[By Ojas Singh & Tanuj Goyal]
The authors are students of Symbiosis Law School, Pune.
INTRODUCTION
On 27 June 2024, SEBI in its board meeting, paved the way for public companies to be delisted through the Fixed Price Offer (FPO), as an alternative mechanism to Reverse Book Building (RBB). The move comes following the release of the consultation paper on 14th August 2023, which included crucial modifications to the SEBI (Delisting of Equity Shares) Regulations 2021 ( Delisting Regulations).
While the RBB model was detected with some irregularities, such as inflated share prices driven by speculative trading and manipulation by some shareholders, a new mechanism is being proposed. The market regulator intends to protect the interests of promoters as well as the shareholders by bringing in a fixed premium and adjusted book value calculations that would reduce market volatility and increase efficiency. However, notwithstanding these intentions, the new framework is not without its share of criticisms and possible pitfalls. This article would consist of a primer on the RBB and the new FPO process, and would then proceed to analyse the benefits and pitfalls of the proposed mechanism.
BACKGROUND
The RBB mechanism was introduced in 2003 through the SEBI (Delisting of Securities) Guidelines 2003. In the RBB process, a delisting company is required to ascertain a minimum floor price for the shares of the company. The calculation of the floor price is very similar to the floor price for an open offer under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code). The price was determined based on many aspects including book value, average market price, and future growth potential. Investors would discover the price through bidding, stating the minimum price at which they were willing to sell their shares. A minimum of 90% of the shareholding had to be acquired by the acquirer through this method to ensure successful delisting.
The delisting, when accepted, leads to the purchase of all shares at a price at or below the Delisting Price, at the Delisting Price. This Delisting Price can be further negotiated by the acquirer through the process of ‘counter-offer’.
Because promoters have to agree for the price discovered through RBB to delist, getting enough public shareholders interested in a delisting proposal and the price at which most shares are offered by public shareholders heavily affects the success of a delisting. A successful delisting can be elusive, as the discovered price through RBB would find itself having an inordinate premium, maybe even above 100% of the Floor Price. For instance as seen in delisting’s such as Brady and Morris Engineering Company Ltd (1128.70%), Universus Photo Imagings Ltd. (164.34%), Shreyas Shipping & Logistics Ltd. (138.35%) and Linde India (517%). In all these cases, delisting attempts were found unsuccessful as the acquirers were not ready to pay the excessively high discovered prices. For example, in the delisting of Universus Photo Imagings Ltd., it could be noted that the discovered price of ₹ 1,500 (Rupees One Thousand Five Hundred) per share was not consented upon by the acquirers, as it was way above the price offered by them (₹ 568 or Rupees five hundred sixty eight per share). Additionally, in some delisting cases, even having an excessive premium over the indicative price offered by the acquirers may not result it in being successful. As seen in the delisting of Elcid Investments Limited, whose market price per share was ₹ 15 (Rupees Fifteen), but the floor price per share was computed to ₹1,61,023 (Rupees One Lakh Sixty-One Thousand Twenty Three) per share. Despite the premium of around 9,50,000%, the delisting price was rejected initially by the shareholders. This delisting underscores the flaws in the RBB process, where even a huge premium over the market price can fail to secure an approval from the shareholders. This trend of inflated pricing under the RBB process, not only thwarted several delisting attempts but also led to a misalignment between the acquirers and shareholders. Additionally, shareholders who would often hold out to higher prices, would further stall the delisting process. SEBI found that most firms that voluntarily delisted through the RBB process paid premiums with a median value of 125% from 2015 to 2018. This shows the unsustainable financial burden faced by the companies, meanwhile the speculative shareholders were allowed to manipulate the process. This manipulation was further aggravated by the rule that promoters could submit counter-offers only if their post-offer shareholding exceeded 90% of the company’s total issued shares. These concerns were reiterated by the SEBI chairperson, who stated that the companies looking to acquire more than 90%, would find the prices heavily inflated due to certain shareholders who would acquire shares to cross the 10%. Subsequently, counter-offers under the RBB could only be made, if the acquirers post-offer shareholding turned out to be above 90% of the company’s total issued shares. These rules give the shareholders the ability to manipulate and exert control over the discovered price.
SEBI acknowledged these concerns in its consultation paper released on August 14, 2023. Accordingly, the regulatory authority introduced the FPO with an aim to reduce speculative trading and provide a balance between the interests of the investors and the acquirers.
DECODING THE CHANGES
Delisting through fixed price offer:
As per the modifications under the Delisting Regulations, the delisting price must be at least 15% over the market price of a share. Public shareholders now only need to decide if they want to tender their shares at a fixed price. A delisting is successful, only when an acquirer’s post-offer shareholding exceeds 90% of a company’s total share capital.
Insertion of Adjusted Book Value for the computation of Floor price:
Before, the ‘floor price’ was computed based on several factors such as Volume Weighted Average Price (VWAP) of acquired shares during 52 weeks prior to the reference date, VWAP of 60 days preceding the reference date etc. as per Regulation 8 of the Takeover Code. Now, adjusted book value will be used as an additional parameter to calculate the floor price. However, the market value for frequently traded listed shares already reflects the fair floor price, which makes the introduction of ‘adjusted book value’ redundant and could unnecessarily complicate the process.
Modifications in the counter-offer mechanism under RBB:
Initially, a counter-offer could only made if the acquirers post-offer shareholding exceeded 90% of a company’s total issued share capital, under the RBB mechanism. As per the modification, the 90% limit to make a counter-offer has been reduced to 75%. But, this reduction in the limit will only be applicable, if a minimum of 50% of the public shareholding has been tendered through the RBB process. Subsequently, as part of the second set of modifications for counter-offers , the counter-offer price in the RBB process must be the higher of : a. The Volume Weighted Average Price (VWAP) of the tendered shares, or b. The initially disclosed floor price. While the changes in counter-offer allow the public shareholders to receive a higher price for their shares, it could be used to tender shares at disproportionate premiums over the floor price.
Reference Date
Reference Date under Regulation 20(3) of the Delisting Regulations, initially was the date when the stock exchange took cognisance of the company’s decision to get delisted. This resulted in a time gap which would lead to a disturbed floor price due to stock price volatility. The new change places the date at the initial public announcement or before the stock exchange notice.
CRITICAL ANALYSIS
The RBB model is prone to market manipulation by the shareholders, which leads to excessive exit prices during delisting. The proposed changes aim to reward proper capital allocation, reduce speculative trading and improve the ease of doing business by providing an efficient way to exit the market. However, there is still some scepticism about the new framework.
The FPO model with a high 90% delisting threshold, will still depend on bringing the expectations of the market and shareholders in line with the intentions of the delisting promoters. This can lead to higher capital costs for companies, as acquirers may need to offer higher premiums to sway the shareholders towards an agreement. Some unsuccessful RBB delisting’s in the past occurred due to shareholders not tendering their shares, hoping for a higher price. This misalignment of interests between parties can still continue in the FPO approach.
Another criticism of Fixed Price delisting is that it lacks the provision for making counter-offers. This can result in shareholders and prospective purchasers not engaging in a flexible pricing process, which can cause the value to be under or overvalued. Furthermore, a six-month cooling-off period is initiated if the delisting request is unsuccessful. This cooling-off phase can make the investors apprehensive of investing in the delisting company, as there is uncertainty about the company’s next move. This uncertainty can also negatively affect the stock price, as seen in the case of Vedanta, where failed delisting attempts created short-term volatility and hesitation among investors. Over time, the cooling-off period could create long-term uncertainty, which could repel shareholders from further delisting attempts, weakening investor participation and thereby impacting the company’s valuation. This can affect the liquidity and the market perception of the company and its shares. The inability to make counter-offers and the mandatory cooling-off period can deter companies from attempting delisting and affect overall market efficiency and investor confidence.
The ‘adjusted book value’ method added to compute the floor price of the shares one-sidedly benefits the shareholders in the case of asset-heavy companies which usually have greater book value due to their engagement in substantial tangible assets. The same is the case with holding companies which have assets in the form of investments in associates, subsidiaries, and other companies resulting in higher book value leading towards increment in the floor price of the shares.
The new insertion in the form of ‘adjusted book value’ complicates the computation process without bringing in too much of a change. It is argued that the market value already reflects the fair value of the floor price in the case of listed companies with frequently traded shares making the ‘adjusted book value’ factor redundant. Moreover, before the modifications, independent valuers had already evaluated the listed companies with infrequently traded shares, considering the factors common to companies plying in the relevant sector. Companies that are intensively engaged in assets may not be able to get their fair value reflected through their book value. Resultantly, a more flexible method of valuation is often relied upon in scenarios where regulations require the same such as in the case of private companies under exchange control regulations. Oftentimes, the method of valuation is left to the assessment of the valuer. Based on the same, it can be inferred that the aim to augment the confidence of the public shareholder in the floor price is not comprehensively achieved through this modification.
The changes made to the Reference Date and modification of the counter-offer mechanism under RBB however do come as a positive step. The Delisting Regulations required the stock exchange to be informed after the board meeting in which delisting was decided upon. Under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, the company is supposed to inform the exchange two days before the board meeting. Additionally, a company is mandated to hold a board meeting within 21 days of an initial public announcement, as per the Delisting Regulations. This led to a time delay between the initial disclosure of the delisting information to the market and the reference date for determining the Floor Price. This time delay resulted in volatility in the floor price. Now, the Reference Date refers to the ‘initial public announcement’ of the delisting decision or before the date of the stock exchange prior notice. This mostly comes off as a positive change as it helps to calculate a more accurate floor price, reducing market fluctuation.
A pre-change requirement was that the acquirer’s post-offer ownership had to constitute 90% of the issued share capital for the acquirer which has now been changed to 75% to make a counter-offer to the price determined under the RBB. This old requirement permitted the process to be influenced by majority shareholders and allowed for the potential failure of a delisting offer, even in cases where a majority of public shareholders may support the delisting proposal. Additionally, acquirers were deprived of the opportunity to submit a counter-offer as a consequence of such failures. This will increase the chances of a successful delisting.
CONCLUSION
While the new regulations aim to simplify the delisting process, they appear to create a mixed outcome. On one hand, the modification made to the Reference Date and counter-offer mechanism, under the RBB, do assist in calculating an accurate floor price, which reduces market manipulation. But, on the other hand, the redundant ‘adjusted book value’, high delisting threshold under FPO and the lack of counter-offer system can result in reduced market efficiency and a misalignment in the interests of the parties.
Perhaps the key to perfection of the FPO in general lies somewhere in the middle: allowing a flexible, short counter-offer window of limited duration. The counter-offer window could be limited to a 15-day negotiation period, in which the acquirers can align themselves with the market expectations, as well as shareholder interests Equally, a cooling-off period cut in half from six months to two months might inject renewed confidence among investors and prevent companies from stagnating in uncertainty. Additionally, the adjusted book value method could also be rejigged to account for tangible and intangible assets. A hybrid valuation model can be utilised, that would blend the company’s market value with asset-specific variables, which would help asset reliant companies to reflect a fair book value. SEBI has made a welcoming move to improve the delisting mechanism, but the limitations of the FPO method indicate a need for further refinement to ensure a balanced approach that protects the interests of both promoters and shareholders.