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Creeping acquisitions versus an open offer

February 07, 2005

The regulators are making it difficult for promoters of listed companies to up their stakes in their companies.

The recent amendments to the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) regulations prevent an acquirer, including a promoter or people acting in concert, from acquiring more than 55 per cent of the shares of a company, except by way of an open offer to the public.

If they do so, they would be compelled to divest the shares, so as to bring the holding back to 55 per cent.

Together with this the continuous listing guidelines are reportedly in the process of being amended and are likely to specify that the minimum public shareholding should be 25 per cent, except in the case of large companies where there may be a need to relax the rules.

Thus, though the new rules don't clearly say so, they seem to suggest that if a promoter wants to raise his stake beyond 75 per cent, he would have to compulsorily delist the company through a reverse book building exercise.

As of now, a delisting is triggered if the promoter's stake breaches the ownership limit specified at the time of listing. The outcome of these new rules is that promoters can now do creeping acquisitions of up to 5 per cent a year, only till their stake touches 55 per cent and not 75 per cent as was allowed earlier.

Promoters such as the Tatas or even multinationals such as Nestle have used the creeping acquisition route to shore up their holdings in their companies.

However, there is a perception that the method is not a transparent one since such purchases are not made known to the public in advance though an announcement is made after every 2 per cent.

On the other hand, an open offer, in which shareholders can participate, is a more transparent mechanism and provides an equal opportunity to all shareholders to participate.

However, while that may be true, a creeping acquisition cannot harm the company or the shareholders because it helps support the share price so that investors can get an exit in the market.

Not allowing a creeping acquisition beyond 55 per cent could put promoters in a bit of a financial spot because they may not be able to come up with the funds to pick up a full 20 per cent of the equity at one time.

There is also the danger of information leaking and the share price getting distorted so that the promoter ends up paying far more.

Also, simply making a public announcement in itself does not necessarily benefit shareholders because there have been situations where big companies have announced buybacks and not bought back a single share even though the market price of the shares has fallen below the buyback price.

On the other hand, companies have been doing creeping acquisitions and supporting the share price that has benefited shareholders.

An open offer is more shareholder-friendly because if the promoter is really keen to up his stake, he will pay an attractive enough price so that he gets a good response and shareholders get an exit at a good price.

But a company should also not be faced with a situation where the promoter is wasting time defending the company against predators, rather than focusing on the business.

Perhaps, the rules could be modified somewhat so that the open offer can be made in two stages; that would ease the pressure on promoters as also ensure that shareholders get a fair price.

The rules do allow promoters to pick up shares in block deals through a memorandum of understanding. That is fair since the block deal is not consummated till the open offer is complete, and so the promoter will be giving other shareholders an option to sell.

If all shareholders do not tender their shares, the promoter can pick up the balance through the block trade. The seller of the block is, however, at a disadvantage since at time of signing the MoU he is not sure whether he will be able to sell all his shares.

The regulators are also believed to be keen to ensure that 25 per cent of the shares should remain in the hands of the public at all times and to that effect the continuous listing guidelines are reportedly being changed.

That is necessary to ensure enough liquidity in the counter. As of now, when a company makes an initial public offering, the minimum public shareholding has to be 25 per cent, unless the offer size is for Rs 100 crore (Rs 1 billion), at least 20 lakh instruments (shares) are offered and the issue is done through a book-building.

In such a case, they can offload just 10 per cent of the equity. Today, there are companies that have a 10 per cent public holding, for instance, a Tata Consultancy Services.

This appears to be justified since big companies raising sums of Rs 3,000 crore (Rs 30 billion) to Rs 4,000 crore (Rs 40 billion) may not need more than that at a point in time so that selling more than 10 per cent of the equity would not be justified.

Besides, if the size of the issue is very large there may not be a good enough response from the capital market and the issue would flop.

Thus, making it compulsory for companies across the board to have a minimum public shareholding of 25 per cent would be arbitrary and some degree of segregation is called for, as is the practice abroad.

The conditions for a smaller float could be changed if necessary; for instance, instead of a minimum issue of Rs 100 crore, perhaps Rs 200 crore (Rs 2 billion) would be more appropriate.

Moreover, it is not the proportion of the paid-up equity that should be the benchmark for the size of the float.

What should be assessed is whether once the company is listed there is adequate trading volume so as to make the stock liquid enough for investors to trade in and out with a minimal impact cost.

A minimum market capitalisation would perhaps be a more relevant number to look at as is done overseas.

Today, there are  a host of companies where the promoter-holding is beyond 75 per cent. That is because regulators at various times have set different conditions for the public shareholding.

So, if in the year of listing the minimum float specified was 10 per cent or 20 per cent, promoters could accordingly maintain their shareholding in their companies.

Now, if the minimum public shareholding is stipulated at 25 per cent, several promoters would have to dilute their holdings below 75 per cent.

If it turns out that regulators do want promoters to delist a company because the promoters want to hold more than 75 per cent, they have a point in saying that the delisting should be through a process of reverse book building.

That's because shareholders should have a say in the price. Otherwise, once a promoter has cornered a majority of the shares and wants to delist the firm, he may not offer shareholders a reasonable price and the latter would be compelled to sell at that price since they would not want to be left holding shares in an illiquid company.

Of course, a handful of shareholders can always manipulate the price and there have been instances of reverse book-building not going through because the price discovered after the book building has been far higher than the market price as has happened in the case of Astra Zeneca and Vikers Systems.

In a book building, the final price is the price at which the maximum number of shares are offered. In the case of Astra Zeneca, the price discovered was almost three times the market price, while in the case of Vikers, it was around twice the market price.

If a reverse book building fails, or in other words, if the promoter rejects the price, the promoter, as of now, has to necessarily divest his stake to the level specified at the time of initial listing.

Therefore, promoters with stakes higher than that level are extremely vulnerable. The regulators need to put some kind of limit on the price because promoters cannot be held to ransom by shareholders with malafide intentions.

At the same time, shareholders must get a fair price.

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