joint Venture

Financing Exports and Imports

Foreign Collaboration Arrangement

Case Study

1. Tata Steel and Suzlon Energy

Deal

Issue of GDR

Merchant Banks (Citigroup, JP Morgan and Deutsche Bank)

FINANCIAL RESTRUCTURING

Financial Restructuring

What is Financial Restructuring?

It is the art of restating the financial position of a company as reflected by its balance sheet as on a given date. In order to achieve such restatement, a complex financial and legal process is involved as it concerns several conflicting interest.

Types of Financial Restructuring

Debt Restructuring: - It refers to that part of the reconstruction of a balance sheet insofar as it relates to the borrowing obligations of the company.

Equity Restructuring / Capital Reduction: - it is the re – organization of the share capital and / or reserves appearing in the balance sheet of a company.

Debt Restructuring

Rational for Debt Restructuring: -

For Healthy companies:

For Sick Units:

Ways in which DRS takes Place

Interest rate relief

Deferment of Past interest due

Waiver of Penalties for Non payment

Re – schedulement of Loan

One Time settlement

Role of Merchant banker in DRS

formulate Viability Plan, assess borrowing cost, carrying cost, future opportunities

To Develop a DRS complying with statutory norms and guidelines issued by RBI

Make presentation in front of the lenders and represent on behalf of the company.

To facilitate transaction services once the DRS Plan gets approvals from all lenders.

Methods of Equity Restructuring

Share capital can be restructured by repurchase of shares from the share holders for cash

to convert the equity capital into loans or redeemable preference shares, so as to be paid off at a later date.

writing down the equity share capital through appropriate accounting entries.

Expansion of share capital by conversion of convertible instruments such as convertible debentures, convertible preference shares, equity warrant and others.

Cancellation of unissued capital

Conversion of loan into equity.

Case Study on Air India Turnaround

Problem: -

Air India run by NACIL

Working capital liabilities have increased from 2,369crs to 15,241crs since Mar, 2006

AI has ordered 111 aircrafts and spent 50000crs but has a equity base of just 145crs.

After the merger of Indian Airlines and Air India, AI losses has grow to 7,200crs.

AI spends almost 60 – 65% of its Working Capital on manpower and fuel consumption

Monthly deficit of 800crs.

Solution

Plans to mobilize additional revenue of 1,800crs by cost cutting

and increase revenue by 1,200 – 1,400crs.

Air India is raising $1bn loan from overseas to fund its fleet

expansion program which is guaranteed by Export Import bank

in US

Appointment of Independent directors on board

Equity infusion of 10k crs and equal amount of soft loan

Conversion of working capital into term loan which stand about

16K crs as on today’s date.

Role of SBI Capital in Restructuring

SBI Caps to suggest a roadmap for the financial restructuring of Air

India in the short and medium term

To facilitate and present the financial restructuring plan in front of the

government on behalf of Air India.

To facilitate transaction like equity issue, soft loan disbursement and

other activities which are required to turn the Airlines around.

To provide advice at every step of restructuring plan and help the

Airlines in carrying out the plan smoothly.

Advising them on cost cutting and various ways in which Air India can

save money to repay off their debt.

What is Factoring ???

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business

Factoring Process Basically there are three parties to the

factoring services as depicted below:

Clientcustomer

factor

BuyerSeller

Financer

Credit sale of goods

Payment of am

ount

Invoice

Pay

men

t upt

o 80

% in

itial

ly

Services provided by Factor Debt administration

Credit Information

Credit Protection

Invoice Discounting or Financing

Benefits of factoring The client will be relieved of the work relating to

sales ledger administration and debt collection

The client can therefore concentrate more on planning production and sales.

The charges paid to a factor which will be marginally high at 1 to 1.5% than the bank charges will be more than compensated by reductions in administrative expenditure.

This will also improve the current ratio of the client and consequently his credit rating.

Types of Factoring

Disclosed

Non Disclosed

With Recourse

Without Recourse

What is Forfeiting??? It is a trade finance extended by a forfaiter to

an exporter/seller for an export/sale transaction involving deferred payment terms over a long period at a firm rate of discount.

Forfaiting is generally extended for export of capital goods, commodities and services where the importer insists on supplies on credit terms.

Mechanism negotiate the proposed export sale contract

exporter approaches the forfaiter to ascertain the terms for forfeiting.

forfaiter collects all the relevant details of the proposed transaction in order to ascertain the country risk and credit risk involved in the transaction

Depending upon the risk Forfaiter quotes discount rates

Exporter quote a contract price to the overseas buyer by loading the discount rate, commitment fee, etc., on the sale price of the goods to be exported.

Contd….. If the deals go through, the exporter and

forfaiter sign a contract

Export takes place against documents guaranteed by the importer’s bank.

The exporter discounts the bill with the forfaiter and the forfaiter presents the same to the importer for payment on due date or even can sell it in secondary market.

Documentation & Cost

Forfaiting transaction is usually covered either by a promissory note or bill of exchange. In either case it has to be guaranteed by a bank

The forfeiting cost for a transaction will be in the form of ‘commitment fee’, ‘discount fee’ and ‘documentation fee’.

What is Hire Purchase???

“An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement”

Specifics: -

1. Payment of periodic instalments

2. Immediate possession of goods by the buyer

3. Ownership of goods remaining with the vendor until the payment of the last instalment

4. Vendor’s right to repossess the goods in the event of default committed by the buyer

5. Treatment of each instalment as hire charge till the payment of the last instalment

What is Leasing??? ‘A lease is an agreement whereby the lessor

conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. Lessor is a person who conveys to another person (lessee) the right to use an asset in consideration of a payment of periodical rental, under a lease agreement. Lessee is a person who obtains from the lessor, the right to use the asset for a periodical rental payment for an agreed period of time.’

Types of Leasing

Finance Leasing: - It is a close alternative to Hire purchase Lessor agrees to transfer the title of the

asset at the end of the lease period Lessee have most of the risk and

rewards associated with the ownership It is used for heavy capital goods like

aircrafts, ships etc.

Operating Lease Lessee has limited right to use the asset

Lessor is responsible for upkeep and maintenance of the assets

Lessee does not have the option to purchase the asset at the end of the lease period

Such type of leasing is suitable for small equipments like computer hardware, vehicles, Mines etc.

Lease period is generally short.

Sale and Lease Back

In this lease agreement the seller sells his asset to the party and lease the same asset back from the buying party.

Assets are not physically exchanged, its only paper transaction.

seller assumes the role of a lessee and the buyer assumes the role of a lessor.

Condt…Condt…

Leveraged Leasing

Third Party called as “lender” is involved.

Lessor borrows the money from lendor keeping the leased asset as collateral security and pay the lender back through the rent proceeds collected from the lessee.

Condt…

Hire Purchase V/s Lease Finance

Ownership

Depreciation

Capitalization

Payment

Salvage Value

Magnitude

Down Payment

Reporting

Maintenance of Asset

Suitability

Nature of Asset

Receipts

BUYBACK AND DELISTING

What is buyback?

Why Buy back?

Unused cash / over capitalized

Under valuation of shares

Tax gains

Market Perceptions

Exit option

Escape monitoring of accounts and legal control

To show better Ratios

Increase promoter stake

particulars overcapitalised optimum Under- capitalised

Sales 100,000 100,000 100,000

EBITDA 24,000 24,000 24,000

EBITDA% 24% 24% 24%

PAT 15,000 14,000 12,000

PAT% 15% 14% 12%

Share capital 50,000 25,000 20,000

Reserves n surplus 100,000 10,000 15,000

Secured borrowings 0 25,000 35,000

Capital Employed 150,000 60,000 40,000

Capital Turnover 0.66 1.67 2.50

ROCE 16% 40% 60%

EPS 3.00 5.60 6.00

Debt-equity(times) 0 0.71 7.00

METHODS OF BUYBACKFor Unlisted Companies For Listed Companies

Letter of offer Fixed price tender offer

------------ Book building Method

----------- Open Market Purchase

Restrictions on buy-back1. A special resolution has to be passed in general meeting of the shareholders

2. Buyback should not exceed 25% of the total paid-up capital and free reserves

3. A declaration of solvency has to be filed with SEBI and Registrar Of Companies

4. The shares bought back should be extinguished and physically destroyed;

5. The company should not make any further issue of securities within 2 years, except bonus, conversion of warrants, etc.

PRICING OF BUY BACK

PARTICULARS.docx

CASE STUDY

Reliance Share buyback Program was triggered off due to under valuation Of the company’s stock vis-à-vis the BSE sensex.

Aim of buy back-

To achieve support of the stock price in face of undervaluation.

Optimize weighted average cost of capital.

Improve financial parameters.

Reducing Floating Stock.

Enhance Long Term performance.

Re-rating Of RIL stock.

DELISTING?

What is De-listing?

TYPES OF DELISTING

Compulsory

Voluntarily

PROJECT COUNSELLING

THE NEED

•Private sector involvement in infrastructure demand for innovative financial structure to deal with the multitude of political, market and credit risk.

•Build credible Structures to ensure that project are economically, socially, environmentally, politically viable

AIM OF PCS

To appraise the project

To finance the project

To make the project report

APPRAISAL OF PROJECT

Technical Appraisal

Financial Appraisal

Ratio Analysis

Economic Appraisal

SOURCES OF FINANCE

Term loansECB

Leasing financeUnsecured loans

Others

DECISION CRITERIAIRR DRC DECISION

High low Very Good

High Avg. Good

High High Consider

Avg. Avg Satisfactory

Low Low Satisfactory

Low Avg. Consider

Low High Reject

CORPORATE RESTRUCTURING

NEED FOR C .R.

To create long term holding structures.

To attain better utilize tax shields and tax write-

offs.

To facilitate distribution of assets and family

settlement.

To exit non-core business.

TYPES OF C. R.

InternalThrough assetThrough Equity

External(split-up)

Through Equity

Through Asset

Subsidiarisation Demerger Hive-off

Divestiture(Sell-off)

De-subsidiarisation

(carve-out)

De-subsidiarisation

(spin-off)

CASE STUDY

Tata Sons Limited, The owner of TCS Division Decided to subsidiarise the division.

•First the company filed for Hive-off under section 391 to 394 of the companies act with high court of judiciary Bombay.

• The consideration of Hive-off was to be settled in cash.• In order to raise cash TCS was taken public and went for an IPO.

• Then company finally went for Equity carve out to dilute the Tata sons stake.

THANK YOU

Merchant Banking

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