[By Aayush Khandelwal and Abhinav Gupta]
The authors are students at National Law University, Jodhpur.
Valuation of share during an open offer has been a constant subject of disputes. The acquirer and shareholders are often at loggerheads in relation to the offer price. Where the acquirer seeks to reduce its cost of acquisition, shareholders seek to extract most out of the exit opportunity. This has led to multiple instances where the offer price was challenged by the shareholders before the Securities and Exchange Board of India (‘SEBI’).
In this article, the authors seek to explore this conundrum surrounding the valuation of shares (offer price) during open offers. In doing so, we discuss the process of valuation of shares in case of open offers. Moreover, we discuss some recent cases where the valuation was challenged by the shareholders, and the price was revised by the regulator. Towards the end, we propose certain changes that can be accommodated in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Regulations’) to provide better protection to shareholders.
Process of Offer Price Determination
In case of acquisition of control,[i] or voting rights beyond the prescribed limit in a company,[ii] the acquirer has to provide an exit opportunity to the shareholders of the company. The price of the open offer has to be determined in accordance with Regulation 8 of the Takeover Regulations.
The above-mentioned Regulation categorizes the shares into two categories to calculate the offer price. One category is of the shares which are frequently traded on the stock exchange, and the other category is of shares that are infrequently traded on the stock exchange. The shares of a company are considered as frequently traded when the traded turnover of the company on the stock exchange in the last one year is more than ten percent of the total shares of the company.[iii]
There arises no difficulty in determining the offer price of the company whose shares are frequently traded as it is determined from the stock trading data of the company.[iv] Whereas, a difficulty arises in determining the offer price of the company whose shares are not frequently traded. The merchant banker, to determine the offer price, is required to take into consideration certain factors such as book value, comparable trading multiple, or parameters as are customary for the valuation of such companies.[v] Book value is not useful for companies that have human capital as a primary asset. Further, the book value of a company can reduce during the time of recession. Therefore, the methods prescribed under the Takeover Regulations for such companies may not give the accurate value of the shares. In such circumstances, the SEBI has the power to appoint an independent merchant banker or chartered accountant to determine the valuation of shares.[vi] There have been many instances where the SEBI has appointed independent valuers to determine the fair price of a share and has directed the acquirer to revise the offer price accordingly.
Challenges to Offer Price
In this section, we have discussed certain recent cases where the shareholders have challenged the offer price provided by the acquirer.
A leading case on the issue regarding the determination of the offer price is Tenneco Inc. v. SEBI, before the Securities Appellate Tribunal (‘SAT’). In this case, Tenneco Inc. indirectly acquired Federal-Mogul Goetz (India) Limited, whose shares were infrequently traded. The acquirer appointed two valuers that determined the fair value per share at INR 372.10 and INR 397.66. Accordingly, the acquirer made an open offer with an offer price of INR 400 per share. Later, SEBI appointed a chartered accountant for the computation of the fair price of the share, per the powers conferred upon it by the Takeover Regulations. SEBI directed Tenneco Inc. to revise the offer price to INR. 608.46. Aggrieved by the direction of SEBI, the acquirer filed an appeal before the SAT. The SAT dismissed the appeal and upheld the direction of SEBI.
Another instance where the open offer price was challenged was the merger of Praxair Inc. and Linde AG which triggered an open offer for the shareholders of Linde India Limited. Upon failure of the delisting offer, the acquirer commenced the open offer again and appointed a merchant banker to determine the offer price as the shares of the company were infrequently traded. The merchant banker arrived at a valuation of INR 276.09 per share. Later, SEBI appointed an independent chartered accountant to determine the fair price of the equity shares of the company. The valuer appointed by SEBI arrived at a valuation of INR 376.63 per-share value of the company.
Recently, an indirect acquisition of ABB Power Products and Systems India Limited has triggered an open offer under the Takeover Regulations. The shares of the company were not frequently traded on any stock exchange, as the offer was announced on the day the company got listed. Accordingly, the independent valuers appointed by the acquirer have determined INR 851 per-share value of the company. Reports suggest that SEBI is scrutinizing the price offered by the acquirer and examining whether the valuation is fair for the investors. It remains to be seen whether SEBI will appoint an independent valuer to protect the interest of the investors.
Increasing the role of directors and appointment of independent adviser:
One major reform in the valuation process during open offers could be providing clarity with respect to the role of directors during a takeover bid. Currently, only a committee of independent directors of the target company has to provide ‘reasoned recommendations’ on the open offer.[vii] Even the role of the board of directors (‘BoD’) is very limited to facilitating the verification of shares,[viii] and providing information on competing offers to shareholders.[ix]
In our opinion, current provisions are ambiguous and do not ensure optimum protection to the shareholders. The regulator should consider providing more elaborate criteria for assessing an open offer by independent directors and increase the duty of BoD. We believe that changes can be made in line with Singapore Code on Takeovers and Mergers (‘Singapore Takeover Code’) and the City Code on Takeovers and Mergers (‘UK Takeover Code’).
Under the Singapore Takeover Code, BoD is mandated to take independent advice on every offer and has to inform shareholders about the same.[x] The UK has a similar mandate for the appointment of an independent adviser by BoD.[xi] Currently, in the Indian regime, there is no provision of appointment of an independent adviser. The regulator should consider including an independent adviser in the takeover process to provide an independent view on the open offer including the offer price.
Moreover, under the UK Takeover Code, the BoD is required to provide its views on the effect of the implementation of the offer on all of the company’s interests. They must provide views on the acquirer’s strategic plans for the company and its impact on the target company’s employment and place of business.[xii] Similarly, the Singapore Takeover Code mandates BoD to provide its view on the offer and treatment of employees post-acquisition.[xiii] The UK Takeover Code also provides that the BoD should not restrict its views merely to the offer price and should consider other relevant factors.
In our opinion, similar to the UK Takeover Code, the BoD should have a proactive role in India. An overall analysis of the open offer by the BoD will ultimately lead to an analysis of the offer price. This mandate combined with the inclusion of independent adviser in the Indian takeover process will benefit on two fronts. First, the assessment of the offer by an independent adviser will act as a source of trust for shareholders and reduce the frequency of objections raised by shareholders about the offer price. Second, an analysis by the independent adviser and BoD at the initial stage will result in faster completion of the takeover process which is often delayed due to shareholders’ dissatisfaction with the offer price.
Adopting internationally accepted pricing method:
Although the valuation of shares of a company is not a precise science, the problem of pricing in the case of a company whose shares are infrequently traded can be addressed by incorporating more detailed valuation provisions under the Takeover Regulations. For instance, the Reserve Bank of India adopted an internationally accepted pricing methodology for the issuance and transfer of shares. An internationally accepted valuation methodology includes the income approach, market-based approach, or asset-based approach. Therefore, by incorporating such valuation methods under the Takeover Regulations, the litigation with respect to offer price can be reduced and a timely exit opportunity can be provided to shareholders.
Challenges to open offer prices are not something new. The tussle between acquirers and shareholders has been going on for a long time now. In such a scenario, the regulator needs to ensure that enough safeguards are put in place to protect the interest of shareholders. Delays in the takeover process can be further tackled by placing enough checks during the offer determination stage. This can be done by strengthening shareholder’s trust in the process and insuring independence of the process. There is a need to bring the Takeover Regulations at par with foreign codes. As suggested by us, the appointment of an independent adviser can be the first positive step towards a big change. Increasing directors’ duty beyond the fiduciary duty is another need of the hour and it remains to be seen how the regulator reacts to such needs.
[i] Regulation 4 of Takeover Regulations.
[ii] Regulation 3 of Takeover Regulations.
[iii] FAQ No. 30, Frequently Asked Questions on Takeover Regulations.
[iv] Regulation 8(2) of Takeover Regulations.
[v] Regulation 8(2)(e) of Takeover Regulations.
[vi] Regulation 8(16) of Takeover Regulations.
[vii] Regulation 26(7) of Takeover Regulations.
[viii] Regulation 26(8) of Takeover Regulations.
[ix] Regulation 26(9) of Takeover Regulations.
[x] Rule 7 of Singapore Takeover Code.
[xi] Rule 3.1 of UK Takeover Code.
[xii] Rule 25.2 of the UK Takeover Code.
[xiii] Rule 24.2 of Singapore Takeover Code.