MERCHANT BANKING

MERCHANT BANKING

Merchant banking : As per SEBI (MB 1992, Regulations), a

merchant banker means a person who is engaged in the business of
securities issue management either by making arrangements
regarding selling, buying of securities; rendering consultancy/
advisory services related to capital market securities.
ORIGIN :
The term merchant banking originated from the London who started
financing foreign trade through acceptance of bills
Later they helped government of under developed countries to raise
long term funds
Later these merchants formed an association which is now called
”Merchant Banking and Securities House Association”
 Scope of Merchant Banking in
India
• Issue management
• Buying
• selling
• Underwriting
• Consultancy services for the issue
• Marketing services for the issue
• Portfolio management ( but needs an additional
registration).

PS: MB’s are precluded to take up any fund based

activity other than associated with securities
market.
MERCHANT BANKING REGULATIONS :
Certificate from SEBI is a must.They are of four types:
Category I merchant bankers : Can act as Issue managers
Category II merchant bankers : Can act only as co-managers
Category III merchant bankers : Can act as co-managers but cannot
undertake portfolio management
Category IV merchant bankers :Can merely act as consultant or
advisor to issue of capital
CAPITAL ADEQUACY NORMS :
Category I : Rs. 5 crores
Category II : Rs.50 lakhs
Category III : Rs.20 lakhs
Category IV : Nil
GUIDELINES FOR MERCHANT BANKERS :
SEBI’s License is a must to act as merchant bankers.
Authorisation criteria include
 Professional qualification in finace,law or business management
 Infrastructure like office space,equipment and man power
 Capital adequacy
 Past track of record, experience,
Every merchant banker should maintain copies of balance sheet,Profit
and loss account, and other required documents.
Half-yearly unaudited result should be submitted to SEBI
SEBI has been vested with the power to suspend or cancel the
authorisation in case of violation of the guidelines
SEBI has the right to send inspecting authority to inspect books of
accounts,records etc… of merchant bankers
Inspections will be conducted by SEBI to ensure that provisions of the
regulations are properly complied

An initial authorisation fee,an annual fee and renewal fee may be
collected by SEBI

A lead manager holding a certificate under category I shall accept a

minimum underwriting obligation of 5% of size of issue or Rs.25 lakhs
whichever is less
CODE OF CONDUCT :

•Should maintain high standards of integrity,dignity and

fairness in conduct of business.
•Should fulfill all obligations in a professional and ethical
manner.
•Should provide true & adequate information to investors
•Shall not be aparty to any Price rigging& false
presentation
•Shall ensure all statutory compliances.
General obligation & responsibility
• Not to engage in any other business other than
securities.
• Maintain Books of A/c, records and furnish
financial statements to SEBI.
• Submission of half yearly results.
• Appointment of lead manager
• Documents to be submitted
• Underwritting guidelines
Role of Merchant banker in Security Issues
Pre Issue:
• Issue planning & advisory
• Underwritting
• Preparing offer document
• Conducting Due diligence
• Issue pricing
• Issue structuring
• Selection of other intermediaries
• Documentation
• Marketing
• Statutory compliances
 Post Issue
• Deciding allotment
• Mailing of allotment letters,share certificates
• Refund
• In case of book built route, decide the cut off
price.
• Addressing investor grievances
• Statutory filling with SEBI, post offer closure
• Liasioning with Stock exchange for listing
 IPO
Topics:
• Pre Issue decision making
• Key concepts
• Issue pricing, structuring, timing
• Procedural aspect
• Regulatory Provisions & SEBI guidelines
• Requirements under Companies Act
• Process for making Issue ( Fixed price, Book building)
• Post issue management
 Pre Issue decision making
• The benefits of going public are:
– Firms can access financial markets and tap a larger
source of capital
– Existing shareholders get an opportunity to exit
( Liquidity event).
– Capital structure: it brings down the debt equity ratio
and thereby increases the future borrowing power of
the firm.
– Equity does not involve fixed debt servicing cost.
– In case of premium pricing, it increases the networth,
without diluting the capital base.
The cons:
•The Loss of control

•Information disclosure requirements

•Exchange listing requirements

•Hostile take over

 Pre Issue decision making

• Significance of an IPO.
• It brings in large capital.
• It creates new ownership
• It creates Market capitalisation for the firm and attatch a
value to it.
• It provide opportunity for performance evaluation of firm
• It brings additional cost of compliance & regulation
• It checks management decisions.
 Pre Issue decision making

• Generally any IPO decision making involves 3

aspects.

1) Strategic perspective
2) Financial perspective
3) Merchant banking perspective
 Strategic perspective
• Long term benefits of listing
• Does it help you to achieve strategic &
financial goals??
• Does your business model need listing??
 Financial perspective
• Fund requirement
• Are there other cheaper alternatives??
• Capital structuring
• Impact on key financial ratios.
 Merchant banking perspective
• Timing
• Issue pricing
• Issue structuring
 Timing
• Bull phase
• High business confidence
• Investor sentiments
• Market conditions
 Pricing
Generally MB use following method.
• Price to earning ratio(P/E Ratio)
• Price to book value ratio(M/B ratio)
 Pricing
P/E ratio.
The firm’s preceding 3 years average EPS
is taken.
The average P/E multiple for the industry is
taken.
2 approaches are adopted
a) Conservative pricing
b) Aggressive pricing
 Pricing- Example
FY 05-06 06-07 07-08

EPS 7 5 3

AVG EPS = 5
Generally we take wt. average. Assuming wt. as(0.2, 0.3,0.5)
Then EPS = (7*.2)+(5*0.3)+(3*0.5)= 6.5
 Pricing
P/E Highest Lowest Average
multiple for
the Industry

For Yr 3 30 10 15
 Pricing
• A) Conservative pricing- 11 * 6.5 = 71.5

• B) Aggressive pricing - 15*6.5 = 97.5

 Issue structuring
• Issue size
• Promoter’s quota
• Firm allotments
• Net public offer
• Face value, premium value
• Final offer price
• Minimum & maximum subscription