MERCHANT BANKING

Contents:

• Merchant Banking : Origin

• Development
• Organizational Aspect
• Importance
• SEBI guidelines
 Merchant Banking: Origin

• Term Merchant bank stems from leading merchants who

transitioned from merchandize business to banking.
• Merchant Banking came into existence in 17th & 18th century
in Italy & France.
• Kings borrowed from merchants to fight wars.
• Merchant banking got fillip after industrial revolution in
England.
• Merchants started to finance the foreign trade through
acceptance of bill.
• Recognized the requirements of upcoming class of
Entrepreneurs for diverse financial services.
• Prominent Merchant Banker:- Baring Brothers, Blackstone,
Goldman Sachs and Antony Gibbs.
 Merchant Banking: Contd.

• As years passed, merchant bankers divested themselves from

merchandising business to providing financial services.
• After second world war industrial activity picked up & they diversified
into various financial activities.
 MERCHANT BANKING IN INDIA
• Nineteen Century- London based merchant banks set up agency houses in India.
Eg. East India House.
• Managing agency system facilitated trade and industry
• Abolished in 1972
• Company form of organization emerged from managing agency system.
• Services of merchant banks and managing agencies were similar.
• Post Second world war-Government set up development institutions-IFCI, IDBI,
ICICI. LIC & UTI came up.
• 1967-Merchant Banking officially came to India through Grindlays Bank
• The Banking commission in its report in 1972 recommended the setting up of
Merchant Banking institutions by commercial banks and Financial institutions.
This marked the beginning of specialized merchant banking in India. To begin
with, Merchant Banking services were offered with traditional banking services.
In the mid-eighties, the Banking Regulations Act was amended permitting
commercial banks to offer a wide range of financial services through the
subsidiaries rule.
 MERCHANT BANKING IN INDIA
• Few Other Institutes who joined the bandwagon:-
Citibank Setup its merchant banking division in Indian in 1970.
Indian banks Started banking Services from 1972.
State bank of India started the merchant banking division in 1972.
Many other banks came after this like ICICI, Canara Bank, UCO bank etc.
 Definition

• Merchant banking can be viewed as operations that provide support,

knowledge & resources to individuals & organizations for starting
improving, expanding and sustaining their business & investment.
• Only a body corporate other than a NBFC is eligible to get registered as a
merchant banker.

• Provide Fund based & Fee bases services

Merchant Bankers provide fees based financial services

• Fee based services: portfolio management, management of public issues,
credit syndication.

Investment Banks Provide fund based services

• Fund based services: Investment in private equity, bridge financing,
working capital financing.
 About Merchant Banking

• Merchant banking primarily involves financial advice and

services for large corporations and wealthy individuals.

• They provide guidance on foreign trade financing, long term

loans for companies, provide consultancy services and stock
underwriting.

• They do not provide regular banking services to general

public rather they cater to the financial needs of corporate
clients
 Difference between the following

•Development banks
•Commercial Banks
•Investment Banks
•Merchant Banks
 Investment Bankers

It performs the following functions

Portfolio
Raise Capital
Management

M&A Research
 Merchant Banking Vs. Investment Banking
• Both provide advisory services for mobilizing capital.
• Financial consultants
• Assist in legal compliance
• Post issue monitoring
In last few years there is a very thin line separating the functions of both
• A merchant banker is a banking corporation authorized by SEBI (other than
a NBFC) to act as an intermediary for raising capital.
• They can pursue only activities related with securities market.
They perform following activities:-
 Managing public issues
 Underwriting
 Acting as a lead manager
 Managing and advising international offerings of ADR, GDR, IDR.
• Investment banks on the other hand provide consultancy and generate
funds.
• Funds are raised thru public issues, venture capital or private equity.
• Eg. Edelweiss Co. provides a wide range of services including private
placement, public issues, mezzanine finance, mergers, acquisition etc.

• [ Eg.Deutsche Bank, Barclays, JP Morgan, Bank of America Merrill Lynch,

Barclays, BNP Paribas, Citi , Credit Suisse, Deutsche Bank, Goldman Sachs ,
Morgan Stanley , SBI Cap, IDBI Cap]
 Major Investment Banks in India

• Avendus
• Bajaj Capital
• Barclays India
• Cholamandalam Investment & Finance Company
• ICICI Securities Ltd
• ICRA Limited
• SBI Capital Markets
• Tata Investment Corporation Limited (TICL)
• Yes Bank’s Investment Banking group
What are the various categories for which registration
can be obtained?

The categories for which registration may be granted are given

below:
• Category I – to carry on the activity of issue management and to
act as adviser, consultant, manager, underwriter, portfolio
manager.
• Category II - to act as adviser, consultant, co-manager, underwriter,
portfolio manager.
• Category III - to act as underwriter, adviser or consultant to an issue
• Category IV – to act only as adviser or consultant to an issue
 Difference b/w Commercial & Merchant banks
Commercial Banking
 Catering needs of common man.
 Anyone can open an A/c.
 Less exposed to risk.
 Related to secondary markets.
 It’s asset oriented.
 Plays the role of financer`s.
Merchant Banking
 Catering needs of corporate
firms.
 It cannot be done.
 More exposed to risk.
 Related to Primary markets.
 It’s management oriented.
 Plays different roles like
underwriting, portfolio etc.
 Services:

• Project counseling.
• Corporate Advisory services
• Working capital finance.
• Portfolio Management.
• Restructuring strategies.
• Credit Syndication.
• Lease Financing.
• Some Other Services.
 Project Counseling
• Technical advice
• Generation & screening of ideas
• Risk & return of the project
• Project implementation, monitoring & control
 Corporate Counseling:

Set of activities undertaken for efficient running of an

enterprise.
Identifying areas of growth & diversification.
Guiding clients on aspects like locational factors,
organizational size, investment decision, choice of product.
 Corporate Restructuring

• Long term strategy to achieve goals.

• Business Acquisitions

• Valuations

• Regulatory compliance
 Restructuring Strategies.

• Deals with Mergers & Acquisitions.

• It’s a specialized service of Merchant bankers wherein they

act as middle-men in negotiating between two companies.

• Offers expert evaluation regarding identification of

organizations with matching characteristics.

• Obtaining approvals from various authorities.

 Restructuring Strategy: Leveraged Buyout (LBO)
CASE:
Tata Tea acquired the UK heavyweight brand Tetley1 for a staggering 271 million pounds. This deal
which happened to be the largest cross-border acquisition by any Indian company, marked the
culmination of Tata Tea's strategy of pushing for aggressive growth and worldwide expansion. The
acquisition of Tetley made Tata Tea the second biggest tea company in the world. (The first being
Unilever, owner of Brooke Bond and Lipton). what made it particularly special was the fact that it was
the first ever leveraged buy-out (LBO)2 by any Indian company. This method of financing had never
been successfully attempted before by any Indian company. Tetley's price tag of 271 mn pounds (US
$450 m) was more than four times the net worth of Tata tea which stood at US $ 114 m. This David &
Goliath aspect was what made the entire transaction so unusual.

What made it possible was the financing mechanism of LBO. This mechanism allowed the acquirer
(Tata Tea) to minimise its cash outlay in making the purchase. What set the deal apart was the LBO
mechanism which financed the acquisition. The LBO seemed to have inherent advantages over cash
transactions. In an LBO, the acquiring company could float a Special Purpose vehicle (SPV) which was
a 100% subsidiary of the acquirer with a minimum equity capital.
 Restructuring Strategy: Leveraged Buyout (LBO)
CASE:

The SPV leveraged this equity to gear up significantly higher debt to buyout the target company. This
debt was paid off by the SPV through the target company's own cash flows. The target company's
assets were pledged with the lending institution and once the debt was redeemed, the acquiring
company had the option to merge with the SPV...
The purchase of Tetley was funded by a combination of equity, subscribed by Tata tea, junior loan stock
subscribed by institutional investors (including the vendor institutions Mezzanine Finance, arranged by
Intermediate Capital Group Plc.) and senior debt facilities arranged and underwritten by Rabobank
International Tata Tea created a Special Purpose Vehicle (SPV)-christened Tata Tea (Great Britain) to
acquire all the properties of Tetley. The SPV was capitalised at 70 mn pounds, of which Tata tea
contributed 60 mn pounds; this included 45 mn pounds raised through a GDR issue. The US subsidiary
of the company, Tata Tea Inc. had contributed the balance 10 mn pounds.

The SPV leveraged the 70 mn pounds equity 3.36 times to raise a debt of 235 mn pounds, to finance
the deal. The entire debt amount of 235 mn pounds comprised 4 tranches (A, B, C and D) whose
tenure varied from 7 years to 9.5 years
 CAPITAL RESTRUCTURING
• Decision on quantity & method of financing

• Proportion between debt and equity

• Capital structure should maximize the value of a firm

• Consideration of factors like profitability, liquidity, control, timings, legal
aspects is important while taking capital restructure decisions.

• Merchant banks use their expertise & advice companies including sick
companies on how to maintain optimum capital structure.
 Services contd.

• Working Capital Finance:

Meeting the day-to-day expenses of an enterprise is working

capital finance.

Assessment of working capital requirements.

Preparing necessary application to negotiation for sanction

of appropriate credit facilities.
 CREDIT SYNDICATION
• Credit syndication refers to the process of providing credit for a project by a
group of credit institutions.
• Used when a single financial firm cannot meet the entire financial needs of
a firm.
• Steps undertaken by a merchant banker are:
• Estimating the total financial requirement.
• Draw a financial plan
• Negotiating with banks/ Financial institutions
• Following up with them and obtaining their sanction for proportionate
share of funds
• Complying legal formalities

Credit syndication also includes working capital finance and bridge loans.
Eg. Bank of India, SBI are the leading players in the Syndication space.
 ISSUE MANGEMENT

• Preparation of action plan and budget of the issue.

• Filing application with SEBI for raising public money.
• Draft prospectus
• Selecting underwriters, brokers, bankers.
• It is mandatory to have a lead manager in a public issue
• Merchant bankers may act as lead manager & perform entire
responsibility of the public issue.
• Co-managers, advisors and consultants are also appointed.
 Assistance in Private Equity
• Private equity is an investment usually very large, made in a closely held
company by a firm made up of high networth individuals and institutional
investors.
• It can also be undertstood as large amount of money raised directly from
high networth individulas & institutions, pooled into a fund that invests
in a range of business ventures.

• Hence equity investment in a co. that is not publicly traded is private

equity, and a firm that trades in private equity is called a private equity
firm.
• Quick access to capital
• PE firm may acquire private co’s, fund their growth.
• PE firms may also buy a publicly traded co’s, make them private,
undertake restructuring process and again relist them on exchange.
• Later they may sell them to other investors or make them public.
• Eq. IDFC PE, Rabo Private Equity, Kotak Private Equity group
 Private Equity

• Equity capital that is not quoted on a public exchange.

• Private equity consists of investors and
funds that invest directly in private companies or conduct buyouts of publi
c companies that resulting a delisting of public equity.
• Capital for private equity is raised from very wealthy individuals and
institutional investors and is used to fund new technologies, expand worki
ng capital, make acquisitions, or strengthen a company's balance sheet.
• The majority of private equity consists of
institutional investors and accredited investors (rich people) who commit l
arge sums of money for
long periods. Private equity investments are often long
term in cases of company turnarounds or a
liquidity event such as an IPO or a sale to a public company.
Eg. Of PE investment by Kotak
 Mezzanine Financing

• A hybrid of debt and equity financing that is typically used to finance the
expansion of existing companies.

• Mezzanine financing is basically debt capital that gives the lender the rights
to convert to an ownership or equity interest in the company if the loan is
not paid back in time and in full.

• It is generally subordinated to debt provided by senior lenders such as

banks and venture capital companies.

• Since mezzanine financing is usually provided to the borrower very quickly

with little due diligence on the part of the lender and little or no collateral
on the part of the borrower, this type of financing is aggressively priced with
the lender seeking a return in the 20-30% range.
• Mezzanine Financing
• India's mezzanine finance market is slowly emerging as a big source of non-traditional funding for corporates
and at the same time providing nonbanking financial companies and private equity firms with an attractive
investment opportunity. Sneha Shah explains this financing concept that falls between debt and equity.

WHAT IS MEZZANINE FINANCE?

Mezzanine finance is a type of structured finance facility. It is a hybrid of debt and equity financing that is typically
used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the
lender the right to convert the loan into equity in case of non-repayment in time and in full. However, in case the
company goes bankrupt, mezzanine lenders stand behind senior secured lenders for repayments.

HOW IS IT DIFFERENT FROM A REGULAR LOAN?

Mezzanine financing is usually provided very quickly with little due diligence and little or no collateral. However,
such kind of financing is aggressively priced with the lender seeking a return in the 20-30% range.

WHO PROVIDES MEZZANINE FINANCING?

A lot of private equity funds have started doing structured deals involving mezzanine financing, though it still
remains the forte of the non-banking financial companies.

WHAT ARE THE ADVANTAGES OF MEZZANINE FINANCING?

Mezzanine financing is treated like equity on a company's balance sheet and may make obtaining standard bank
financing easier. To attract mezzanine financing, a company usually must demonstrate a track record in the
industry with an established reputation and product, a history of profitability and a viable expansion plan. For
lenders, though the risk is higher, the option to convert debt into equity in case of non-repayment insulates them
from downside risks.
 Portfolio Management.

• Making decisions for the investment of cash resources of a

corporate enterprise in marketable securities.

• Decides quantum, timing & type of security to be bought.

• Help in achieving maximum return with minimum risk by

proper combination of securities.
 Lease Financing.

• It’s an important alternative source of financing a capital

outlay.
• Involves letting out assets on lease for use by the lessee for a
particular period of time.
• Providing advice on viability of leasing & choice of
favorable rental structure.
 STRUCTURED PRODUCTS

• Derivative instruments like options, futures etc.

• Equity-linked note (ELN) is a debt instrument, usually a bond, that differs
from a standard fixed-income security in that the final payout is based on the
return of the underlying equity, which can be a single stock, basket of stocks,
or an equity index. Equity-linked notes are a type of structured products. A
typical ELN is principal-protected, i.e. the investor is guaranteed to receive
100% of the original amount invested at maturity but receives no interest.
Usually, the final payout is the amount invested, times the gain in the
underlying stock or index times a note-specific participation rate, which can
be more or less than 100%. For example, if the underlying equity gains 50%
during the investment period and the participation rate is 80%, the investor
receives 1.40 dollars for each dollar invested. If the equity remains
unchanged or declines, the investor still receives one dollar per dollar
invested (as long as the issuer does not default). Generally, the participation
rate is better in longer maturity notes, since the total amount of interest
given up by the investor is higher.
 Other Services:

• Relief to Sick Industries:

Rejuvenating old lines & ailing units by appraising

technology, process etc.

Evolving rehabilitation packages acceptable to financial

institutions/banks.

Exploring possibilities of mergers & acqusitions.

 Merchant Banking
• Advantages:
Merchant banks perform functions
that cannot be carried out by
businesses on their own.
Merchant banks have access to
traders, financial institutions, and
markets that companies or individuals
could not possibly reach.
By using their skills and contacts,
merchant banks can get the best
possible deals for their clients.
• Disadvantages:
Merchant banks are really only for
large corporate customers, or
extremely wealthy smaller
businesses owned by individual
clients.
Not all deals carried out by merchant
banks meet with unqualified success.
There is always risk attached to the
kinds of deal that merchant banks
undertake.
 Institutes offering Merchant Banking Services

• Public Sector • Private Sector

SBI capital markets ltd
Punjab national bank
Bank of Maharashtra
Karur Vysya bank ltd
State Bank of Bikaner and
Jaipur.
IFCI financial services ltd.
ICICI Securities Ltd
Axis Bank Ltd
Bajaj Capital Ltd
Reliance Securities Limited
Kotak Mahindra Capital
Company Ltd
Yes Bank Ltd
 Key Foreign Players

Goldman Sachs (India) Securities Pvt. Ltd.

Morgan Stanley India Company Pvt. Ltd.
Barclays Securities (India) Pvt. Ltd.
Bank Of America
Citigroup Global Markets India Pvt. Ltd.
DSP Merrill Lynch Ltd.
 Category I merchant bankers

• Arihant Capital Markets Ltd.

• Canara Bank
• Karvy
• DSP Merrill Lynch, ICICI Securities, IL&FS Investmart Securities Ltd. SBI
Paital Markets, JP Morgan India Pvt. Ltd.