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Monday, 27 June 2011

Seems to be the moment of reckoning for local broking firms

During the bull market of 2007-08, Japan's Nomura was widely tipped to acquire Enam for USD 1 billion. In November last year, Enam eventually sold its investment banking and equity businesses to Axis Bank for Rs 2067 crore (roughly USD 460 million). At that time, many felt it was a big come down for the Enam promoters, having had to settle for less than half the valuation it was said to command some three years ago. But eight months on, it appears as though Enam founders Vallabh Bhansali and Nemish Shah could not have hoped for a better timing to the deal.
Promoters of quite a few domestic brokerages are said to be doing the rounds of banks and private equity firms, hoping to sell a strategic stake to them, or even the entire business. And despite most of these firms available at less than the book value, buyers are not forthcoming. And in cases where they have shown interest, the bids are way below what the brokerages are quoting.
Over the weekend, Rakesh Jhunjhunwala-promoted Alchemy Group closed down its institutional broking business, which gets its revenues from executing share trades for foreign and domestic institutional investors.
Market buzz is that Alchemy was in talks to sell the business to a foreign brokerage which had acquired a leading retail broking chain some years back. But the parties could not reach a mutually agreeable price, and the business had to be shuttered.
Likewise, most domestic brokerages with an institutional broking division have been feeling the heat for a while now. Some of the listed entities are hanging on, because of deeper pockets compared to many of their weaker rivals, and also in the hope that there will be less competition when things start looking. But many brokerages are unlikely to survive the current downturn in the market.
And even some of the large listed players are trying to figure out ways to have a meaningful presence in the institutional broking business. That is because the institutional broking pie has not grown in the last four years, and competition from foreign firms has been fierce.
Have a look at these numbers. In calendar 2007—the peak of the bull run—gross purchases and sales of Indian shares by foreign funds totaled over Rs 15.39 lakh crore, with net inflows being around USD 15 billion.
Brokerages make a commission of anywhere between 0.20-0.35% on a cash market transaction, and barely 0.01% on an equity derivative trade.
In 2010, foreign funds net invested a record USD 30 billion into Indian shares, but the gross turnover (purchase + sales) was Rs 14.94 lakh crore, lower than what it was in 2007.
Similar was the trend in gross mutual fund transactions. In 2007, gross turnover of local mutual funds was Rs 3.6 lakh crore. In 2010, that figure was 3.47 lakh crore.
Calendar year
FII gross turnover       (Rs crore)
MF gross turnover (Rs crore)
Till Jun 23,  2011

Undoubtedly, that is bad news for the broking firms, which have seen their cost structures rising during this period, and the entry of new foreign players.
In 2007, it was felt that domestic brokerages had finally come into their own, after having played second fiddle to their foreign rivals for many years.
Players like Motilal Oswal Securities, IIFL (formerly India Infoline) and Edelweiss Capital raised capital through initial offerings, and were able to hire the best of talent through a combination of competitive salaries and stock options. IIFL set the benchmark when it hired four senior level executives from foreign brokerage CLSA for a compensation package till then unheard among local broking firms.
Some of the unlisted players like Anand Rathi and Antique Stock Broking too were able to attract staff from foreign broking houses by paying handsome bonuses and sweat equity.
Many market experts had predicted that foreign brokerages would eventually be marginalised, as they would lose talent to their domestic rivals.  Also, raising capital was no longer a hurdle for local brokerages. The listed ones could raise money through institutional investors, and there were plenty of private equity investors wanting to invest in the unlisted players.
But the scene has dramatically changed now. Domestic brokerages have managed to retain their key personnel, but are in constant fear of losing them to aggressive foreign brokerages desperate to flag off operations in India. Sagging share prices means it is no longer to hire senior executives with stock options as the carrot.
Raising capital is no longer easy, for both listed and unlisted players. And it is difficult to have a meaningful presence in the institutional broking space without a strong balance sheet. After all, the ability to do large trades depends on the balance sheet size, as it would mean having to deposit bigger margins with the stock exchanges. Besides, the foreign funds have to be convinced that the brokerage has financial muscle to be trusted with large transactions, the payments for which will be made only after the trade is executed.
The bigger players will survive this downturn, like they have survived similar ones earlier. But whether they will emerge in the same form as before is the key question.

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