DSIJ Mindshare

Who Will Blink? SEBI or India Inc.

Bringing down promoter holdings to under 75 per cent was a ruling meant to ensure an increase in the free float of shares and enable fair price discovery. Various contortions are also being allowed to ensure that promoters somehow adhere to the rule. Will the SEBI get tough with companies that fail to meet the deadline? What does all this mean for investors? DSIJ explains

The stock market, for long, has been considered one of the closest examples of perfectly competitive markets. One of the factors to have helped this competitiveness is a large number of buyers and sellers that constitute the ecosystem. To achieve this, a large number of shares should be distributed among shareholders so as to discover a fair price of the stock. It is also assumed that with a large number of shareholders which essentially means larger public float, there is little scope for price manipulation and unscrupulous trading. The concentration of shares in a few hands and a consequent shrinkage of the floating stock have the propensity to lead to undesirable transactions in securities. Beside this, a larger floating stock also serves the purpose of redistribution of wealth in a more equitable manner. This gives the general public an opportunity to have a share in the wealth generated by the listed companies in return for the capital provided to them.

As academic as it may sound, these were precisely the two reasons why in 2009 the then Finance Minster Pranab Mukherjee, proposed to increase the public float in Indian listed companies to a minimum of 25 per cent. On the other hand, any figure more than that would have discouraged promoters from listing their stock and the already listed ones would have probably opted for a voluntary delisting. And hence to balance the interest of both, public as well as promoters, this provision was proposed.

Following this, the Securities Contracts (Regulation) Rules (SCRR) was amended in 2010 to achieve and maintain a minimum public shareholding at 25 per cent by June 2013. However, in case of public sector companies the requirement was limited to 10 per cent of minimum public shareholding with an extended deadline (more details on this are provided in the latter part of the story).

At the end of June 2010, when the SCRR was amended, the average public float in Indian listed companies was less than 15 per cent, which included the entire space of listed companies on the BSE. However, if we consider only companies which are a part of the BSE 500 Index, public holding stood at a mere 8.58 per cent then. Therefore, increasing the public float was seen as an imperative so as to curb all irregularities which were more a result of the lower public holding and eventually allowing the fruits of economic growth to be well distributed among a larger mass.
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Global Comparison

How compatible is the 25 per cent requirement with global norms? Barring the London stock exchange, there are no major stock exchanges in the world where a blanket percentage of minimum public shareholding is a mandatory requirement. A case in point is the NYSE Euronext, where 1.1 million publicly held shares are a requirement for the continuous listing of a company’s stock or in case of the Hang Seng (Hong Kong) where the percentage of public float depends on the market capitalisation. So a percentage of the total shares to be held is not a norm anywhere in the world except in the UK and will soon be the case in India too.

The Current Scenario

When this provision was proposed at the end of June 2010, there were around 120 actively trading companies excluding the public sector units, where the minimum public shareholding was less than 25 per cent. Since then, approximately 48 of these companies have opted for different routes such as a follow on public offer (FPO), institutional placement programme (IPP) or open for sale (OFS) to bring down the promoters’ holdings to below 75 per cent. There were other relaxations too that have been provided to various companies to adhere to this diktat. Still, there are around 30 companies who are yet to announce or take any steps to increase their public shareholding. The mix of companies that make up this list of around 30 is a well diversified one. It comprises of domestic companies as well as MNCs as also the band within which the dilution needs to happen. Here is what each of these segments is currently looking like.

The MNC Float: Will They Delist?

It is a known fact that many Multi National Companies (MNCs) have created great wealth for the Indian investors. The kind of management bandwidth, product innovation and corporate governance practices that MNCs bring to the Indian markets, has always been appreciated by investors here. MNCs, on the other hand, have rewarded shareholders significantly through hefty dividends and humongous capital appreciation. Colgate Palmolive, HUL and Nestle are a few examples of this. The value creation record of MNCs in India has indeed been splendid.[PAGE BREAK]

While all this sounds good enough, there is one lacuna that affects this set of companies – a lower public float with a majority of these companies being closely held. Hence, the beneficiaries of this are few, in spite of these companies witnessing a good price appreciation in their stock prices. MNC associate companies are always alleged to make a deliberate attempt at keeping the public float lower. Given a chance, these companies would try to get delisted and operate as independent entities. The parent companies tend to benefit from such a scenario.

In the past, MNCs have done this. A share buyback was the most preferred way of pulling in the floating stock and then getting delisted. Many who got a whiff of this special opportunity did generate good returns from it. Some of the recent examples are Atlas Copco, Alfa Laval (India) and GSK Consumer Products where the buyback offer prices were revised upwards many a times, ultimately resulting in higher returns for investors. While GSK Consumer Healthcare witnessed an up-move from Rs 3000 in November 2012 to its current levels of Rs 4128 on account of the open offer, Atlas Copco revised the buyback price upwards multiple times almost trebling the shareholder returns. Similar was the story of Alfa Laval which witnessed a strong up-move since the announcement of a buyback by the parent company. A recent example is that of HUL which has announced a buyback which helped the scrip reach new highs.

So, this kind of strategy has worked for investors in the past and investors should be looking for such opportunities here too. Many MNCs may opt for a delisting rather than adhere to the mandatory rule of bringing down promoter holding to below 75 per cent.

A look at the list of companies which are yet to comply with this diktat (bringing down promoter holding to below 75 per cent) throws up some opportunities. There is Fresenius Kabi Oncology which has already announced a buyback at Rs 130. However, the scrip is currently trading at Rs 124 on the bourses. Thus, despite a difference between the offer price and the current market price, the tax element will eat up all the gains. Hence, unless and until the company further raises its buyback offer price, investors are unlikely to gain from this.

Another company that has announced a buyback is Fairfield Atlas. The company announced a buyback at a price of Rs 135 per share while the scrip is trading at Rs 200. So again, the offer is unlikely to succeed and promoters may have to either increase the offer price or enhance the free float by adhering to the diktat. In any case, there is hardly any chance that investors would benefit. The management is not likely to bring up the offer price to the current market price levels and if at all the company goes in for an OFS or an institutional placement, the increased float will obviously bring down the share price.

Two other examples are Sharp India and Wendt India where the promoter holding stands at more than 80 per cent. Though these companies are yet to come out with any offer for sale or institutional private placement (IPP), we feel it would be difficult for these companies to go for a buyback too. Reason is, they would have to come up with a buyback at higher prices and both these companies lack the cash resources to come up with a buyback at a higher price. There could be an IPP, but here again a retail shareholder hardly stands to benefit out of such a placement.
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The Domestic Scene

While MNCs are just a part of the whole discussion, a bigger chunk is that of domestic companies. There are many Indian promoters who are yet to comply with the stipulated norms of bringing down promoters’ shareholding.

There are a total 138 companies (excluding MNCs and PSUs) which are yet to comply with the regulation. However, of the above, 74 companies are either suspended by the exchanges on account of some penal factor or are illiquid stocks (not traded at all or traded only marginally).

Out of the remaining 64 companies, around 34 have announced some or the other method of bringing down promoter holding like an IPP or an OFS or have actually announced a delisting. While these methods look like time tested or at least naturally in the course of markets, a few have announced certain innovative ways like announcing a bonus for non-promoters, mergers or even re-classification of promoters to adhere to the norms. The best example is that of Wipro. The company has gone a step ahead and transferred the stake to an independent trust. This falls within the ambit of the regulations.

So what will be the impact on the share prices of companies? In case of Wipro, there is hardly any impact on the share price as the stake will change hands without any right price discovery. So the whole idea of increasing the public float for a right discovery of price is being diluted here itself.

Another route that the SEBI has permitted is the reclassification of promoters. Shree Digvijay Cement Company has gone ahead and reclassified some of the promoters as non-promoters. The same route was followed by Gillette India which is an MNC. Again - no price discovery here.

The third innovative way that companies resorted to was to issue bonus shares to non-promoters. Bonus shares were allowed to be given to non-promoters and as a result, the promoter shareholding automatically came down. Companies like Nagarjuna Agrichem, Nitta Gelatin India and Transformers & Rectifiers (India) have resorted to this option. Though the current shareholders gain marginally, promoters tend to lose. Though the shareholders are gaining, there is no price discovery at all. So in case of the companies and cases mentioned above, there is no way that an opportunity to gain came the way of shareholders, especially on the retail side.

Apart from the above, there are companies coming out either with an IPP or an OFS which may affect the stock prices on the bourses. The companies having promoters holding of more than 85 per cent are likely to be impacted more in such cases. The simple reason being, more number of shares would be offered in the OFS or the IPP. The impact would be more severe in case of companies coming out with an OFS where the retail participation would probably go up. In case the company resorts to an IPP, the institutions that are desirous of buying shares in larger quantities would opt in keeping the price largely unaffected. Our stand gets vindicated from the fact that Thomas Cook which opted for an IPP route managed to generate better response with the IPP having issued shares worth Rs 185 crore and which were oversubscribed to the tune of Rs 224 crore. Similar is the story of Timken India, Fortis Healthcare and DLF. The scrip prices have improved since the IPP has happened.
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However, share prices of the companies that are having promoter holding of more than 85 per cent may correct significantly if a large supply of shares comes in the secondary markets. For example, to comply with the SEBI norms, more than 1.43 crore shares of Bajaj Corp would come into the secondary markets. This is around 63 per cent of the existing free float and amount to Rs 364 crore. One can surely make out the kind of negative impact this would have on the share prices.

The Remaining Batch

While the above is the story of those who have already initiated action, there are 30 odd companies that are yet to initiate any process to bring down promoter holding to below 75 per cent. This comprises of companies like Essar Shipping, Essar Ports, Bombay Rayon Fashions, Muthoot Finance and L&T Finance Holdings. Company managements aren’t really forthcoming on what they would be doing to adhere to this diktat.

We are of the opinion that once these companies try to tap the markets, this would surely bring a chunk of equity supply into the secondary markets. There would be a supply of equities worth around Rs 14227 crore if the companies come up with new issuance of shares and Rs 10670 crore if they resort to offer promoter holding to the public.

The big names that could be affected are Oracle Financial Services Software raising Rs 1150 crore (Rs 1535 crore if it issues new equity), L&T Finance Holdings raising Rs 1000 crore (Rs 1330 crore) and Adani Ports & SEZ raising Rs 776 crore (Rs 1035 crore).

Companies like Bombay Rayon Fashion Jaypee Infratech, Omaxe, Adani Enterprises and Sun TV are some companies which will face a lot of pressure on their stock prices as each one needs to raise more than Rs 300 crore in the next one and a half month.

Will SEBI Act Tough?

The moot question is what if these companies fail to comply with the regulation? Will SEBI force them to liquidate? We tried to get some straight answers to the many questions that shroud the entire exercise from the regulator but to no avail. The regulator claims that it has said whatever it had to on this issue. There is nothing more to add. Our emailed questionnaire to the right points at the regulator’s office went unanswered. If forced selling happens, on account of an equity oversupply in the secondary market, the IPO market would feel the heat. There are already three companies which have withdrawn their IPOs from the market recently. Apart from that, the higher supply would also take the respective share prices downwards. If the SEBI manages to go ahead with a force selling, share prices would surely decline.
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What Happens To PSUs?

Public Sector enterprises seem to be all geared up to comply with this SEBI guideline. Though the deadline in case of PSUs is August 8, 2013, preparations are on in full swing at the Department of Disinvestment (DOD). This follows clear instructions from the finance ministry. The real problem with PSUs is that unlike private companies, where promoters can offload their equity easily, for selling any kind of Government shareholding, PSUs have to refer to the DOD, under the Ministry of Finance. They have to follow all departmental and inter-mistrial procedures. In spite of that, companies on their part are hopeful that they will do so within time.

PSUs have to bring down their promoter holding to less than 90 per cent. There are 11 PSUs where the promoter holding is in excess of 90 per cent. “It is correct that these companies must adhere to a minimum public shareholding norm before August 2013 to avoid any penal action from the SEBI and we are on with this task which will hopefully be completed within the next two months”, informed a senior DOD official. DOD is preparing a timetable to come out with an Offer for Sale (OFS) for these companies and in all probability, it will kick-start the process with the OFS of MMTC. The government also knows the benefit of the OFS route and hence is sticking with the same. “Though Institutional placement program (IPP) is also available to companies, we don’t want to take it for a simple reason that it requires filing of prospectus that we don’t prefer. Instead, an OFS would serve our purpose with ease and speed”, quipped the DOD official.

Out of the 11 PSUs that need to comply with this norm, MMTC, NFL, HCL, Neyveli Lignite, STC and ITDC are those that are profit making and command a good rapport in the capital markets. DOD is actually finalising its strategy to come out with an OFS of these six companies in the next two months. As mentioned earlier, MMTC is already on the finance ministry’s agenda of disinvestment, whereby it wants to offload 9.33 per cent of the equity held by the government. At its current price (CMP Rs 264 on May 10) it will fetch the government around Rs 2500 crore. 

“We are fully prepared at our end, and if all goes well, then the OFS will hit the market within a few weeks, finalising of the timing is at the final stage at the DOD”, commented M G Gupta, Director Finance MMTC. Apart from MMTC, Hindustan Copper (HCL) would be the other prominent company in terms of market capitalisation. This company needs to dilute 4.01 per cent equity and at the current valuation (CMP Rs 111), it can fetch up to Rs 412 crore to the government. “HCL would only be a big ticket company in terms of value and its OFS can come by June-July 2013”, informed the DOD official. NFL OFS planning is also at a final stage. “We are in continuous discussion with the DOD and whenever we receive a go ahead from the government, we will come up with our OFS. In all probability, we will be able to comply with the minimum public shareholding norm”, comments Tek Chand, CS, NFL.
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But there is a catch here! Other than the six profit making companies, there are some companies that are loss making, these comprise of HMT, Scooters India, ITI and lesser known Andrew Yule & company. The government has a real problem with these companies as it is really hard to dilute the equity of these companies. “The problem with loss making PSUs is that it would be really difficult to find buyers for these companies’ stocks in the market. In such a scenario, we don’t have any other way to comply with the norm. The government and the SEBI know this situation as well”, said the DOD official. As the SEBI is giving all sorts of relaxations to companies for them to somehow comply with this norm, it seems more likely that some exception could be created for such loss making firms that have been referred to the BIFR.

The government seems to be fully committed to adhering to the minimum public shareholding norm and any hope for extending this deadline is bleak. Also, with the entry of OFS, retail investors can have stocks of some blue chip companies at a much cheaper rate. MMTC, HCL and NFL can be considered.

Conclusion

The success of diktats is determined by the achievement of the intent. When the provision of bringing down promoter holding to below 75 per cent in case of listed entities (90 per cent in case of PSUs) was first brought in, it was with an intent of increasing the free float, ensure a better price discovery from the larger spread of the number of shareholders and in turn bring achieve inclusive wealth creation.

But what has actually been happening on this front is quite surprising. As mentioned earlier, all kinds of contortions have been allowed by the regulator only to ensure that the rule is followed practically. What about the spirit? Well if you look at the way promoters have been going about it so far, you would certainly agree that the spirit of the rule has gone haywire. How much of stock has come into the markets following this rule? It would certainly be a good idea if the floating stock of companies had gone up in order to facilitate this rule, thereby putting a larger number of shares in the hands of the public. Now, public again means not just anybody other than promoters as has been classified by the rule, but primarily, retail investors. Only when retail investors are involved, real inclusive wealth generation can take place. On the other hand, it seems that in a bid to ensure adherence to the rule, the regulator himself has been aiding promoters by allowing companies on a case to case basis to apply for concessions in the rule and allowing them. Some very interesting cases in this category have already been discussed above (Wipro transferring the stock to a trust and holding it there). It would really be interesting to see the regulator keep its real intent in mind while ensuring the adherence to the rule rather than allow the rule to be bent in order to achieve something that is not helping the real investor in any way. After all, people will judge you by your actions, not your intentions. You may have a heart of gold -- but so does a hard-boiled egg.
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“If The SEBI Orders Compulsory Delisting, Shareholders Are Free To Contest The Same”

Akila Agrawal
Partner, Amarchand Mangaldas

Is the SEBI empowered under the Securities Contracts (Regulations) Rules, 1957, (as amended in June 2010) to delist the shares of those companies who don't comply with the minimum public shareholding norm of 25 per cent?

Yes. Under the provisions of the SEBI (Delisting of Equity Shares) Regulations, 2009 read with the Securities Contract (Regulation) Act, 1956 and the SCR Rules, SEBI/ stock exchanges could at its discretion compulsorily delist the equity shares of a company if the public shareholding of the company falls below the required minimum level.

What will be the impact on the companies which won't comply with the minimum public shareholding norm by June 2013?

Such companies will be in breach of the provisions of the Securities Contract (Regulation) Rules, 1957 and the listing agreements entered into by such companies with the stock exchanges. Consequently, they could be penalised by the SEBI and the stock exchanges.

Do companies have any kind of safeguard against such penal actions by the SEBI or getting delisted is the only consequence of defaulting? 

As I have told you, the SEBI and the stock exchanges are empowered to compulsorily delist the shares of a company in case it fails to achieve the minimum public shareholding of 25 per cent by June 3, 2013. That does not necessarily mean that they will exercise their discretion to compulsorily delist the non-compliant companies, bearing in mind the hardship this may cause to public shareholders.

The SEBI has already issued standard letters to all non-compliant companies. In the said letter, it has stated that failure to comply with the minimum public shareholder norms within the stipulated timeframe may invite appropriate proceedings and penalties like monetary penalties, freezing of the voting rights etc. It does not specifically enumerate compulsory delisting as a measure against failure to comply. If the SEBI orders compulsory delisting, shareholders who are aggrieved by the decision are free to contest the same. 

Would delisting of stocks in India by the SEBI or the stock exchanges be that easy or it would require some other concrete reason to do so?

Given that compulsory delisting may prejudicially affect the interests of public shareholders it should be the last resort adopted by the SEBI i.e. when it is unable to ensure compliance with the public shareholding norms through any of the other measures.
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What other penal actions can the SEBI undertake under this provision?

  • In addition to ordering compulsory delisting, the SEBI has wide powers under the SEBI Act, 1992 to impose various penalties on non-compliant companies and their promoters. Such penalties may include:
  • Imposing monetary penalties on promoters 
  • Initiating criminal prosecution of promoters
  • Directing promoters to divest their shareholding so as to achieve minimum public shareholding
  • Freezing the voting rights
  • Freezing corporate benefits
  • Moving the scrip to trade to trade segment
  • Excluding the scrip from the F&O segment  
  • Restraining promoters from accessing the securities market except to comply with the minimum public shareholding requirements.

If a company has sincerely tried to comply with this shareholding norm via available routes like FPO, OFS or IPP but failed due to reasons beyond its control like lack of demand, then is there any chance that it will get any kind of extension to comply with this norm?

It is difficult to predict the approach that will be adopted by the SEBI in such cases. At the moment, it appears that the SEBI will treat such a company more leniently than others who may have not taken any steps to comply.

In case some company's promoter doesn't adhere to this norm within the stipulated time and the SEBI takes some penal action (like delisting) against it, what rights do the minority shareholders have against such a harsh step in order to safeguard their interests?

Look, compulsory delisting is a very harsh step and I don’t think the SEBI would do it in such cases and as per my knowledge I haven’t come across any such case of compulsory delisting. Now if any shareholder is aggrieved by any such order of the SEBI, he/she can easily go to the SAT against that order and put his case that due to non-compliance by the promoters his interest has been impacted. After that, the SAT will examine that case on the merits of the facts. 

SEBI is now giving various relaxations to companies in its listing rules and other provisions on case to case basis so that companies would be able to comply with this norm. Is this a right approach legally?

As long as such relaxations are based on valid justification and are not arbitrary, they will stand the scrutiny by a court of law. There are various options available to companies and the SEBI can give approvals and relaxations on a case to case basis. 

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