Slump Sales: Safeguards?
Published on Sat, Apr 30 16:32, Updated at Wed, May 04 at 19:14
Source : CNBC-TV18 | Watch Video :
Piramal-Abbott, Indo Asian Fusegear and Legrand, Schneider and Zicon, Kanoria and Aditya Birla, Smartlink and Schneider again- there has been a slump sale party going on. Unfortunately shareholders have not been invited. Is that fair?
CNBC TV18ís Menaka Doshi speaks to Amrish Shah, Partner, EY; Shuva Mandal, Partner, AZB & Partners and Vikramaditya Khanna, Professor of Law at the University of Michigan.
Doshi: The question I would like to open with is that slump sales are well within the law. There is no grey area being exploited here as long as there is a shareholder vote. Slump sales are fully permitted, they are not in contravention of any regulation or law but did the law envisage the sale of core businesses of this nature and of the kind that we have laid out in the story earlier to this?
Shah: Even if you do a business which is 5 or10% of your overall constituency, even then you need to go to the shareholder and go through the process of getting their approval. So itís not a question of when you cross 50% limit or something else.
Doshi: But that shareholder process, as we know, is not necessarily representative of the shareholder or the minority opinion because if you are a promoter-led company and promoter owns more than 20-25-30%- that approval is going to go through anyways irrespective of what the minority thinks?
Shah: Absolutely. Today itís a majority rule for this type of slump sales or transfer of businesses. They improved it a bit by saying compulsory postal ballot requirement and in the thought that it will improve minority participation. But we know what the general level of participation in such scenarios and if the majority believe that itís good for the company, then probably it is good for every shareholder.
Mandal: Just take off from where Amrish left on the last sentence- itís the majority decision which is deciding the fact whether the slump sale is to proceed or not. Proceeds from that are trapped in the company. This is not a situation where there are differing interests that the minority does not get the cash or the promoter gets the cash. So where do we see the line that there is no alignment of the interest. What is good for the promoter is also good for the minority. Yes, there could be a different sense of expectation. The minority doesnít know what is going to happen to the cash or the promoter has a better visibility on what is happening to the cash. So I think your question is rather framed or ought to be looking at into- should the promoter have a clear communication strategy or should the promoter have certain obligations to the company to disclose what is the next step after the slump sale because that is where the disconnect is. I donít think in the market anybody is objecting to why has there been a slump sale. The question is what is next.
Doshi: I am going to respond to that in two ways- first, if you are selling 90% of your business through a slump sale, at some point, there seems to be something wrong with that. 90% of your business is being sold but this is still not considered a takeover- you are still able to sort of sidestep everything else that Takeover Regulations require when there is a change in control. To me, seemingly, something is wrong with that picture. Second, if shareholders thought that whatever is in the interest of the promoters is in the interest of the broader family of shareholders, then what explains the fact that in two out of three cases that we are citing in the story- in the Piramal case as well as in the Kanoria case- the stock prices have come off substantially even though large amounts of cash are coming into the company. So there is this sense of uncertainty as to we donít fully trust the promoter with regards to what he is going to do with that money. How he is going to diversify, what is going to ultimately happen to the business- we invested in a pharmaceuticals business now if this is going to become real estate- thatís not what we wanted. So there is some unfairness to this and there is not necessarily always true that promoterís interest is also the interest of larger shareholders.
Khanna: I would go one step further and say that the Indian situation is somewhat unusual- in the sense that you could sell 90% of your assets and not be subject to the same kinds of regulations that you would if you had sold your shares. In most, at least in United States and many other countries, the sale of substantially all of your assets and the sale of substantially all of your shares are governed by the same set of rules because they are functionally equivalent. One of the interesting things, I think, when you are looking at the Indian situation is a fact that right now we donít have the understanding of fiduciary duties owed from a controller to the minority. Currently the idea of fiduciary duty, if by anybody, is of the directors to the company. What that means, of course, is if the company approves any particular transaction which a promoter control company could, you wouldnít be able to have any redresses of minority whereas, in at least United States and some of the jurisdictions, the controller owes a duty to the minorities, specifically as a subset of shareholders, to behave fairly with them and that can sometimes be trigged in these kinds of situations.
Doshi: What does behave fairly mean? For instance if you were to transfer that rule to India, what would it mean in the Piramal case or in the Kanoria case or the Schneider case?
Khanna: At least in the United States, the two core elements of fairness are fairness of process in terms of how the transactions are structured and fairness as to price Ė what was the price that was obtained. That deals usually with what the transaction is. It sounds that main concerns is not so much the transaction here.
Doshi: Absolutely not because these are all superb valuations that all these companies have got for the assets that they have sold?
Khanna: Thatís correct. Although one way to look at this is that they have got great valuations but you donít know the counterfactual which is- how good the valuations could have been had they done the transaction differently which is why they have processing query separate from the pricing query. So usually what they look at is how they structure the sale and what do they do afterwards?
Doshi: But none of this seems to answer the issue that minority shareholders currently have which is that the company is benefiting from a superb valuation for its assets, all that money or cash is coming into the company but we are not being able to participate in it. Like Anil Singhvi pointed out in a discussion we were doing regarding Piramal. He says your stock price is Rs 500. If I was to breakdown the Rs 17,000 crore that you are getting from the sale to Abbott, it would roughly work out to Rs 800 a share. I am not getting any part of that Rs 800 nor is your stock price appreciating enough for me to be able to partake in that enhanced valuation. So I am getting nothing out of this except for the uncertainty or what the promoters are going to do with the money?
Shah: Just to step back, first thing is what is the transaction that is available to the company? Is it the transaction on the shares or transaction on the business? Thatís very important to know because if itís only going to be the transaction of the business being sold as a slump sale, where is the question of somebody looking at the company being sold because the acquirer may not be interested in the company.
Doshi: This is, I think, in response to your point that we donít know what price could have been fetched if it was done through the conventional M&A rules and I think the common argument I get from everyone I talk to is that, most likely, we would not even have had a buyer if we had to go through the conventional rules.
Mandal: Because if you take several global multinationals, they would be extremely hesitant to take the burden of acquiring a listed entity in India because this is relatively an unknown territory for them- rightly or wrongly -when it comes to governance issues and handling minority. So, several of them would like private transactions and therefore the preference for slump sale. Donít forget there are also liability issues. Sometimes people donít want to buy companies because there could be liabilities in maybe smaller businesses which they donít want to inherit. So there are more focused business considerations why the acquirer would like a slump sale and as Amrish has rightly put it what does the seller do? He sees 10 times the money through a slump sale and maybe no buyer for a share sale.
Shah: Or the control premium on the business changes because itís either a share deal, then itís an X amount or its business and itís an X + Y amount. Thatís the call that a seller will have to make.
Khanna: One of the puzzles, I would think, is that if you have Rs 10,000 crore, even if you donít know what the person will do with, that money is sitting in the company. You have assumed ĎXí hypothesis that is actually an increase above what a company was worth. So, even with uncertainty, you would expect the share price to increase. If you donít actually see that, there is something strange going on. Regardless of what he does with that, he hasnít burnt it yet. So you should see some increase in share price but not seeing it is something of a puzzle.
Shah: The only difference in the Indian capital markets versus the global capital markets is that traditionally Indian capital markets have never given higher valuations for holding companies- thatís the fundamental difference- whereas globally, it is generally the holding company which is the listed entity and everything else is below it in different entities. Thatís the big difference.
Doshi: I am not making the case against slump sales because I understand there is a clear business need for it and several deals would not get done at all if it wasnít for a slump sale. But I think there is some concern at the level of the minority shareholder that how do I get some benefit out of this which is not just maybe a special dividend thatís done after such a transaction takes place. Or in the case of Piramal, the company did do a 20% tender offer buyback at Rs 600. I am not taking that away from the companies and their promoters but I am saying is there any other way to safeguard shareholders especially in extreme situations when 90% of the business of the company is sold. Is there someway to safeguard shareholders? Should we be thinking of safeguards?
Khanna: If one wanted to play devils advocate, for just a moment, one argument could be that shareholders, before any sale, have some percentage stake in the assets of the company- all thatís changed is the nature of the assets - from physical capacity they were to monetary assets. In theory that shouldnít really change their interest because it has just change form not value; if anything, it has increased. That shouldnít be a problem per se unless you think that something will be done with that money that doesnít benefit those shareholders. That's a devils advocate argument you may take. The counter point basically, I think, would be that we donít know what the person is going to do with the money, how do we know that they have got the highest price? Usually, the concern whenever you are selling the assets of the entire company, is either that the controller will get a low price which is usually when they sell to a related party. Or alternatively, the timing of the sale will be strategic - meaning that they unload assets just before they are about to make tons of money for someone. They donít want this set of shareholders to benefit from that; they want another set of shareholders to benefit from that. Thatís a difficult to police unless you have some kind of expert system, for example, where you have fiduciary duty analysis or if you have some kind of majority- minority ratification although I understand that would require other kind of changes.
Doshi: And in neither of these circumstances, at this point of time, this is really a concern as of yet.
Khanna: That is correct.
Shah: If you just go back in history, maybe 21 months back in India, there would have at least been couple of instances- related party transactions- which some of the significant minorities have objected and the Boards have had to retract. So itís not that it has happened in India. So if you look at it from that perspective- while these are not related party transactions at all; they are independent third-party transactions. So obviously, the promoter- who is the majority shareholder- is looking at maximizing the interest for the company and therefore it will benefit everybody.
Doshi: Letís come back to the safeguards
Mandal: There is skin in the game. I think the promoter has as much skin in the game as minority.
Doshi: Sometimes itís too much or much more? Can the case be made?
Mandal: Thatís good for the minority.
Doshi: How do you explain selling 90% of the business? How do you defend that?
Mandal: Letís take an example. Letís take a pharmaceutical company and it is getting, say, 90% of its revenue from 1 molecule. Itís in the high end of the revenue cycle, he sells it. Now when you say he shouldnít be selling it and he shouldnít be investing in the R&D for the next molecule, I mean any new age company and I am not saying this is the best example.
Doshi: Itís tough to analyze.
Mandal: We are second guessing company decisions here which we are all entitled to in a forum but from a pure legal perspective- when you are looking at company management- thatís only the boardís decision.
Doshi: Are you making the case that there is no need for any further safeguard, outside of the fact, that any sale of business of this nature needs to be voted upon by shareholders through a postal ballot and achieve simple majority- even if that simple majority is entirely achieved by the promoter voting at this stage.
Mandal: I think probably the only additional safeguard I would probably advocate is if a company is changing its line of business- which is not what any rule at presently spoken about- at that point there has to be a shareholder vote probably. If it is the change in the line of the business, substantial change and there is a threshold for that.
Doshi: Shareholder vote with simple majority or are you asking for higher thresholds to ensure that minority in fact does get a voice?
Mandal: You can have it with higher threshold. I donít think we are debating the thresholds. I think we are debating the process that whether shareholders should have a say if there is a change in line of business. All the issues that you raised are not about slump sale, they are about what next.
Doshi: Whatís going to happen to the cash? Ok change in line of business should get, may be, shareholder approval safeguard?
Shah: Coming back to the other point that 90% of your business being transferred and all of that- are we sitting in judgment to say that 90% is going to go up or shrink or is this the right time to divest because there is extra competition coming in, there is a change in the economic scenario- who is going to take that judgmental call? At the end of the day, it is a very specific call to be made. So are we saying that the minority shareholders know so much about the business that they are willing to take that call or block that resolution in that sense or is it that the majority is aware about it and what is going to unfold and therefore looking at the divestment in interest of everybody and obviously in their own interest because they hold the majority in their company. Thatís one point.
And coming back to safeguards, they moved from simple majority to a postal ballot and we have seen there is no change in the end results in terms of extra voting coming from the balance shareholders in that sense. You move it further the needle- how much will it improve because its then upon the minority shareholders to participate. So I think itís up to them.
Doshi: But at least thatís where you can then say that listen you have no reason to complain because you had an opportunity to vote out this transaction, you didnít use your vote, so now live with it?
Shah: Beyond a point, what stops them today?
Doshi: Well, you know all three companies. Piramal owned 50% in his company, Smartlink 67%, Kanoria 57%.
Shah: So tomorrow if you move to a 75% or whatever that limit is, because the way we have the voting in this country and the participation of the minority shareholders, even that will be a easy task to achieve.
Doshi: One lawyer- Jayesh - brought up the point that the Companies bill 2008 does in fact suggests a special resolution in the case of the sale of an undertaking- thatís 20% of net worth or 20% of revenue of a company- may be that sort of fits into some of the safeguard conversation that we are having; though its not known whether an enhanced threshold will in fact mean much?
Mandal: Whether you go to the UK, whether you go to India - thresholds are thresholds and in all mature jurisdictions you do have controlling stakes but I think the slight differentiation where we are probably lagging behind is the extent of disclosure, the justifications. So today in UK, for example, if you were to do a Class one type transaction- which a major slump sale deal- you would have to disclose to shareholders the need for it, the affect on your balance sheet, there is a huge fiduciary that comes in there. There is an investment bank that needs to come in, supplement the information, sign off on the data, does it meet certain financial parameters. So the point being, the checks and balances and the decision making has a certain fiduciary obligation that goes with it. So I think the point that probably we could say is perhaps lacking in India and that is across the system, not unique to the slump sale discussion, is how much of the fiduciary is there today on the directors that requites them to make a far more, if you may say, more data based or a more knowledgeable decision.
Shah: Basically, I think, whether moving the threshold from a majority to a special is going to serve the purpose- that is a question mark because if you look at all of this, the key thing is what are the type of disclosures.
Doshi: So more disclosures is one other suggestion that I got from a bunch of lawyers I was talking to.
Shah: And right up to the usage of the funds that are going to come into the company.
Doshi: So more disclosures on the deal itself, on the use of funds, may be even a shareholder approval if that user fund means a big diversification?
Shah: If you see when the rights issue happens, you disclose something in the offer document there and then you are suppose to again disclose, at the end of the year, how you have used those funds and it keep on happening for a couple of years.
Mandal: Promise versus performance.
Shah: Yes, so something like that can also be built in to say that we did this, we have now done this instead of this but these are the reasons because things keep on changing.
Doshi: Have we run the gambit of safeguards that would work?
Khanna: I like that disclosure option- thatís generally good especially because there are lot of analysts in the market who would be reading and paying attention because that should have an impact on stock price. About the shareholder vote, there are a lot of strange aspects to shareholder votes. In a lot of countries, where they have increased thresholds, the outcome hasnít changed. Usually the reason is that partially the controller will buy a few more shares and partially what also happens is, when you look at minority shareholders, for them to be bothered to pay attention to vote- they need to have a substantial stake in the firm.
Doshi: In which case we shouldnít have been doing this discussion at all because if they are not bothered to vote, then they have no business complaining; right?
Khanna: Which is the problem with most minorities that they usually have such a small stake in the company that its not rational for them to get informed about the business which is why they essentially, in some respects, delegate to the controller. They say it is okay, we are own 10 shares out of 20 million, we are not going to read the materials you present to us, we have delegated the decision to you. If you donít like what you are doing, we will sell our shares. For bigger shareholders, those who own 2-5%, they have some rationale to actually bother to look at the materials and make a decision and so when we are thinking about shareholder voting, if the idea is that you increase the threshold, one has to be cognizant of the fact that a lot of shareholders will simply not vote. The alternative is to have a majority- minority ratification, which flips the burden on the other leg; thatís something I think SEBI has been trying to suggest for certain kind of things.
Doshi: There was one suggestion that may be if you were to consider the promoter and interested party- I will go back to the Piramal transaction- the promoter in fact got a non-compete fee in that transaction. Now does that make him an interested party and if it does, because he has benefited more than all other shareholders of that company, should he have abstained from voting and should that be the case here onwards that if the promoter gains special interest in that deal which other shareholders donít get, then he should be abstaining?
Khanna: My sense is that, a special deal if itís not disclosed, shouldnít be.. (Interrupted by Doshi)
Doshi: It was disclosed, it was fully disclosed.
Khanna: If its disclosed, all that simply suggests is that if the shareholders vote would not carry the day anyway, now it wonít carry the day with a little bit of salt on it. If they know that he is getting something but there is not much they can do about it and so if you are trying to discount his vote- in the context that it is conflicted- he is always conflicted in that sense because he is a controlling shareholder. He can determine what to do with the assets. The fact that he gets a separate fee- a non-compete fee- is neither necessarily here nor there. As a controller, even if he didnít get a fee, he could determine the salaries of people and that would of course have a natural impact.
Doshi: If I would just summarize- more disclosures and may be a shareholder vote on how that money is being put to use, especially if it is a non-core diversification- probably are the only two safeguards that all three of you agree on?
Mandal: If you go back, if you take the emotion away from the whole Satyam episode, what was the hue and cry about? Other than the related party transaction, it was the fact that a software company diversified suddenly into real estate. So even two years down the line, we have left that door even open now and none of us have answered the question that to whether a major diversification event in a company is a shareholder vote item.
Doshi: Yes and I remember the Board of directors in Satyam saying we didnít think we needed to get shareholder approval even though it was such a big diversification.
Mandal: Which is right, which is legally right?
Doshi: Legally right but not may be in the best principles of governance.
Mandal: Thatís right.