24 October 2011

Takeover regulations - back on track

I have a piece in today's Economic Times titled (the online version has a different name): Takeover regulations, back on track. Here are excerpts:

SEBI has recently notified a new set of regulations for takeover of listed companies. Thankfully, we have a new set of takeover regulations that do not attempt to solve problems of other countries.

Briefly, the current law in India provides for alerting the marketplace to acquisition of substantial shares or control in listed Indian companies. The regulations also provide for a compulsory tender offer for 20% shares from other shareholders once a larger acquisition of shares (or control) is made, typically acquisition of over 15% in a go or over 5% a year once a 15% shareholding is already owned triggers a tender offer. The compulsory tender offer would now get triggered at the 25% level and the offer size must be 26% of the company's equity capital. In addition, those holding over 25%, can acquire up to 5% a year without the open-offer trigger. These changes will impact different kinds of people differently. A key beneficiary would be private equity players who would be able to hold a more substantial shareholding in listed companies. This is good for corporate governance as the interests of private equity players are aligned with that of the minority shareholder.

The law as enacted is at divergence to the advisory committee report that recommended a 100% open offer, in vogue in Europe and some other countries. In other words, it was recommended that where a person acquires control or substantial number of shares, the acquirer must put up as much as five times the amount of money compared to the existing regime of 20% open offer. With the higher cost, there was a possibility of a severe shrinkage of the market for control. In fact, this hypothesis is supported by an annexure to the report itself that shows that over 85% of all offers in the past several years have occurred at the 20% stake level - the minimum mandated.

In addition, a 100% open offer is not a 'global standard' as some people have portrayed it. The most active market for control, the US, does not have a compulsory open offer at all. Equally specious is the argument that not allowing 100% offers would take away the right of shareholders to exit the company. We are talking about publicly-listed companies here and no one is taking away any exit rights of investors. In fact, a bulk of open offers are barely subscribed to because the difference in price between the open offer and the exchange-traded price - which combined with a more tax-efficient sale - is often minimal or negative.

Connected to the previous argument, for people advocating the committee view, is that a less-than-100% open offer would be unfair to minority shareholders. I have argued in Two steps back for takeover rules (ET, August 12, 2010) that a 100% open offer would be grossly unfair to minority shareholders. Such large offers would make acquisitions prohibitively expensive and would desiccate the market for control - leaving shareholders worse off not just in not getting open offers but suffering the worsening of corporate governance as existing promoters entrench themselves further into management of companies.

An import of the provision from some capital-rich western countries is inappropriate given capital scarcity in India. Combined with the restrictive lending standards imposed by the central bank on acquisition debt financing and, we have an uneven playing field for Indian acquirers compared to overseas acquirers who can leverage their balance-sheet without such restrictions. The late chairman of the committee fairly admitted this issue in an interview and thought RBI should resolve this problem. Combine this with RBI's subsequent hardline position reflected in the Sebi's board meeting of July 2011 and this wasn't about to be resolved.
There are some problems too with the regulations. A year continues to be defined as one ending on March 31. This allows an acquirer to acquire 10% in two days versus the intention of permitting 5% in a whole year. The biggest issue is that for acquisitions past 25%, gross acquisitions are taken into account to calculate the threshold. So, if a person who owns 30% equity buys 5%, then sells all 5% and then buys 100 shares, he would have triggered open offer requirements even though the addition to his holding is only 100 shares rather than the triggering 5%. This illogical provision can hardly be adequately condemned. As this isn't reflected in board meeting minutes that discussed threshold numbers, this may warrant deletion.

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