Coal India fees go up in smoke


Chris Wright
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When one bank pitched a fee of one one-millionth of a percent to be a bookrunner on the landmark Coal India IPO, every other lead manager had to accept the same level. Even officials at the issuer weren’t happy with the economics of the deal. But such is the way of Indian equity capital markets, as Chris Wright reports.

YOUR $34 DOESN’T go as far as it used to in Mumbai. It might get you a modest platter at the famed Peshawari restaurant, or a small round of drinks at one of the top new bars such as Wink or Aer, but it certainly won’t cover a hotel car to the airport.

It will, however, buy you all six bookrunners on the largest IPO in Indian history.

Bookrunners on the Coal India deal – Citi, Deutsche Bank, Morgan Stanley, DSP Merrill Lynch, Kotak Mahindra, Enam ­Securities – received just 0.000001% of the $3.46 billion proceeds on this landmark deal – between them. And the extraordinary thing is, that’s not because it’s what the government offered; it is what the banks pitched. Or, to be precise, one did and the rest were obliged to match it.

"It has never been our intention to get banks to bid zero fees or near-zero fees," says Sumit Bose, secretary of the Department of Disinvestment in India’s Ministry of Finance in New Delhi. "That’s their choice." And what’s even more remarkable is that this was supposed to be a deal that ended the self-defeating low-balling of investment banking fees in Indian stock market deals.

Pitches for government share sales used to go like this. The government would put out a request for proposals (RFP), and then the banks would provide both a technical pitch – outlining such things as their knowledge of the company and the sector, and their track record on execution – and a financial one, covering the proposed fees. The government would assess the technical pitches, and shortlist typically 10 banks that met the grade. The financial bids of those 10, hitherto sealed, were then opened, with the one with the lowest fee pitch declared the lead bank. Then the government would work down the rest of the list in order of fees and invite them to match the winning low bid, until as many banks as were needed as bookrunners had agreed to the terms.

This has long led to absurdly low fee pitches since under this system your technical excellence only gets you onto the shortlist, not the deal. So with Coal India, a decision was made to do things differently: this time, a weighting was applied both to the technical pitch and the financial bids, with 70% of the weighting going to technical achievement. In other words, out of 100 marks available, the low level of your fee could win you only a maximum of 30.

But there was a flaw in this plan: the scoring given to the financial bid. The lowest fee bid would get all 30 points, and then the others would get marks in proportion to how their bid compared. So if the lowest bid is 0.5% and you have bid 1%, you get 15 points; if your bid was 1.5%, you get 10 points.

Following this through to its natural conclusion, banks realized that something odd would happen with particularly low bids. The difference between 0.001% and 0.0001% in cash terms is not that much for an investment bank. But in the scoring system, a bank would get 10 times as many marks as the other: 30 marks versus three marks, plenty enough to knock you out of the running.

"So then," one bookrunner notes, "it became a question of who could put in the most zeroes."

Citi eventually wedged five of them after the decimal point, equating to about $34.60 – and the system remained that everyone else who wanted to come into the deal, including those who led the technical assessment, was obliged to match it.

After two days of pitching in the Department of Disinvestment offices in New Delhi in early May, the bookrunners found out their points on the second night, and also discovered what the fees would be. Some, who did not get on to the deal, were stunned. "My recollection is one of utter disbelief," says a banker. "We went in with what I personally thought was an absurdly low pitch. We didn’t even get close."

Another, who did get on the deal, recalls: "We didn’t bid very fancy fees, but we bid at a level where we at least thought we would not be out of pocket. We may not make money, but we won’t lose money." Bidding too high made it so much more expensive than the lower bids that the bank almost missed out on the deal completely.

All part of the madness

But the other bookrunners are surprisingly magnanimous about it today. "We were angry for a day, maybe a week," says one. "But, you know, these deals aren’t really about the fees." Another adds: "It’s Citi in one deal, it’s somebody else in another deal. I can’t blame Citi only. Everybody is part of this madness."

"How can you not be part of the largest IPO in the history of the Indian capital markets?"

Ravi Kapoor, Citi

Citi’s managing director and head of global banking for India, Ravi Kapoor

So why do it? Citi’s managing director and head of global banking for India, Ravi Kapoor, declines to comment specifically on the fee structure but has no regrets. "It’s a path-breaking and landmark deal, India’s largest IPO from the world’s largest coal mining company," he says. "How can you not be a part of the largest IPO in the history of the Indian capital markets? It was important to be part of such a historic offering, and it was a resounding success." He adds: "You have to play by the rule book, which is transparently laid out for everyone."

The situation for bankers was even worse than it looks, because part of the terms of the deal required them to take on many of the expenses, such as regulatory processing fees, stock exchange fees and even printing of forms. Based purely on the IPO itself, everyone lost money on it.

However, it’s easier for a bank like Citi to pitch a near-zero fee than for some others, because it has many other ways of making money from the deal. Of the bookrunners, both Deutsche Bank and Citi have extensive foreign exchange and custody capability: both important in this deal. This was one of the first instances of the Securities and Exchange Board of India requiring institutional investors to provide full margin coverage, which means they had to commit all of the money they were bidding for no matter how much allocation they expected to get. That created a need for foreign exchange and hedging capability, from which Citi and Deutsche benefited, while local bookrunners with big brokerage operations were able to recoup their money in the first week of trading.

But a bank didn’t have to be in the transaction to do any of those things. As one bookrunner observes: "The people who probably made the most out of this deal were HSBC and Standard Chartered, the biggest custodians. And they weren’t even in the deal." Merrill Lynch and Morgan Stanley, without big FX or custodian operations, must have had a harder time recouping the costs.

Still, none of the bookrunners talk of the deal with anything other than enormous pride, and believe it was absolutely worthwhile to be in there – not just for league table credit but prestige on being on such a landmark deal. And nobody is under any illusions that this is simply how deals tend to go in India.

"Lead managers have only themselves to blame for it and nobody else," says Saurabh Sonthalia, managing director and head of capital markets at DSP Merrill Lynch. "It’s inexplicable. It’s the internal competition, and everybody talks about it: everybody agrees that this is something that we must desist from doing. And then we continue doing it, deal after deal. I can’t explain it."

Another banker says that some years ago an agreement was reached that there was a point below which no banks would pitch. "And then somebody broke the consensus and bid zero. So we stopped trusting each other again."

"The reality is, it’s the banks that are spoiling this," he continues. "But nobody looks at fees in bidding for these transactions. There are a lot of franchises you want to be associated with, but not many can give you a cheque for $600 million of league table credit in one hit."

Local disbelief

This wasn’t quite what the government had in mind when it shifted to the 70-30 structure. Bose in the finance ministry argues that shifting to the new system meant that "at least two bankers" who, in the previous system, would have made it on to the deal on the basis of a low-ball bid over technical ability, did not do so; the corollary is that two banks with technical strength but not a low bid did get on the deal whereas they wouldn’t have before. (Bose won’t name them but it is understood one was Bank of America Merrill Lynch – which, in the end, had to match Citi’s bid anyway.) But it didn’t stop the low-ball bids? "No, it did not stop that, but it actually worked, to the extent that two banks came in on the basis of this new mix," Bose says.

Local banks look on with some disbelief at the whole process, particularly when they find their own fees brought low as a consequence. "It was the international banks that skewed the fee to such low levels this time around," says S Subramanian, managing director of investment banking at Enam Securities. "We were surprised at that number." Still, Enam could have said no; but decided it needed to be on the deal.

In theory, this is all going to change. When the RFPs came out for the next big deal, for Indian Oil Corporation, the government had set a floor of Rs600,000 ($13,000) for the minimum fees. That’s still not much, particularly seeing as it will be split six ways, and it’s already blindingly obvious to everyone that nobody will pitch above the minimum.

"As long as the government puts fees as part of the criteria for selection of the banks, there will be one or two that are so keen to do the trade that the fee levels are not going to change," says Sanjay Sharma, head of equity capital markets for India at Deutsche Bank. "However, if a bank has made the call that it’s important to do a particular trade, you’re not going to put less effort on it because it pays no fees."

see also:
Bhattacharyya and the Coal India story
Coal India IPO sets a record