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A lower stakes game

The lowering of the maximum promoter stake is good for public ownership but has come at an awkward time


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As far as Budget measures that impact large Indian businesses, perhaps the least expected was the reduction in maximum promoter stake from 75 percent to 65 per cent. What's more, unlike almost everything else in the lengthy budget speech, the Finance Minister did not offer any immediate rationale for this change. Para 32 of the speech reads 'It is the right time to consider increasing minimum public shareholding in listed companies. I have asked SEBI to consider raising the current threshold of 25% to 35%.'

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Why is it the right time? We don't actually know. We also do not know whether SEBI will just 'consider this' or take it as a command to be followed but the equity markets certainly think that this is a done deal. Sooner or later, promoters who have more than 65% stake in their companies will have to sell off enough shares to bring it down to that number. Some will choose to sell off their stake, some companies could sell fresh shares with the promoters not subscribing or some combination thereof.

In any case, there would be a greater number of shares in the equity market for the same underlying economic value. By basic principles, the share prices must fall if the quantum of money that's able and willing to buy the share stays the same. In a comparison of two hypothetical situations with all other things being equal, the value of the investments of the current investors must be lower than they would otherwise have been. That does not mean that the value would fall, it could just rise less than it would otherwise. All this is hypothetical but not a far out conjecture--it's based on sound principles that are generally true.

Of course, it's not as if lowering the promoter stake has no merit. A higher quantum of stock available to the public would make shares more liquid as well as less volatile. The price that the market discovers should be truer to actual economic value of the stock.

Even so, there is no way to quantify the positive and negative impacts and say that yes, 65% is the right level and not some other level. The 75% limit itself does not have a long history--it was brought in only in 2010, with the initial deadline set to 2013. The 2013 date proved impossible to adhere to for a large number of companies and kept getting postponed and is in fact, still not universally achieved. Ironically, the promoter who has had the most trouble hitting 25% is the Government of India, and several PSUs have still not managed to comply with the rule. Going by that experience, and the fact that at this stage this is officially just a suggestion to SEBI, we're probably several years away from the time when all promoter stakes must come down to 65%.

Over such a long period of time, the dominant driver of a stock's price and performance is bound to the actual fundamentals of a company. Good stocks will make money for investors and bad stocks will not. A gradual divestment by the promoter will have a transient impact on price and liquidity, with no more than a fleeting effect on stock prices of stocks that are investment-worthy. There might be some tactical advantage or disadvantage here and there for punters, but no lasting change in the fundamental investment story of a stock.

The only shareholder whose ability to create wealth will be reduced will obviously be the promoter who prefers to retain a high stake. For example, the Tata group today has a claim on 72 percent of the future stream of wealth TCS will generate but this will be reduced to 65% now. The seven per cent they will forego will go to other shareholders instead. From the standpoint of what a vibrant stock-ownership culture is supposed to achieve, that can't be a bad thing.

However, one can definitely put a mild question mark on the timing of this change. There are a lot of storms that have gathered in the skies above Indian business and this promoter stake change just adds to the regulatory workload and stress which has in any case become pretty high in recent years.

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