Rules of the M&A Game 1: The Opening Debate
The art of deal-making has been in multi-billion dollar enterprise in
The track as it has been commonly referred to has asked the public for feedback and we thought we would give it some serious food for thought. So over the course of this special series, we are going to focus on some of the most contentious aspects of the existing takeover code and to do that I will be joined by
Cyril Shroff, Managing Partner, Amarchand Mangaldas, Gautam Doshi, Group MD, Reliance ADAG and Amit Chandra, MD, Bain Capital Advisors (India) to set the context and begin the debate on CNBC-TV18.
Q: Let me start by asking you the broader question of why we need a review. It is a young law, it is a 1997 regulation and it is a very slim law as well, it is not as if it has become very bulky, there have been many additions, changes. Why do we need a new law?
Shroff: Many reasons - the context firstly has been set by the terms of reference of the track itself where they recognize the need to align with global trends. Secondly, a lot of interpretation has taken place in the last ten years or so by SEBI and the courts as well as the takeover panel. So all of that has to be given effect to but most importantly I think the economic conditions have changed. First and foremost just a composition of corporate
Q: Do you agree that we need to tweak, change, reform, revise or rewrite this code in any fashion?
Doshi: Certainly we do need to tweak and change. There are a few quirks here and there which one has discovered over the years and those are things which one needs to clarify but I donít think they need to rewrite the entire takeover code. So the base is correct, the principle seems to be right, they seem to work for so many years, wherever one has noticed areas where some oddities have been left out, some loopholes which one can use, those need to be plucked and to that extent needs to be improved.
Q: So only minor tweaking is what you are saying or what you are recommending?
Doshi: Thatís right.
Q: Do you agree with that minor tweaking or a major rewrite?
Shroff: Major rewrite.
Q: Where do you stand on this?
Chandra: I think I am somewhere in the middle. I feel there is enough case history which now exist and thatís valuable case history and one can learn a lot from all of that and I agree with Cyril, I think conditions have changed dramatically and I would add one more aspect to the change in conditions that he brought out which is there has been emergence of new asset classes as well like private equity and when the law was originally written, it was written with a particular intent, it did not have things like private equity in mind and private equity today is a very valuable source of capital for the Indian market. So I think there is definitely a case to rewrite significant portions of the law and it doesnít mean you need a new law but I think it means you do need some significant changes to it.
Q: When you say significant can you specify which what kind of changes you would like to see?
Chandra: Absolutely; for example when the law was first written 15% was set as a major threshold. I think there is a good case to discuss whether that 15% which is actually a corner stone of the entire law whether thatís the right threshold, whether that threshold needs to be change. There were changes which were brought in which were quite sweeping and did not distinguish between strategic investors and more financial investors. I think whether thatís from an insider trading perspective or itís from the perspective of the rights that financial investors truly needed to be more aligned with the minority shareholders as oppose to with the promoters and I think that entire portion needs to be rewritten as well. I think those two are cornerstones of the original law and I think those are up for discussion in my opinion.
Q: If you were to change the threshold limits would you consider that minor tweaking or a major rewrite of sorts. Is that what you refer to when you say minor tweaking?
Doshi: I would certainly consider that to be a minor tweaking if you only change the threshold limit. But if you are changing 15 to 30 then you have to change a lot of the other aspects of the law also. You just cannot change the threshold limit without changing the whole concept around it So in that case it would be a major change. So when I was talking about minor tweaking, I was considering that perhaps the threshold doesnít need change.
Q: Why do you believe that 15% doesnít need to be changed?
Doshi: The question is, 15 a level at which somebody can control a company especially if the balance shareholding is widely dispersed have Indian promoters been able to control companies with 15-20% shareholding and the answer is yes and I think itís true even today. There was a time when groups like the Tata Group use to have less than that and quite a few of that listed companies and yet controlled and thatís even true today. So if 15 is a threshold at which control can change then 15 is an adequate threshold.
Q: Do you agree with that? Does this all boil down to how we perceive control. Is it at 15, is it at 30 Ė that is the heart of this entire review.
Shroff: I think there two-three main things which, the heart of the review control is one of them; the other one is the linkage between the concept of substantial acquisition of shares and control. I think the manner in which the Sebi act itself postulates that it requires a regulation for two things; one, substantial acquisition of shares and takeovers or which would mean control. The linkage between these two is unclear. Ordinarily one would never believe that 15% you can control a company but itís because of the social and the economic setting of
Q: What are we trying to or which interests are we trying to balance in this code, are we trying to design this code in a fashion where we are protecting promoter interest so to speak because many people thought that the existing code did that or is it minority shareholders or shareholders like Mr Chandraís company who maybe invested in companies more as a financial stake and less as a controlling stake?
Shroff: The client so to speak of the old code was the promoter group but I think in 2009 and 2010 and going forward, we have to look at all the constituents of the market. We have to look at the majority, the minority, the promoters and other investors as well. It is only when you find the right balance between all these three that you are going to have an efficient market. You have to accept the proposition that healthy M&A activity is good for everybody. If you donít accept that proposition I think we are going to lose a lot of value, that should be the starting point. So I disagree with the question itself as to whether there should be a slant in terms of trying to protect any one particular constituency. The question is how do we balance all of these together.
Chandra: I agree with that. I think the 15% number was a number that was thrown out, it didnít have precedent and it was thrown out particularly in the context of promoter holdings in India being very low at that point of time and not just Tatas even in the Birla Group you had very low holdings, high teens, low twenties stood as good level of control and I think all of that has definitely changed and 15 doesnít really have necessarily a global precedent which one can hang a hat against and say, how does this compare? I think in any case with the change and with generally promoter holdings going up much higher, there is a case for asking ourselves whether 15 should be 20, it should be 25 or it should be in line with global precedent which is 30 or 35 or no limit at all. I think no limit at all obviously is probably excessive. It is always better in India to have some degree of clarity on law and where there is degree of clarity, those thresholds are much higher. So I think given everything, the 15% number definitely should be up for review.
Q: We are still looking at this from a promoter perspective, right? Stakes have gone up therefore we need to relook at the whole threshold situation and hike it. Is that a fair way to look at this takeover regulation?
Doshi: Undoubtedly that is one of the criterions but not the only criteria and there is a lot for the other criterions which Mr Shroff had mentioned in particular any criteria which helps healthy M&A activity is welcome and that is certainly one thing which we should be looking for.
Q: What is healthy, that is a great word to use because is hostile unhealthy, is more M&A healthy, is it making some of our companies defenseless or more vulnerable, two takeovers, is that healthy?
Doshi: I think hostile or making them vulnerable to some extent is healthy because that is the way in which you compel managements to be efficient because otherwise they are at the risk of losing their companies. So that is what perhaps one is talking about healthy and the other is more M&A activities rather than less. Those are the two criterions but even by those two criterions I think 15 is good enough. So I am not necessarily saying that because of that one needs to change the threshold limit.
Q: Why do you think 15 is good enough? What about the argument that both of them are making that promoter stakes have gone up?
Doshi: Just because promotersí stakes have gone up, the point is should the promoter for example be able to sell half his holding if we assume it is 30 at a higher price when the rest of the minority are not able to recover the same price.
Shroff: I think thatís more a detail issue of pricing and in terms of whether byparting with that half year holding you are parting with any element of control or not because if you are not parting with any element of control the promoter should be free to do it. I do not see why there should be another price.
Chandra: I would agree with Cyril on that. I think there has to be a distinction made between the 15% threshold and control and thatís the key argument. I think where control changes then even if it changes for 5% I think tender offers should be made, there is no disagreement on that. I think the 15 number in my opinion was a low number and I would like to add one more aspect to all of this which I touched upon earlier which is, if we are thinking about this only from a merger and acquisition (M&A) perspective or from a promoter perspective, I think we are missing out one thing which is again going back to Ė and I do not mean to be self-serving on this but going back to private equity as an asset class Ė lot of Indian companies because we have early listing is a paradigm in India, we have 6,000 listed companies way in excess of what we should have of an economy and a market of our size. Lot of these companies have no interest from the capital market per se at large, institutional investors do not trade in 4,000-5,000 of these companies. We want to encourage financing for all these companies. Private equity and venture capital is a logical source for capital for all of them which private equity, venture capital player wants to go and take a 10-15% stake in the company with absolutely no rights. The whole private equity industry is build upon making sure that there is high governance standard and there is high degree of ability to at least influence the course of a companyís action. You want to therefore make sure and thatís not necessarily strategic; it may not all happen with a change in control but it may happen that you have vetoes which actually land up helping the minority investors in the company because you are adding an institutional element to a company where there is none. So I think the development of private equity and venture capital as an asset class combined with the fact that we have 6,000 listed companies makes a pretty strong compelling case for 15% number to be actually higher to facilitate genuine corporate finance activity in these companies in a manner in which in fact improves corporate governance in India.
Q: In this case even if you were to increase or enhance the threshold to 20-25 or 30 which we will take up in subsequent episodes, the very fact is that Sebi still looks upon in share holder agreements as an attribute of control and therefore triggering the code so are we talking about relooking at this entire concept of control in this country, do we need to throw out all our earlier assumptions of what is control or do we need to do nothing?
Doshi: We certainly need to relook at the concept of control where it has gone too far, a simple way to write is not control and that is something which is not in the law and that is something which Sebi has interpreted into it and that is something which we need to re-look at and either change that interpretation or if that is necessary then perhaps that is something which needs a clarification but thatís what I mean by minor tweaking because its not in the law its only something which has come in by interpretation and we need to clarify it one way or the other, if you intend it then let It be clearly in black and white and let people know that it is going to be controlled. I donít think you should intend it but if thatís what you intend, let it be there.
Q: This raises the other important point that is that there is only so much that you can write down in black and white in the law and at the end of the day its how the regulator looks at some of these issues whether its equated with control or other issues of hostile takeovers, there is nothing in our law which disallows a hostile take over?
Shroff: The takeover code o the face of it is very acquirer friendly but we know the reality is the other way around, so hardly any takeover defenses.
Q: So what explains that?
Shroff: There are a number of things, the economic conditions; sometimes the financing is not available and then a number of our foreign investment laws until recently would have come in the way, the foreign acquirer would have to go through the FIPB approvals, so there were a lot of other extraneous hurdles that were there, plus there are so many illogical milestones along the way other than 15% which we spend time talking about, this 5% per annum makes no sense at all, the creeping acquisition and whatís the logic of 55%, the strange thing is that in our code, only two milestones which are relevant for control under the company law which is 26% and 51% are not even milestones under the code, so on one hand you have companies act which is the base, talking of 26 and 51% and the last time and the takeover code it doesnít even mention them, so we can imagine the level of disconnect between.
Q: If it is to be about full rewrite is there a model code that we need to model our code on. is it the way that UK looks at takeovers through the takeover panel, is it the way US is which is lot more open and it doesnít define everything so clearly?
Shroff: In a nutshell we should stick to UK which is already the base as the DNA of our code is from the UK but it needs to be modernized and it needs to be tropical to suit our conditions because in UK as well as a strong concentration of promoter holding, very dispersed whereas the reality of India is that despite all the changes that have taken place we still have a strong promoter holdings and concentrations so there needs to be changes to recognize that and I am sure we will deal with it in subsequent episodes as well but in one line there needs to be recognition of a negative control something which is different than positive control and once you recognize these fundamental concepts.
Chandra: I tend to agree with Cyril, I think the US regime frankly not suited to the Indian markets because its built upon the premise that the courts provide enormous and speedy justice to minority investors and the reality here is obviously different.
Q: They seem to have fewer family run businesses to put up so to speak?
Chandra: Yes and even where they do, its not so much of an issue, so because again you have recourse to the courts to distinguish between a family and a non-family company, so I think we are better off following the UK system and within that framework relooking at things like threshold, positive versus negative control and in some ways that is what Gautam is saying that its tweaking law but in some ways its rewriting some major parts of it.
Shroff: Also in your last comment, having a regime which covers 0-100%, you are talking about taking control, so eventually unless you are able to take a company private in an efficient sort of a way, none of the concerns which the financial investors have would be really resolved.
Q: So we have new delisting notifications getting notified, just a few months ago we are now looking at this takeover code in some sense in parts because if you donít reform the delisting guidelines and regulations get notified, just a few months ago now we are looking at this takeover in some sense in parts because if you donít reform the delisting guideline?
Shroff: This is upto 75% and 25% is hanging some where.
Q: So what is the big problem for investors, if you want to really do the private equity in this country and take public companies private, there is no way you can do it?
Shroff: How about having a single law for zero to hundred.
Q: So what are we talking about we are we just tweaking. What do you think needs to be taken up on an urgent basis are you finally convinced that maybe we can relook at this holistically and rewrite this entire thing right from what is controlled to being able to go private?
Doshi: We do need to relook at it holistically and on that there is no question whether at the end of it we will want to change a lot of it is a question mark but yes there are areas where we will have to and if think we can bring in the delisting part of it that is absolutely essential whether we keep it in two different laws or whether we bring it into the takeover code is a different matter.
Shroff: But it must flow seamlessly.