Investment Banking – An Industry Analysis

WELINGKAR INSTITUTE OF MANAGEMENT

DEVELOPMENT AND RESEARCH

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 CONTENTS

S.no Particulars Page number

1 Investment Banking – A Brief Overview 3

2 Merchant Banking – A Brief Overview 5
3 The Indian and Global Players 6
4 The functions of the investment banker 9
- Capital markets 9
 IPO 9
 RIGHTS ISSUE 11
 BONUS ISSUE 11
 PRIVATE PLACEMENTS 11
 BOUGTH OUT DEALS 15
- Mergers And Acquisition 16
 Introduction 16
 Reasons for merger 17
 Mechanics of merger 17
 Procedure for Take Over - Acquisition 17
 A Few Important Definitions 19
 International trends 22
 Current trends – Indian scenario 24
- Corporate Restructuring 26
- Financial and Project Advisory Services 26
5 Structural analysis of investment banking 28
6 Bibliography 32

Investment Banking

DEFINITION:

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Investment Banking - Businesses specializing in the formation of capital. This is done by
outright purchase and sale of securities offered by the issuer, standby underwriting or
"best efforts selling."

Investment banking is a very vast area in the field of banking and finance. Typically,
investment banking includes the following activities:

 Advising
 Administration
 Underwriting
 Distribution
 Other related activities which most investment bankers undertake are Mergers
and Acquisitions, Investment management, securities sales and securities trading
as well as insurance product designing, pension plans designing, hedging foreign
currency positions, real estate dealing and other asset management services.

So in short investment banking includes the activity of raising funds, managing them,
advising about investments and marketing of financial products. While there are
separate investment banks in the US and Europe, in India some of the commercial
banks undertake investment banking in Toto or a part of it. It is to be understood that
merchant banking is just a part of investment banking and not the other way round.

 Advising Functions

The advising function starts with the investment banker assessing the fund requirements
of its client, whether individual or corporate. The requirements are not only related to
the amount of funds required, but also the purpose and time for which the requirement
is there. After that, the investment banker will advise the client about the cost and
benefits of various sources of finance that are viable and the timing of each one for
raising the required funds. Finally it will advise the client about the best source and
recommend a group of institutions that can assemble the package and fulfill the funding
needs. The advising functions include IPO, mergers and acquisitions, corporate debt
restructuring, individual investment services.

 Administration function

After deciding on the funding strategy, the second function is the administrative
function, under which the investment banker has to prepare the documentation and a
myriad of details associated with the regulatory framework of the country in which the
funds are being raised. As the financial regulations and covenants are routine
considerations to the investment banker but may be obscure issues to the general
business community, the investment banker can provide a valuable service in this area.
As such, an investment banker is to know the legal and regulatory framework of the
country as well as thorough knowledge of the success history of past issues. Among the
administrative functions that an investment banker is supposed to render are the
preparation of the documentation of the issue and the prospectus.

 Underwriting function

Underwriting means guaranteeing a fixed price to the security issuer in exchange for its
securities. Investment bankers undertake underwriting of the issue that are brought to
the market by their clients. This activity involves risk to the investment banker if the

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underwriting price is very high. In addition, investment bankers get involved into
bought-out deals and private placement of issues.

 Distribution

Distribution function involves the placement of newly issued securities in the hands of
the investor. The investment banker is expected to build up a proper channel for the
distribution of the issue and form a syndicate of underwriters to minimize the risks on
the issue as well as to stabilize the price. It also involves the printing of the security
papers, allotment, registrars work among others.

 Investment management function

Given the fact that investment managers are involved with the issues from the
beginning, they have the strength to analyze the securities and firms that issue them.
As such they can leverage their abilities in other areas. Secondly, given the fact that in
various countries the management of the primary issues is dwindling, investment
bankers have been attracted towards the secondary market and investment
management on their own. The investment management function also includes the
management of funds entrusted by the client to the investment banker. An investment
banker also invites funds from the public in general and manages the same under
guarantee to provide a certain percentage of returns which is any time higher than the
returns the individual can obtain on his own. Funds thus received are invested in various
stock and bond issues, as well as guilt-edged instruments. Such investment bankers are
also known as money managers.

A study of investment bankers worldwide has shown that they provide the following
types of management services in a number of different ways: individual investment
services, money management, pooling of funds for joint investment, index fund
investments and consultancy services.

 Mergers & Acquisitions

Mergers & Acquisitions is an other area where investment bankers have been active for
quite a long time. They help their clients find out prospective merger partners or an
acquisition target or prospective clients for sale. In addition, they may be asked to
devise appropriate strategies for the acquisition, including the raising of sufficient funds
for the same.

 Other activities

In addition to the above mentioned activities, Investment bankers have been interested
in the designation of insurance products, pension plans, hedging risk and risk
management, foreign currency activities, real estate dealing etc. The field of an
investment banker has been growing fast owing to the fact that the finance industry is
seeing a lot of innovations and new concepts are fast emerging.

Merchant banking:

Merchant banking acts as intermediaries between the issuer of capital and the ultimate
investors who purchase these securities. Merchant banking can be broadly defined as

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financial intermediation that matches the entities that need capital and those that have
capital. Merchant Banks facilitate the process of flow of capital in the market.

The Securities and the exchange Board of India (merchant Bankers) Rules 1992 Define
Merchant Banker as:

“ A person who is engaged in the business of issue management either by making

arrangements regarding selling, buying, or subscribing to securities as Managers,
consultant, advisor or rendering corporate advisory services in relation to such issue
management”

Investment banking includes the activity of raising funds, managing them, advising
about investments and marketing of financial products whereas a merchant banker acts
as intermediaries between the issuer of capital and the ultimate investors who purchase
these securities.

It is to be understood that merchant banking is just a part of investment banking and

not the other way round.

Securities

Issuer Merchant banker Investor

Cash

Diagram1: Merchant Banking Process

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Scope of merchant banking

SEBI

Regulatory Compliance
framework

Capital MERCHANT Return

BANKER s
ISSUER INVESTOR
Market Protection
informa
tion
Guidance Co- ordination

INTERMEDIA
RIES

Diagram 2: relationship of the merchant banker

A merchant banker plays a vital role in channelizing the financial surplus of the society
into productive investment avenues. The merchant banker has a fiduciary role in relation
to the investors.

He is required to exercise due diligence to ensure the adequacy and appropriateness of

the disclosures made in the offer document

The merchant banker is the leader among all the intermediaries associated with the
issue. He is required to guide and co-ordinate the activities of the registrar to the issue.

The merchant banker has to ensure the compliance of all the laws and regulations
governing the securities market. He may also be called upon to assist the statutory
authorities in developing a regulatory framework for orderly growth of capital markets.

INVESTMENT BANKING - INDIAN SCENARIO

Indian companies in strategic alliances with Global Investment Banks

1. JM Morgan Stanley

JM Morgan Stanley (JMMS) is a pre-eminent financial services firm, a joint venture

between JM Financial Group and Morgan Stanley. JM MORGAN STANLEY combines the

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strong domestic franchise of the JM Financial Group with the international experience
and expertise of Morgan Stanley.
JM Morgan Stanley is the leader in Mergers, Acquisition & Restructuring businesses in
India and in lead managing equity, debt and equity related issuances in Indian and
international capital markets. They have been rated as the Best Investment Bank in
India for Mergers & Acquisitions for two consecutive years. It has also been the #1 Lead
Manager of public issuance of equity, debt and equity related securities by Indian
issuers. Their relationship with Morgan Stanley’s global network spanning 28 countries
provides them the ability to deliver cutting-edge global capital markets solutions for
their India based clients.
2. DSP Merrill Lynch

DSP Merrill Lynch Limited (DSP ML) -DSP ML is a leading financial service provider in
India. It has been formed by the culmination of a long-standing relationship between
DSP Financial Consultants Limited (DSP), and Merrill Lynch and Co. (ML), the leading
international capital raising, financial management and advisory company.

In India, DSP ML is the leading underwriter and broker for debt and equity securities and
a leading advisor to corporations and institutions. DSP ML is also among the first firms to
set up a full-fledged research team in India. The Company is among the major players in
the debt and equity markets and is also a primary dealer of Government Securities.

Banking Subsidiaries

3. ICICI Securities limited

ICICI Securities is a strongly positioned investment bank in India and provides products
and services in Fixed Income, Equities and Corporate Finance. In the fixed income
business ICICI Securities is a leading market participant in the country. ICICI Securities
fixed income activities include interest rate trading, derivatives trading, research and
issue management.

ICICI Securities is amongst the largest arranger of funds in Debt and Equity segments
and also amongst the leading advisors in Mergers and Acquisitions. Its clients include a
wide range of Indian and foreign corporations and institutional investors.

ICICI Securities continued to maintain its leadership position in the industry and
delivered a remarkable performance. ICICI Securities net worth was Rs. 3.51 billion, an
increase of 10.03% over the previous year. ICICI Securities was placed as a No. 1
advisor for M&As in India, with closure of 4 deals aggregating to US $ 142.47 million
(This is as per recent rankings published by Bloomberg for the first quarter of 2003).

4. HSBC Securities and Capital markets (India) Pvt. Ltd

HSBC is one of the market leaders in the stake enhancement business through the Open
Offer and Buy Back route. Recent deals concluded include that of Sandvik AB, Modi
Rubber Ltd., Reckitt Benckiser (India) Ltd.

Recent advisory transactions concluded include the highly innovative capital

restructuring and deemed dividend payment for Hindustan Lever Limited. Other deals
include the investment by the AP Moller Group into the Gujarat Pipavav project, the sale

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of the Calcutta cellular business by Spice to the Bharati group.

During a exceedingly volatile period HSBC helped conclude 2 media IPO's for Mukta Arts
Ltd. and Creative Eye Ltd. HSBC also concluded the rights issue of SKF Bearings Ltd.
5. SBI Capital Markets

It provides services in M &A, project advisory, structured finance and capital markets. It
is the leading domestic player in the privatization business, with more than 7 years of
experience in this field.

The project advisory and structured finance group has a formidable presence in the in
infrastructural development in India. This group provides services in the sectors of
power, hydrocarbons, urban infrastructure, transportation, telecom and other sectors.

In FY 2002, they handled a complex sell-off transaction of Tractebel S.A.'s stake in

Jindal Tractebel Power Company. SBI CAP also advised Vysya Bank in its sale of stake of
ICRA to Moody's.

Niche companies

Small investment bankers are beginning to identify niche segments and portfolio
management for retail investors to propel their revenue streams. In fact, specialization
has been thrust on most of these smaller players almost entirely by the heat of
competition. Most of these small players are simply not in a position to match the
resources of the bigger players in pitching for the glamorous big-ticket business.

1. Ambit Finance

Ambit Finance provides services in the field of Mergers & Acquisitions Advisory,
transaction structuring to ensure tax efficient acquisitions / spin-offs / divestitures, co-
ordination with key institutions, investors and market regulators.

2. Allegro Capital Services

Among the investment banks specializing in CDRs include Allegro Capital Advisors, which
has the first mover advantage in this business. Allegro is a small investment bank
started by a small group of finance professionals. Allegro handled the Rs 2000-crore
CDR mandate of SPIC Petrochem, of Duncan’s for restructuring involving Rs 1000 crore
and Unimers India Ltd involving Rs 50 crore.

3. Enam Securities

Enam Securities provides investment banking, corporate advisory, equity, debt and
capital market services to companies and institutions. Our distinguished record of
success evolves from our understanding of the capital markets. Enam is also one of the
largest underwriters in India. They had underwritten 29.9 crore of Mukta Arts IPO. Enam
is India’s undisputed leader in mobilizing resources for IPOs. With its network of over
5,000 dedicated franchisees, Enam mobilizes approximately 10% of all funds raised in
the Indian equity markets.

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 Functions of an investment banker

Initial public offering:

An initial public offering is the first public offer of securities by a company since its
inception. The security offered in an IPO is generally either equity or convertible
instruments. The decision to go public is a critical one as it results in dilution of
ownership stake and diffusion of corporate control. An IPO can be used both as financing
strategy and exit strategy. In a financial strategy the main purpose of the IPO is to raise
funds for the company. An IPO can be used as an exit strategy when the existing
investors offload their equity holdings the public.

Reasons for going public

 Raising funds to finance capital expenditure programs like expansion,

diversification, modernization
 Financing of increased working capital requirements
 Financing acquisition like manufacturing unit, brand acquisition, tender offers for
shares of another firm
 Debt refinancing
 Exit route for existing investors

IPO Scenario in the Past – A Comparison with the Present

As soon as the stock markets turned buoyant and share prices began to chart a
distinctly upward course, the corporate sector, the financial segment and investors –
individual as well as institutional- have been anxiously waiting not only for the revival
but also for a boom in the Indian primary capital market, which, under the influence of
foreign institutional investors, is referred to as the IPO market, these days. Infact as
many as 605 companies including the public sector units, multi nationals, large sized
Indian companies and promoters of new enterprise have planned to enter the market
and 135 of them are all set to come out with issues at the most opportune time.

It is a universal truth that when there is a primary market boom, business thugs and
cheats always jump into the fray to take advantage of the bullish environment. This is
what precisely happened during the nineties IPO boom.

The unprecedent boom in the first half of the nineties, the primary market had literally
turned down for the count. Between April 1992 and March 1996 over 4000 companies
had raised over rs54000 crores through public and hybrid issues. During the same
period another 1500 companies had raised over 34000 crores through rights issues at a
very high premiums. Most of these companies literally cheated the investors as some of
them disappeared from the scene altogether and that too, in such a fashion that even
SEBI is finding it difficult to trace them. Many others who charged very high premiums
are being quoted at heavy discounts and, all those concerned, investors, individuals as
well as institutional, have lost millions of rupees.

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THE SCENEARIO AFTER NINETIES IN THE PRIMARY MARKET:

 Investors shying away:

Hundreds and thousands of investors shied away from the market and issue after issue
thereafter started getting bombed on account of extremely poor response. The outcome
was obvious- the new issue market was in a bas state. In 2001-02 there were only six
IPO’s and of these six three were floated by nationalized banks, while the manufacturing
services sector had just three issues. A figure of six issues in a year that too after as
many as 1423 issues in 1995-96 was alarming in terms of response.

 Poor mobilization:

The combined mobilization during the last five years was only 7516 crores which is only
15% less than even a single year mobilization of 8686 crores in 1995-96. As the
lukewarm response from the public was quite understandable, as not only fly by night
operators had cheated them but even the so called industrials groups like the guptas of
the Lloyds robbed them by inflating their performance and charging fantastically high
premiums. As a result people got disgusted with the corporates and their promoters and
moved away from the market altogether.

On account of bitter experiences through the nineties with the equity market and with
several other scams on one hand and government backed, high assurance return
schemes, made even better by tax benefits on the other, the Indian investor has
become averse to risk. A report by RBI shows that a meager 4% of India’s household
savings is invested in securities down from 23% in 1991-92. The report further reveals
that the rest was in fixed deposits (44%), government –backed instruments including
provident funds and pension funds, insurance and idle cash. equity income cannot grow
when safety becomes the primary concerns.

 Drop in capital formation:

As funds could not be raised from the market, several new projects got delayed and
several projects remained only on the paper. This development, coupled with the
recessionary trends in the U.S led to a market drop in business activity and loss of
employment for thousands.the process of capital formation slowed down considerably,
ultimately pushing down the rate of economic growth of the country.

As the public response was extremely poor, companies did not dare to enter the market.
This does not mean that companies did not want to raise capital. In fact, as many, as
605 companies many waiting for years, want to come out with public issue, to
collectively raise over 60000 crores.of these 135 companies have almost finalized their
plans to enter the market the moment primary market gives a favorable signal.

IS THE PRIMARY MARKET ON THE VERGE OF REVIVAL OR A BOOM?

It is said that primary market follows the secondary market. Since secondary market
has already entered a period of boom with price indices shooting up by more than 50%
in recent month. The primary market in these circumstances is bound to turn active.

The growth of corporate India is based on strong industrial performance backed by

overall macroeconomic fundamentals like low interest rates, low inflation and favorable
fiscal policies.

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This could be a start of an IPO boom and could happen because of four reasons:
 The returns of small savings have crashed by more than 4% points in the recent
years
 Tax benefits are fast disappearing
 Safe government institutions have been increasingly on the default track
 There is inflation, hurting the real rate of return.

On the other hand the equity market is in a bull phase. Even though investors have
suffered loss in the past they will be cautious and go only for selective issues and a
number of good and established companies will enter the market and there will be
enough choice for the investors to invest.

Looking at the strong fundamentals of the economy there is a likely hood of an IPO
boom.

Rights issue:

Shares offered by a public company to its existing equity shareholders are called rights
shares. Because they are offered to the shareholders as a matter of legal rights.

Bonus issue:

The issue of bonus shares is a common feature for certain public companies. When a
company is prosperous and accumulates large surplus, it converts some of this surplus
as capital and divides this capital among the members in proportion to their holdings.
This is generally made to bring in line the paid up capital with the capital employed by
the company.

Private Placements:

A private placement is a method of raising capital in which companies directly sell their
securities to a limited number of sophisticated and discerning investors.

The convenience of structuring of the issues to match the needs of issuers with those of
investors coupled with savings in terms of time and cost has contributed to the rapid
growth of the market for private placement of debt.

There are several inherent advantages for tapping private placement route for raising
resources. While it is cost and time effective method of raising funds and can be
structured to meet the needs of the entrepreneurs, it does not require detailed
compliance with formalities as required in public or rights issue.

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Example: Reliance industries raised the highest amount in history by way of private
placements of equity shares. It raised 945 crore by privately placing shares with three
domestic financial institutions of whom UTI was the most important. Around 24.5 million
shares were placed at a price of Rs 385 per share as against the price of Rs 377 then
prevailing.

Features

 There are no entry barriers for the private placement market

 There is no need for registration of the offer document with SEBI. The procedural
formalities are simple
 The terms of the issue can be negotiated between the issuers and the investors
 The company has a choice of investors in private placements
 The transaction costs are low
 Credit rating is optional in case of debt instruments
 The execution of deal is faster

Players in the placement market

 Mutual fund
 Financial institutions
 Banks
 Insurance companies
 Foreign institutional investors
 High net worth individuals
 Unit trust of India
 Private equity funds

The main issuers in the private placement market are

 Listed companies
 Financial institutions
 Unlisted and closely held companies
 Public sector undertakings
 Government corporations i.e. institutions created by special act of
parliament/state legislature for a specific purposes.

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Merits of Private Placement

 Accessibility: There are no entry barriers for a company to access the private
placement market. Unlike the public issue market, an existing company does not
require a dividend track record for 3 years does a Greenfield project require
mandatory appraisal and funding by bank/financial institution. This route is also
available to unlisted and closely held companies. Further public offering may not
be viable if the amount proposed to be raised is very small.

 Speed: a private placement deal can be successfully executed much faster than
a public offering. The procedural formalities for a private placement transaction
are minimal. The time- frame required to plan and complete a public offering
ranges between 4 to 6 months. On the other hand, a private placement deal can
be successfully closed in 4 to 6 weeks. This result is substantial saving of time
and energy for the issuer.

 Flexibility: In a private placement, there is greater flexibility in working out the

terms of the issue. In addition to greater flexibility at the time of structuring the
issue initially, there may be more latitude to re-negotiate the terms of the issue
subsequently and even roll – over the debt. This is because the issuer has to deal
with only a few institutional investors in private placement market.

Besides, one of the most attractive feature of private placement market is that it
can be tailored to the needs of first generation entrepreneurs who are
comparatively less known to the public which makes their public issue less
attractive. It also satisfies investors who want large holdings, but whose needs
cannot obviously be met in case of public issue. Thus for large investors, stocks
will be available in the quantity they desire at reasonable transaction cost
compared to secondary market buying.

 Lower transaction cost: A public issue entails several statutory and non-
statutory expenses associated with underwriting, brokerage, printing, mailing,
announcements, promotion and so on. In the absence of advertisement and
prospectus, the issue expenses in case of private placement is as low as 2% of
the total issue amount as compared to 10 to 12% in case of public issue.

 Confidentiality: Private placements also have the advantage of confidentiality of

information. In a competitive environment, keeping strategic business secrets
pertaining to a firm is of crucial importance.

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 Methods Adopted for Private Placement

Procedure normally adopted by companies for private placement

General body meeting where

shareholders approval is
sought Issue price fixed
through road shows

Discussion on premium to be
charged
Issue price arrived at
by consensus

Specific RBI clearance

sought for different
categories e.g.; MF’s, FI’s,
Banks

Investment Banker
consulted for issue
placement

The procedure normally adopted by companies for private placement is that a

general body meeting is held where the shareholders approval is sought for private
placing the shares. The modalities of it are discussed and the amount of premium that
should be charged is put up for discussion. In doing so, the share price is either fixed
through consensus or by making marketability assessment at road shows. Then a
clearance is sought from RBI for various categories to which the issue is targeted
namely, mutual funds, financial institutions etc.

For any merchant banker, the return on investment would be the sole criterion for
striking a deal on private placements. As such he examines each issue scientifically and
objectively. The usual procedure adopted by merchant banker would be:

 A detailed research is done on the company vis-à-vis the feasibility of new

project, projected earnings potential, industry scenario etc. if the research
reports favors a “buy”, he proceeds further

 He establishes a network with clients namely MF’s, FII’s etc. to ascertain their
inclination towards the project.

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  Collectively or individually they make a visit to the plant to check for facts and
have first hand information. If satisfied, price negotiations between clients,
company and banker takes place. If the response is positive the deal on private
placement is struck.

THE REGULATORY FRAMEWORK

There are no comprehensive guidelines on private placements by SEBI.

Bought Out Deals

A buy-out is a process whereby an investor or a group of investors buys-out a significant

portion of the equity of an unlisted company with a view to make it public within an
agreed time-frame. To put it simply, buyouts are nothing but wholesale investments.

Advantages of Bought out deals

 Benefits to the issuer

For the issuer with a good project, it means obtaining funds upfront at a minimal cost
without the fear of under subscription in a depressed market.

 Benefits to the intermediary

For an intermediary, it could mean an annualized return of 30-35 percent on a

conservative basis.

 Benefits to the investor

For the investor, the benefit would be two fold. One, of entering into a stock at the initial
public offering stage with the comfort of professional evaluation of a merchant banker
who holds stakes in it, and two, the assurance of entering at a time when the gestation
should logically have been over.

Example

The most symbiotic of the structured deals was the Rs. 156 crore Infrastructure Leasing
and financial services variable premium BOD with UTI. In September 1994, 19.6 lakhs
shares of ILFS were sold to UTI at a premium of Rs. 50. UTI, as a warehouser, will
continue to hold the shares till the time of the IPO, to be floated at a premium of Rs.
100 or so. The benefit of ILFS is that given the expectation of good results, the
premium could even be as high as Rs. 125-145, and that would accrue to ILFS. For UTI,
the benefit is that it would get interest on the entire consideration, though it was
required to pay part of the sum to ILFS.

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 MERGERS AND ACQUISITIONS

INTRODUCTION

Mergers

M& A
Takeover
s
Purchase of a
division/plant
Mergers, Acquisitions &
Restructuring Joint ventures

Portfolio restructuring
Corporate
restructurin
g
Financial
Restructurin
g
Organizational
restructuring

Mergers & acquisitions are divided as shown above.

Many businesses which are low growth areas or at matured stage of life cycle or very
high growth areas like BPO/ IT services are majorly looking for M&A’s.

Indian corporate world is on search of organic/ inorganic growth to compete in a world

market. M&A’s are important in consolidation / unlocking value of assets which are
underutilized because of lack of availability of demand of that particular product &
Services. Many of the top IB’s are strategic alliances between strong Indian domestic
player and Global MNC.

Mergers: A Merger refers to a combination of two or more companies into one company
involving absorption or consolidation

Absorption: One Company acquires another company.

Consolidation: Two or more company’s combine to form a new company.

In India, mergers called amalgamation in legal parlance.

Horizontal: Merger of companies in the same line of business.
Vertical: Merger of companies engaged at different stages of production in an industry
Conglomerate: Merger of firm’s unrelated areas of business.

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Reasons for Mergers

Synergy

V (A+T) > COA + COT

V= VALUE after acquisition of combined entity.
COA = Cost of Acquisition (shares & cash)
COT = Cost o f Target company
 Mergers are useful only if there is some value addition to the acquiring company
and value of the combined entity should be greater than cost of acquisition and
value of target company.
 This value creation is due to plant rationalization of both the companies,
improving is due to technology /patent resource utilization.
 Economies of scale.

Mechanics of mergers

Legal Procedure

1. Determination of object clause of both the companies.

2. Intimation to Stock exchanges.
3. Approval of draft amalgamation proposal by respective board members.
4. Application to High Court.
5. Dispatch of notice to shareholders & creditors.
6. Holding of meetings of shareholders & creditors
7. Petition to the courts for confirmation & passing of court order.
8. Filling the order with the registrar.
9. Transfer of assets & liabilities
10. Issues of shares & debentures.

Tax treatment & Accounting for Amalgamation will be treatment.

Takeovers- Acquisition / Procedure for takeover

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997

Takeover: When an "acquirer" takes over the control of the "target company", it is
termed as Takeover. When an acquirer acquires "substantial quantity of shares or voting
rights" of the Target Company, it results into substantial acquisition of shares.
A Target company: A Target company is a listed company i.e. whose shares are listed
on any stock exchange and whose shares or voting rights are acquired/ being acquired
or whose control is taken over/being taken over by an acquirer.
Acquirer: An Acquirer means and includes persons acting in concert (PAC) with him i.e.
any individual/company/any other legal entity which intends to acquire or acquires
substantial quantity of shares or voting rights of target company or acquires or agrees to
acquire control over the target company
 A public announcement is an announcement made in the newspapers by the
acquirer primarily disclosing his intention to acquire shares of the target company
from existing shareholders by means of an open offer.

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  The acquirer has to make an offer for a minimum of 20% or the balance, if the
balance is less than 20%.
The Acquirer is required to appoint a Merchant Banker (MB) registered with SEBI
before making a PA (Role of investment bank as a merchant bank starts here).
PA is required to be made through the said MB.
 A due diligence certificate is also required to be filed along with the draft letter of
offer.
 SEBI has to accept these documents
The acquirer/ Merchant Banker will decide offer price
The relevant parameters are:
(a) Negotiated price under the agreement, which triggered the open offer.

(b) Price paid by the acquirer or persons acting in concert with him for
acquisition, if any, including by way of allotment in a public or rights or
preferential issue during the twenty six week period prior to the date of
public announcement, whichever is higher;

(c) The average of the weekly high and low of the closing prices of the shares
of the target company as quoted on the stock exchange where the shares of
the company are most frequently traded during the twenty six weeks or the
average of the daily high and low prices of the shares as quoted on the stock
exchange where the shares of the company are most frequently traded
during the two weeks preceding the date of public announcement, whichever
is higher.

Competitive bid: Competitive bid is an offer made by a person, other than the acquirer
who has made the first public announcement.

The subsisting offers is better and also not to cause last minute decisions / confusions,
the offer price and size are effectively frozen for the last 7 working days prior to the
closing date of the offers.

An acquirer cannot withdraw the offer once made barring special incidences
Privatization: some modified rules
 Transfer of shares and control to the strategic partner/ acquirer even before
completing the open offer formalities in terms of the Regulations;
 The date of entering into the share purchase agreement would be the reference
date for making the public announcement.
 The date on which the Central Government opens the financial bids would be the
reference date for classifying the shares of the company as frequently or
infrequently traded and for determination of the offer price.
 Non-applicability of requirement of second offer for subsequent stage of
acquisition subject to certain conditions
 Prohibition from making a competitive bid.
It may be noted that these amendments were made only for the purpose of
PSU disinvestments and are not available to other acquisitions.

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Definitions
Divestitures: Refers to the sale of a subsidiary company, also called "spin-off." An
example is when AT&T was forced to divest (breakup) by the U.S. Dept of Justice

Spin-offs: A new, independent company created through selling or distributing new

shares for an existing part of another company
Spin-offs may be done through a rights offering.

 Sometimes known as a partial spin-off, a carve out occurs when a parent

company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or
rights offering.
 In most cases the parent company will spin-off the remaining interests to existing
shareholders at a later date when the stock price is much higher.
 Also known as a "carve out" or an "equity carve out."

Disinvestments

 The sale or liquidation of an asset or subsidiary of an organization or

government. Also known as divestiture.
 Privatization: Companies are not the only ones involved with disinvestments
initiatives, Many governments disinvest departments into private companies

Joint ventures

The cooperation of two or more individuals or businesses in a specific enterprise, each

agreeing to share profit, loss, and control

This is a good way for companies to partner without having to merge. JVs are typically
termed as a partnership

Strategic partnerships

 An arrangement between two companies who have decided to share resources

that one company may not have while holding something that another has.
 A strategic alliance may also refer to a joint venture. This is becoming a common
business practice, as it is an excellent way to improve efficiency

De-mergers

 A corporate strategy to sell off subsidiaries or divisions of a company.

Recapitalization

 Restructuring a company's debt and equity mixture without affecting the total
amount of balance sheet equity

Hostile Takeover

 A takeover attempt that is strongly resisted by the target firm.

 Hostile takeovers are usually bad news, as the employee moral of the target firm
can quickly turn to animosity against the acquiring firm.

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From acquirer’s point of view

Lady Macbeth Strategy

 A corporate takeover strategy whereby a third party poses as a white knight to

gain trust, but then turns around and joins with unfriendly bidders.

Bankmail

 When a company planning to takeover another firm signs an agreement with a

bank that prevents the bank from financing any other potential acquirer's bid
 Bankmail agreements are entered into in order to stop other potential acquirers
from receiving similar financing arrangements

Greenmail

 A situation in which a large block of stock is held by an unfriendly company. This

forces the target company to repurchase the stock at a substantial premium to
prevent a takeover
 A dirty tactic, but it is very effective

Leveraged Buyout – LBO

 A strategy involving the acquisition of another company using borrowed money

(bonds or loans). The acquiring company uses its own assets as collateral for the
loan in hopes that the future cash flows will cover the loan payments
 There is usually a ratio of 90% debt to 10% equity. Because of this high
debt/equity ratio, the bonds are usually not investment grade and are referred to
as junk bonds

Busted Takeover

 A highly leveraged takeover. Consequently, some of the acquired company's

assets must be sold off for the deal to go through.
 The proceeds from the sale of these assets are then used towards the purchase
price of the acquisition

Management Buyout – MBO

 When the managers and/or executive of a company purchase controlling interest

in a company
 In most cases, the management will buyout all the shareholders and then take
the company private

Anti takeover defense mechanisms (Targeted company strategy)

A wide range of anti takeover defences have been employed by target companies to
prevent bidders.

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Pre offer Defenses

Staggered board:

The board comprises three equal groups of directors. Each year one group is elected.

Super majority clause

A very high percentage of votes, usually 80% or so is required to approve a merger.

Macaroni Defense

 An approach taken by a company that does not want to be taken over. The
company issues a large number of bonds with the condition they must be
redeemed at a high price if the company is taken over
 Why is it called Macaroni Defense? Because if a company is in danger, the
redemption price of the bonds expands like Macaroni in a pot

Lobster Trap

 A strategy used by a target firm to prevent a hostile takeover. In a lobster trap,

the company passes a provision preventing anyone with more than 10%
ownership from converting convertible securities into voting stock.
 Examples of convertible securities include convertible bonds, convertible
preferred stock, and warrants

Poison pills

Existing shareholders are granted the right to buy bonds or preference stock that get
converted into the stock of the acquiring firm, in the event of merger, on very
favorable terms.

People Pill

 A defensive strategy taken by a company to prevent a hostile takeover. However,

the target company engages in an activity that may actually ruin the company,
instead of merely halting the takeover. Also known as the "Jonestown Defense
 This is an extreme version of the poison pill

Suicide Pill
 A corporate takeover strategy whereby a third party poses as a white knight to
gain trust, but then turns around and joins with unfriendly bidders
 This is a variation of the poison pill defense

Sandbag

o A stalling tactic used by management to deter a company that is showing

interest in taking them over.
o The company stalls in hopes that a more favorable company will take
them over.

Dual class Recapitalisation

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 A new class of equity shareholders, which enjoys superior voting rights, is
created.

Golden parachute

The incumbent management is entitled to receive fabulous compensation in the

event of takeover.

Post offer Defenses

1. Pacman Defense: the target company makes a counter bid for the bidder.
2. Litigation: The target company files a suit against the bidding company for anti
trust or securities laws violation.
3. Asset restructuring: The target company sells it’s most precious assets,’ The
crown jewels’ and /or buys assets the bidder does not want or that may pose anti
trust problems for it.
4. Liability Restructuring: The target company repurchases it’s own it’s own shares
at substantial premium over or issues shares to a friendly third party.

India:

 Make preferential Allotment

 Effect Creeping Enhancement

 Amalgamate Group companies

 Sell Off Crown Jewels

 Search For the white Knight

International Trends

Source: Pricewaterhouse Coopers’ (PWC) latest report, Technology Sector

Insights

 Large cross-border transactions and consolidation have marked an upturn in

mergers and acquisitions (M&As) in the technology sector globally during the first
half of 2003.
 The top 10 deals were struck in telecom sector, which is looking at ways to reduce
debt and refocus on its core activities.

Market confidence with the return of large transactions in 2003

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Current Trends (India)

Source: PricewaterhouseCoopers’ (PWC) latest report, Technology Sector

Insights

- 23 -
 In India, M&A in the technology sector (including telecom) accounted for
approximately 19 per cent of the total deal value during first half of 2003.
 Information technology contributed 5 percent and telecom 14 per cent of the
total deal value during this period.

 In the business process outsourcing (BPO) segment, most deals in India have
been backed by venture capital, said PWC director Deepak Kapoor.

 Cross-border deals have increased in 2003 as acquirers have become less risk
averse and have regained confidence in the economy.

 Another important factor has been the increasing convergence between

technologies, such as voice and data networks.

 This will continue as hardware, software, telecommunications and IT services

companies look to merge

 Worldwide, software and IT services accounted for 50 per cent of total technology
deals in terms of numbers and 32 per cent by value in the first half of 2003.

 Prominent among these were large telecommunications deals, accounting for 30

per cent and 55 per cent of total market volume and value respectively.

 Hardware suppliers have suffered with deal values falling from 20 per cent in
2002 to less than 3 per cent in the first half of 2003

M&A LEAGUE Table (1 April 2002 – 31 March 2003)

Advisor Volume Deal count

Morgan Stanley 2595.08 11
Merrill Lynch & co. 1423.38 16
ICICI Securities & Finance 754.51 7
Deloitte Haskins & Sells 652.17 2
Lazard LLC 454.48 16
JPMorgan 369.2 5
ENAM Financial Consultants 325.43 7
Citigroup 306.24 2
UBS 304.22 1
Ernest &Young 296.22 20
Source: Business India

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(Source: SEBI DATA April –Oct 03)

Open offer of takeover from April-Oct 30

No. Of takeovers 37 Value: 1630.99 crs

Reasons for acquisitions

 SUBSTANTIAL ACQUISITION
 CONSOLIDATION OF HOLDINGS

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  CHANGE IN CONTROL

Corporate Restructuring

An aggressive and dynamic economic environment has compelled companies to re-

evaluate their capital structures to maintain financial competitiveness and enhance
operating efficiencies. The economy is also faced with the inherent challenge of
"stressed financial assets", where large funding exposures - both debt and equity need
to be recovered or restructured in ways that benefit all stakeholders -- lenders, investors
and the business.

Asset reconstruction seeks to re-allocate capital to the most efficient factors of

production. This includes settlements between lenders and borrowers objectivised to
align capital servicing with expected business performance. It also seeks to create exit
mechanisms where required to allow financially stronger or more efficient managements
to take over a stressed business on the basis of a settlement with existing lenders and
equity holders.

 Negotiating with lenders for settlements or restructuring loans;

 Balance Sheet restructuring to align the capital structure to the business
requirements
 Fund raising for re-financing high-cost capital Participating in tri-partite
arrangements (between lenders, borrowers and investors) enabling friendly take-
overs of stressed companies and businesses.

Financial Advisory Services

Objective

“Successfully organize, manage and monitor Individual or company's finances - giving

one greater financial control, liquidity and return on one’s Funds “

Customers generally are not experts in financial fields. They expect to get high returns
on their capital invested. This is exactly what experts in that domain do. The investment
banker carefully evaluates a proposal, and based on the pros and cons, and depending
upon the risk profile of the proposal, decides whether it is worth it putting an investor’s
money in the proposal or not. In short, the expert advises on the field where the
customer can get a good return on investment.

Each of the investment banker’s clients has diverse and changing needs for whom they
offer innovative and sound investment solutions to suit their specific requirements

This is important because it meets clients’ investment needs.

It offers an array of financial planning and business management solutions from the
initial growth stage of a developing business to the disposition of a mature business, no
matter what one’s business or its stage of development.

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Service offerings

 Structure: Review company/ Organization existing financial structures and

recommend, where appropriate, more effective arrangements for holding assets

 Family wealth advices

 Determining the viability of an employee stock ownership plan (ESOP).

Corporate finance, advice to valuing one’s business for financial, estate and

 Taxation: Consider taxation planning issues, forecast tax commitments assess

the most effective way to meet those commitments through cash flow
management

 Investments: Critically review one’s existing approach to investment, strategic

asset allocation and risk profile Identify new investment opportunities

 Superannuation: Critically review one’s current superannuation arrangements,

including options such as self managed and externally managed superannuation
strategies and develop one’s retirement planning strategy.

 Risk management: Review One’s needs for insurance to ensure one is protected
with appropriate levels of cover for Life, Disability and Trauma review policy
conditions to ensure they are appropriate for one.

 Estate planning: Determine one’s strategy for transferring one’s accumulated

wealth to invest in real estates.

 Retirement planning, insurance

 Cash Management Services

 Portfolio Management.

Project advisory

Investment bankers are sometimes associated with their clients from the early stage of
their project. They assist the companies in conceptualizing the project idea when it is in
an unformulated stage. Once the project is conceptualized, they carry out the initial
feasibility studies to examine its viability. Investment bankers provide inputs to their
clients in preparation of the detailed project report. They also offer project appraisal
services to clients.

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STRUCTURAL ANALYSIS OF INVESTMENT BANKING INDUSTRY:

Forces driving industry competition

(PORTER’S MODEL)

Potential entrants

Threat of
new entrants
Bargaining
power of Bargaining
suppliers Industry competition power of buyers
Suppliers Buyer
Rivalry among
existing firms

Threat of substitute
products or services

Substitutes

Threat of entry

New entrants into the industry may pose a threat to the existing players. Major threats
to entry into an industry depend on:

Entry barriers

Barriers to entry may be because of

 Economies of scale
 Product differentiation
 Capital requirements
 Switching costs
 Access to distribution channels
 Government policy
 Relationship with customers
 Efficiency of employees

Economies of scale

A merchant baker is in the business of providing financial intermediation services. This

requires a team of good professionals, well equipped with infrastructure facilities for
research, distribution etc. it is an expensive proposition to build and sustain the skill
base of the firm. The firm can justify the investments in developing them and expenses

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to sustain them, only if the firm is able to generate adequate number of deals. A new
firm may not be able to match an existing firm in terms of size and number of orders.

Product differentiation:

In investment banking industry, product expertise on both the issuing and investing side
needs to be developed or acquired. Generally product differentiation is not very high
because the ultimate deal structure is designed as per the advise of the client. The area
where an investment banker can make the difference is in the execution of the deal.
Though new financial innovations also help a firm to differentiate from others, but they
are easily imitated in this industry.

For example: videocon leasing and industrial finance ltd. introduced the concept of
bought-out deal for the first time for raising capital for patheja forgings ltd.
JM Financial has designed and executed several innovative deals. In 1979, JM designed
fully convertible debentures for TISCO. Zero coupon fully convertible debentures in
mahindra and mahindra’s issue, deep discount bonds for IDBI and triple option
convertible debentures in 1993 for reliance petroleum. It is however difficult to
differentiate between services rendered by various investment banking outfits in India.

Capital requirements:

SEBI has fixed the minimum net worth norm at rs.5 crore for investment bankers. The
earlier norm of Rs 1 crores was considered too low and the market witnessed entry of
several new players. SEBI was then forced to raise the figure to Rs 5 crores to make it
an effective entry barrier. The capital of the investment banker determines the quantum
of underwriting exposure that he can take. Further the underwriter’s ability to accept
devolvements is a function of his capital.

Switching cost:

These are one time costs incurred by the customer in switching from one – supplier to
another. Investment banking, basically being a services industry, clients are free to
choose the investment banker on their choice depending upon the services offered by
them. There is absolutely no switching cost. Hence this acts as a low entry barrier to
new firms. If the new firms have got the capacity to satisfy the client needs, innovate
new products and customize deal structures, they can easily attract clients of other
firms.

Access to distribution channels:

Existing firms have already built up good distribution channels and good customer
relationship on a long-term basis, which might act as a major barrier to new entrant.

For example:

Public sector merchant bankers like FI’s and nationalized banks have very good retail
network in India thus putting them at an advantage. After Indian companies were
allowed to tap foreign capital markets, Indian merchant bankers played only an advisory
role, while the issues were lead managed by foreign merchant bankers. Domestic
merchant bankers never had distribution channel networks in foreign countries. In
addition to that, they lacked necessary expertise and reputation to compete with
international players.

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This is a major pre-requisite for the industry and this definitely acts as a major barrier to
the entry of new firms.

Government policies:

The investment bankers have to be registered with SEBI and no firm shall carry on any
activity as an investment banker unless it holds a certificate granted by the board under
the regulations of SEBI.

Relationship with customers:

It is the major asset of all existing investment bakers. The reputation of the investment
banker, the quality of services offered, the research facilities developed by the
organization, the human assets which a merchant banking firm has puts the existing
firm in an advantageous position. In order to compete with such an established firm, the
new investment-banking outfit might experience all these major barriers. Here the
concept of relationship management holds good.

Efficiency of employees:

All those working here are professionals with great analytical abilities and their efficiency
is going to increase with the increase in experience. Ability to offer services effectively
as a result of experience must also be considered.

Hence it can be concluded that entry barriers are very low in this industry.

Competition:

Competition based on factors such as prices, advertising, goodwill, product innovations,

customer services, after sale services, etc. also act as a major entry barrier to new firm.

A unique feature of this industry is the extent of ties among the investment banks
themselves. They share customers, work together, jointly underwrite deals, and
negotiate with each other in mergers and acquisitions transactions. However, the
investment banks compete for business from the same customer.

In India only 25% of the merchant bankers are active in issue management while the
rest are involved in underwriting. The smaller merchant bankers usually take care of
issues of low size. Low entry barriers into the industry have led to mushrooming of
merchant banking outfits in India.

Pressure from substitutes:

Substitute products to issue management may be new innovations in the methods of

raising funds. For instances, companies might prefer placing the issue instead of public
offering.

Previously all the public issues were routed through regional stock exchanges. But with
establishment of OTCEI in the year 1990 with the facility for screen based automated
computerized trading system, it has acted as a substitute to smaller public issues. In
OTCEI, sponsors place the scrips with members of OTC who will in turn offload the scrips

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to public thus reducing the issue costs. So establishment of such exchanges like NSE
and OTCEI will act as substitutes to other stock exchange.

BARGAINING POWER OF BUYERS:

The customers of merchant bankers mainly include promoters on one side and
investors on the other side. The main job of a merchant banker is to act as an
intermediary between these two sides while designing a new instrument or executing a
public issue. The success of a merchant banker depends upon the success of the issue
therefore the most important attribute of a merchant banker is to have good expertise in
his field of specialization and the ability to know the pulse of the market and to put
together a deal.

The merchant banker’s responsibility has increased due to the abolition of CCI,
which resulted in free pricing. A merchant banker has to be careful while fixing up
premiums. The investment banker should fix up maximum premium keeping in mind the
companies. However the investment banker should keep the investors in mind too and
not fix up an unduly high premium. So the merchant banker must try to balance
between the two types of customers.

Brand Equity

In India the success of an issue may also be determined by the reputation of its
lead manager. Reputation is extremely important because in a service business of
unique deals, the customer wants perfect execution of the deal. So, in the process of
selecting an investment banker, a customer will look for quality service which takes the
form of “skilled professionals”, “commitment to relationships”, “team work”, and
“communication”. All these features help in differentiating two firms and hence
establishing an image for itself which can be termed as a major asset or “Brand Equity’
which is unique or exclusive to it.

So, ultimately, it can be concluded that bargaining power of buyers is very high
because they are free to approach any merchant banker who is ready to offer him
quality services.

BARGAINING POWER OF SUPPLIERS

Since merchant-banking industry is a service industry, no definite suppliers can be

identified because skills of professionals are used in the process. But persons who
support the merchant banker in the successful execution of the issue like registrars,
printers, advertisers, underwriters, bankers, legal advisors etc. can be considered as
suppliers because without their co-operation and support the public issue cannot see
light.
People rendering these services are in large number in the market, hence
bargaining power of suppliers can be considered to be very less.

It can be concluded that Investment Banking Industry in India is characterized by

low entry barriers, high competition, high bargaining power of customers and finally the
success of the merchant banking firm depends on the relationships with clients, image of
the firms and quality of services offered.

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 BIBLIOGRAPHY

1. www.sebi.gov.in

2. www.morganstanley.com

3. www.TheDeal.com

4. Business India

5. Fortune India

6. Chartered financial analyst – Investment Banking

7. www.investopedia.com

8. www.dspml.com

9. The Analyst

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