Mumbai: The corporate acquisition game is set to become more expensive after a panel set up by capital market regulator Securities and Exchange Board of India (Sebi) suggested sweeping changes in Indian takeover rules, by raising the ownership level beyond which an acquirer has to make a mandatory open offer to buy shares from other shareholders and saying that the acquirer has to offer to buy all the remaining shares in the target firm so that all shareholders have an equal chance to exit their investments.
The panel has also suggested a new method to decide the price at which shareholders can tender their shares in an open offer, a move that could benefit all shareholders who want to sell their holdings to an acquirer.
The most significant change is that the threshold for an open offer will be raised from the current 15% to 25% and the acquirer will have to make an open offer to buy 100% of a target company’s shares against the current 20%, if the recommendations of the panel headed by C. Achuthan, a former head of the Securities Appellate Tribunal, are accepted after public discussion.
The new 25% threshold will bring Indian takeover rules close to the takeover rules in some developed markets such as the UK, where open offers are triggered once the shareholding crosses 30% of a target company.
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While the new takeover norms tilt the scales in favour of incumbent managements during takeover battles by raising the cost of an acquisition, Achuthan clarified that the panel was more focused on protecting investor interest: “If the person does not have enough money to meet the cost of acquisition, he better not acquire,” he said.
The changes recommended by the Achuthan panel aim to keep only serious takeover artists in the game, make it easier for existing majority stakeholders to consolidate management control and treat all retail shareholders at par during open offers.
Some market experts, however, feel that the new rules will put existing managements under pressure. “Hundred percent public offer is good for investors. But allowing 25% leeway for the acquirers can be a little destabilizing for the promoters. It is dangerous. I get a feeling that promoters need to keep their holdings high to ward off potential hostile attempts. On that count, the present system seems good,” said K.R. Choksey, chairman of brokerage firm KR Choksey Shares and Securities Pvt. Ltd.
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The suggested changes in takeover rules come at a time when mergers and acquisition activity is growing in India. The first takeover norms in India were put in place in 1997 and were reviewed in 2002.
Nearly 10 months after the committee was formed to recommend suitable changes in the existing takeover code, investors can now look forward to better corporate governance practices in their companies and ensure that minority shareholders’ interest is not compromised during takeover battles.
To ensure that all shareholders of the target firm get a fair value for shares tendered in an open offer, the panel has proposed that the minimum price payable shall be the highest of four options—the negotiated price that triggered the open offer, the volume-weighted average price paid by the acquirer in the preceding 52 weeks, the highest price paid by the acquirer during the preceding 26 weeks, or the market price based on the volume-weighted average market prices in the preceding 60 trading days.
At present, open offers are priced at the higher of weekly averages of market prices for 26 weeks or two weeks.
Indian company law gives an investor the power to block special resolutions if it holds above 25% in the target firm. While the panel’s proposal will make it easier for private equity (PE) investors to increase their holdings up to 24.99% in target firms, setting the open offer trigger at 25% could be a setback for these investors, who wanted Sebi to allow them to acquire beyond the 25% threshold to have a say in the management of listed companies, without requiring to make an open offer.
Anant Kulkarni, executive director (private equity) at JM Financial Investment Managers Ltd, said: “This is a welcome change because this was one of the constraints in PIPE (private investment in public equity) transactions, especially in mid-cap companies. It gives more elbow room to PE (private equity) investors.”
“It can help listed mid-cap companies to raise PE money more easily than before. It would be more helpful if it (the threshold) could be raised to 26%. This is because, unlike in private transactions, in PIPE deals we don’t have typical shareholder rights,” he added.
PIPE deals involve investment by PE firms in listed companies.
The recommendations that acquirers should offer to buy the other 75% of a target company’s equity once the 25% threshold is crossed could help even small investors exit at the offer price. “...an open offer ought to be for all the shares of the target company to ensure equality of opportunity and fair treatment of all shareholders, big and small. With the existing norm to acquire a minimum of just 20% by an open offer, often only large existing investors get the advantage of selling shares, while small retail investors are kept deprived from an exit option,” says the panel’s report.
The panel’s proposal to acquire up to 100% in a target firm through an open offer, will, however, be exempted for voluntary open offers by promoter groups.
In case of voluntary open offers, when an entity already holds more than 25% stake, the open offer size has been proposed for a minimum 10% stake. If the entity wants to increase its voting rights without making an open offer, it can do so by acquiring up to 5% in the target company in a given fiscal year. Under the existing rules, such offers can be made only by shareholders holding more than 55%. However, such voluntary open offers will not be allowed for an acquirer that has bought shares in the target firm in the preceding 52 weeks.
In case of indirect acquisitions of the target company, the offer price would stand increased at the rate of 10% per annum, estimated on a pro-rata basis for the period from the date of announcement of the primary transaction. All open offers, under normal circumstances, have to be completed within 57 business days from the date of announcement.
According to a recent government directive, every listed entity is required to maintain a minimum public shareholding of 25%. For companies that currently do not comply with this rule, the promoters are required to bring down their stake by at least 5% every year till the promoter holding comes down to 75%. The Sebi panel’s proposal to make an open offer for the entire 75% stake after the open offer trigger may lead to an acquisition of 100% stake by an acquirer firm, resulting in a delisting of the target firm. The panel suggested that if the delisting clause is triggered due to such acquisitions, the acquirer can either opt for delisting or bring down its holding to meet the continuous listing requirements.
In case the acquirer intends to delist the target firm, the former may state its intentions upfront. But if the delisting code is triggered without any such disclosure, the acquirer would be required to either proportionately reduce both its acquisitions under the agreement that triggered the open offer and the acquisitions under the open offer or to bring down his holding to comply with continuous listing requirements. This option is not available under the existing regulations.
According to Sourav Mallik, executive director (mergers and acquisitions) at Kotak Mahindra Capital Co. Ltd, currently, the average promoter holding in firms is in the range of 49%. “So in this context, the 25% shareholding is not a threat. But every company is not an average.”
“Additionally, for a company with a promoter holding of the average 49%, the cost of financing the extra bit for the open offer will not go up by that much,” Mallik added.
In an effort to strengthen the corporate governance norms in Indian firms further, the committee has also suggested alterations in the definition of control. Sebi currently defines control as “the right to appoint majority directors on board or control the management or policy decisions...directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner”.
The panel said that only those acquirers could be allowed to take over a target firm’s control which genuinely have the ability to control the management and take corporate policy decisions. The panel recommends that the definition of “control” has to be modified to include “ability” in addition to “right” to appoint majority of the directors or to control the management or policy decisions would constitute control, in case of acquisition of control through open offers. Further, for any such open offers, it will be mandatory to take a recommendation by a committee of independent directors of the target firm. This is currently optional.
The committee has removed the ambiguity surrounding indirect acquisitions. “Currently, there are two dates and this creates a lot of confusion. Now we have only one date, the date on which the parent company is taken over. That will be the trigger and the price will be as on that date,” Achuthan said.
However, if the local company waits for the transaction to consummate and then makes the announcement (for open offer), they have to compensate the shareholders for the notional loss incurred due to the delay in payment. “This we have recommended to be the interest that they would have earned in a bank fixed deposit,” he added.