The equity and equity-linked new issues market in India has never been more diverse, and seldom, if ever, so well balanced. There will surely be some hiccups along the way, but the growth path seems sustainable —providing common sense prevails. Mark B Johnson reports.
India is not China. It is not producing China's seemingly perennial flow of multi-billion dollar IPOs and follow-on offers. But in the past few years India has emerged from being an also-ran in the region's new issues market to appear as a prominent player. The stock market has raced ahead, and so has the pace of equity and equity-linked issuance.
In the global debt markets, India's spreads are well inside the levels implied by its lowly rating. And the country's stock market, as measured by the BSE Sensex, trades at a price/earnings premium and a yield discount to the rest of Asia. Thanks to the surge in values since mid-2003, India's share of Asia's total market capitalisation has more than doubled from less than 5% in 2001 to nearly 11% today.
"Investors are increasingly comfortable with what they see and hear," says Gokul Laroia, Morgan Stanley's head of global capital markets for Asia Pacific in Hong Kong. "The country has an immense array of intelligent, eloquent people, the corporate governance is better than in many markets in the region, the regulatory environment is consistent and thorough, the banks are strong, companies are generally under-leveraged, and the markets are liquid. This all adds up to a country that is attracting more and more attention from global investors."
Set in a historic perspective, equity issuance from India so far this year has been outstanding, with a steady flow of IPOs, follow-on offers, disposals and equity-linked issues only partly satiating the growing demands of local and international investors for entry points to the market.
In March, private equity firm Warburg Pincus sold a 6% stake in Bharti Tele-Ventures, India's largest private mobile telephone company, to raise gross proceeds of about $560m through UBS. That deal was quickly followed by UTI Bank's $239m GDR sale, led by Citigroup and Merrill Lynch.
Banks to the fore
The banks have featured prominently in equity issuance in 2005. HDFC Bank raised $250m early in the year and then in March ICICI Bank, India's largest private sector bank, transferred $466m of stock to the American depositary receipt market in what became India's biggest ADR issue.
The American depositary receipt issue consisted of secondary shares, bought back from holders of the local stock in a tendering process and repackaged and then sold on at a premium in ADR format.
The deal, managed by the powerful triumvirate of Merrill Lynch, Morgan Stanley and UBS, was priced at parity to the existing ADRs and at a premium of 18% to the closing price of the locally traded shares on March 11.
The company had two objectives with the tender and resale. First, it should increase the liquidity of its ADRs by expanding their number by 24%, to around 27% of its equity.
Second, it increased the foreign holdings in ADR format while reducing the qualified foreign institutional investors' holdings of local shares. This is useful because foreigners can own up to 74% of an Indian bank's total equity, but only 49% of its local shares.
The buyback and resale as ADRs followed the template created in the landmark tender and resale for Infosys, the Indian IT and consulting business, in August 2003.
In May this year Infosys conducted a repeat exercise, but on a far larger scale than in 2003. India's second largest software services firm raised gross proceeds of $938m through Citigroup, Deutsche Bank, Goldman Sachs and UBS. This far eclipsed the smaller $322.5m Satyam Computer sale that had taken place a few weeks earlier.
The performance of the two Infosys transactions highlights the markedly improved sentiment towards India. In the 2003 sale the ADR premium contracted sharply and in this latest deal only slightly. Moreover, the compressed three day roadshow for the 2005 sale underscored how much easier it had become to sell the Indian growth story.
In the IPO sector, the $436m Jet Airways offer in early March was almost 19 times covered, generating a landslide of $8bn of demand. The deal was arranged by what seemed a surfeit of talent — Citigroup, Deutsche Bank, HSBC, Kotak Mahindra, Merrill and UBS.
A plethora of mainly domestic IPOs have been priced throughout the year, helping the new listings market surge to what should be a record this year.
One potential threat is that recent indications from the regulators might affect the DR market. Although market participants have not yet fully understood either the rules or the implications, it appears that DR issuance might be hampered by restrictive pricing rules.
And the recent regulations that require all Indian-incorporated companies to list first in India has put an end to international bankers' hopes that India could provide more Nasdaq IPOs.
The Indian equity-linked bond market is enjoying another banner year. Most of the excesses of early 2004 that caused secondary market prices to crash in May last year have been squeezed out of the system.
"The CB market has continued the remarkable activity levels it achieved in 2004 and there are a few more smaller deals in the pipeline before we expect the issue flow to slow down, going into 2006," reports Vedika Bhandarkar, managing director and head of investment banking at JP Morgan in Mumbai.
The combination of relatively low interest rates, rising stock prices, high conversion premiums and premium redemption structures has proved an appetising cocktail for the many large and smaller size issuers.
India has punched way beyond its weight in CBs, against the background of a sluggish global market for equity-linked issuance due to modest volatility and generally rising interest rates.
By September 23, there had been 30 CB issues totalling $2.54bn, according to Dealogic. By comparison, there were only about $150m of deals in each of 2002 and 2003, before the market burst into life with nearly $2.3bn of issuance in 2004.
In a typical deal for a mid-cap Indian company, JP Morgan sold $100m of convertible bonds for pharmaceutical and chemicals company Jubilant Organosys in early May.
The deal size of $100m represented nearly 18% of Jubilant's market capitalisation at that time and around 326 days of trading volume. The standard five year bonds (the legal minimum for CBs in India) were priced with a yield to maturity of 6.6%, based on a redemption price of 138.40 and a conversion premium of 50%.
|The largest Indian convertible bonds in 2005|
|Issuer||Announcement date||Amount ($m)||Maturity||Yield to maturity||Conversion premium||Books|
|Housing Development Finance Corp||24 Aug||500||27 Sep 2010||4.62||30%||ABN Amro Rothschild, Barclays Capital, Citigroup, JP Morgan|
|Tata Power Co||8 Feb||200||25 Feb 2010||3.91||50%||JP Morgan|
|Essar Oil||25 Jan||166||25 Jan 2018||7.04||31%||CLSA|
|Tata Chemicals||26 Jan||150||1 Feb 2010||4.80||50%||Citigroup, Deutsche Bank, Merrill Lynch|
|Sterling Biotech||8 Sep||140||30 Sep 2010||6.35||21%||Barclays Capital|
|Amtek Auto||26 Apr||125||26 Apr 2010||5.77||25%||Barclays Capital|
|Jaiprakash Associates||27 Jan||100||16 Feb 2010||6.06||33%||Barclays Capital|
Says Bhandarkar: "Such issues provide an opportunity to Indian companies, especially the mid-cap companies whose access to funds is relatively limited, to raise funds at attractive terms to finance their growth plans."
Achintya Mangla is head of JP Morgan's equity-linked business for Asia. "The Indian CB market is a great example of convertible bonds providing issuers with the perfect growth capital," he observes. "For investors, it is a nice way to get defensive exposure to a market with enormous growth but also one which is still illiquid and volatile."
He continues: "The development of this market has also been facilitated in part by the rapid development of the credit linked note or asset swap market. Indian banks have moved fast to capitalise on this new opportunity to enlarge their assets and get a yield advantage over regular loans."
Barclays Capital, arriving late to the Indian equity-linked party, has been making up for lost time. Having started originating deals only this year, the bank had by the second week of September completed six convertible bond issues, raising $1bn, and had more in the pipeline.
"We have made this market one of our key focus areas in Asia and we intend to build on this success," says Doug Decker, head of convertible bond origination at Barclays Capital in London.
The Indian CB market has benefited this year from a largely sane approach to pricing. The new issues have on the whole confirmed a trend for lower conversion premiums as investors have become more selective over the types of structures in which they will invest.
"Conversion premiums have dropped from the 50% to 70% levels earlier this year to a more comfortable 20% to 40%," says Decker.
Of late, deals have also begun to offer a modest positive coupon to complement the healthy yield to maturity that Indian CBs generally offer through the premium redemption structure.
"What this all means is that the subsidy provided by the option to the overall pricing structure is now greater than it was before," Decker concludes.
This general trend towards more rational pricing was borne out in the first week of September with the $140m issue Barcap arranged for Sterling Biotech. The issuer is paying a coupon of 50bp a year, a yield to maturity of 6.45% and a premium of 24% to the closing price.
Decker also notes that the reset feature is now more prevalent. "The resets that we see nowadays are effectively credit mitigants. If the stock price goes down, the conversion price will follow, at least to the conversion price floor," he says. "That increases the probability of conversion and therefore reduces the exposure to credit risk. The reset has come into India during the past year and offers a lot of value to investors."
A move from euphoria to sound optimism is how Mangla views the evolution of pricing. He recalls how in late 2003 and early 2004 investors were addled with the opportunity to buy into India through the CB market, and were willing to take outright fundamental views and price the options at a premium to historical volatility.
But that came to an end with the sharp correction around May 2004. In the months that followed, volatility fell off as the market recovered gradually and the issues that had been sold in the first few months of 2004 continued to trade well below par.
By October last year, when Indian issuers again ventured forth, investors had become more cautious, demanding fairer valuations, at only a slight premium to the rest of the region.
From the issuer's perspective, the good news was that a more mature credit market had developed that offered credit protection and much tighter credit levels. This has, to some extent, mitigated the impact of lower CB pricing. And the market is also open to a far broader array of issuers, from large corporations to mid-cap stocks of $400m and below.