The Great Indian Asset Sale: conditions apply
The government wants to send a tough message to promoters. Last week’s amendment of the Insolvency and Bankruptcy Code makes it very difficult for promoters of a company that is a loan defaulter to submit a resolution plan. They now stare at the prospect of losing management control over their company.
This is as close as India will come to allowing hostile takeovers, if hostile is defined as a situation where control is wrested away from unwilling promoters.
In India, the owner as manager is common as most companies are family-owned. That’s why promoters have been singled out by the amendment, which says it wants to keep out certain persons because of their antecedents so that it does not affect the credibility of the process. One of the tests is that the person should not be a promoter whose company has been in default for a year or more and who has not paid all overdue amounts along with interest and charges before submitting the plan.
It effectively bars promoters and connected persons from bidding not just for their own company, but for any company that comes up in the insolvency process. There could be a loophole where the promoters clear their outstanding before submitting a resolution plant but that seems unlikely in large default cases.
The provision guards against the risk that promoters submit an attractive resolution plan but are unable to deliver and the asset turns bad again. And it also guards against any criticism if an asset is written down and handed back to the same owner.
On the flip side, this could hit the bidding process. New bidders were expecting promoters to bid emotionally to retain their assets and were therefore bidding on replacement value basis, says Abizer Diwanji, partner and national leader (financial services) at EY. Now, their bidding will become more rational.
But the absence of promoters may also lead to more interest in the assets, since more prospective bidders may perceive their chances as having improved.
The resolution process is also likely to end up altering industry structures. Take steel, for example, which features prominently in the initial list. The big and relatively healthy companies such as Tata Steel Ltd and JSW Steel Ltd will be happy to bid, as they seek to consolidate their market position and are seeking to increase capacity.
But an upturn in the steel cycle has also improved the industry’s prospects. Foreign companies such as ArcelorMittal would be keen as acquiring an operating asset with raw material and fuel linkages, which reduces their start-up time and also gives them a strong foothold in the domestic industry. That is a risk to the incumbents as these companies have the resources to pump in capital and expertise to not only turn around the business but also expand capacity. There is the question of what this amendment will do to small and medium enterprises, whose owners may become ineligible to submit a bid in their own cases. They may end up losing their firms even while they may not be intentional defaulters.
What should minority shareholders make of all this? The run-up in share prices of some of these companies suggests that investors believe they could gain in the insolvency process. That could be a long shot. The value of assets may be much less than their book value. Take steel, for example. A recent Credit Suisse report on corporate debt says even after improved prospects for the sector, share of debt with interest coverage less than 1 time is 55% and 50% of debt is with companies with a net debt to Ebitda of more than 12 times. It says banks have recognised nearly 40% to 70% of steel loans as non-performing.
Also, the resolution process gives the applicant virtually a blank canvas for a resolution plan. While shareholders may be expecting that the listed company will get a new owner, the regulations allow a number of other options such as merger with another entity or even sale of assets. That calls for caution in taking stock calls based on expectations from the insolvency resolution process. A minority shareholder is on the same footing as a promoter—he is a shareholder in a company that has defaulted on its loan repayment. If insolvency does not succeed and the company goes into liquidation, then equity shareholders are last in the distribution queue.