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Investment Banking

Non-Fund based Merchant Banking Services for : Management of Public offers of equity/debt instruments Open offers under takeover code. Buy-back / Delisting offers Advisory and Transaction services in : Project Financing Syndicated Loans / Structured finance products

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Investment Banking

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  1. Non-Fund based Merchant Banking Services for: Management of Public offers of equity/debt instruments Open offers under takeover code. Buy-back / Delisting offers Advisory and Transaction services in: Project Financing Syndicated Loans / Structured finance products Venture capital / private equity Private placement of debt / equity Business advisory / financial restructuring Corporate Re-organisation such as M & A demergers, hire off asset sell off Govt. disinvestments & Privatisation Fund based Underwriting Market making Investments in Primary markets Investment Banking

  2. Regulatory & Statutory Authorities • Department of company affairs • SEBI • Department of economic affairs • Reserve Bank of India • Stock Exchange Boards • Central board of Direct Taxes • Central board of Excise & Customs • SFIO • Enforcements Directorate

  3. SEBI – Market regulator • SEBI was incorporated in April 1988 with an objective to act as a regulatory for capital markets. • Functions: • a. Investor protection : to ensure steady flow of savings in the capital mkts. • b. Ensuring fair practices by issuers of securities. • c. Promotion of efficient services by brokers, merchant bankers and other intermediaries.

  4. SEBI Guidelines • Influences raising of capital • Issuer status • Initial Public Offering : Treasury issue / offer for sale • Composite issues. • Deployment of issue proceeds. • Lock in period • Preferential offers brought under purview

  5. Equity capital to be greater than Rs. 10 crores for listing on • BSE / NSE and Rs. 5 crores for other exchanges & conformity with other listing guidelines • At least 25% to be offered to public by way of a prospectus to be in conformity with listing guidelines. • Book building / Private placement allowed. • Debt : Equity : Normally 2:1, relaxed in capital intensive projects. • Offer for Sale : IPO / Secondary Public Offer • Disclosures in offer document.

  6. Norms for issuance of capital • Public issue by Unlisted Companies: • No unlisted company shall make a public issue unless the company has : • IPO’s of issue size up to 5 times the pre-issue net worth can be allowed only if the company has a track record of distributable profits in terms of section 205 of companies act, for at least three out of the immediately preceding five years.For issue size greater than 5 times net worth book building mandatory • A pre issue Net worth of at least Rupees One crore in at least three out of the preceding five years with the minimum requirement to be met for the immediately preceding two years.

  7. An unlisted company which does not satisfy the above conditions can make a public issue provided a Public Financial Institution or a Scheduled commercial bank : • Has appraised the project and has financed at least 10% of the cost of the project by way of Equity / Debt. • Book building made mandatory in respect of IPO’s without track record including the stipulation that 60% to be alloted to QIB’s • The appraising Bank / Institution brings in the money at least one day before the opening of the public issue. • Minimum level of public offering has to be at least 10% of post issue capital.

  8. PRICING OF SECURITIES BY COMPANIES • Companies eligible to make Public Issues can freely price their securities. • Differential Pricing : Allotments made to firm category must be at a price higher than that made to open public category.

  9. Public Issue By Listed Companies • A Listed Company shall be eligible to make a public issue if as a result of the proposed issue Net worth of the Company becomes more than Five times the Net worth prior to the Issue. And also the Company satisfies the conditions as applicable to an Unlisted Company pertaining to track record of distributable dividends as per sec 205 of companies act. • Free pricing to be determined by lead managers. • The above guidelines are not applicable to : • Banks / NBFC’s • Infrastructure Projects

  10. Methodologies for making issues • 100% Retail (Fixed price) Issue • Book Built (Price discovery) Issue • Floor price fixation • Cap not more than 20% of floor price • Book running lead manager • Updation of bids on real time basis during biding period • Red Herring prospectus • Allocation / reservation for institutional / QIB’s

  11. Guidelines for Debt Securities Creation of a Debenture redemption reserve mandatory in the event maturity in excess of 18 months.DRR aggregating to 50% of the issue price to be created before redemption commences. Creation of charge within 6 months Conversion of Instruments : - Conversion at the option of the investor if conversion terms not specified at issuance time. - FCD’s with conversion periods greater than 36 months shall give put and call options to the investors. - If conversion is between 18 and 36 months conversion at the option of the investor.

  12. Other regulations • Credit Rating of Debt Instruments mandatory irrespective of maturity or conversion terms.For debt securities greater than Rs 100 crs credit rating from two agencies mandatory. • All credit ratings obtained in the last 3 years shall be disclosed in the offer document. • Outstanding warrants or financial Instruments would get the same rights / benefits . • All partly paid up shares shall be made fully paid up / forfeited before a public issue. • Interest rates & terms of conversion freely determined

  13. Pre Issue Obligations • Lead Merchant Banker shall exercise due-diligence • Inter - se allocation of responsibilities • Appointment of intermediaries • Underwriter’s ability to discharge obligations • Offer document to be made public • Appointment of compliance officer • Press advertisements • Agreements with depositories • Additional disclosures regarding Khoka buy back,security etc

  14. Promoters contribution &Lock in arrangements • In a public issue by an unlisted company the promoters contribution shall be at least 20% of the post issue capital. • In a public issue by a listed company the promoters shall participate either to the extent of 20% of the proposed issue or ensure post-issue holding of 20%. • In case of any issue to the public promoters equity upto 20% will be locked in for a period of 3 years from the date of the public issue or the date of commencement of commercial production which ever is later.. • In case of public issue by an unlisted company promoters holding in excess of 20% will be locked in for 1 year. • Locked in securities can only be pledged with banks & FI’s as collateral's for loans given to the company.

  15. DISCLOSURES IN OFFER DOCUMENT • Minimum Subscription Clause • Issue Schedule • Intermediaries and Auditors • Credit Rating • Underwriting of the issue • Capital Structure of the Company • Details of major shareholders • Terms of Issue • Utilisation of Issue proceeds

  16. Project cost & Means of Financing • Company,Management,project details • Plant,Machinery,Process & Technology • Collaborations,Performance guarantees etc. • Products & Services,Capacity & Future prospects • Stock market data,Past prices,Bonuses etc. • Financials of group companies • Basis of issue pricing • Past Financial data

  17. Foreign Direct Investments • Inward Investments : • FIPB & Automatic approval routes • Exemptions for SEZ’s • RBI delegated to sanction under automatic fresh ECB’s up to$400 million with interest cap of : Libor + for normal projects Libor + for infrastructure Repayment beyond 8 years. • RBI delegated authority to approve pre-payments if met from offshore issuance of equity. • Outward FDI up to 3 times the network under automatic approval route. • Inward FDI in secondary markets and real estate regulated.

  18. Structured Financial Products • R u p e e c o n v e r t i b i l i t y • C o s t d r i v e n e c o n o m y • E c o n o m i e s o f s c a l e • I n t e r e s t r a t e v o l a t i l i t y • B u y - b a c k o p t i on • R i s k A s s i g n e m e n t

  19. Transaction costs and phasing out of intermediaries • Partial convertibility of currency thereby opening accesses to offshore financing • Tax asymmetries that can produce tax savings for the issuer, investors or both • Opportunities to reduce or reallocate risk • . Volatile inflation indexed interest rates • Better understanding of risk-return characteristics of existing • Investor wish list. • Make debt attractive by offering sweeteners.

  20. Structured financing Instruments • * Equity shares with differential voting rights • (limited to 25% of issued capital) • * External commercial borrowings & Depository receipts • Non Voting shares. • Multiple option debentures / SPN’s • Exchangeables • Deep discount bonds. • Floating rate notes • Rupee enhanced structured bonds • Zero coupon bonds • NCD with tradable warrant. • * Derivative linked bonds.

  21. Offshore financing • Rupee convertibility on current account • Low cost borrowings • Large avenues of funds with low flotation cost . • Elimination of licensing has resulted in large size projects which need low cost means of financing. to ensure project viability • In FCCB’s / GDR’s company’s issue rupee denominated instruments and hence do not carry foreign exchange risk

  22. No voting rights thereby does not result in dilution of control • Flexibility in tax planning • Lower tax rates on dividends/ interest rates • Reduces wt. av. cost of capital • No lock in period for GDR’s • Improves credibility of the issuer due to international due diligence • Risk of foreign exchange fluctuations • Ideal source for companies with a natural hedge

  23. ECB’s • Swapping of ECB’s with other corporate loans disallowed. • Priority to infrastructure projects. • GOI approval for issue size beyond $400 million • Funds to be utilised for financing imports and to be parked offshore till point of usage. • Remain as debt throughout the life of the instrument. • Average life to be 8 years. • Interest rate ceiling of Libor + 200 basis points.

  24. Depository receipts • Depository receipts are negotiable certificates that represent company’s publicly traded equity. • Can be quoted on any international exchange. • Company’s could directly issues GDR’S or by conversion of FCCB’s. • Indian company will issue shares to custodian in India who will inturn instruct foreign depository to issue receipts which can be traded since Indian stocks cannot be traded on international exchanges. • Provides international investor with settlement in his local exchange. • Investor can convert GDR’s into a fixed number of equity shares at any time. • Depositary receipts have no voting rights. • Trading of depositary receipts outside India will not attract tax liability in India.

  25. FCCB’s • ‘ Put’ option to investor and ‘call’ option to “company”. • In the event FCCB is used to part finance project cost then “put” option would normally not be given during the gestation period. • Interest : Libor based (depending on conversion rate) with a cap of 150 basis points over Libor

  26. Deep discount bonds • * Zero coupon bond • * Redeemed at face value • Bond structure : • Deep discount bond has a face value of Rs. 1,00,000/-. It was issued at a discounted price of Rs. 2,700/- with a maturity period of 25 years. withdrawal / redemption Deemed face value • At the end of 5 years Rs. 5,700/- • At the end of 10 years Rs.12,000/- • At the end of 15 years Rs. 25,000/- • At the end of 20 years Rs. 50,000/- • Taxed at 10% under 54 E / Non availability of indexation benefit

  27. Basis of evaluation • Redemption / Investors Cost to • withdrawal yield the company • ----------------------- ----------------- ------------- • AFTER 5 YEARS 13.56% 16.11% • AFTER 10 YEARS 14.15% 16.00% • AFTER 15 YEARS 14.49% 15.99% • AFTER 20 YEARS 4.51% 15.71% • ON MATURITY 14.54% 15.54%

  28. Optional convertible debentures • Issuer :Reliance petroleum Limited. • Terms of the TOCD: • - Face value - Rs. 60/- • - Part A - Rs. 20/- • - Part B - Rs. 40/- • Part ‘A’ Convertible into 2 equity shares at par Part ‘B’ Non convertible portion • - Investor will receive two warrants per debentures to be called after 48 months.

  29. CONVERSION TERMS FOR PART A • - 1Equity share of Rs.10/- at par on allotment • - 1 Equity share of Rs. 10/- at par 18 months • from the date of allotment. • No interest on the part ‘B’ of the TOCD for • the first 5 years.

  30. REEDEMPTION OF PART ‘B’ OF RS. 40/- • PRINCIPAL INTEREST TOTAL • 6TH YEAR 10 10 20 • 7TH YEAR 15 15 30 • 8TH YEAR 15 15 30 • -------- • 80 • -------- • Warrants: • Two freely tradable warrants entitling the holder of the warrant to one equity share per warrant at Rs 20/-.

  31. Options avaliable OPTION I : a) Retain the non convertible portion till maturity. b) Sell warrants in the market. OPTION II : a) Surrender the non convertible portion and get two equity shares. b) Surrender the warrants and get 2 equity shares by paying Rs 20/- per warrant. OPTION III : a) Retain the non convertible portion till maturity. b) Surrender warrants receive 2 equity shares at Rs. 20

  32. Assumptions • In all options the two initial equity shares that the investor gets from part ‘A’ are held by him & do not receive dividend. • The IRR to the investor & cost of capital to the company will be affected by the dividend policy. • If shares received from part ‘A’ are sold in this time period, the IRR to the investor will be higher depending on the time & price. • - Assumes no servicing cost for premium collected.

  33. Advantages of the structure • - Investor • Equity portion allows high capital appreciation & participation in profits. • Debt part allows returns at a reasonable yield if equity returns are marginal. • Warrants allow entitlement to further equity at investors option. • - Company • Would reduce interest during construction period for projects with large gestation periods. • Warrants add attraction to the instrument. • Low cost of instrument. • No servicing cost for 5 years.

  34. Assumes market price of Rs. 45/- per share for analysis. • Option I : • Cash flow (from investor’s point of view) • Year 1 2 3 4* 5 6 7 • cash • flow -20 -10 -30 • 50 17 25.5 25.5 • ** (2x20 = Rs. 40/- cost of warrants) • IRR = 16%

  35. Cash flow (from company point of view) • Year 1 2 3 4 5 6 7 • Cash • Flow 20 10 30 • +40 -20 -30 -30 • Cost of capital = 3% • Option II • Cash flow (investor) • year 1 2 3 4 5 6 7 • Cash -20 -10 -30 -40 • Flow 100 * - - - - • IRR = 26% • * 4 equity shares sold at rs. 25/- each

  36. Cash flows (company) • Year 0 1 2 3 4 5 6 7 8 • Cash +20 +10 +30 +40 • Flow • COC = negative (if one assumes funds collected are • reinvested on short term basis) • Option III • Cash flow (investor) • Year 1 2 3 4 5 6 7 • Cash -20 -10 -30 -40 • Flow 50 17 25.5 25.5 • IRR = 17% • Cash flow (company) • (same as option I)

  37. Enhanced structure bond • Local currency agency structured bond to cover imported Equipments with Rupee financing solution with limited foreign exposure risk • Multi laterals / Bilateral provide guarantees for investments from OECD countries to Emerging markets. • Credit enhancement by way of partial guarantees with more underlying flexibility in the structuring of the instrument. • Key advantage is not tying to any specific country as done by Export credit agencies like Exam banks etc. • Rupee credit enhanced structured bond is estimated to be atleast 200 to 250 basis points cheaper than Indian FI debt

  38. Potential Credit Enhancers • ECAs provide term funding linked to import of capital goods as well as equity investments from OECD countries to emerging markets.Attractive financing can be achieved by utilising gurantees and / or subsidies. • Local bond / Debenture issuance denominated in local currency backed by credit enhancement by an ECA / Agency. • Borrower has a rupee currency obligation for the door to door tenure, except in the event of default. • Investor base includes local banks,mutual funds and insurance companies. • Credit enhancement leads to an improved rating

  39. Local currency agency enhanced bonds • Diversification of funding and credit base • Long tenor upto 10 year door to door • Matches project periods with debt maturities • Stable capital structure and forex risk is a contingent risk • Increased visibility / profile in local bond market • Various categories of investors may offer “tenor buckets”, the issue could be structured with tranches of varying maturities.( “STRIPS” ) • Secured by charge on fixed assets and colaterals such as Pledge of shares etc.

  40. Factors to be considered • Macro economic stability: interest,inflation and exchange rate • Capital markets liquidity and distribution of securities • Pricing bench marks: Deep and liquid Govt bonds can act as fundamentals for corporate bonds as they provide low risk pricing bench marks. • Legal and infrastructural frame work such as securities law,bankruptcy process,settlement process. • Size of government local bond issuance and avaliability of local credit rating agencies

  41. Transaction cost calculation

  42. Secured premium notes • Instrument details • Face value -Rs. 300/- to be fully called in 12 to 18 months from allotment. • An attached warrant which will entitle the holder of the warrant to get one equity share of Rs. 10/- at a premium of Rs. 70/-. • An SPN holder is not entitled to interest for the first three years. • The face value of each SPN will be redeemed over 4 instalments of Rs. 150 each ( Rs. 75/- as principal repayment and Rs. 75/- as additional sum towards interest & redemption premium).

  43. Analysis • OPTION I : • SPN holder does not exercise the warrant • Year 1 2 3 4 5 6 7 • Outflow (150) (150) • Inflow • Cap. repayment 75 75 75 75 • Redemption premium 18.75 18.75 18.75 18.75 • Cap. gains tax (3.75) (3.75) (3.75) (3.75) • @20% • Interest 56.25 56.25 56.25 56.25 • Tax on int @30% (16.875)(16.875)(16.875)(16.875) • Net flow (150) (150) 129.375 129.875 129.875 129.875 • IRR = 15.10% (pretax) / 11.66 % (post tax )

  44. OPTION II : • SPN holder exercises the warrant and sells the shares or sells off the warrant • year 1 2 3 4 5 6 • outflow 150 35.5 • inflow(pretax) 150 150 150 150 • (post tax) 129 129 129 129 • IRR = 24.41% pretax • 21.81% post tax

  45. Company cash flows • Year 1 2 3 4 5 6 7 • Inflow 150 150 • Outflow • Cap repayment 75 75 75 75 • Redn. premium 18.75 18.75 18.75 18.75 • Interest 56.25 56.25 56.25 56.25 • Tax shield 37.5 37.5 37.5 37.5 • Net flow 150 150 (112.5)(112.5)(112.5) (112.5) • Cost of capital (post tax) = 8.25%

  46. Sale proceeds to investors Rs. 194.50 • (value of Tisco share ) • Less warrant premium Rs. 80.00 • -------------- • Net proceeds Rs. 114.00 • -------------- • Outflow of 2nd call Rs. 150. -------------- • Net flow (35.50)

  47. Warrants • Warrant - a call option from a company permitting the debenture holder to buy a certain no. of shares at a specified price. • Characteristics of warrants • Exercise price • Exercise ratio • Expiration date • Detachability • * Investor receives fixed interest return and capital gains due to shares • Lower coupon rate could be offered by companies. • Excersing of a warrant has dilution effect

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