The next steps in Mistry versus Tata

Apart from the pulls and pressures around the controversial Parliament project, it has escaped no one’s attention that this development comes 10 days before the Supreme Court is to hear on 28 October what is being dubbed the corporate battle of the century.

People close to both the Tata and SP groups maintain they want a quick end to a three-and-a-half-year legal battle that began after Cyrus Mistry was unceremoniously sacked over purported lack of leadership abilities.

But it is going to be far from easy for the SP group to end a bond that has lasted 70 years. Particularly when the split has been so acrimonious and so much money is at stake. The value of the Mistry family shareholding in Tata Sons (18% stake) has ballooned by 2000 times since 1965, when it acquired a stake in Tata Sons for ₹69 crore. Today, this valuation as per court documents now stands at a massive ₹1.5 trillion.

Tata Sons has so far not received any offer from the Mistry family; and the latter has indicated that it would make a formal offer before the apex court.

Apart from deep-rooted bitterness between the business groups, there are numerous obstacles: disagreement over the valuation of Tata Sons, for one. From where will Tata Sons raise and arrange for so much money? How will the House of Tatas manage to convince external investors (for that is one option) to invest in a closed private company? Will the Mistry family play ball?

“Well, there is a solution. But whether it is a quick fix will depend on the two sides adopting a conciliatory approach on valuations and timelines. Lack of this will just drag the matter on and on. Tatas would want this to be finally over and for SP group this solution helps in their financial woes. The Supreme Court typically does not want to interfere in private disputes and would anyways suggest a mediation-based approach," said H.P. Ranina, senior Supreme Court advocate.

We might get some indication on 28 October. Fact is, the Supreme Court will continue to play a major role given that the stake buyout may be a staggered process. A court-monitored mediation process would involve both the groups appointing mediators and agreeing on a principal mediator. Mediators would look into valuation, timeline of exit, interim solutions and processes.

“Both sides are honourable, and one can expect them to stick to their side of the bargain once the mediation sets the structure in place," said a former director on the Tata Sons board on condition of anonymity.

In a series of interactions with all stakeholders, Mint has pieced together the financial and legal issues that will drive the separation; and the potential impact on both the warring parties. What follows is the road map to a possible solution as well as the sticking points. Spokespersons for Tata Sons and Mistry’s office did not reply to email queries sent by Mint.

The stage

Mistry’s sacking in October 2016 started an acrimonious, protracted legal battle which is far from over. In brief, the Mumbai National Company Law Tribunal in July 2018 had summarily dismissed Mistry’s petition that minority investors were oppressed as Tata Sons’ affairs were mismanaged. Then, in December 2019, the National Company Law Appellate Tribunal (NCLAT) ruled in the favour of Mistry firms. This seesaw battle has now landed with the Supreme Court.

People in the know say that the final parting has been well thought out. For the Mistry family, their shareholding in Tata Sons is effectively useless, except to get dividends. The recent bid to monetize their shares in Tata Sons (when the Mistry family pledged 9.19% stake held by Cyrus Investments with lenders in August and September) was thwarted. Tata Sons moved an application on 5 September to prevent share pledging as it could have led to share transfers in violation of the right of first refusal.

Ergo, the SP group, which has already defaulted on its debt obligations to subsidiaries and on some bonds, is stuck with an asset that it cannot monetize.

SP group, being mainly in the infrastructure and real estate sector, has been severely affected due to covid-19. Cash flows from operations and asset monetization has suffered. The promoter’s fund raising aggregating ₹11,000 crore has not been successful till date. It faces difficulty in servicing its ₹30,000 crore worth of debt.

“The SP group is not facing a debt issue, but a maturity and cash-flow issue. It has too many short-term borrowings coming up for maturity which is not being met with asset monetization at equal pace. The group has already sought debt restructuring from its lenders," said a person familiar with SP group’s thinking on condition of anonymity.

On the other hand, while the Tatas have been hoping to part ways from Mistry for a large part of the past four years, Mistrys’ move to pledge shares presented a clear trigger for the end game to begin.

“Pledging shares is typically the last resort—it’s akin to selling family silver. Tatas could sense the desperation here. Ratan Tata had personally briefed Harish Salve (counsel for Tata Sons) before the hearing on 22 September that if Mistrys speak about their financial hardships, he should say that Tatas are willing to buy their shares at market value," said a person familiar with the Tata group thinking.

The legalese

The lawyers of both the groups—Karanjawala and Co. and senior counsel Harish Salve for Tata Sons; Desai & Diwanji and senior counsel C. Aryama Sundaram for the SP group—are working on the arguments for the main petition.

The Mistry firms will formally seek a separation on 28 October. “There are provisions and case precedence where if minority shareholders believe that there is no other remedy for their grievance of oppression, they can seek separation/stake sale as a final relief," said a person familiar with the SP group’s thinking.

This route of settlement was proposed by the NCLAT too when it was hearing the matter. “During that time, SP group was not interested in relinquishing the shares. But Tata Sons’ application to prevent Mistry family from pledging their shares has made SP group realize that co-existence is not possible," the person quoted above added.

A crucial factor is whether the Tatas would press for expunging the findings of NCLAT order which had found it a fit case of oppression. “It is quite likely that Tata group for a smoother process will seek that the NCLAT findings are expunged. With Mistry agreeing to exit the entire case would fall. In these cases, typically the court’s want parties to go for an amicable settlement," said a person familiar with the thinking of the Tata group.

Of course, there are some who worry if an amicable settlement is indeed possible given all the strong statements from both sides. Ratan Tata in his affidavit in apex court called sacking Mistry as a painful decision; in the same breath he called Mistry a “trojan horse". The Mistrys termed Tata Sons’ move to block fundraise through pledging shares as a “vindictive move".

The apex court could suggest settlement without hearing the petition and the Mistry’s may have to forgo the charges of oppression against Tata Sons.

“What is the alternative? If the Supreme Court hears the entire petition and comes to the same conclusion that Mistrys must be given a fair equitable exit. If the court does not find merit in the petition can it force Mistrys to continue being a shareholder? Logically the separation has to be court-monitored without the SP group feeling short-changed," said Ramesh Vaidyanathan, founder, Advaya Legal.

Article 75 of Tata Sons Articles of Association (AoA) gives Tata Sons the first right of refusal. The Mistrys would also press for Tatas to not use the ‘squeeze out’ clause of Article 75 to force them to sell at a depressed valuation, said the person familiar with SP Group thinking.

While there is risk of Mistry firms being squeezed out, it seems that Tata Sons will avoid this route. “Estimating a lower valuation for Mistry shares would hurt the Tata brand and set a precedent for any future transactions of Tata Sons and the group companies. On the other hand, a one-shot ₹1.5 trillion deal would require serious funds. Perhaps a staggered deal makes more sense for the Tata group," said the person familiar with the Tata group thinking cited above.

SP group, on the other hand, has valued their shareholding at ₹1.78 trillion.

The mechanics

Given the large sums involved, a transaction structure involving a staggered buyout appears to be the most logical solution for both groups. That is if Tata Sons wants to avoid dipping into its profits, which were down by 61% for FY20 as several group companies faced the brunt of covid-19.

Both Tata Sons and the SP group are valuing the shares on four parameters—the value of unlisted companies, the value of listed entities, brand value and debt.

In the past, the Tata group has pledged shares of listed companies with the financial services businesses of the Tata group. So far there hasn’t been a concern of loss of control, but the amount to be raised now will need external (non-group) financiers. This will reverse the group’s efforts over the past 24 months to reduce debt, shore up shareholding in listed companies, and untangle the cross holdings across the group. In short, the move will saddle it with more debt.

An analysis of the financials of Tata Sons and various group companies shows that for a complete buyout, Tata Sons would have to heavily rely on Tata Consultancy Services. Profits in Tata Sons as of March 2020 are down to ₹11,000 crore versus the ₹28,500 crore in 2018-19. The cloud over Tata Steel Europe and Tata Teleservices continues to hound this salt-to-steel conglomerate.

The Tata group is in talks to buy 49% held by AirAsia Malaysia in AirAsia India. The group is also looking to increase its footprint in the online grocery segment and is in the middle of creating a super-app. All of these will require funds. So, one way to buy out Mistry stake without taking on debt in the short term is to acquire Mistry stake in parts.

“SP group does not want to put additional pressure on the Tata group companies and further negatively impact their financials. SP group is open to being flexible as long as the offer for their shares is fair and captures the true value of tangible and intangible assets," said the person cited earlier who is familiar with SP group’s thinking.

As per a Mint report on 9 October, Tata may offer as much as $3 billion ( ₹21,900 crore) upfront to buy a part of the Mistry family’s 18.4% stake in the Tata group holding company. A major part of the funds would come from TCS buyback where Tata Sons own a 72% stake. Tata Sons is expected to get up to ₹11,528 crore from the share buyback. The dividends will add ₹3,244 crore to Tata Sons’ kitty. Over and above this, Tata Sons has its own surplus investment.

This would go a long way in reducing much of the SP group’s debt—which is ₹30,000 crore.

The other option—an external investor—would require the incoming investor to be prepared that Tata Sons will be driven by Tata Trusts and they would benefit only to the extent of dividends.

According to Amit Tandon, chief executive, Institutional Investor Advisory Services, an external investor may come with caveats. “Outside investors in Tata Sons will want the company to go back to being a public company from its current private limited state. The group’s structural constraints will likely come to the fore," said Tandon.