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Life of a Merchant Banker

Sunit Joshi
Mr. Sunit Joshi, Executive Vice President, Capital Markets Group, SBI Capital Markets speaks about the role of merchant banking in the Indian capital market.




 



Sunit Joshi heads the Capital Markets Group in SBI Capital Markets Ltd. He is a qualified Chartered Accountant and has over 30 years of varied experience - especially in commercial and International Banking with State Bank of India (SBI). After joining SBI Capital Markets in early 2010, he has overseen several public equity offerings and Rights Issues/QIPs, apart from various other capital market related transactions - including advisories.

This interview was conducted by students from SIMSREE Finance Forum (Sydenham Institute of Management Studies Research & Entrepreneurship Education).


What is the future outlook of the Indian Equity Markets in this fiscal year?

As you know, predicting the stock markets is like crystal ball gazing, but going by the GDP growth of over 8.5 percent so far for the current year and the estimate of around 9 percent for the next financial year, the trend should be positive.  India’s growth story is not only intact but also robust.  Inflation is a concern and this is one of the major reasons why stock markets are weak right now.  As you know, stock markets really don’t work on logic, but are more sentiment driven, and at present the sentiments are weak.  Major reasons for our equity markets being in the present state are inflation and also governance issues, which have been cropping up for the past few months - like the CWG imbroglio, the 2G spectrum allocation controversy, the bank loans problem that surfaced in November 2010, etc.  On top of this, there have been some negative global cues - the euro crisis that has gradually subsided, and now the Middle East turmoil is pushing the crude prices to higher levels.  These events are affecting the markets. But let me clarify that the equity markets are not completely tanking, and the Sensex is not falling below 17,500 points.  It fell below 18,000 to around 17,600, and has again bounced back. 

Going forward, from June onwards, I can’t say for sure, but I do foresee a bright future.  Markets can’t remain bleak forever; new issues have to come out and there is appetite from retail as well as institutional investors.  The secondary market activity will also continue to grow.  FIIs have withdrawn funds from our equity markets in January and February 2011.  But unless there are great opportunities elsewhere, they will return. While the FII outflows have not been very high, this does affect the sentiments and FII inflows/outflows continue to drive the state of equity markets in India.


Which sectors, according to you, would outperform this year?

Growth driven sectors - such as infrastructure would definitely be on a high, considering the Government’s continuing thrust on building infrastructure.  Pharma is a high growth sector with potential for higher returns. Even the financial services sector stocks - especially the Public Sector (PSUs) Banks, whose stocks are quoting at quite low Price to Book (P/B) Value of close to 1 or just a little above 1, have good growth potential. Ideally, these stocks should command a much higher price, as was the case until the middle of November 2010.


How do you see the IPO and M&A scene developing in 2011?

M&As are likely to happen in sectors where there is higher competition.  A couple of deals that have taken place recently include iGATE’s acquisition of Patni Computers in the IT space.  We recently saw Jindal Steel picking up majority stake in Ispat. In Pharma sector, Reckitt Benckiser took over Paras Pharma.  Most recently, British Petroleum has picked up 30 percent stake in Reliance Industries Ltd.  The BP-RIL deal is a big positive signal for the markets - amid the generally poor performance of stock markets.  So, these are positive events that have happened.  The Cairn-Vedanta Deal has been stuck for the past few months because of the ONGC royalty payment issue.  M&As will continue to happen, and wherever you have more competition, it is easier for the industry to consolidate - with some promoters opting to go out after making a decent return on what they had originally invested.


Talking about the next financial year, what do you think would be the preferred instrument for corporates for fundraising? Would it be debt or equity?

We hope the corporate bond market picks up.  Going forward, bonds should substitute loans to a greater extent. But there isn’t any substitute for equity.  Because if one is setting up a large project, the lenders would provide loans to cover only a part of the project cost and the promoter has to bring in the equity.  This need to raise capital would drive equity issues and the activity should pick up again in the next fiscal (2010-11).

Corporate Debt (i.e. bond) market is not picking up for a few reasons: a) the investor in these instruments has no direct control and b) the instrument is not liquid.  There needs to be someone who makes the market, i.e. someone buys and also sells these bonds - by offering two-way quotes.   As for control, an investor in bonds is also a lender effectively, but when a bank lends by way of loan, it has greater control on the day-to-day activities of the borrower company.  The bank providing loans obtains regular MIS data and documents every month, it verifies the business place or plant.  But an investor in bonds has no control on the day-to-day activities of the borrower company.  Although these instruments are rated by rating agencies, people do not entirely go by such ratings.  The major investors for corporate bonds are still banks.  Institutions like Provident Funds have limitations on how much they can invest in corporate bonds. Similarly, Insurance Companies and Pension Funds also have limitations on investing in corporate bonds. Banks are already in the business of lending to the corporate, and it all depends upon the banks to decide whether it is more beneficial to lend through bonds or by way of loans.  Banks often feel that, from control point of view, it is advisable to lend via the loans route.  So, there is some disconnect here.  But, the bonds market is gradually developing and we see a good future for this market. 

Also, more FII investments are coming into corporate bonds.  There is a cap on their investments too, but that is yet to be reached.  Since interest rates on bonds are high as compared to international interest rates, they can invest, and hold till maturity if they can’t sell the bonds due to lack of liquidity in the bonds market, If they can hedge the currency risk properly or the Rupee does not depreciate much, the 9-10 percent interest on such instruments can yield very good returns.  Even though the FIIs are still not investing in bonds as much as in equities, they are slowly coming in.  FIIs prefer equity and last calendar year’s figures stand at $29 billion of net inflows in equities, whereas in debt markets it was less than $10 billion.  Retail participation can also be encouraged and the market should be made more liquid. There is appetite from both institutional and retail investors for fixed income securities and many bonds are also listed, but in the absence of liquidity, there are not many active buyers in the secondary market.  It is a vicious cycle that needs to be broken.


SEBI has expressed reservations on investment bankers quoting near-zero fees to bag divestment issuance. How do you view this issue?

First of all, let me clarify that SEBI has not expressed any reservations or concerns on this aspect.  In government mandates the issue size is usually very large and the investment bank gets good league table rankings.  The disinvestment public offerings are complex transactions and also greatly improve the reputation and credentials of the merchant bankers associated with such large and prestigious transactions, which is helpful in securing other business.  Also, in terms of experience, such transactions have a lot of value.  A merchant banker in these issues deals with the PSU itself, the administrative ministry of the government controlling the PSU and also the Disinvestment Department.  So, you are actually dealing with three different entities, whereas in most other issues in the private sector, you are dealing with only the issuer company or additionally the private equity investor.  This provides the merchant banker with a different learning and perspective.  In any case, who Is benefitting from the low fees? Since it is the PSU concerned and the owner, i.e. the government that are benefitting, we do not see any issue with the near-zero fees.  Obviously, this does not happen in the case of private sector’s public issues.  



SEBI has raised concerns on IPO pricing. This was further corroborated by a report released by CAR ratings. Analysis of 116 IPOs between August 2007 and August 2010 revealed that “about 62 percent of IPOs are currently trading lower than the IPO price band”. Are IPOs generally overvalued?

SEBI Chairman did say that merchant bankers should ensure that IPOs are not overpriced.  SEBI also feels that merchant bankers tend to overprice the IPOs because their fees may be linked to the total issue size.  But in most cases, the fees are not necessarily linked to the issue size.  Secondly, the overall issue size may be going up by only 5 to 10 percent because of the perceived higher pricing and the issue management fees could be only 1 or 2 percent of that, and I don’t think that this aspect would really have any bearing on the pricing guidance by the merchant bankers.  Thirdly, the merchant bankers also have to time and again go back to their large key investors - as well as to the retail investors.  If Institutional Investors are disappointed over and over again, then the merchant bankers would face difficulty in raising capital from the markets.  I do not think it is the merchant banker who overvalues the issue. Merchant banks only advise the issuing company on fixing the price band.  Ideally, the price band should be arrived at as a consensus between the issuer company and the merchant bankers.  The promoter naturally believes that he must get the best possible value for his company in the market. Now, the question to address is - what is the best price? Best price can differ in different markets. What was the best price in October last year may not be the best price today, when the markets are down.  For instance, if in October 2010, the offer price of an IPO was Rs.100, and if today it is quoting at Rs. 90 or 80 or even 75, can we blame the decision of fixing the price at Rs. 100, taken in October 2010?  The markets could as well have gone up every month and the stock could have been trading at well above the offer price now - at say Rs. 120 or even higher.

As per a recent article in Outlook Profit, in the IPOs managed since January 2005, SBI Capital Markets has the best performance ratio in terms of outperformers vis-à-vis underperformers at 16:15, whereas all other leading merchant banks have an adverse ratio.  While we would like to take some credit for this, the fact is that most public issues happen in buoyant market.  At the time of issue, it is never in the minds of merchant bankers that the stock would not perform well post-listing.  It is never the approach that once the issue is successful with the best possible pricing, the merchant bankers are not responsible for the stock’s performance.  Otherwise you are not acting professionally.  Also, we have to go back to the same investors time and again.  We also need to stand by our reputation in the market.  When the markets are doing badly, then you will find that many of the recent issues are faring poorly.  In calendar year 2010 there were about 70 odd issues and I think more than 60-70 percent of these are quoting below the offer price, because the markets were doing well then and now the markets are down - especially for stocks of mid caps / small caps and a few sectors like infrastructure.  It is also true that promoters, especially in bullish markets, try to sell the issues at as high a price as possible, since the general sentiments are positive. I wouldn’t even blame the promoters, because everyone wants to get the best possible price for their issue.  Merchant bankers and the issuer discuss different price ranges and then a consensus is arrived and the price band is fixed.  In a buoyant market, if the issue has been launched at - what is later perceived to be - a high price and is well subscribed, I think it would not be fair to blame either the issuer company or the merchant banker(s).  Finally, it is a fact that, between the promoter and the merchant bankers, it is the promoter who aims to secure a higher price.


During the global melt-down in 2008-09, the rating agencies were in the news for all the wrong reasons. Do you think rating agencies still have credibility in the market?

I would say that having ratings is much better than not having them at all.  Their assessment has been wrong at times.  The ratings need to be closely linked to the company’s actual performance, quarter-on-quarter sales / profit and the economic environment in general as well as the growth prospects for the company as well as the sector, etc.  The rating agencies need to analyse the financial projections and accord the company the rating that it truly deserves.


Do you expect consolidation in the merchant banking space, after the Axis-Enam deal?

Yes, Indian merchant banking space is a little too crowded, in terms of number of players.  I think the foreign banks are becoming quite strong and are looking to expanding their presence further in merchant banking here, also because there isn’t much activity happening in developed countries. So there is immense competition.  There are quite a few domestic banks as well and lots of small merchant bankers have also come up.  In the Axis-Enam deal, an investment bank with strong merchant banking capabilities and broking & distribution network has tied up with a large commercial bank, so that the synergies could be exploited.  There could be more such deals happening in the future.


What are the key take-aways from the global crisis for a finance student?

The global melt-down in 2008-09 was a great learning experience for all of us.  The simple learning is - anything which looks extremely bright and rosy needs to be dealt with caution. Everything was going well in the US, when the crisis surfaced - with the real estate loans turning bad.
Lack of prudence on the part of financial sector players - coupled with the relatively weak regulation - aggravated the problem.  Rating agencies were also to be blamed.

The culture of bonuses and performance-linked incentives also contributed to the crisis to some extent, although it would be unfair to single this out as the major factor.  But greed, while it can propel growth and prosperity, has its flip side. India was fortunately not too badly affected, mainly because of our prudent banking policies & practices.

As finance students, you should understand all these aspects of the global crisis, so that you can act in the right manner when you enter the industry.


What according to you, are the skills required to excel in Merchant Banking career?

I think general awareness of the financial markets and knowledge of economics is very important. Domain expertise in a particular sector or capital markets can always be acquired.  But if you are not aware about the developments taking place across the globe, then you will not acquire the overall perspective.  You will not have the broad picture in mind while interacting with clients and other.  You may do well in a niche area like regulatory or compliance, but not overall.  So, my advice is to develop a genuine interest in the happenings in the worlds of finance, industry and economy, and read business newspapers, watch business news channels and keep updating yourself.

 


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