Indian Merchant

Banking Summit
24th September, 2010
Association of Merchant Bankers of India

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 About AMBI
In the early 1990s, the merchant banking industry in India witnessed a phenomenal growth with over
1500 merchant bankers registered with SEBI. In order to ensure the well being of the industry and for
promoting healthy business practices, it became necessary to set up a Self Regulatory Organisation
within the industry. This led to the birth of the Association of Merchant Bankers of India (AMBI).
AMBI was promoted to exercise overall supervision over its members in the matters of compliance
with statutory rules and regulations pertaining to merchant banking and other activities.

AMBI was granted recognition by SEBI to set up professional standards, for providing efficient
services and to establish standard practices in merchant banking and financial services. AMBI, in
consultation with SEBI, is working towards improving the compliance of statutory requirement in a
systematic manner.

AMBI's primary objective is to ensure that its members render services to all its constituents within
an agreed framework of ethical principles and practices. It also works as a trade body promoting the
interests of the industry and of its members.

AMBI's Activities
The spectrum of AMBI's activities is wide.

AMBI is the nodal point for the assimilation and dissemination of information relating to the merchant
banking industry. Thus AMBI ensures that its members are aware of the latest rules/guidelines
issued by various statutory authorities, as also other matters of interest.

AMBI is the merchant banking industry's sole representative to all statutory authorities, in particular,
SEBI. The Chairman of AMBI is on the Primary Market Advisory Committee of SEBI.

To ensure healthy competition within the industry, AMBI has published its Code of Conduct for
Merchant Bankers. This document sets out the broad parameters and the spirit in which the
members of AMBI should conduct business.

AMBI has also produced a Due Diligence Handbook, which has proved to be a useful tool for
merchant bankers. This handbook is currently under revision.

For the benefit of investors, AMBI has brought out an Investor's Education Handbook.

Concurrent with the activity of educating investors, AMBI regularly conducts/sponsors talks and
seminars on financial matters.

AMBI regularly submits a Pre-Budget Memorandum to the Finance Ministry. This memorandum
expresses the concerns of the industry and requests specific changes in various financial
legislations that would help better the range of services and opportunities provided by the industry.

AMBI is also the intra-industry arbitrator on all matters arising between its members.
AMBI Members
AMBI presently boasts of a very strong membership of 48 investment bankers, representing all
segments.

AMBI-in a new direction

AMBI is now reinventing itself. Represented by the best minds in the country, it has the necessary
resource and mandate to make a significant mark in the Indian capital market

Over the immediate future, it plans to undertake a wide range of activities. For example:

• hold its first Annual Merchant Banking Summit, which will discuss and debate on the emerging
challenges and opportunities for the investment banking industry

• launch a dedicated AMBI website to showcase our industry

• seminars

• panel discussions

• research initiatives.
 Investment Banking: Back in Business

“ The old that is strong does not wither,

Deep roots are not reached by the frost...
From the ashes a fire shall be woken,
A light from the shadows shall spring;
Renewed shall be blade that was broken,
The crownless again shall be king

”
After the hiatus, the financial markets are back with a bang. The benchmark indices like Sensex and
Nifty are inching up and are at the highest levels witnessed in the last two years. According to CARE
Research, the strong domestic demand, fiscal stimulus packages of the Government and proactive
actions of the Reserve Bank of India has led to a sharp revival of the Indian economy. The various
segments of the Indian financial markets have witnessed resurgence, including the Initial Public
Offer (IPO) market, Merger and Acquisition (M&A) market and the Private Equity/Venture Capital
(PE/VC) market.

The investment banking industry that saw a lacklustre period in 2008 and 2009 is back in business.
The potential opportunity offered by Indian consumers and the infrastructure sector is
acknowledged by the global investors, who are willing to invest into India. The domestic investors
too are enthused by the Indian growth story.

While investors across the globe are in search of new investment avenues in India, the Indian
companies seeking to raise money through PE/VC route either for expansions/starting new
ventures or for en-cashing their investments by reducing their stake. On the back of the buoyant
domestic demand, companies are planning expansions and thus CARE Research believes that
there is significant need for funds and thus many PE deals would come up in the near future. With
soaring equity markets and healthy investor appetite, both, private placement and IPO issuances
are increasing.

CARE Research expects the deal pipeline for the investment banking industry to remain robust in
the next 1 – 2 years. Thus, after a brief pause, the investment banking industry is back in business.

1. Tolkien, J. R. R. (1954), The Fellowship of the Ring, The Lord of the Rings

1
 Executive Summary
Initial Public Offering (IPO) Market
IPO activity to rebound in 2010 driven by public sector institutions: The recent data showcases revival
of the IPO market. As many as 39 IPOs hit the market, raising total funds to tune of about Rs 24,696
crore in FY10, with the buoyancy continuing in the first half of FY11. CARE Research expects the IPO
pipeline to remain robust on account of (a) aggressive disinvestment plan by the Government of India
(GoI) to raise up to Rs.40,000 crore by FY2011 and (b) volume of draft offer documents filed with SEBI
has seen substantial recovery in FY10. Furthermore, as per the recent Government mandate, all listed
profitable Public Sector Units (PSUs) should have a minimum public holding of 10% and all unlisted
profitable PSUs should be listed while retaining a minimum 51% government stake and management
control with the Government. According to CARE Research, this mandate along with the divestment
plan is likely to substantially increase the share of public sector institutions in the primary market.

Mergers & Acquisitions (M&A)

M&A activity in 2010 may reach to 2007 peaks: The total M&A activity in India surged during the 2005-
07 period amid healthy global liquidity and increased attractiveness of emerging markets like India.
However, M&A activity dipped sharply during the 2007-09 period on the back of global economic
slowdown and liquidity crisis. However, on the back of global economic revival and ease in the liquidity
situation coupled with financial markets also recovering, the M&A space is also likely to demonstrate
gradual recovery. Furthermore, the M&A data-points for 1H2010 are showing signs of renewed
optimism with the possibility that the total M&A activity in 2010 may reach its 2007 peak levels.

Outbound and cross-border deals to revive: In the past, India has been 'net acquirer' with total value of
outbound deals exceeding the total value of inbound deals by a wide margin. However, the trend was
momentarily reversed in 2009 when the global economic slowdown prompted Indian corporate
houses to adopt a more cautious approach towards overseas acquisitions and focus on relatively safe
domestic deals. However, the recent M&A data for the first half of 2010 are indicating resurgence of
cross-border and inbound deals in value terms. The total value of cross-border deals for 1H2010 stood
at about $23 billion, 41% higher than that of domestic deals. Additionally, outbound deals have
contributed close to 45% of the total deal value for 1H2010.

M&A activities to heighten across sectors: In 2007, telecom and metals/mining sectors dominated the
Indian M&A space primarily due to the several billion-dollar deals in those sectors. While telecom
continues to be one of the preferred sectors for M&A activities in India, some of the other sectors,
witnessing lot of activities in terms of value, are pharma/healthcare and banking/Financial Institutions
(FIs). Going forward, CARE Research expects M&A activities to pick-up in emerging sectors such as
IT/ITeS, telecom, pharmaceuticals and biotech. Furthermore, the economic recovery is likely to push
consolidations in the mature sectors such as metal/mining, oil and gas and textiles resulting in M&A
activities in these sectors as well.

2
Private Equity (PE) & Venture Capital (VC) Market
Average deal size expected to further go down: The Indian PE/VC market saw highest activity in
2007 and consecutively average deal size also peaked to about Rs.210 crore per deal. However,
PE/VC volumes in 2008 and 2009 started witnessing shrinkage in average deal size as market
participants preferred lower or middle-market transactions possibly due to the global economic
slowdown. Going forward, CARE Research expects investors to show more appetite for lower to
middle-market deals in order to mitigate risk thereby, further depressing the average deal size.

Banking (microfinance), education/healthcare, infrastructure and construction sectors to see

substantial investment going forward: Historically, banking/FIs and energy and consumer products
have been the preferred sectors of investors. However, going forward, we are expecting investors to
diversify to microfinance institutions, education/healthcare, infrastructure and construction sectors.
CARE Research believes that the Government's initiatives on social spending provide huge growth
opportunities for investors to invest in the companies exposed to these emerging sectors.
Furthermore, the global economic recovery is likely to increase attractiveness of emerging markets
like India for investment purpose.

3
 The Challenges
Lack of disclosures and transparency: In India, the disclosure and transparency requirement in
M&A transactions has been hazy. This information asymmetry raises concerns over fundamentals
of the firm and consecutively increases the expected return from its securities. In the opinion of
CARE Research, the above issue can be addressed by two ways. Firstly, the regulator can prepare a
standardized reporting format wherein critical information about the deal is disclosed by the
companies. Furthermore, after the deal is concluded, the parties involved in the transaction should
be mandated to furnish detailed financial statements for at least a few quarters on a standalone and
consolidated basis. Secondly, the participating companies and facilitating agency (such as
merchant bankers) may voluntarily disclose critical facts about the deal in the public place which is
not mandated by regulations.

Increasing retail participation remains a challenge for primary as well as secondary market:
The retail participation in the IPO market has been lukewarm with major issues struggling to get their
full 35% retail subscription. In order to address the issue, SEBI has proposed increasing cap on retail
investment in public issue from the existing Rs.1,00,000 to Rs.2,00,000. CARE Research believes
that the above proposal, even if approved would not help large-sized public issue (issue size of
Rs.4,000-6,000 crore) in getting full 35% retail subscription. For instance, even under the most
optimistic scenario of about 65,000 applications with an average application size of Rs.1,65,000
would not be able to support an issue size larger than Rs.3,000 crore. However, subscription
performances of some of the recent issues highlight the fact that retail investors would continue to
show healthy appetite for fundamentally sound companies with attractive valuations.

The situation is no different in the secondary market, with merely 7.80% of the total domestic
household savings going to mutual funds investment. The primary reason attributed to this is the
lack of in-depth analytical information and independent professional assessment of company
fundamentals and its valuation. For example, out of total 5,000 listed companies, active research
coverage is available for only about 200 companies. This has resulted in retail investors restricting
themselves to bigger companies ignoring many small but fundamentally sound companies with
attractive valuations. For example, non-institutional ownership in SENSEX (large-cap) is about 40
% of free-float (FF), whereas non-institutional ownership in BSE-500 (excluding Sensex,
predominantly mid and small caps) is only about 18 % of FF. This poses a pressing need for
independent research houses as it could provide more visibility to fundamentals of various
companies, thereby shielding retail investors from any speculative activities.

Lack of robust infrastructure: In the last few years, infrastructure and regulations pertaining to the
secondary market have almost reached global standards. However, similar kind of infrastructural
development in the primary market is absent given the oscillating nature of the business. The
outsourcing of post-issue labour intensive tasks to third-party agencies, lacking proper processes or
infrastructure, may hamper the issuance process.

4
Mispricing of IPOs: As per a survey conducted by Associated Chambers of Commerce and
Industry of India (ASSOCHAM), majority of CEOs and CFOs attributed the lukewarm response to
IPOs to bad pricing and weak market sentiments. CARE Research has studied price performance of
about 116 IPOs issued between August-2007 to August-2010 period. The analysis revealed that
about 62% IPOs are currently trading lower than the lower IPO price band, whereas about 35% are
currently trading higher than the upper IPO price band. The extent of mispricing is somewhat abated
in IPOs issued in 2009 and 2010, with majority of IPOs outperforming their initial pricing. However,
price performance of newly listed IPOs remains to be seen over the next 2-3 years, as the current
outperformance may be an offshoot of the ongoing buoyancy in secondary market.

5
 Introduction
The Indian capital market has come a long way since last two decades after the economic reforms in
1992. The infamous stock market scam in which funds from banking transactions were illegally
diverted to artificially inflate stock prices triggered a series of reforms in both primary and secondary
markets. The most notable amongst these was the abolition of the Controller of Capital Issues (CCI)
and the subsequent creation of the Securities and Exchanges Board of India (SEBI). Prior to 1992,
CCI had full control on the pricing of capital issues in India. CCI used to arrive at the fair issue price by
using accounting information leading to under-priced issues in many cases. This led to companies
shying away from going public and relied heavily on debt as a source of funding. However, the CCI
was abolished in 1992 and consecutively the regulatory control on the pricing of new issues was
removed. Accordingly, companies turned to capital markets and consecutively reduced their
dependence on debt as a source of funding. However, the free pricing regime resulted in over-
pricing of capital issues and large preferential allotment of shares. Realizing the need to regulate the
market and ensure adequate disclosure, SEBI took up the role of capital market regulator in late-
1992. SEBI was delegated with the powers to monitor and regulate stock exchanges, their
members, the companies (listed or willing to list on the exchanges), stock brokers, portfolio
managers, merchant bankers, intermediaries and other participants of stock markets.

The secondary markets saw a similar extent of reforms. Stringent regulations relating to stock
exchanges, capital adequacy, diversity of ownership of exchanges and insider trading was
formulated. The most commendable of these secondary market reforms were SEBI's initiative in
1993 to shift all exchanges from open-outcry to screen-based trading. Additionally, prior to 1994,
India's secondary stock market was dominated by the Bombay Stock Exchange (BSE) located in
Mumbai and participants from other parts of the country were unable to participate in price discovery.
This led to wide disparity in prices in markets outside Mumbai and inside Mumbai, resulting in
arbitrage opportunities. In this light, the National Stock Exchange (NSE) was established with its
trading network spanning across the country.

These structural changes in the Indian capital market changed the facet of the business.

6
 Initial Public Offering Market

Background
FY93-96 was inundated with IPO issuances as the economic deregulation led to buoyancy in the
Indian capital market. Indian corporate houses, with an objective to benefit from the economic
reforms, raised significant funds from the capital market. The number of public issues (IPO and
rights issue) almost doubled from 773 issues in FY94 to 1,426 in FY96. The IPO market was the
major contributor to this growth, raising approximately Rs.35,360 crores from 3,288 issuances
during the aforesaid period. Robust industrial production and healthy GDP growth rate fuelled the
growth in IPO markets. However, the euphoria soon ended, as large overcapacities along with the
slack demand dampened corporate earnings. Furthermore, many companies raising money during
this period were of poor fundamentals, below average promoter track record with inadequate
disclosures. The situation was accentuated by the East-Asian crisis whereby most of the Foreign
Institutional Investors (FIIs) reduced their exposure to developing economies like India. The IPO
market slid, with just Rs.404 crore raised through 18 issues in FY99. The bad experience of IPOs led
to risk aversion by the investors. The secondary market too remained sluggish and investors
preferred to invest in fixed deposits rather than equities. The unattractive nature of equity markets
prompted many promoters to opt for private placements. Following this, the IPO market went into
hibernation for close to six years.

Nevertheless, the IPO market remained as one of the most promising ways of raising funds for the
Indian corporate sector. This has also been a preferred option by the promoters and the Government
to en-cash their investments. During 1993-08 period, Rs.1,49,671 crore was raised by 4,538
companies through IPOs. The IPO market, after being severely hammered by the burst of the
'dotcom bubble', showed a healthy growth through 2002-08. The capital market saw another wave of
IPOs starting in FY04 with the emergence of service sectors and the introduction of book-building
process for price discovery, which renewed investor interest in the primary market. IPO issuances in
FY04-08 period, focused primarily on companies in emerging sectors such as media, financial
services, power and consumer discretionary, as against earlier years when the market was
dominated by issues from companies in the manufacturing sector.

7
Figure 1: Capital Raised Through IPOs

Year No. Amount Issue Size

(Rs crore) (Rs crore/issue)
FY94 692 7,864 11
FY95 1,239 16,572 13
FY96 1357 10,924 8
FY97 717 5,959 8
FY98 52 1,048 20
FY99 18 404 22
FY00 51 2,719 53
FY01 114 2,722 24
FY02 7 1,202 172
FY03 6 1,039 173
FY04 21 3,434 164
FY05 23 13,749 598
FY06 79 10,936 138
FY07 77 28,504 370
FY08 85 42,595 501
FY09 21 2,082 99
FY10 39 24,696 633
FY 11 (til July) 14 12,115 865

Source: CARE Research and SEBI

Figure 2: Sector-wise break-up of Capital Mobilised through Public and Rights Issues

FY06 FY07 FY08 FY09 FY10

Bankingtfls 48.4 14.8 37.6 12.1 8.6
Cement & Construction 3.7 8.2 21.7 0.5 4.8
Power 7.9 0.1 15.8 5.9 43.9
Entertainment 2.6 3.6 0.5 7.1 4.3
Health Care 2.4 0.6 0.6 0.9 1.8
Information Technology 3.3 6.2 0.8 0.3 0.9
Others 31.7 66.5 23.0 73.2 35.5
Total 100.0 100.0 100.0 100.0 100.0

Source: CARE Research and SEBI

8
However, the Indian IPO market witnessed a considerable decline in the year 2009, owing to the global
economic slowdown. IPO statistics has been worst in terms of both volume of issues and amount
raised. In February 2008, three large IPO offerings namely Wockhardt Hospitals Ltd., Emaar MGF
and SVEC Constructions were shelved due to weak investor sentiment. As per a survey conducted by
ASSOCHAM, majority of CEOs and CFOs attributed the lukewarm response to bad pricing of the
issues and weak market sentiments. The IPO activities almost dried up in Q3 and Q4 of FY09 with
merely two IPO issues totalling Rs.50 crores.

Figure 3: IPO – Quarterly Capital Raised and Issuances

18000 30
16000
25
14000
Amount (Rs. Crore)

12000 20

No. of Insurances
10000
15
8000
6000 10
4000
5
2000
0 0
Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10

Q1FY11

JULY 10
Amount Volume (RHS)

Source: CARE Research and SEBI

Outlook
IPO activity rebounds in 2010; trend to persist in next 10 – 12 months

The recent data-points demonstrate renewed interest in the IPO market by the companies. As many as
39 IPOs hit the market, raising a total fund in tune of about Rs 24,696 crore in FY10. In the first four
months of FY11 till July, 14 IPOs hit the market, raising a total fund in tune of about Rs 12,115 crores,
suggesting persistence of buoyancy.

obust on two counts. Firstly, the Central Government has chalked out an aggressive divestment plan,
with a target to rise up to Rs.40,000 crore through disinvestments in FY11. As per the recent criteria set
by the Cabinet, all listed profitable PSUs should have a minimum public holding of 10% and all unlisted
profitable PSUs should be listed while retaining a minimum 51% stake and management control with
the Government. The above decision would make as many as 60 PSUs suitable for disinvestment.
Secondly, the volume of draft offer documents filed with SEBI has seen a substantial recovery in FY11.
Although the number is not as high as in the FY06-08 period, the broad trend signifies healthy pipeline
of IPOs. The above two factors along with stabilizing secondary market is likely to make IPO, an
attractive option to raise money in 2010.

9
Figure 4: Number of draft offer documents filed with SEBI
50

No. of Draft offer documents 43

40 39
37
32
30
27
32 24
20 21

15
14
10 10

4
0 2
0 0
Q4FY07

Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10

Q1FY11

Q1FY11#
#: In Q2FY11 till September 15, 2010.
Source: CARE Research and SEBI

Public sector offering to support the primary markets

Historically, private sector has dominated the primary market, both in terms of amount raised and
the number of deals. However, the public issues are comparatively larger in size but fewer in
number. Going forward, we expect funds mobilized from the private sector to give more visibility to
the primary market. Nevertheless, with a number of PSUs aiming for divestment, the public sector is
likely to dominate the IPO market in the next few months.

Figure 5: Sector-wise break-up of Capital Mobilised through Public and Rights Issues
Year Total Private Public
No Volume No Volume No Volume
(Rs crore) (Rs crore) (Rs crore)

FY05 60 28,256 55 17,162 5 11,094

FY06 139 27,382 131 20,199 8 7,183
FY07 124 33,507 122 31,728 2 1,779
FY08 124 87,029 120 67,311 4 19,718
FY09 47 16,220 47 16,220 0 0
FY10 76 57,555 71 32,477 5 25,078
Q1FY11 15 9927 14 8864 1 1063

Source: CARE Research and SEBI

10
Traditional sectors continuing to show major capital raising activities
Banking/finance, cement/construction and energy/power have been the most active sectors in the
IPO market. Although entertainment has also emerged recently, the three traditional sectors have
been driving the capital raising activities in India.

Figure 6 : Sector-wise break-up of Capital Mobilised through Public and Rights Issues
%
FY06 FY07 FY08 FY09 FY10 FY11
(till June)
Banking/Fis 48.4 14.8 37.6 12.1 8.6 2.2
Cement & Construction 3.7 8.2 21.7 0.5 4.8 0.0
Power 7.9 0.1 15.8 5.9 43.9 0.0
Entertainment 2.6 3.6 0.5 7.1 4.3 0.0
Health Care 2.4 0.6 0.6 0.9 1.8 6.8
Information Technology 3.3 6.2 0.8 0.3 0.9 0.0
Food Processing 1.6 1.9 0.1 0.0 0.8 42.0
Others 30.1 64.6 22.9 73.2 34.8 49.1
Total 100.0 100.0 100.0 100.0 100.0 100.0
Source: CARE Research and SEBI

11
 Mergers & Acquisitions Market

Current Trends and Outlook

M & A activity in 2010 may reach to 2007 peaks

The total M&A activity in India surged during the period 2005-07, increasing by almost three fold in
value terms and two fold in volume terms. This upsurge was widely attributed to healthy global liquidity
and increased attractiveness of emerging markets like India. However, M&A activity dipped sharply
during the period 2007-09 on the back of global economic slowdown and the liquidity crisis. The total
volume of deals almost halved from their 2007 levels and consecutively the total deal value in calendar
year 2009 eroded to almost 2004 levels. However, on the back of global economic revival and ease in
the liquidity situation coupled with financial markets also recovering, the M&A space is also likely to
demonstrate a gradual recovery. Furthermore, the M&A data-points for 1H2010 are showing signs of
renewed optimism with a possibility that the total M&A activity in 2010 may reach its 2007 peak levels.

Figure 7 : Indian M&A Activity

M&A Deal Value# ($ billions) M&A Deal Volume#

60 800

51 700
50
M&A Deal Value ($ billion)

600
M&A Deal Volume

40
500

30 31 29 400

300
20 20
16 200
10 12
100

0 0

2005 2006 2007 2008 2009 H110 2005 2006 2007 2008 2009 H110

#- Adjusted for cancellation of the GTL/Reliance Infratel deal

Source: CARE Research and Industry

Outbound and cross-border deals to revive

In the past, India has been 'net acquirer' with the total value of outbound deals (Indian companies
acquiring overseas companies) exceeding the total value of inbound deals (foreign companies
acquiring Indian companies) by a wide margin. Furthermore, cross-border deals (outbound +
inbound) have outpaced domestic deals in value terms. However, the trend was momentarily
reversed in 2009 when the global economic slowdown prompted Indian corporate houses to adopt a
more cautious approach towards overseas acquisitions and focus on relatively safe domestic deals.

12
Consecutively, domestic deals dominated cross-border deals in value terms for the first time in the
five-year period. Similarly, the value of inbound M&A deals totalled at $3.9 billion, almost three times
that of outbound deals. However, the recent M&A data for the first half of 2010 are indicating a
resurgence of cross-border and inbound deals in value terms. The total value of cross-border deals
for 1H2010 stood at about $23 billion, 41% higher than that of domestic deals. Additionally,
outbound deals have contributed close to 45% of the total deal value for 1H2010.

Figure 8 : Break-up of M&A Activity

Value (%) Volume (%)
2005 2006 2007 2008 2009 H110 2005 2006 2007 2008 2009 H110
Inbound 31.7 26.6 30.3 40.5 32.4 18.7 16.3 15.8 16.6 18.9 22.4 11.8
Outbound 26.3 48.8 64.1 42.6 11.5 62.2 39.7 39.6 35.9 43.2 24.8 28.3
Cross Border 58.0 75.4 94.4 83.2 43.9 50.9 56.0 55.4 52.5 62.1 47.3 40.1
Domestic 42.0 24.6 5.6 16.8 56.1 19.1 44.0 44.6 47.5 37.9 52.7 59.9
Total M&A 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: CARE Research and Industry

The adjusted deal size to moderate

In 2007 and 2008, the size of M&A deals averaged $70-75 million, with outbound deals relatively
larger than domestic deals in value terms. The average size dropped to merely $36 million in 2009,
possibly due to investor's preference for smaller deals in order to reduce their risk exposure.
However, in 1H2010, the average size of the deal shot up to close to $77 million per deal. CARE
Research notes that this does not necessarily signify a structural shift to higher value M&A deals, as
the year 2010 was marked with seven deals executed at a value exceeding $1.0 billion each. After
adjusting for the $10.7 billion Bharti Airtel/Zain Africa deal, the average deal size comes down to a
moderate level of about $48 million. (The $11 billion GTL/Reliance Infratel deal was called off in
September 2010)

Figure 9 : M&A – Average value per deal ($ million)

2005 2006 2007 2008 2009 H110

Inbound 92 71 138 146 52 122
Outbound 32 52 135 67 17 169
Cross Border 49 58 136 91 34 155
Domestic 45 23 9 30 39 25
Total M&A 48 42 76 68 36 77
Source: CARE Research and Industry

13
M&A activities to heighten across sectors

In 2007, telecom and metals/mining sectors dominated the Indian M&A space together contributing
close to 66% to the overall deal value. This was primarily attributed to several billion-dollar deals in
telecom (Vodafone/Hutch-$10.83 billion) and metal/mining (Tata/Corus-$12.2 billion,
Hindalco/Novelis-$6.0 billion and Essar/Algoma-$1.6 billion) sectors. Telecom continues to be one
of the preferred sectors for M&A activities in India, contributing close to 50% of the total deal value in
1H2010. Some of the other sectors, witnessing lot of activities in terms of value, are
pharma/healthcare and banking/FIs. Going forward, we are expecting M&A activities to pick-up in
emerging sectors such as IT/ITeS, telecom, pharmaceuticals and biotech. Furthermore, the
economic recovery is likely to push consolidations in the mature sectors such as metal/mining, oil
and gas and textiles resulting in M&A activities in these sectors as well.

Figure 10 : Sector Breakup of M&A Deal Value (%)

2007 1H2010
Breweries & Distilleries 2.2 2.8
IT &ITeS 5.6 1.4
Pharma, Healthcare & Biotech 2.9 16.6
Telecom 22.2 50.2
Banking/FIs 1.0 9.7
Real Estate/Infra structure 1.0 2.8
Metals & Mining 43.4 9.7
Others 21.8 6.9
100.0 100.0

Source: CARE Research and Industry

14
 Private Equity & Venture Capital Market

Background
The concept of Venture Capital and Private Equity was introduced in India in the early-1970s, when a
government committee highlighted the need of easy availability of capital for faster development of
the SME sector in India. Following this, GoI formulated guidelines for venture capitals in India in 1988.
Although the above initiatives marked the beginning of PE/VC investment in the country, the industry
was primarily restricted to the public sector financial institutions such as Technology Development
and Information Company of India Ltd. (TDICI), GVFL Limited (formerly Gujarat Venture Finance
Limited) and Andhra Pradesh Industrial Development Corporation (APIDC). Stringent policy
framework and the pre-liberalization era restricted development of the PE/VC industry in India.
However, the real development happened only after the economic liberalization in 1992, when the
CCI was abolished and subsequently SEBI was appointed as the capital market regulator.

Figure 11 : Evolution of Venture Capital Funds in India

180 160
160 140
140
120

No. of Foreign Venture

120
100

Capital Investors
No. of VC funds

100
80
80
60
60
40 40

20 20

0 0
2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Venture Capital Funds Foreign Venture Capital Investors

Source: CARE Research and SEBI

The PE/VC industry experienced the first wave of rapid growth in late-1990s when capital-starved
Information Technology (IT) and telecom companies started receiving huge investments from foreign
venture capital funds. However the dot-com bubble burst pushed many PE/VC companies into losses,
especially those who were heavily exposed to start-ups/early stage dot-com companies. As a result,
PE/VC activities declined severely in 2001-03 period.

15
The industry showed signs of recovery by end of 2004. The PE/VC investors substantially increased
their exposure to the Indian markets, augmenting their total investments by almost 3.5 times from
2003 levels. However, the investments were more focused on late-stage companies and sector
diversification. The industry witnessed phenomenal growth rates in the 2005-07 period, when FIIs,
attracted by growth prospects of Indian economy and as a matter of diversification, invested
substantially in Indian markets. The year 2007 saw peak PE/VC activity numbers both in terms of
volume of deals and total value of the deals.

Figure 12 : PE/VC Activity in India

90,000 400
80,000 350
Values of Deals (Rs. Crore)

70,000 300
60,000
250
50,000

No. of Deals
200
40,000
150
30,000
20,000 100

10,000 50

0 0
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010
Value of Deals Number of Deals

Source: CARE Research and Industry

Outlook
Average deal size expected to further go down

Indian PE/VC market saw highest activity in 2007 with a total capital infusion of about Rs.76,500 crore
(~$17 billion) from 365 deals. Consecutively, the average deal size also peaked to approximately
Rs.210 crore per deal. However, PE/VC volumes in 2008 and 2009 started witnessing shrinkage in the
average deal size as market participants preferred lower or middle-market transactions, possibly due
to the global economic slowdown. The average deal value in 2008 and 2009 was about 29% and 48%
lower than 2007 levels respectively. Going forward, we are expecting investors to show more appetite
for lower to middle-market deals in order to mitigate risk, thereby further depressing the average deal
size.

16
Figure 13 : Average Deal Size for PE/VC Activity in India
250

210
200
Average Deal Size (Rs. Crore)
150 148

113 110 112

100 105

68
50
38 34 38
19
0
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010
Source: CARE Research and Industry

Microfinance, education/healthcare, infrastructure and construction sectors to see substantial

investment going forward

Historically, banking/FIs, energy and consumer products have been the preferred sectors of investors.
However, going forward, we are expecting investors to diversify to microfinance, education/healthcare,
infrastructure and construction sectors. We believe that the Government's initiatives on social
spending provide huge growth opportunities for investors to invest in the companies exposed to these
emerging sectors. Furthermore, the global economic recovery is likely to increase attractiveness of
emerging markets like India for investment purpose.

Figure 14 : Sectoral Distribution of PE Investments (1H 2010)

Infrastructure
Telecom
16
Banking/Fis
28
5 Consumer Products
5 Technology
5 Healthcare
5 Cement & building Material
13
10 Real Estate/construction
13
Others

Source: IBEF

17
 The Challenges

Lack of disclosures and transparency in M&A transactions

In India, the disclosure and transparency requirement in M&A transactions has been hazy.
Information disclosed by the involved parties is often inadequate for investors to make informed
decisions. This information asymmetry raises concerns over fundamentals of the firm and the
expected return from its securities. By providing adequate disclosures and information, the firm can
convince investors to accept a lower rate of return, thereby reducing its cost of capital.

The above issue can be addressed by two ways. Firstly, the regulator can prepare a standardized
reporting format wherein critical information about the deal is disclosed by the companies.
Furthermore, after the deal is concluded, the parties involved in the transaction should be mandated
to furnish detailed financial statements for at least a few quarters on a standalone and consolidated
basis. This would help investors in evaluating performance of each of the businesses and
associated synergies. It may be noted that a similar disclosure requirement already existing for
companies raising capital from the primary market through IPOs wherein critical facts and
associated risk factors are enumerated by the issuing companies. Secondly, the participating
companies and facilitating agency (such as merchant bankers) may voluntarily disclose critical facts
about the deal in public place which is not mandated by regulations.

Increasing retail participation remains a challenge for primary as well as secondary market

Primary market:
SEBI has recently proposed increasing the cap on retail investment in public issue from the existing
Rs.1,00,000 to Rs.2,00,000, in order to attract more retail investors in the primary market. The
proposal is based on two observations made by SEBI from recent public offerings. (a) 75% of
applications in the retail investor category falls in Rs.80,000-1,00,000 band, whereas applications
lower than Rs.5,00,000 size in the non-institutional investor category is negligible. (b) Number of
applications received in retail investor category ranges between 35,000 to 70,000.

CARE Research believes that the above proposal, even if approved may not be sufficient for large-
sized public issue (issue size of Rs.4,000-6,000 crore) in getting full 35% retail subscription. For
instance, even under the most optimistic scenario of about 65,000 applications with an average
application size of Rs.1,65,000 would not be able to support an issue size larger than Rs.3,000
crore. The move is largely been seen as SEBI's efforts to revive retail participation in primary
markets. However, subscription performances of some of the recent issues highlight the fact that
retail investors would continue to show healthy appetite for fundamentally sound companies with
attractive valuations.

18
Figure 14 : Subscription Details for Selected Issues
Issue Size Issue Subscription (times)
(Rs crore) Overall QIB HNI Retail
NMDC 9,967 1.25 2.28 0.22 0.22
NTPC 8,286 1.20 2.18 0.43 0.16
REC 3,486 3.14 5.52 2.05 0.23
Standard Chartered 2,486 2.20 4.15 1.90 0.25
Jaypee Infratech 2,262 1.24 1.77 1.15 0.61
SKS Micro finance 1,629 13.69 20.38 18.26 2.81
DB Reality 1,500 2.95 4.47 4.25 0.37
SJVN 1,079 6.64 9.03 3.39 3.12
Source: CARE Research and Industry

Secondary Market:
Participation of retail investors in Indian equity markets is limited. For instance, the share of mutual funds
in the total domestic household savings stands at about 7.80% (as on FY08), significantly lower than that
of US at about 45%. Furthermore, Out of the total 188 million investors holding financial assets, only eight
million have exposure in debt and equity markets, either directly or indirectly. The primary reason
attributed to this is the lack of in-depth analytical information and independent professional assessment
of company fundamentals and its valuation. For example, out of total 5,000 listed companies, active
research coverage is available for only about 200 companies. This has resulted in retail investors
restricting themselves to bigger companies - many small but fundamentally sound companies with
attractive valuations get ignored due to the lack of information or visibility. For example, non-institutional
ownership in SENSEX (large-cap) is about 40 % of free-float (FF), whereas non-institutional ownership in
BSE-500 (excluding Sensex, predominantly mid and small caps) is only about 18 % of FF. This poses a
pressing need for independent research houses as it could provide more visibility to fundamentals of
various companies, thereby shielding retail investors from any speculative activities.

Figure 15 : Historic Trading Details at BSE and NSE

Average Trade Average Trade No. of Companies

Size (Rs) Price#(Rs) Listed
BSE NSE BSE NSE BSE NSE
FY06 30,911 25,044 123 186 4,781 1,069
FY07 27,618 24,790 171 227 4,821 1,228
FY08 29,771 30,280 160 237 4,887 1,381
FY09 20,342 20,161 149 193 4,929 1,432
FY10 22,768 24,608 121 187 4,975 1,470
FY11(till June) 20,575 22,888 114 198 4,986 1,490
#- Estimated by CARE Research
Source: CARE Research and SEBI

19
Lack of robust infrastructure
In the last few years, infrastructure and regulations pertaining to the secondary market have almost
reached global standards. However, a similar kind of infrastructural development in the primary market is
absent given the oscillating nature of the business. Any additional capacity built-in by registrars would
remain idled in case issues are relatively few or small. Similarly, registrars with low capacities would
struggle to conclude deal proceedings within the prescribed time-frame.

Registrars of the issue typically subcontract the post-issue labour intensive job such as data entry work
to outside agencies. Although data entry work seems to be relatively easy and straight-forward, it is
crucial in ensuring successful completion of the issue process. These data-entry agencies may not have
strong processes or the necessary technological infrastructure to ensure seamless completion of the
work. Furthermore, their services are also available at a relatively cheaper rate, which may tempt
registrars to select them for the work. The chance of erroneous data entry increases greatly in case of
large issues involving thousands of applications.

Mispricing of IPOs
As per a survey conducted by ASSOCHAM, majority of CEOs and CFOs attributed the lukewarm
response to IPOs to bad pricing and weak market sentiments. CARE Research has studied price
performance of about 116 IPOs issued between August-2007 to August-2010 period. The analysis
revealed that about 62% IPOs are currently trading lower than the lower IPO price band, whereas about
35% are currently trading higher than the upper IPO price band. The IPO mispricing was prevalent in
2007 and 2008 with about 75% of the issues being overpriced. The mispricing has somehow abated in
IPOs issued in 2009 and 2010, with the majority of IPOs outperforming their initial pricing. However, the
price performance of newly-listed IPOs remains to be seen over the next 2-3 years as the current
outperformance may be an offshoot of the ongoing buoyancy in the secondary market.

Figure 16 : Price Performance of IPOs

Sample Size Percent of Script Currently Trading
Year (number of IPOs) Lower than Higher than
Lower IPO Within IPO Upper IPO
Price Band Price Band Price Band
2010 23 34.8% 8.7% 56,5%
2009 13 30.8% 7.7% 61.5%
2008 44 75.0% 0.0% 25.0%
2007 36 75.0% 0.0% 25.0%
Total 116 62.1% 2.6% 35.3%
Source: CARE Research

20
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