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May 30, 2008

Deal Analysis: HSBC’s acquisition of retail broking firm IL&FS Investsmart

By Girirajan. M & Pawan Kumar. R; Venture Intelligence

Deal Summary. HSBC has entered into agreements to acquire stakes held by Promoters - E*Trade (43.85%) and IL&FS (29.36%) - in IL&FS Investsmart Limited (IIL), a publicly listed retail brokerage. The offer, at Rs. 200/share, values IIL at $330 million. In addition, IL&FS is to be paid an additional $19 million as part of a three year non-compete agreement. HSBC is also in the process of making an open offer for additional 20% stake as per Indian securities laws.

About IIL.
IIL was founded in October 1997 as a subsidiary of Infrastructure Leasing & Financial Services (IL&FS) to focus on capital market related activities. It currently has almost 1.4 lakh customers across 133 cities and towns across India. The company went public in July 2005.

In November 2004, Private Equity firm SAIF Partners and US-based online broking firm E*Trade had picked up a combined 34% stake in IIL by investing $14.2 million. (Incidentally, SAIF’s parent firm – the Japan-based SoftBank - was one of the earliest investors in E*Trade.) By early 2007, E*Trade had increased its original 14% stake to 43.85%.

Shareholding Pattern*

*As of Mar 31 ‘08

However, IIL has been an underperformer compared to its peers in the broking sector. (See Table Below)

* All figures in Rs. Crores and rounded; ^Market Cap as of end April; Source: Moneypore / Moneycontrol

Deal Trigger:
With E*Trade getting badly affected by the US credit crisis late last year (the company has lost about 85% of its market value since the beginning of 2007), the company decided to put its stake in IIL on the block.

Deal Impact: While pointing out that the deal is still awaiting clearances, Tarun Kataria, Chairman-HSBC Securities and Capital Markets, is confident that HSBC is entering the retail broking space at the right time and at an attractive valuation.

The deal will fetch E*Trade about $145 million - a gain of $20-30 million over its investments. Ravi Adusumalli, Partner and Head of SAIF’s India office, said he was quite happy with the way the IIL investment has panned out. His firm would most likely tender its shares as part of HSBC’s open offer fetching it an about 4X return.

Other aspects of the deal that are expected to get answered as it goes through the mandatory clearances include the non-compete premium being paid to IL&FS (Will minority shareholders need to be paid this premium as well?) and the status of the commodities brokerage business of IIL (since Indian regulations forbid banks from owning commodities brokerages).

While the brokerage sector might be witnessing a boom phase in India right now, consolidation is inevitable in the longer term. The top Indian 10 brokers have just 24% market share compared to over 60% in the US. Also, Venture Intelligence data indicates almost 20 investments by Private Equity firms in brokerages since 2005. As these investors look for exit routes in the coming years, more M&A action can be expected in this sector.

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