China; The Rough Guide

Greed may be good, according to George Soros but back home our regulators beg to differ.

With the recent set of amendments to the Substantial Acquisition of Shares and Takeovers) Regulations, 1997 in tow (new code), Securities and Exchange Board of India (Sebi) has brought preferential allotment of shares under the purview of the new code (contrary to the recommendation of the Bhagwati Committee) and tightened indirect acquisition norms, thus, dramatically increasing the acquisition cost for companies.

Further, the new code has decided to bring down the creeping acquisition limit from the current 10% per year to 5% which will be effected from October 1, ‘02.

Indirect holdings: The Indian corporate takeover saga is replete with examples of backdoor acquisitions, which many a company have undertaken to avoid the open offer requirements.

This loophole is sought to be plugged by Sebi which now stipulates that any indirect acquisition of over 15% would trigger an open offer. This means that if an acquirer gains control or acquires over 15% stake in one company and that company has a more than 15% stake in any other listed company, the acquirer, would have to make open offers to the shareholders of the second company.

If the first entity is also listed, the acquirer will have to make open offers for both the companies. While under the earlier guidelines, the indirect acquisition envisaged acquisition through holding companies, the amendment now covers any form of indirect acquisition and not limited to only holding companies. The new provisions apply to even offshore companies.

Cost of acquisition: The new code has made acquisitions an expensive proposition. For the purpose of determining the offer price, in addition to the existing 26 week criteria, an additional criteria of the weekly average of two weeks preceeding the date of public announcement has been added to Regulation 20(4).

This would ensure that the existing shareholders benefit from any sudden spurt in the share price that may have preceded the public announcement.

While benefiting the investors, this could significantly increase overall cost of acquisition for the acquirer as invariably, the market rumors lead to such fluctuation in price prior to any proposed acquisition.

Further, any non-compete payment made by the acquirer to any person other than the target company which is in excess of 25% of the offer price, shall be added to the offer price.

Under the amended guidelines, the form of consideration payable by the acquirer excludes preference shares.

Moreover, an acquirer who has made a public offer is not allowed to acquire further shares (that is, creeping acquisition) for a period of 6 months following the public offer at a price which is lower than the public offer price, except if such acquisition is through the stock exchange.

Global acquisitions: However, global acquisitions have been given some leeway. A public announcement for a global acquisition can be made within three months from the date of acquisition, which under the erstwhile Takeover Code was required to be made within four days of the date of the acquisition.

In this bargain, the small investor stands to gain as the offer price of the shares would be higher of the date of acquisition or the date of the public announcement.

Preferential allotments: The new code has also removed the automatic exemption granted to preferential allotments. This means that any acquisition of over 15% in a company through preferential allotment would trigger an automatic open offer for another 20%.

This would have serious implications in terms of the foreign private equity players or strategic investors who primarily have used this route to acquire a strategic stake in the Indian company.

This amendment would thereby mandate the foreign investors to offer an exit option to the investors unwilling to stake their money on a new management.

This could substantially increase the cost of investment for such strategic investors, thereby discouraging them from taking stakes in listed companies.

One possible rationale for exempting the preferential issue of shares was the fact that any such resolution would generally require a special resolution thereby taking consent of a majority of the shareholders.

Though this exemption may have been misused by some promoters, a complete withdrawal of such exemption will spell doom for strategic investors.

However, the new code continues to exempt the acquirer from public offer if the change in control is approved by the shareholders through a special resolution (earlier ordinary resolution).

Can an argument be put forth to Sebi that if the change in control which is approved by the shareholders through a special resolution is exempt from public offer provisions, why should preferential issue of shares which is also approved by a special resolution not be exempt from public offer requirements?

The new code also removes concessions for acquirers who hold 75% or above and wish to increase their stake further. Although, earlier, the acquirer was permitted to make an offer for less than 20%, now the acquirer will have to offer to buy a minimum 20% from the public which could potentially result in a possible delisting of the company.

The new code has clarified that any conditional offer will have to be for a minimum of 20% of the paid-up capital of the target. Further, in case of offers conditional upon minimum level of acceptance, the level of acceptance will have to be less than 20%.

In sync with good corporate governance practices, disclosure requirements under the new code have also been tightened. Disclosures at 5%, 10%,14% and any 2% change over 15% levels is required to be made to the target company and the stock exchanges.

This will lend needed transparency to a system which so far was ruled by people who were privy to information. Further, the threats of a hostile takeover could be mitigated due to such information being freely available.

The new code seems to love the small investor. Shareholders will be allowed to withdraw shares tendered in an open offer upto 3 days prior to the closure of the offer, thereby giving them the option to get the best price by either tendering it to the competitive bidder who is making a counter offer or sell it in the open market.