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Towards more equitable norms

Many provisions of the new norms aim to make it possible for retail investors to reap the same benefits from a takeover as promoters

Market regulator Securities and Exchange Board of India (SEBI) has proposed to revise the takeover code for companies in India. Thus norms for mergers and acquisitions (M&A) in India are set for a major overhaul. Further, the new rules are likely to make M&As more expensive. But they are also likely to ensure equality of opportunity and fair treatment of all company shareholders - big and small.

The proposals
The takeover committee has suggested revision of the threshold limit for mandatory open offer from the current 15 per cent to 25 per cent. This higher proposed threshold limit will bring Indian takeover rules closer to the norms prevalent in developed economies, where the threshold is 30 per cent or above. Further, the committee has suggested that the open offer size be revised from the current 20 per cent to 100 per cent. Under the proposed code, if the acquirer intends to delist the target company after acquiring it, he would have to state his intention upfront.

The new rules make it mandatory for a committee of independent directors of the target company to issue a recommendation on the open offer. This has been done with the purpose of ensuring that investors are able to take more informed decisions.

The committee has also made changes to the rules governing competing offers. It has suggested an increase in the period for making a competing bid. It has also prohibited acquirers from being represented on the board of the target company.

In order to usher in transparency into the way M&As are structured, the new proposals have suggested that no non-compete fee should be paid to the promoters of the target company by the acquirers.

An important recommendation is regarding offering one price to all shareholders. As for the method of fixing the open offer price, the panel has proposed that the minimum price payable shall be the highest of these 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 lastly, the market price based on the volume-weighted average market price in the preceding 60 trading days.

The timeline for completing the entire process is to be reduced from 95 calendar days to 57 business days. The committee has also set the minimum size of voluntary open offers at 10 per cent which can be increased until the offer does not result in a breach of the maximum non-public shareholding.

Likely impact
High cost of acquisition. Market experts believe that 100 per cent mandatory offer will drastically push up the cost of acquisition. In the present scenario, once an open offer is triggered, acquirers need to make an offer to buy at least 20 per cent of the shares. If the proposed norms are accepted, they will have to make an offer to buy all the shares. This will increase the cost of acquisition drastically. However, the panel has expanded the number of payment options by including securities such as debentures and convertibles in addition to cash and shares.

Equality of opportunity. On the positive side, experts believe that the proposed norms are more investor friendly. Under the existing norms since the open offer is only for 20 per cent of shares, retail shareholders often do not get the chance to avail of the offer price and exit, if they wish to. But with the revised code (which makes it mandatory for the acquirer to offer to buy 100 per cent shares), all retail investors will get a chance to participate in open offers. Moreover, they will be paid the same price as the promoters.

Trigger delisting. According to a report by SMC Capital, “The suggested norm increasing open offer size from 20 per cent to 100 per cent is quite significant. If as part of the response to the open offer the acquirer's stake reaches 90 per cent, then the acquired company can even be delisted. If this takes place, it may be a curtain-raiser for hostile takeovers in India. Under the current guidelines, the voluntary open offer cannot take the acquirer's holding beyond 75 per cent, making it difficult for anyone to complete 100 per cent buyout.”

Strategic investors may scale up their investments. Since the cost of acquisition is set to increase, the new norms will encourage only serious deals. The proposed increase in the acquisition threshold limit is set to give strategic investors such as foreign institutional investors, hedge funds, and private equity funds greater legroom to increase their shareholding, which is not possible under the existing guidelines.

Corporate governance to get a boost. According to a report by Religare Capital Markets, the new regulations propose various steps that are likely to improve corporate governance. Some of these include preventing material transactions during the offer period, obtaining published opinion from independent directors of the target company, and disallowing representatives of the acquirer company on the board of the target company before 100 per cent prior payment (in escrow) is made, or until competing offers have been made. Non-compete fee has also been done away with and would now be included in the offer price (this could raise the overall consideration, though).

Observations
An SMC Capital report highlights that out of BSE 500 companies, in 215 companies the promoters own less than 50 per cent stake, making them vulnerable to takeovers. Out of such 215 companies, in 76 companies at least one single shareholder owns between 10 per cent and 49.99 per cent. Hence, in these 76 companies, the vulnerability of being taken over is quite high. This is especially true considering the fact that the new guidelines have permitted the seamless integration between open offers and delisting. Above all, if these suggestions become rules, they are likely to help make mergers and takeovers more equitable, especially in favour of retail investors.