Drying up of the initial public offer (IPO) market and a general slowdown in mergers and acquisitions activity are expected to take a toll on domestic brokerages.
Despite an average correction of around 30% from the beginning of the year, brokerages could see more downslides, reckon research analysts. A Deutsche Bank report on Indian brokerages states ?a fragmented market, structural weaknesses such as relatively low product diversity and a distinct reversal of both the trend and the cyclical component could lead to a significant de-rating from current above-market multiples?.
Even though a lot of Indian brokerages have been tom-tomming the fact that they are diversified and integrated, more than 80% of their revenues are related to the market, either through trading incomes or from merchant banking activities. Wealth management, the favourite value-added service, is an extremely competitive business. The banking sector, with its ability to service a large number of customer needs, is a dominant player here. According to the Deutsche Bank report, wealth management accounts for less than 5% of the revenues.
With the IPO market drying up, revenue growth has been hit significantly. Moreover, trading activity too is suffering. Average turnover velocity or average daily volume as a percentage of market capitalisation, which measures the extent of trading activity, is slated to drop from a high of 1.4% to 1.2% levels, reckons the Deutsche Bank report.
?Underlying volumes have not gone up significantly and much of the increase in trading has an element of listing froth in it. With the drying up of the primary market, this lever to trading should no longer be available in the near term,? says the report.
The IPO market has seen deals worth Rs 1,500 crore in the first half of FY2009, down from the Rs 23,700 crore levels in the same time of the previous year. Mergers and acquisitions income has been dismal and income from investment banking is down by 32% in the first half of the current year compared with the previous year.
A Prabhudas Lilladher report states, ?The meagre amount raised since February was mostly by small/mid-sized companies whose issues were managed by Tier-2 bankers. Thus the impact on large bankers such as Kotak, Citicorp, JM and UBS has been quite debilitating.? Also the practice of Indian brokerages to quote at a premium, as against the global trend where brokerages attract commodity company valuations, is expected to correct as the exact nature of their business is understood by the investing community. However a revival in the IPO market could change sentiments in brokerage and investment banking companies.
?The (IPO) pipeline could be worth a massive Rs.50,000-60,000 crore? says the Prabhudas Lilladher report. This could improve the earnings capability. Moreover, participatory note-linked derivatives are scheduled to be phased out in 18 months. Hence a 20% recovery in trading is expected. However, it is likely to be realised in FY2010.