Margin-hit retail broking business set for consolidation

27/7/10 ET

Benchmark indices have more than doubled in the past 15 months, and many individual stocks have risen much more. But if leading retail broking firms are to be believed, this has not really translated into huge gains for them by way of increased broking commission.

The dismal performance of the shares of listed broking firms already testifies to this. And now the buzz on Dalal Street is that many mid-sized broking firms have begun sending out feelers, expressing interest in joint ventures, strategic stake sales, and in some cases, ven an outright sale of their retail broking operations.

“The revenue pool is not growing with falling yields (lower broking commission),” said Rashesh Shah, chairman and managing director, Edelweiss Capital, adding, “Also with rising employee and other costs, increased compliance and capital needs, many mid-sized firms will look for consolidation.”

And it is not just the second-tier firms that are looking to cash out, or shore up their capital reserves. Citi Venture Capital International, the majority shareholder in Sharekhan — among the top 10 broking firms in the country — is said to be in talks for either a stake dilution, or an outright sale. CVCI declined to comment on the matter.

Talk in stock market circles is that privately-held Prabhudas Lilladher —one of the oldest broking firms in the country — and listed firm Networth Stock Broking are among the other firms looking for strategic investors.

Prabhudas Lilladher denied that it was looking for strategic investors, or planning to raise capital in the near term. Mumbai-based Networth Stock Broking denied that it was looking to exit its retail operations. “We have no plans to sell our retail business, but would be looking to raise capital from time to time, and preferably from a strategic investor who has a long-term view on the business,” Girish Dev, executive director, Networth Stock Broking, told ET. The company had reported a net profit of `3 crore for financial year 2007-08, but lost `14 crore in 2008-09 and nearly `12 crore in 2009-10.

Fierce competition among retail broking has resulted in a steady decline in broking commission in the past couple of decades. From a peak value of 2% in the early 90s, broking charges today range anywhere between 0.05% and 0.30%, depending on the volumes generated by the client.

When the market was on an uptrend between mid-2003 till the start of 2008, the increase in traded turnover more than made up for lower commissions. Somewhere in 2007, many broking firms went on an expansion-spree — hiring staff and adding branches — convinced that the good times would last forever. In hindsight, that turned out to be a costly mistake, and most firms are still paying for it.

Nirmal Jain, chairman and managing director of IIFL (formerly India Infoline), feels that current market conditions are ideal for consolidation within the retail broking space. “Valuations are neither too high like they were in 2007-08, and nor are they too low,” Mr Jain said, adding, “So, it makes sense both from a buyer as well as a seller’s perspectives. We could see quite a few deals happening in the next 6-12 months.”

Mr Jain’s firm is keen on an acquisition, if it’s satisfied with the scale of operation and valuation. But not everybody is as optimistic of too many deals happening in the near future. “There may be many players up for sale; but how many of them offer a value proposition,” asks Divyesh Shah, chief executive officer, Indiabulls Securities, one of the top five retail broking firms.

While there are no concrete numbers to prove it, most broking firms admit their active client base has shrunk in the past two-and-a-half years. A good number of retail investors, who lost heavily during the market crash of January 2008, never returned, and the ones, who returned, scaled down their bets. Average daily cash market volume in 2007-08 was `14,148 crore.

This fell to `11,325 crore the following year, when the market corrected, and rose to `16,959 in 2009-10. However, delivery-based trades (in value terms) fell to `14.08 trillion from `14.92 trillion during this period. The commission earned by broking firms on delivery-based trades is five times or more than what they get from non-delivery trades (transactions that are squared off the same day).

Also, the activity shifting from futures contracts to options contracts post the market correction hurts broking firms’ bottomline. That is because commissions on futures transactions are significantly higher than those charged on options trades. In 2007-08, the total value of trades in the futures segment was `113.69 trillion. This fell to `91.29 trillion in 2009-10. On the other hand, the notional value of transactions in options contracts rose to `181.69 trillion in 2009-10 from `134.49 trillion in 2007-08. These trends are unlikely to change anytime soon, say market experts.

All most all the top brokers are unanimous that it is going to be an uphill task for second-tier broking firms in the coming days. But that may not necessarily mean too many deals happening. Mr Shah feels that at best, there could be a couple of deals over the next 12 months, and he does not mind being involved in one as the buyer.

“We are currently focused on Anagram integration. But we are always open to inorganic growth opportunities, as we certainly see benefits of scale and scope being achieved through consolidation,” he says. And not all the top broking firms are keen on growth through acquisition. “We have a strong branch network of our own, and are not looking for any acquisitions at the moment,” says Motilal Oswal, chairman and managing director, Motilal Oswal Securities.

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