Another pure-play investment bank bites the dust

Another pure-play investment bank bites the dust

Enam Securities Pvt. Ltd has agreed to hive off its investment banking, institutional and retail equities broking business and the distribution of financial products to a wholly owned subsidiary of Axis Bank Ltd.

Globally, after the financial crisis, major stand-alone investment banks went bankrupt were merged into commercial banks or transformed themselves into bank holding companies. Back home, Kotak Mahindra, which in its original form was a major investment banking and broking firm, transformed into a banking firm after the central bank granted it a licence. SSKI Securities got sold to infrastructure finance firm Infrastructure Development Finance Co. Ltd.

Also See Increasing Competition (Graphic)

A reason could be that the agency business has become extremely competitive, with yields narrowing with increasing competition. Besides, yields in the broking business have been falling because of an increasing proportion of derivatives trading vis-à-vis cash market trading.

And within the derivatives segment, the proportion of options trading has risen. Options constituted 63% of total market turnover in the recently concluded September quarter, compared with 10-11% less than three years ago.

Agency commission is substantially lower in this segment, since the broking fee is charged only on the option premium. For this reason, shares of Indian broking firms are still languishing way below their peaks in early 2008.

Of course, Enam is also a strong player in the investment banking space—it has the second largest market share in the equity IPO underwriter business in the past two years, according to Bloomberg League Table data. But again, competition in this space is leading to minimal commissions being charged in this segment—especially for large government IPOs.

But this is not to say that firms such as Enam are in dire straits. In the period between April and mid-October 2010, Enam’s to-be hived-off business reported annualized revenue of 330 crore, 36% higher than the revenue in FY10. It also managed a healthy pre-tax margin of 42%, higher than the FY10 margin of 38%.

But, while results look healthy, it makes sense to partner with a commercial bank, and gain from the balance sheet strength of Axis Bank. Besides, the two firms share commonality with respect to client profile, and should be able to drive synergies after coming together.

From the perspective of Enam’s shareholders (just four individuals), the deal has been structured in an interesting way, such that they are doing away with the agency part of the business, while retaining the portfolio management business, where yields are higher. Even for this relatively less lucrative part of their business, they have eked out a decent deal, with the business being valued at around 21 times annualized earnings for the April-October period. This is based on the assumption that the company pays tax at the rate of 30%, like most financial services firms.

Broking firms such as India Infoline Ltd, Edelweiss Capital Ltd and Motilal Oswal Financial Services Ltd trade at between 16-17 times estimated earnings for FY11, according to Prabhudas Lilladher Pvt. Ltd’s estimates.

From Axis’s point of view, the premium seems well justified, considering that it is getting its hands on an established franchise along with its top management and personnel. Besides, the dilution in its equity base is just 3.3% and there is no cash outflow—based on the annualized earnings and expected equity expansion, the dilution in earnings per share will only be marginal.

Graphic by Yogesh Kumar/Mint

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