Tuesday, 18 December 2018

Becoming smarter

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The equity capital markets have come under intense scrutiny after a series of big public sector follow-ons and IPOs at the start of the year. After a string of disappointments, has India finally found the right formula?

State divestments have dominated India’s primary equity capital markets in 2010, with the government raising Rs220bn (US$4.7bn) from share placements in the first three months of 2010.

The scale of the fundraising highlighted the depth of demand among global investors for emerging market assets, but the exercise also revealed a rare degree of flexibility on the part of the government. Bankers now see few obstacles in the government’s path as it looks to raise about US$9bn in the fiscal year ending March 2011.

“The success of the divestment programme so far has simply been because of the variety of the offerings,” said one senior banker. “You look at the list and there are large and small-cap companies which are all in leading positions in their business space. This caters to varied investor appetites, generating strong interest and helping the government meet its fundraising goals.”

The first divestments that came through in the first quarter of 2010, however, were not very successful - in the sense they were not widely sold and attracted next to no retail participation. Last-minute scrambling and a strong domestic institutional bid - mainly from state-owned investors -helped some deals get across the line, notably the US$2bn follow-on public offering of mining company NMDC in March.

What also helped was a rare display of flexibility by the Indian Government, which put in place a series of measures designed to ease the progress of the stake sales. At the start of the year, the path to market was kept clear for the divestments by market regulator Securities and Exchange Board of India, which prioritised approvals for state selldowns over other IPO or follow-on offer candidates.

The early deals attracted criticism that the government was pushing for too high a price, not paying enough to its bookrunners, as well as for the unusual structure of the offerings.

In the first three stake sales completed earlier in 2010, the government paid next to nothing in fees to its bookrunners. The government paid out a mere Rs104m (US$2.3m) against the Rs219.6bn it raised through selldowns in National Thermal Power Corp, Rural Electrification Corp and NMDC earlier in 2010. The fees paid translate to an average of 0.04% shared between the 15 banks that ran the books on the three offerings.

Those deals failed to attract wide distribution and were shunned by retail investors, prompting suggestions that bookrunners had no incentive to vigorously market the deals and simply add to their losses on the deal.

Instead of ignoring that criticism, the Indian Government looked to resolve each of the main concerns proactively - a welcome change from the notoriously bureaucratic country.

The French auction process was blamed for the lack of retail interest on the NTPC public offering, so the government changed tack on its sale of shares in REC. The modifications to the institutional bidding process under the auction method led to a better response from foreign investors.

By the time it came to the NMDC follow-on public offering, the government had abandoned the French auction method altogether and instead sold shares through a more traditional bookbuilding process.

The other stake sales in Satluj Jal Vidyut Nigam and Engineers India that followed stuck with the traditional bookbuilding structure.

The government has also tweaked the mandate process in response to criticism that it was offering fees that were too low. The request for proposals sent out in early May ahead of Coal India’s up to US$3.4bn IPO specified that the financial elements of a bid would have a low weighting of 30%, versus a 70% weighting for technical elements - a clear departure from past practice.

Coal India’s IPO will be the biggest divestment planned for 2010, and the government was keen to avoid any negative noise around the high-profile mandate. Arrangers pitching for the deal were invited first to present to ministers in New Delhi in May, before a shortlist was announced based on those presentations. The financial bidding, which spells out the fees the arrangers will charge, only opened once that shortlist was already completed.

That showed a greater focus on technical expertise, including research capabilities, global presence and distribution, local presence, commitment to India and retail distribution strength, marketing strategy and post-issue market support.

But even that did not stop banks from tabling incredibly aggressive bids. In the end final fees were an astonishing 0.000001% of the deal - a sign that banks remain happy to do deals at any price in return for profile and league table position. Any earlier criticism directed at the government for the low fees on offer should have been at the banks themselves.

Bank of America Merrill Lynch, Citigroup, Deutsche Bank, Enam, Kotak Mahindra and Morgan Stanley will run the books on Coal India’s float.

Anchors away

The government has also decided to allow anchor investors to participate in the Coal India float - a decision that is being hailed as a big boost for a deal that may become the biggest Indian IPO on record.

“It will be the first state-run IPO to be sold to anchor investors, which shows the government is willing to adopt market practices and wants to achieve the broadest possible distribution with its stake sales,” said one banker.

The government had earlier ruled out anchor tranches in public sector floats as it was worried it would be seen as giving preferential treatment to certain investors over others. The size of the deal and desire to capture a growing institutional bid for emerging market paper is said to be behind the latest decision.

Coal India’s deal will rival the US$2.5bn 2008 listing of Reliance Power as the country’s biggest float on record, making it an important benchmark for India’s fickle IPO market.

Bankers expect interest in Coal India’s stock to be huge as there are no listed peers in the sector and it offers investors a direct play on the India infrastructure development story. However, pricing will be crucial as the deal is expected to have a big impact on sentiment towards future Indian listings.

The last jumbo IPO, that of Reliance Power in January 2008, was hugely oversubscribed, but investor sentiment died after it traded poorly in the secondary market.

“This deal, irrespective of the size, is likely to be a huge sell-out provided the government leaves some value on the table,” said one banker. Different valuation levels are currently being banded about, with some bankers proffering an enterprise value of eight to nine times Ebitda. That will give the company a total equity value of US$28bn-$34bn. A 10% sale of that will bring the government about US$2.8bn-US$3.4bn. Expectations are that the deal will launch sometime around October 18-20 and the share price on offer will be upwards of Rs200.

Bankers are expecting pricing to be realistic, given that the government has managed to generate huge interest in recent divestments by simply pricing some of the deals near market-demanded levels, noted bankers.

Engineers India’s FPO, which HSBC, IDFC, ICICI Securities and SBI Capital Markets led, raised Rs9.86bn after pricing at the top of the Rs270-Rs290 range. The stock is now trading around Rs326. Engineers India’s follow-on also received a total of 168,000 retail applications, giving it the broadest distribution of any divestment completed this year.

Coming up are a series of jumbo stake sales in Hindustan Copper, Power Grid, Steel Authority of India and Shipping Corp of India. All of them follow the newly devised mandate bidding system and the traditional bookbuilding process. Fee levels are still low relative to the levels seen in China, US and European markets though they are inching up on some deals.

The Indian Government will be paying slightly higher fees on the up to US$1bn state divestment in Hindustan Copper. Enam, ICICI Securities, Kotak Mahindra, SBI Capital and UBS were mandated for the deal, which is expected to be launched into the markets in September/October.

Bankers said fee levels were fixed at 0.48% after bids had ranged from 0.48% to 1.2%.

Shipping Corp of India has mandated ICICI Securities, IDFC Capital and SBI Capital for its IPO of up to US$300m, expected to hit the markets later this year and it is said to be paying about 0.25% in fees.

Over-aggressive bidding, however, remains a feature of the public sector equity market. The government chose Goldman Sachs, ICICI Securities, JP Morgan and SBI Caps for Power Grid Corp’s FPO of up to US$1.8bn after a total of 17 banks had bid for the deal, and the lowest fee bid for the mandate was said to be a mere 0.00000001%.

At the time of writing, around 15 banks had pitched for the follow-on public offer of Steel Authority of India (SAIL). They will make presentations between August 30 and September 1 before the government chooses the final six bookrunners for a deal that is estimated at up to Rs83.2bn (US$1.8bn). As usual, banks are said to have pitched close to zero fees.

Shankar Ramakrishnan

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