It is not just initial public offers (IPOs) in India that attract high drama with bidding wars, a scramble for allotments and acrimony between investors and promoters on pricing. Delisting offers, which are the mirror image of IPOs, see equal fireworks too. With Covid battering investor sentiment, quite a few listed companies — Prabhat Dairy, Vedanta, Hexaware Technologies and Adani Power — have proposed to bid goodbye to the market by voluntarily delisting their shares. Going by history, this may be the beginning of a long-winded saga.

Elaborate rules

To ensure that companies don’t take a revolving door approach to markets, SEBI specifies an elaborate set of regulations not prevalent in other markets for companies wanting to go private.

To delist, a company needs approval from its board and votes in the ratio of 2:1 from its public shareholders. Once the exchanges grant in-principle approval, the company is required to mail letters of offer to shareholders, with a detailed rationale.

To ensure that promoters pay a fair price to delist, they are required to open a book-built auction on the exchanges to invite bids from public shareholders. The floor price is decided by a long formula from SEBI’s takeover code (the highest of negotiated price or acquisition price paid for the company, weighted average traded price in the 60 days leading up to the offer and so on). If the share is infrequently traded, an independent valuer must determine the floor price. Investors can bid any price at or above the floor pricee;this forms the basis of the ‘discovered price’ at which promoters are obliged to mop up shares.

If the discovered price is unacceptable to the promoter, or if the offer fails to get him to a 90 per cent shareholding, the delisting fails. Where it succeeds, shareholders have a full year after the offer closes to tender their shares at the discovered price.

In theory, these regulations would seem a pretty good way to balance the interests of promoters seeking to go private with investors who are being pushed to permanently give up their rights to a profit share in the business. In practise, however, a good number of delisting offers remain in limbo due to an unending tug-of-war between promoters and investors.

Games investors play

Despite the auction mechanism and formula-based floor price, the exit price has proved the key sticking point for many a delisting offer.

Last year, an attempt by BOC UK, the parent of industrial gases-maker Linde India, to delist the latter failed after the book-building process ‘discovered’ a price of ₹2,025 per share, against the floor price of ₹428.5 set by the company. Reports suggest that a mutual fund holding a 9 per cent-plus stake in the company was unwilling to tender its shares below ₹2,000, scuttling the offer.

This isn’t a lone case. When SEBI reviewed its voluntary delisting regulations in 2014, it found that of the 38 attempts from 2009 to 2014, nine failed. Seven transactions were concluded at the floor price, while the discovered price averaged a 70 per cent premium. In 11 offers, investors demanded two-three times the floor price, prompting promoters to shelve the idea. A second review in 2018 showed that not much changed. Of the 15 companies that launched offers, only seven were concluded at floor price, with eight ‘discovering’ prices 8-240 per cent above the floor price. Notable in this batch were Panasonic Appliances (₹380 versus ₹167), Fulford India (₹2,400 versus ₹702), Essar Oil (₹263 versus ₹146), and Essar Ports (₹133 versus ₹94).

Given that the promoter mopping up a 90 per cent stake is a pre-condition to delist, even a single shareholder demanding an outlandish price can scuttle a delisting proposal that others are okay to go with. Speculative bidders can also use clever ploys to manipulate the auction price, from cornering shares in low-float companies to cartelising, while small shareholders remain clueless on how the process works.

While these findings led SEBI to make multiple tweaks to its delisting rules — setting the delisting threshold at 90 per cent, aligning the floor price formula with the takeover code and bringing in a provision for promoters to make a counter-offer — this hasn’t materially improved outcomes.

Games companies play

If over-smart investors play their part in thwarting delisting offers, company promoters do their bit too. Many promoters, in an inversion of their IPO strategy, choose moribund markets or a sectoral downturn to launch their delisting offers. It is no coincidence that market lows such as 2003-04, 2008-09 and 2013-14 saw a long line-up of delisting candidates.

Where the sector or markets are not faring too badly, some companies report a sudden deterioration in their finances that miraculously coincides with their delisting plans. Reckitt Benckiser India, a solid FMCG performer, reported a series of profit dips and even a quarterly loss during its delisting efforts in 2002-03. Vedanta, on the verge of delisting, has just announced a loss of over ₹12,521 crore for the March 2020 quarter, after a massive impairment charge.

Promoters are also not averse to some behind-the-scenes parleying. A favourite ploy is to offload part holdings or issue new shares to ‘friendly’ entities which then help the delisting along by masquerading as public shareholders. A recent SEBI order detailed how Astra Zeneca Pharma, after two failed attempts to delist in 2004 and 2010 at a high discovered price, placed a chunk of its shares with a group of FIIs, allegedly to help a third delisting attempt.

The way forward

Resolving this stalemate is quite important because, in the long run, forcing companies that are keen on going dark to remain publicly listed is counter-productive. In the Indian context, given weak boards, promoters with high equity stakes have many methods to decimate shareholder value — from siphoning off funds through related party deals to shifting profitable lines to unlisted arms or cutting back on dividends.

SEBI can consider three specific tweaks to its delisting regulations to smoothen the road.

One, the FOMO resulting from high discovered prices is a key reason why public investors are reluctant to bid in delisting offers. This can perhaps be addressed by reviewing the floor pricing formula. Given that an investor tendering in a delisting offer makes an irreversible decision to give up his share in all future profits, using traded prices or negotiated prices as valuation benchmarks for the business appears inappropriate. Valuation based on fundamental metrics such as book value or discounted cash flows may help arrive at a fairer exit price for investors. Companies must be required to commission such valuation reports by independent valuers, disclose the numbers and set the floor price based on them, with a control premium factored in.

Two, in IPOs, allowing retail investors to bid at cutoff prices set by institutions/large investors has proved an effective way to ensure that they don’t need to take a valuation call. This should be possible for the reverse book-building process too.

Finally, independent directors can be required to provide objective advice to public shareholders on delisting offers. Better still, they must commission independent reports from consultants or proxy advisory firms to arm shareholders with objective recommendations on delisting offers.

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