IMB Brochure Final 2

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Indian MerchantBanking Summit

th24 September, 2010

BACKGROUND PAPER

Knowledge Partner

Association of Merchant Bankers of India

Professional Risk Opinion




As we continue our journey towards excellence

we would like to take this opportunity to thank all investors,

lenders, issuers for making us the preferred rating agency

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Ratings • Insurance Claims Paying Ability Ratings • Micro Finance Ratings

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CREDIT ANALYSIS & RESEARCH LTD.Mumbai New Delhi Kolkata Chennai Ahmedabad Bangalore Hyderabad

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No part of this publication may be produced or transmitted in any form or by any means withoutprior permission.

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Published by Association of Merchant Bankers of India and Credit Analysis and Research Ltd.

© with Credit Analysis and Research Limited

All rights reserved.



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 theinterests 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.

About AMBI



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



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 24,696crore 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 theIndian 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.

Executive Summary

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 tomiddle-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



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.

The Challenges

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



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.

Introduction

6



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 IPOmarket 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.

Initial Public Offering Market

7



Figure 1: Capital Raised Through IPOs

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

Source: CARE Research and SEBI


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 164FY05 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

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 4.3Health 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

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


Volume (RHS) Amount

18000

16000

14000

12000

10000

8000

6000

4000

2000

0

30

25

20

15

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0

Q 1 F Y 0 8

Q 2 F Y 0 8

Q 3 F Y 0 8

Q 4 F Y 0 8

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Q 2 F Y 0 9

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Q 4 F Y 0 9

Q 1 F Y 1 0

Q 2 F Y 1 0

Q 3 F Y 1 0

Q 4 F Y 1 0

Q 1 F Y 1 1

J U L Y 1 0

A m o u n t ( R s . C r o r e )

N o . o

f I n s u r a n c e s

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 setby 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

#: In Q2FY11 till September 15, 2010.


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.

50

40

30

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Q 4 F Y 0 7

Q 1 F Y 0 8

Q 2 F Y 0 8

Q 3 F Y 0 8

Q 4 F Y 0 8

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Q 4 F Y 0 9

Q 1 F Y 1 0

Q 2 F Y 1 0

Q 3 F Y 1 0

Q 4 F Y 1 0

Q 1 F Y 1 1

Q 1 F Y 1 1 #

N o . o f D r a f t o f f e r d o c u m e n t s

32

32

43

39

27

1514

10

42

21

0 0

37

24

10

Figure 5: Sector-wise break-up of Capital Mobilised through Public and Rights Issues


Year 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

Total



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

11



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.

Mergers & Acquisitions Market

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.

Figure 7 : Indian M&A Activity

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

#- Adjusted for cancellation of the GTL/Reliance Infratel dealSource: CARE Research and Industry

60

50

40

30

20

10

0

2005

M & A D e a l V a l u

e ( $ b i l l i o n )

16

31

51

29

12

20

2006 2007 2008 2009 H110

800

700

600

500

400

300

200

100

0

2005

M & A D e a

l V o l u m e

2006 2007 2008 2009 H110

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

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)

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

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 155Domestic 45 23 9 30 39 25

Total M&A 48 42 76 68 36 77

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 bill ion-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 in1H2010. 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 1H2010Breweries & 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

14



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.

Private Equity & Venture Capital Market

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.

Figure 11 : Evolution of Venture Capital Funds in India


180

160

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100

80

60

40

20

0

2 0 0 1

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Foreign Venture Capital InvestorsVenture Capital Funds

N o . o f

V C

f u n d s

N o . o f F o r e i g n V e n t u r e

C a p i t a

l I n v e s t o r s

160

140

120

100

80

60

40

20

0

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


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.

90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

400

350

300

250

200

150

100

50

0

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

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2 0 1 0

Number of DealsValue of Deals

V a l u e s o f D e a l s

( R s . C r o r e )

N o . o f D e a l s

16



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)

Source: IBEF

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


250

200

150

100

50

0

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

A v e r a g e D e a l S i z e ( R s .

C r o r e )

38

105

68

110 112

210

148

113

3438

19

Infrastructure

Telecom

Banking/Fis

Consumer Products

Technology

Healthcare

Cement & building Material

Real Estate/construction

Others13

13

285

5

5

5

10

16

17



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 andassociated 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.

The Challenges

18



Figure 14 : Subscription Details for Selected Issues


Secondary Market:

Participation of retail investors in Indian equity markets is limited. For instance, the share of mutual fundsin 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

#- Estimated by CARE ResearchSource: CARE Research and SEBI

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

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

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

Source: CARE Research

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%

20



Research

EQUI GRADEAnalytical Power for Investment Decisions

it e h in ol es the ses m o e u en al the ompany and the al n iEqu y res arc v v as s ent f th f ndam t s of c v uatio of ts

ui seq ty hares.

n in ent h f equ es i no off b R rough ts rodu t RE ad . AA depend researc o iti s w ered y CA E th i p c CA Equi Gr e n

n ent as s ent ity s by C E w d imm se alu i reli li depend ses m of equ hares AR oul add en v e to ts abi ity and

bi ty C E Equi oul del e i c tic as ts ik the fun ental of the om acredi li . AR Grade w d v nto ri al pec l e dam s c p ny and

e l on of its ty A qu d w d enabl t e nf m i i .th va uati equi . C RE E i Gra e oul e investors o mak more i or ed dec s ons

CREDIT ANALYSIS & RESEARCH LTD.

4th Floor, Godrej Coliseum, Somaiya Hospital Road, Off Eastern Express Highway, Sion (East), Mumbai - 400 022

Tel: +91-022- 6754 3456, Fax: +91-022- 6754 3457, E-mail: [email protected]

Mr. P. N. Satheeskumar • Cell : +919820416004 • Tel: +912267543555 • e-mail :[email protected]. Revati Kasture • Cell : +919324258129 • Tel: +912267543465 • e-mail: [email protected]



Association of Merchant Bankers of India

• Strong heritage, major shareholders of CAREare IDBI Bank, Canara Bank and State Bankof India

• Second largest credit rating agency inIndia

• CARE is the preferred rating agency by thecompanies across different sectors

• An Independent External Rating Committee

• Wide acceptance by the lenders & investors

• Proven track record for the last 17 years

CARE is recognised by all statutoryauthorities in India for its credit ratingactivities

• Founder member of Associat ion oCredit Rating Agencies in Asia (ACRAA)

• Providing Technical assistance to CrediRating Agencies in Mexico, Ecuador, Nepaand Bangladesh

•

• Sole representative to the merchantbanking industry

• A nodal point for the assimilation and

dissemination of information relating tothe merchant banking industry

• Published a Code of Conduct for Merchant Bankers

• Brought out a Due Diligence Handbookand an Investor's Education Handbook

• A very strong membership of 48investment bankers, representing allsegments

• A trade body promoting the interests of the industry and of its members


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