Lecture Retail and merchant banking – Lecture 31

The financial services sector is an important constituent of the financial system and plays a significant role in the realm of economic development of a country. Merchant Banking is a prominent component of the financial sector of our country.

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Revise Lecture 31

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• Merchant Banking

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Merchant Banking – An

Overview

• The financial services sector is an

important constituent of the financial

system and plays a significant role in the realm of economic development of a

country

• Merchant Banking is a prominent

component of the financial sector of our

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Overview

• In the U.S., investment bankers cater to

the needs of business enterprises carrying out merchant banking functions The main functions of merchant banking are the

following;

1. Corporate counselling

2. Project counselling

3. Pre-investment studies

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Overview

4 Capital restructuring

5 Credit syndication and project finance

6 Issue management and underwriting

7 Portfolio management

8 Working capital finance

9 Acceptance creat and bill discounting

10 Mergers, Amalgamations and takeovers

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Overview

11 Venture capital

12 Lease financing

13 Foreign currency finance

14 Fixed deposit broking

15 Mutual funds

16 Relief to sick industries

17 Project appraisal

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• Categories of Securities Issue

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Public Issue Management

• Corporate enterprise use several sources for raising funds from the capital market

• Issue of securities constitutes an important mode of raising such finances

• Security issues takes the following forms;

1. Public issue

2. Right issue

Private placement 8

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Public issue of securities:

• When capital funds are raised through the issue of a prospectus, it is called ‘public

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• The prospectus has to disclose all the

essential facts about the company to the prospective purchasers of the shares

• SECP insists on the adequacy of

disclosure of information that should serve

as the basis for investors to make a

decision about the investment of their

money

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Right issue:

• When shares are issued to the existing

shareholding of a company on a privileged basis, it is called as ‘Rights Issue’

• The existing shareholders have a

pre-emptive right to subscribe to the new issue

of shares

• Rights shares are offered as additional

issues by corporates to mop up further

capital funds 11

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• In this case, no prospectus is issued, since

it is presumed that the investors have

sufficient knowledge and experience and are capable of evaluating the risks of the investment 12

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• Private placement covers shares,

preference shares and debentures

• The role of financial intermediary, such as merchant bankers and lead managers,

assumes greater significance in private

placement

• They involve themselves in the task of

preparing an offer memorandum and

negotiating with investors 13

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• Issue Manager

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Issue Manager (Requirements)

The Issue manager needs to satisfy the

following requirements before being allowed

by the SECP to carry out various issue

management activities;

1. Adequate and necessary infrastructure

such as adequate office space,

equipments and manpower to effectively discharge activities

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Issue Manager (Requirements)

2 Minimum number of two persons

needed, who are professionally qualified

in Law, Finance or Banking management and have the experience to conduct the business of the merchant banker

3 Fulfilling the capital adequacy

requirements, i.e a minimum net worth of

Rs 5 crores

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• Categories of Issue managers

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Categories of Issue managers

• SECP has classified Issue managers into four categories as follows;

1 Merchant banker who is authorized to act

as issue manager, advisor, consultant,

underwriter and portfolio manager

2 Merchant banker who is authorized to act only as advisor, consultant, underwriter and portfolio manager

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Categories of Issue managers

3 Merchant banker who is authorized to act

as underwriter, advisor to an issue

4 Merchant banker who is authorized to act only as advisor or consultant to an issue

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• Role of Issue manager

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Role of Issue manager

The merchant banker as an issue

manager is helpful is the following ways;

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• Activities involved in public issue management

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Activities involved in public issue

management:

• The various activities involved in raising funds from the capital markets are the following;

Pre-issue Activities:

1. Signing of MoU

2. Obtaining appraisal note

3. Optimum capital structure 23

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management:

4 Convening meeting

5 Appointment of financial intermediary

6 Preparing documents

7 Due diligence certificate

8 Submission of offer document

9 Finalization of collection centres

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management:

10 Filing with RoC

11 Launching the issue

12 Promoter’s contribution

13 Issue closure

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Lecture 32

issues

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Marketing of New Issues

Methods of marketing securities:

• Following are the various methods being adopted by corporate entities for

marketing the securities in the New Issues Market;

1. Pure prospectus method

2. Offer for sale method

3. Private placement method

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Methods of marketing securities:

4 Initial public offers (IPOs) method

5 Right issue method

6 Bonus issue method

7 Book-building method

8 Stock option method

9 Bought-out deals method

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Pure prospectus method:

• The method whereby a corporate

enterprise mops up capital funds from the general public by means of an issue of a prospectus, is called ‘pure prospectus

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Advantages:

• The pure prospectus method of marketing the securities serves as an excellent mode

of disclosure of all the information

pertaining to the issue The method

promotes confidence of investors through transparency and non-discriminatory basis

of allotment

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Drawbacks:

1. High issue costs

2. Time consuming

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Offer for Sale method:

• Where the marketing of securities takes place through intermediaries, such as

issue houses, stockbrokers and others, it

is a case of ‘Offer for Sale Method’

• Under this method, the sale of securities takes place in two stages

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• First stage, the issuer company makes an en-block sale of securities to

intermediaries such as the issue houses and share brokers at an agreed price

• Second stage, the securities are re-sold to ultimate investors at a market-related

price The difference between the

purchase price and the issue price

constitutes ‘profit’ for the intermediaries.33

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Private Placement Method:

• A method of marketing of securities

whereby the issuer makes the offer of sale

to individuals and institutions privately

without the issue of a prospectus is known

as ‘Private Placement Method’

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Advantages:

1. Less expensive as various types of costs

associated with the issue are borne by

the issue houses and other

intermediaries

2. Placement of securities suits the

requirements of small companies

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Disadvantages:

1. Concentration of securities in a few

hands

2. Depriving the common investors of an

opportunity to subscribe to the issue, thus affecting their confidence level

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Initial Public Offer (IPO) Method:

• The public issue made by a corporate

entity for the first time in its life is called

‘Initial Public Offer’ (IPO)

• Under this method of marketing, securities are issued to successful applicants on the basis of the orders placed by them,

through their brokers

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Initial Public Offer (IPO) Method:

• The job of selling the stock is entrusted to

a popular intermediary, the underwriter

Advantage:

The biggest advantage of this method of

marketing of securities is that there is no

need for the investors to part with the money even before the shares are allotted in his

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Right Issue Method:

• Where the shares of an existing company are offered to its existing shareholders, it takes the form of ‘rights issue’

• Under this method, the existing company issues shares to its existing shareholders

in proportion to the number of shares

already held by them

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Advantages:

• Economy: Rights issue constitutes the

most economical method of raising fresh capital, as it involves no underwriting and brokerage costs

• Further, the expenses by way of

advertisement and administration, etc are

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Drawbacks:

Restrictive: The facility of rights issue is

available only to existing companies and not

to new companies

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Bonus Issues method:

• Where the accumulated reserves and

surplus of profits of a company are

converted into paid up capital, it takes the form of issue of ‘bonus shares’

• It merely implies capitalization of existing reserves and surplus of a company

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Bonus Issues method:

• Advantage:

1. It saves the company enormously of the

hassles of capital issue

2. The issue is free

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Book-building Method:

A method of marketing the shares of a

company whereby the quantum and the price of the securities to be issued will be decided on the basis of the ‘bids’ received from the prospective shareholders by the lead merchant bankers is known as ‘book-building method’

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• Under the book-building method, share

prices are determined on the basis of real demand for the shares at various price

levels in the market

• For discovering the price at which issue should be made, bids are invited from

prospectus investors from which the

demand at various price level is noted

The merchant bankers undertake full

responsibility for the issue

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Advantages:

1. Reduction in the duration between

allotment and listing

2. Reliable allotment procedure

3. Quick listing in stock exchange possible

4. No price manipulation as the price is

determined on the basis of the bids

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Stock Option or Employee Stock Option Scheme (ESOP):

• A method of marketing the securities of a company whereby its employees are

encouraged to take up shares and

subscribe to it is known as ‘stock option

• It is a voluntary scheme on the part of the company to encourage employees

participation in the company

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Stock Option or Employee Stock Option Scheme (ESOP):

• The scheme also offers an incentive to the employees to stay in the company

• The scheme is particularly useful in the

case of companies whose business

activity is dominantly based on the talent

of the employees, as in the case of

software industry

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Bought-out Deals:

A method of marketing of securities of a

body corporate whereby the promoters of an unlisted company make an outright sale of a chunk of equity shares to a single sponsor

or the lead sponsor is known as ‘bought-out deals’

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Bought-out Deals: Features:

1. Parties:

•. There are three parties involved in the

bought-out deals They are promoters of the company, sponsors and co-sponsors who are generally merchant bankers and investors

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2 Outright sale:

• Under this arrangement, there is an

outright sale of a chunk of equity shares to

a single sponsor or lead sponsor

3 Sale price:

• The sale price is finalized through

negotiations between the issuing company and the purchaser, the sale being

influenced by such factors as project

evaluation, promoters image and

reputation, current market sentiments,

prospects of off-loading these shares at a future date, etc

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5 Listing:

• The investor- sponsor make a profit, when

at future date, the shares get listed and

higher prices prevail Listing generally

takes place at a time when the company is performing well in terms of higher profits

and larger cash generations from projects

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