Will the new Takeover Code plug all the gaps in the old rules? The Smart Investor investigates.
Will the new Takeover Code offer enough protection to the prey in the corporate jungle? Or will it be heavily tilted in favour of the predators? Generally, most of the experts are of the opinion that the code is well-balanced. Despite this, there are certain issues that need to be addressed. The Smart Investor takes a look at these issues.
The final draft of the Takeover Code has been submitted by the Bhagwati Committee to Sebi (See box: Major recommendations). The final draft made 13 changes to the earlier draft. After studying the recommendations, the government watchdog agreed to accept almost all the conditions, bar a few minor changes. But the jury is still out on the question as to just how far is the new Takeover Code an improvement over the old rules.
The Smart Investor decided to meet market and legal experts, consultants and corporate conclusion to find out their reactions to the new takeover code. And from their opinions, it seems that while there are some improvements, the new Takeover Code still falls far short of the ideal. Here's why.
The problem arises because there are several recommendations that seem to have little logical base. Take, for example the condition that an offerer must acquire a minimum of 20 per cent from the public (also called partial offer) after acquiring 10 per cent of the company.
This comes as a disappointment because nowhere in the world is a partial offer is allowed. France was probably the last country to have a condition of partial offer but the experiment failed. Comments Munesh Kha-nna, associate partner, Arthur Andersen, It is a typically beauracratic figure. Why 20 per cent? Why not 30 per cent or for that matter 40 per cent? There does not seem to be any logical answer to the question. However, even this requirement is a substantial improvement over Sebi (Substantial Acqui-sition of Shares and Takeovers) Regulation, 1994.
Regulation 21 (1) of the Sebi regulation states that where an acquirer holds more than 10 per cent shares at the time of commencement of the these regulation and was not required to comply with the provisions of clause 40A and 40B of the Listing Agreement, the public offer.... shall be to acquire a minimum of such percentage as would increase his shareholding to at least 30 per cent of the total shares of the company.
According to a prominent chartered accountant a view can be taken that if the promoters' holding is already 27 per cent, it is required to pick up a maximum of 3 per cent and Sebi has the power to grant the exemption to avoid the hassle of pro-rata acceptance to meet 3 per cent requirement. It can also be interpreted that in case the holdings of promoters is more than 30 per cent, no public offer need be made.
Preferential offer : It is really surprising that the preferential offer is not covered by the committee. According to Justice Bhagwati, the reason for partial offer is to allow level playing field between Indian and foreign companies. Since bank finance is not available to Indian firms only foreign companies will be able to takeover companies. This can't be true. Existing managements have a protective weapon in the form of preferential allotment.
An issue that has not been addressed by the committee is that of preferential allotment. Under Sec 81 (1A) of the Companies Act, a management of the company can make a preferential allotment to any party at the price to be determined as per the SEBI formula. This route, we believe, can be used by the existing management to strengthen their holding at the cost of minority shareholders. It works like this. Mana-gement may offer warrants convertible at a future date, to themselves. An acquirer is required to notify the bourses when he acquires 5 per cent stake.
This leads to a situation where management can dilute the equity to protect itself at the cost of non management shareholders. Though SEBI guidelines require that the specific details as to whom an offer is made and for what purpose funds are raised must be provided to shareholders, it is routine to get around it. The fund raising exercise can be justified on grounds as flimsy as long term working capital. An example is that of Phil Corporation. It has made a preferential offer to the management and as a result, the equity will be diluted by 26.45 per cent. According to the management, being a growing company, it needs funds for capital expenditure and working capital. The company which was primarily engaged in photographic material has recently diversified in to snack food business. Such loopholes need to be plugged. It gives the existing management the God given right to manage the company howsoever incompetently.
Another view point that has been put forward is that in India we do not have any defense mechanism like buyback of shares and allowing companies to go private. This matter is not in the purview of the committee and requires an amendment to the Companies Act.
We believe that protection granted by 81 (1A) is the poison pill option for existing management. Buyback of shares incre-ases the value for shareholders and the opposite happens in case of preferential allotment.
An argument put forward by the committee is that since the preferential allotment is authorised by shareholders, it is in the interest of shareholders. But, it must be remembered that preferential allotment to management at a hefty discount to market price was being done after taking the consent of the shareholders. The pricing formula for preferential allotment is precisely to counter this.
Management is not prevented from putting a resolution to vote even when a bid is made on the company. If this is not poison pill what is? Mrugesh Shah, partner, Mahajan & Aibara, disagrees. According to him there is no way that Escorts could have matched the might of Swaraj Paul by making preferential allotment to themselves. In case of Consolidated Coffee (CCL), Tata Tea shares were swapped for CCL shares. Getting Tata Tea shares was a very attractive proposition for the CCL shareholders and any attempt by CCL management would have failed.
Not satisfied with this, SEBI did one more favour to the existing management. For the purpose of open offer, an acquirer will be required to pay higher of the price at which preferential allotment was made or the highest price paid by the acquirer. The preferential offer will be priced on the basis of average high-low price of last 26 weeks before which offer was made. Obviously, existing management is at an advantage as it can hike its stake cheaply.
It may be noted that prior to the recommendations made by the committee, SEBI on its own was insisting that preferential allotment resolution has to be specific. The companies were required to provide information as to whom the allotment is being made, equity will be diluted by what amount and to what use funds will be put.
However, not all the experts agree on this point. According to a vice president of a finance company, it is not that non management shareholders are at a disadvantage. They are not required to vote on a very vague resolution as was the case earlier. Now the resolution has to be very specific. It is required to be stated as to whom the allotment is made, the pricing is determined as per SEBI formula and whether there will be any change in the control of the company. FIs normally vote against the preferential offer and remember that mutual funds have been given voting rights. They can block the resolution as well. As regards the manner in which EGMs are held and resolutions are passed, it is poinetd out that we may need to introduce postal ballots but that will require amendment to the Companies Act which is outside the purview of the committee.
The chain principle: If company X acquires company Y, and as a result of this several other companies, which are controlled by company Y are also being acquired, then a public offer has to be made to the shareholders of each of the companies. Experts are of the opinion that this principle can be interpreted to mean that a company can offer more than 10 per cent of its equity to a group company through preferential resolution and in case the company is taken over, the bidder will be required to take over both the companies. Explains Mrugesh Shah, It is not explicit as to whether it is applicable to listed companies. If it is, then this route can be used to defeat the whole purpose of the code. For example, British Steel may be interested in taking over TISCO but most certainly won't be interested in making an open offer for Telco. Dinesh Vyas, senior advocate, Supreme Court, is of the opinion that a view supporting this interpretation can be taken.
Mananagement and preferential offer: Should the management be allowed to vote on resolutions of preferential offer? Experts differ on the issue. According to Munesh Khanna of Arthur Andersen and Arvind Mahajan, director, A. F. Ferguson, the management should not be allowed to vote. But the vice-president of a prominent finance company disagrees. He holds that in the long run only the high quality managements will survive. He points out that there is no case where high growth has been achieved by the management retaining a high stake. Growth requires funds and equity dilution is inev-itable. Reliance and Ranbaxy are two obvious examples.
There are two ways in which a management can retain control. One is by majority shareholding and the other is by size. Over a period of time, the company grows to such an extent that it becomes extremely difficult to takeover. The sheer size (in terms of market capitalisation) won't permit the takeover. So, for the survival of high quality management, the voting by management should be allowed.
A chartered accountant supports the case of voting by management. He asks that if management is not allowed to vote on preferential offer, being the interested party, how will dividend be approved or allotment of bonus shares be approved? Dividend is not an issue for management but it certainly is for the minority shareholders.
Mrugesh Shah disagrees. He sayss that as required under sec 300(1) of the Companies Act, when a matter in which a director is interested will not be allowed to vote at a board meeting on that resolution. Why should the interested directors vote on preferential allotment resolution?
Rights issues: The committee was of the opinion that they could be misused and it may be possible for persons now in control of the company to hand over control through a combination of unattractive pricing and rights renunciation to the acquirer.
The committee recommended that additional allotment to the persons now in control of the company be excluded from the purview of the code provided he had disclosed in the offer letter that he intends to take up additional shares if the issue is unsubscribed.
This move is hailed by the experts. Explains the vice-president of the finance company: It must be understood in the broader sense of the term. When a management gives an undertaking in the letter of offer that it will buy out the unsubscribed portion in the event of issue being unsubscribed, it is virtually underwriting the issue.
The message is clear that management is confident of the prospects of the company. In case the issue is not subscribed to the extent of 90 per cent, the issue will devolve but this is being prevented. Even non management shareholders are given a right to acquire the shares at the same price and if they don't chose to subscribe, but the management wants to go ahead with the project, it should be allowed to. In fact, it will have a positive impact on the price, he said.
Buyback : A section of the players are of the view that a defence mechanism like allowing buyback of shares is needed. The committee is rightly of the view that recommending an amendment to the Companies Act to allow companies to buyback shares is outside its purview. Munesh Khanna suggests a way out. According to him, the ceiling of exempting the management to make open market purchases should be brought down from 75 per cent to 50 per cent and management need not make a public offer if the creeping acquisition is violated. Why?
One, management with 50 per cent stake is normally in control of the company and hence need not make a public offer. Second, if the management is of the opinion that shares are undervalued, it can buy from the market and enhance shareholder value. As a measure to prevent insider trading, management must be asked to make an offer to existing shareholders by advertising in at least two English dailies with national circulation and a vernacular newspaper - preferably in the language of the state where the corporate office (or registered office) of the company is located.
Misconceptions: One point where there is a lot of misconception is: what happens when management holds over 75 per cent and wants to hike its stake? Then a public offer is not required. The common misconception is that in case the public holding in a company falls below 25 per cent, the company will be delisted. This is not true. Listing agreement does not have any such condition. The requirement is that at the time of the IPO, the minimum offer that should be made to public must be 25 per cent of the equity of the company or else listing will not be allowed. No norms are prescribed for the post-listing minimum public holding.
Another point which is not clear to everyone is the issue of an acquirer holding over 51 per cent and increasing his stake. It has been reported that such an acquirer will be required to make an offer to the public if he exceeds creeping acquisition requirements. All that he is required to do is to acquire shares through a tender offer.
Loopholes: The Foreign Inves-tment Promotion Board (FIPB) does not allow MNCs to hike stake over 74 per cent in some industries. What will happen if an MNC which already holds 51 per cent in a firm, operates in a restricted industry and wants to hike its stake to 60 per cent. As per the code it will be required to buy at least 20 per cent more and FIPB does not permit the stake to go above 74 per cent. In such circumstances, what will prevail: the code or the FIPB guideline?
Shah also raises many questions. What will be the criterion for pure share swap deals (as in Tata Tea-Consolidated Coffee)? Should the acquirer deposit money in an escrow acc-ount? What happens if a rights issue devolves and a third party picks up the stake? What will be the pricing norm? How will the pricing be determined for a PCD or NCD with convertible warrants attached? How will the discount for debt portion be factored? Any answers, anyone?
