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New Takeover Norms May Spur PE Play In Listed Mid-Caps

19 July, 2010

The recommendations submitted by the market regulator Securities and Exchange Board of India’s Achuthan Committee on Takeover Regulations could have far reaching implications on the mergers & acquisitions and private equity deal environment. The panel has suggested raising the threshold for open offers to 25% from 15% limit now. Also, these

offers will now be made for the entire remaining shares of the target firm, thus raising the stakes in M&A game.

“One aspect (of the recommendations) is to fine tune the code in terms of both growing and current needs of the Indian capital markets. Another is to bring accepted, established international practices into our code,” said Rohit Berry, partner at BMR Advisors.

While increasing the open offer threshold to 25% is a great a idea, pushing up the creeping acquisition limit for parties who are already in control shouldn’t have been an issue, feels Vijay Sambamurthi, founding partner at law firm Lexygen. The creeping acquisition limit

remains at 5%.

The panel has also said that creeping acquisition permitted only to acquirers who already hold more than 25% of the voting capital, subject to the aggregate post-acquisition shareholding not exceeding the maximum permissible non-public shareholding.

The change in regulations also means that private equity investors can take a significant stake of up to 25% without having to make open offers. Investment in publicly listed companies still accounts for a major portion of private equity deals in India. Private investment in public equity or PIPEs, as such deals are called, constituted $8.05 billion across 228 deals since 2007, according to VCCEdge.

The step is expected to be a boon for growth capital deals, where the PE firm typically tend to acquire 10-20% stake. Few PE firms make an open offer, keeping their holdings just shy of the 15% mark. To circumvent this rule, several PE firms have also used routes like buying stakes through a mix of common equity shares and the rest through global depository receipts (GDRs).

According to Munesh Khanna, CEO & MD- Investment Banking, Centrum Capital Ltd, the proposed change in open offer limit to 25% from 15% will have a tremendous impact in the Indian PE space, especially in areas of small and mid-cap companies. He told VCCircle, “There are many small, mid-cap companies vying for funds. Those companies with Rs 250-450 crore market cap, the fundraising through QIP or follow-on offer is not practical. The only viable option before them was the PE route. However, the PE firms were not keen to acquire the minority stake below 15% as it was too small for them. But the new 25% open offer limit will bring too many investments in those mid-cap firms.”

However, concerns still remain. “For some complex growth equity deals, the proposed rules on reckoning indirect acquisition of shares may spell needless problems, as the said rules equate indirect ownership to direct ownership if the target company is a “substantial part of” a holding company where a change in ownership occurs. This rule, in my view, will quite likely cause concern amongst PE investors as it could affect the levels of accountability which they could have held the promoters to through mechanisms like performance-based adjustments to valuation and ownership,” said Sambamurthi of Lexygen.

But there may be a silver lining for the buyout funds operating in India. “The language in the draft regulations which permit an acquirer to make an offer for 100% of the target and to choose to delist the target by overriding the provisions of the SEBI Delisting regulations seems to lend itself to facilitating “take-private” deals, which had suffered enormously on account of some of the disappointing provisions of the SEBI Delisting regulations,”

said Sambamurthi. Last year, the delisting norms were changed and said a de-listed company cannot go for a re-listing for 5 more years (this period was 2 years earlier).

“However, one would need to see the final shape the regulations take before turning optimistic,” he added.

M&A: Higher Stakes

The acquisitions are now expected to become an expensive affair with buyer now expected to be make an offer for the entire remaining stake of the target firm. A firm earlier willing to buy only 20%  stake through open offer will now need to arrange finances for 2 or 3 times that amount. So, companies will have to re-configure arrangements in

the face of new regulations.

“It is expected that there will be some thought provoking questions by corporates,” said Berry. The buyers are now unlikely to take the fact of depositing the amount for up to 100% acquisition in the escrow account.

The 100% open offer requirement could result in an acquirer ending up holding beyond the maximum permissible non-public shareholding, which may require the acquirer to either delist or bring down his holding to meet the continuous listing requirements. Under the new

recommendations, acquirer will have to state upfront intentions to delist.

When the response to the open offer is below the delisting threshold, the acquirer would be required to either proportionately reduce both his acquisitions under the agreement that triggered the open offer and the acquisitions under the open offer or to bring down his holding to comply with continuous listing requirements.

Also, while the 100% offer move has been welcomed, it may also lead corporates into a tight spot as it does not address dissenting shareholders. For instance, if a firm buys a 40% stake from a promoter group and makes an open offer which is only able to acquire 45%,  then it cannot delist. This acquirer will have sell shares in the target in excess of 10% (in order to meet minimum flotation norms), which may cause a loss because of liquidity drying up in the stock. 

“If you want a rational regulation, then it cannot place undue emphasis on one party’s interests alone,” explains Sambamurthi. “As long as a certain majority of shareholders approve the transaction and the board recommends the deal, there should be a mechanism where the acquirer can “squeeze out” the rest at a certain price. The current regulations as well as the proposed new regulations both effectively permit a dissenting minority to hold all other consenting stakeholders to ransom, which is not conducive to a healthy M&A environment.”

The new regulations provide more openness, transparency, fairness and expert opinion for common public shareholders. The new suggestions also include a recommendation on the open offer by a committee of independent directors, which was voluntary till now.

The panel’s clarification on indirect acquisition has also been welcomed. The Achuthan committee has said ability to indirectly exercise voting rights beyond the trigger threshold limits in, or exercise control over a target company, would attract the obligation to make an open offer, regardless of whether such target company is a predominant part of the business or entity being acquired.

The committee has further recommended that if the indirectly-acquired target company is a predominant part of the business or entity being acquired, the same would be treated as a direct acquisition for all purposes. But the parameters to determine whether a business is

predominant part could be open to vagaries of the capital markets.

In terms of competitive bids, the panel has sought to increase the period for making a competing bid and prohibit acquirers from being represented in the board of target company. Also in stock transactions, the panel has set eligibility conditions so that the shares given in consideration for the open offer are indeed liquid and an acceptable replacement for cash.


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New Takeover Norms May Spur PE Play In Listed Mid-Caps

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