Rules of the M&A Game 4: Indirect Acquisitions & De-listing
Itís been a decade of intense deal making for India Inc. Rules of the M&A Game examines the changes required for Indiaís Takeover code.
The debate on Indirect Acquisitions: An indirect acquisition is an acquisition of a company whether listed or unlisted, whether India or abroad, that effects a change in control as defined under Takeover Regulations 10-11-12 in a listed company in India. An indirect acquisition is subject to open offer obligations.
Proportionality: To calculate Pro-rata shareholding acquired in underlying company by virtue of acquiring the intermediate company.
Effectuality: To determine if the acquisition of the intermediate company has lead to a change in control in the underlying company
But a more recent Supreme Court judgement in the Technipís case upheld the application of the Chain Principle to indirect acquisitions. The Chain Principle says that a mandatory offer applies either when the resultant shareholding in the underlying company constitutes a substantial part that is more than one-third of the assets of the intermediate company or when one of the main purposes for acquiring the intermediate company is to get control of the underlying company.
Below is a verbatim transcript of the interview Cyril Shroff, Managing Partners at Amarchand Mangalsas, Amrish Shah, ED of PwC, Sandeep Parekh, Former ED of SEBI & Visiting Faculty, IIM (A) and MR Prasanna, Group General Counsel of Aditya Birla Group on CNBC-TV18. Also watch the accompanying video.
Menaka Doshi: We apply the Chain Principle to indirect acquisitions in this country; does that need to change in any fashion? Does it need to get formalized by mention in this reviewed code?
Shroff: There are 2-3points; one is that Chain Principle needs to be formalized by putting it in the black letter code, it is currently there through interpretation of judgements even though it was there originally in the Bhagwati Report. So that is suggestion number one. Suggestion number two is that there needs to be more clarity in terms of when you are applying the Change Principle for indirect acquisitions? What is the principle that you are going to follow? Are you going to follow and arithmetic proportionality test of seeing what proportion of effective holding you have or are you going to look at the impact in terms of what it has in terms of control? I think there needs to be clarity on this, which Sebi quite often is changing by case to case causing a lot of confusion. Say this or that but be clear about it.
The third point I have on indirect acquisitions is in terms of how you determine price. In a case where you are acquiring an intermediate company which has multiple assets ó it could be a global acquisition, it could be an Indian acquisition. There is always a rolled up price which is paid for the bundle below it and only one or two of the asset sitting below the intermediate company maybe listed. So should you have discretion to substitute the stock market-based price by transaction price? Currently again it's going on by a case by case basis- there needs to be clarity in terms of how is it that parties would be allowed to allocation value. Is it something which they put in the contract or should there be some fair valuation basis. This causes a lot of confusion and a lot of delay when open offers are filed Ė there is a big discussion and negotiation, effectively which is quite often very discretionary and arbitrary which takes place with Sebi. It is quite unhealthy and I donít think it's always in the interest of the shareholders.
These are the three big headline changes that need to be made. There are lots more other nuances in terms of timing or when the open offer should be allowed or not.
Doshi: What I understand is that what everybody seems to be asking for is sort of an enforcement of Materiality Clause, saying that if the target company constitutes a substantial part of the intermediate asset company or whether your objective was to acquire control of the target company through the intermediate company.
Shroff: So there is no quarrel with the notion that an indirect acquisition should result in an indirect open offer, it has a downward impact.
Doshi: And that open offer should be priced accordingly ó for instance, if the target company again is a large part of the assets of the intermediate company then you should bring in negotiated price into that conversation. if it is not and if it is a fraction less than 10-20% then you go by historical market based pricing. In that sense it seems to be consensus in all of this.
Parekh: If you get to looking at materiality, are you looking at the listed subsidiary is the material part of the parent - is that the question? If that is the question then I donít think that should be the question because you might be a shareholder of the company which is only 1% of the parent. For you, your target company is very important, you are a shareholder of this company. It makes no difference whether you are 1% of the parent or 20% of the parent.
Doshi: But if you just test that with large global M&A that takes place, for instance, If I was to fictitiously say that General Electric acquires Boeing in the world, should a Boeing incorporated company in India Ė he is not acquiring it if Boeing was listed in India to be able to acquire the Indian arm of it. So why donít we put this in context and say that you cannot subject large global M&A to these kind of nonsensical domestic issues?
Parekh: It is not nonsensical firstly; itís a listed Indian company. There are very few listed Indian subsidiaries of large conglomerates
Doshi: If it is a listed Indian company then we are saying you put in tests for mandatory tender offers Ė what about the pricing? Are you going to determine the pricing based on the negotiated price between GE and Boeing or are you going to look at historic market pricing?
Parekh: I think we are mixing up the pricing of the parent with the pricing of the target. It is a listed company; itís traded on the stock exchange.
Doshi: That is what we are saying - go by historic market pricing, donít try to derive the value of the open offer from the negotiated price?
Parekh: We are on the exemption issue right.
Shroff: We are on two issues; whether open offer should be made in India at all or not and if so what price? Should it be a market based price or do you go with the example of the GE-Boeing transaction?
Parekh: I am not too concerned about the price because usually itís listed and it's liquid, so you know the market price.
Shroff: But Sebi very often second guesses the price.
Doshi: (Sebi) Takes on the negotiated price which has nothing to do necessarily with the Indian subsidiary?
Parekh: I totally support Mr Shroffís stand that it should be black and white. It should be fixed and you should be able to understand what the regulation requires of you.
Doshi: Your only problem is with the exemption?
Parekh: My only problem is with the materiality issue.
Doshi: So what would you consider material or immaterial?
Parekh: As a shareholder with a target, my company is material to me. It makes no difference whether the target is a very small component of the parent.
Shroff: This is inherent in the Supreme Court judgement as well where there is some suggestion that if they are not material the Chain Principle should not apply. But I would go with what Mr Parekh says. In as much for the shareholder sitting over here it's material to him, whether it's material in the larger scheme of things or not, so long as the price issue is sensibly resolved, I think its fine.
Prasanna: I have a different view on that. I feel that you have to look at control as is classical understood, both from ownership and management. If there is a significant change in the management control and all the affairs are continuing the way they are in India, the shareholder should not really have a great concern and the materiality test should be seen in that context - whether this overseas acquisition has actually triggered in a substantial manner.
Doshi: You are adding nuance to a materiality test that he disagrees with in the basic form as well?
Prasanna: I agree, he (Parekh) always disagrees.
Doshi: Do you have a last word on this?
Shah: I think if you look at other jurisdictions and if you have to draw some parallels, there they have laid down tests of what it constitutes in terms of materiality or significance in the parent company and if we are saying that we want to realign, also look at global precedence, then we should move to that is what I think.
Doshi: I know that there is a separate set of norms for delisting that is not contained with the takeover regulations at all. The big question I would like to start off with and get each one of your quick view is - should it be some part either embedded within the takeover regulations or atleast in harmony with the takeover regulations and should we create a 0-100% regime so to speak when it comes to M&A?
Prasanna: The delisting regulations are as recent as June 2009 and then the revision of the takeover code that's happening, I think they have to see the interface between the two. I have one primary issue - there is no listing agreement. In the sense there is no specific regulation, we've got the agreement all the conditions and obligations put in a form of a contract in the listing agreement, but there is no regulation. The question is that why is the delisting regulations are hanging in the air. They are not a continuation or an integral part of a listing agreement which says, if you do this you are not going to be listed or if you want to get out of the listing agreement you must do some things. So I am really surprised. It is legal fiction, that there is a listing agreement which doesnít talk about anything about consequences of delisting and there are some delisting regulations.
Parekh: First of all the listing agreement is not a contract. If you violate it you can go to jail for ten years. It is by no means or no stretch of imagination a contract. It is a law.
Prasanna: If you contractually agree to abide by certain set of regulations, it still is a contract. A law applies in rem. When a law is made applicable in person by law it is actually a contract. It is important to understand that if a company doesnít enter into a listing agreement the regulations do not apply so therefore itís a contractual invitation to get bound by regulations.
Shroff: I think the bigger issue is part of what is known as the 'going private' regime in the world and no sophisticated M&A regime anywhere in the world is complete unless it takes you from 0-100. I think we have the worldís worst going private and de-listing regime and that is almost saying that, and this needs relooking at, because that is again not only in the interest of the minority finally, but also in the interest of the majority. What if promoters are sitting at 75% or somewhere in between 75-90% and why do they need to even keep this company floated at all and they need to be able to take it private and do things with the company and if necessary relist again. Why are no buyouts taking place in India? And this is the reason I donít think this is something that is good for us. Whether this hits in two pieces of paper or one called the takeover code and other the delisting regulation I am agnostic to that and they should just work seamlessly and effortlessly between one and the other so that an acquirer really knows here is how I can go to 100 and these are the rules of the game. The price could be different and I have no problem with that.
Doshi: This is at least the fact that you should have the ability to go from 0-100 is an important one, including the squeeze out?
Shah: The point that Cyril is making is stopping big M&As in India because if you see today, what is happening actually isóif you are doing a 67% acquisition and a 20% open offer, you stand at 87% and if you want to delist you first come to 75% and if you are in that limit so you have a distress sale of 12% because you canít apply the delisting regulation unless you are complying with the listing agreement itself and therefore there is a sort of hesitance on the acquirerís part to go into such swings.
Doshi: So you are agreeing that the current regulations are pathetic?
Prasanna: The delisting regulations are not at all attractive for anyone to go through that long haul process and in fact I would rather go with a takeover code route which is a finite programme and a finite timeline as opposed to going through this delisting regulation.
Doshi: I am also talking about the fact that many companies have attempted in the recent past wherever we have had instances of foreign MNCs taking over some Indian IT companies they have attempted to subsequent open offers to try and reach threshold limits to be able to go to get delisted, its taken them many years to get there and even then they have share holders holding out despite the fact that the process is a four-five years process. Before you object to this, I have just one issue to raise to you, in the pervious panels there seems to be some consensus that when you do a tender offer you should do a 100% tender offer andódonít do a limited 20% tender offer, make it available to all share holders and everyone has a fair opportunity to exit. My question to you is, if we do move to that ideal regime of a 100% open offer, so the acquirer is making an exit opportunity available to all share holders then is it not fair that the acquirer also has this opportunity to be able to take this company private without 40 people dragging him to court?
Parekh: Firstly; there is a difference being offered and in acceptance, even in jurisdictions which say 100% offer is to be made it doesnít mean you have to because then you will be violating listing agreement.
Doshi: You can use that response in that 100% offer to then progressively delist, many jurisdictions from what I understand allow you to delist through the tender offer?
Parekh: Let me just break it up into delisting and we would break it up into basically buying of the shares of the shareholders which they call a freeze out in the US and also deal with them separately. For example, in the US, delisting is federal subject and the squeeze out is actually a state subject and they have very different consequences, the federal law is very investor-friendly and the US law was called hotel California it was very difficult to delist.
The other exact opposite is Delaware for squeeze out. Itís very easy to squeeze out because it is the most hostile jurisdictions in the world to shareholders and they say that please come and adjust with us because you can do whatever you want with the share holders.
The first issue is that by delisting you have gone to the public and here I am giving you the promise that to list these shares and based on that promise you raise money from the public and if you want to delist you do it on their terms you say they will dictate the price and you donít have to accept it.
Doshi: So what you are saying is that the reverse book building effect which is one of the biggest issues and the lack of squeeze out which is the second most onerous issue that plagues this delisting regime should stay because its perfect, you want status quo on delisting?
Parekh: You canít fight economics here. Itís just demand and supply and if you just walk into this place even and want to buy this room and I pay you more than the market price?
Shroff: Lets just separate the issue and lets have a conceptual issue with perhaps what Sandeep was saying is that whether it should be a forced regime for a squeeze out or not I think that is integral to the whole private regime and we have otherwise some small share holders sticking out just for the purpose of it being difficult and if its good enough for 90% or 95 or whatever is the threshold as you said why is it not good enough for that balance stub which remains.
Parekh: Because if it is someoneís property and you just canít steal it.
Shroff: As long as you donít get a fair value.
Prasanna: The regulations actually give ht share holders the ability to influence the pricing but not only that once the final price is determined they need not tender and there was one year put option in the sense any time in that one year after that.
Shroff: In order to protect the smaller share holder we are forgetting about the majority share holder.
Doshi: I agree and I feel that if we are going to move to a slightly fairer regime by saying that do a 100% open offer and give every shareholder the opportunity to exit, then equally you should give the acquirer the opportunity to take this company private?
Shroff: The delisting price should be higher than the takeover price whether it should be reverse book building or some fixed premium or some other methodology, and that is up for debate.
Doshi: Are you in favour of reverse book building?
Shroff: It has been misused and it results in an unfair outcome.
Doshi: You are not in favour of reverse book building because it is just a hugely onerous process?
Shah: You could look at a 12 month price and take that price, whatever is high.
Parekh: One person cannot hold out, you have to hold at least ten shares or slightly less according to the new regulations. So you are an individual shareholder holding 100 shares and you do not have the capacity to hold out.
Shroff: I think we are talking of the 90-100% where you have through a combination of takeovers or delisting, if you are now letís say at 91% why should that last 9% not be squeezed out so long as the value is fair.
Parekh: There is only about 10% a shareholder could hold out you can force a delisting even if the 10% shareholder is holding out. So, squeezing out is a different issue.
Doshi: Whether you went through an M&A route or the other?
Shroff: Whatever, I am at 91% and I have made an offer and he is holding out for no reason except to hold out and it has been good enough for everybody or should they be squeezed out completely or not.
Parekh: Many MNCís, Carrier and Cadbury have held out even till today.
Shroff: If it is good enough for everyone then its fine.
Parekh: That is not the point. The point is that you are stealing my property.
Shah: There is a very different thing. It is also hurting the majority of the minority and that is the important point that one needs to look at.
So if you allow letís say not 20% but the whole hog, to 100%, the majority of the minority may want to tender in. But if you donít allow that they will also be faced with proportionality.
Doshi: I am going to quickly get comments from each one of you on what you think needs to be done to fix the delisting because we came to some consensus on exemptions, some consensus in indirect acquisitions. We are deadlocked on de-listing. What needs to change in the process of de-listing for you to believe that the environment is more enabled towards M&A? I am not talking about non M&A de-listing, making that distinction at least through M&A, if you are acquiring control and therefore you have to do tender offers which are mandatory then shouldnít you be given the roadmap to be able to go fully private?
Prasanna: I do believe that we should go fully private if you have that roadmap. According to me, this de-listing regulation which has come on the statute table is something which is going to be very onerous.
It is a long winded path and it is important for an integrated approach. The takeover code or the listing agreement all of them should create an amalgam which is a comprehensive code. We have too many regulations floating around and delisting regulations only add to the confusion
Doshi: And the only way to do that is if we were to rethink the entire reverse book building aspect and the squeeze out aspect. We desperately need a squeeze-out and we desperately need to find a better pricing mechanism than reverse booking building because that sometimes gets very unreasonable?
Shah: Absolutely. Clearly in an M&A situation you need to go to 0-100. As I said majority of minority maybe in favour of that so why punish them. I am in favour of 0-100.
Obviously you may have whatever qualifications you want to put that shareholders may pass a resolution or board of that target company may pass the resolution, so give it more of anti-abuse if somebody is going to use it as an abuse provision.
Some checks can be put in. But once those are done and you cross letís say 75, then you de-list and you cross 90, you do squeeze out. That is also prevalent in some other jurisdictions
Doshi: Do we need two regimes maybe one for de-listing because of M&A activity and one which is outside the purview of M&A activity; itís just a company that actually decided it doesnít want to stay public anymore?
Shroff: Technically, you need two pieces of paper or two regulations because you maybe delisting without an underlying M&A transactions.
But they need to work harmoniously with each other and I think the regulator canít avoid this debate because if the takeover code changes include making a 100% offer, which maybe on the cards, so you are there now talking of going up under a takeover code process upto 100%.
How can you avoid the discussion as part o the de-listing process, it is really the same territory that you are covering and there needs to be commonality in terms of an approach.
I am not getting into pricing issue because de-listing per se for pricing, the subset of issues relating to the squeeze out there is different set of issue and it goes well beyond the takeover code. It covers de-listing guidelines; it covers the Companies Act. There is a broader set of issues to be dealt with over there.
But first letís get conceptual clarity on whether the headline issue or whether going private in India there is clearly roadmap or not.
Today, the answer is no, which cannot be good. And if we are trying to become a sophisticated economy and if you donít have a going private roadmap it is very retrograde.
Doshi: If we were to make a distinction between going private via M&A and in that case if you were to do mandatory tender offer of 100%. So you are making available an exit opportunity for all shareholders then donít you think at least in those cases the ability to de-list should be an easier one?
Parekh: We have been pioneers in book building for IPOs. We were the first country to introduce book building in IPOs pursuant to the Malegam Committee report. And we are also the first country in the world to use reverse book building for delisting.
I think itís a brilliant matching of demand and supply. Even a 10% shareholder cannot block de-listing. In some cases he can. But usually you have to have more than 10% to actually block this.
So your whole conception that person with few thousand shares can block this de-listing process is wrong.