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Takeover Code: The basics

Apr 13, 2012

Construction major IVRCL has been in the limelight in recent times. This is on account of news of a possible hostile takeover (one that is done against the will of the existing promoter) by the diversified Essel Group. The latter has acquired shares of the former's through open market transactions over the last few days. The Group presently owns a higher stake (on paper) than the promoters' of IVRCL themselves. Ergo the discussions about a possible takeover have emerged.

There have been similar kinds of situations not so long ago as well. Two of the major ones involved FMCG major ITC. The tobacco to hotels conglomerate increased its presence in the hotel space by acquiring shares of EIH and Hotel Leelaventure. The FMCG major did not cross the open offer threshold limit of 15% (at that time; explained later as well). The company continues to hold less than 15% stake in these companies as of the latest available data.

Anyways, with all these developments happening (and the probability of more taking place in the future) it would be good for investors to have basics understanding about the revised takeover code, which was released by the Securities and Exchange Board of India (SEBI) in mid 2011. The new takeover code came into force on October 22, 2011.

It must be noted that while the takeover code covers many aspects and in quite detail, we will touch upon the broader aspects of the code.

Trigger point

To start with, the trigger point of an open offer has been increased from 15% to 25%. What does this mean? If a person, individually or through PACs (persons acting on concert) acquires 24.99% of the shares or voting rights in a listed company, it will not trigger an open offer.

Definition of PAC

As per SEBI (Securities Exchange Board of India), 'PACs are individual(s)/company(ies) or any other legal entity(ies) who, with a common objective or purpose of acquisition of shares or voting rights in, or exercise of control over the target company, pursuant to an agreement or understanding, formal or informal, directly or indirectly cooperate for acquisition of shares or voting rights in, or exercise of control over the target company.'

If the acquirer or the PAC acquires more than 25% of the shares, then the acquirer(s) needs to purchase a minimum of 26% (from 20% earlier) of additional stake in the target company (also known as triggering an open offer). The takeover would be from the existing public shareholders of the target company.

Clarity required

As the new takeover code was released a while ago, the SEBI is believed to be reviewing some provisions of the code that have been identified by industry participants as impractical and hampering the deal-making process. To be precise, how 'PAC' is defined is what is being reviewed. As per The Takeover Regulations Advisory Committee (TRAC), the committee which submitted the report to SEBI in mid 2010 with the proposed new norms, acquirers or PACs should be disclosed as such for at least three years prior to the proposed acquisition. As per a leading business daily industry players believe the three-year period is too long and the definitions should be transaction-based rather than time-based.

Creeping acquisitions

While the above-mentioned are the rules to be followed by new acquirers, there is also a separate provision for existing stakeholders who already hold more than 25% of the shares of voting rights in companies. For such acquirers to increase their stake, they would be allowed to do so by acquiring shares to the extent of 5% in any financial year up to the maximum permissible non-public shareholding limit (i.e. 75%). The earlier limit for the same was 15% to 55%. This setting is termed as 'Creeping Acquisition'. Acquisition of shares or voting rights in excess of this limit would trigger an open offer. Within this, there are certain rules related to the computation of this 5% creeping acquisition that have been included in the new code. These in brief include the consideration of gross additions and disregards sales and dilution.

Further, the Individual acquirer shareholding shall also be considered for determining the open offer trigger points apart from consolidated promoter shareholding. We will explain this with the help of an example. Suppose an individual holds 24.99% stake in a company. He is a part of a PAC that holds around 34.99% stake in the company. Suppose this individual were to acquire an additional 0.01% stake. Even though this is an individual action, it would still trigger the open offer under the takeover code.

Apart from creeping acquisition, existing acquirers (holding more than 25% stake in a company) can also make a voluntary offer to acquire a minimum of 10% of the total shares of the target company. However, this is applicable on two key conditions - the post offer shareholding should not exceed 75%; and, the acquirer would be eligible for the same only if he has not acquired shares of the target company in the previous 52-weeks (without attracting an open offer). Further, the acquirer can acquire more shares (except through a similar route) only after six months of completion of such an open offer. However, in the case of the acquirer's stake increasing beyond the permissible non-public shareholding limit, then he will be required to bring the stake down to 75% within a particular time period. Further, the acquirer is also not permitted to make a voluntary delisting offer under the SEBI Delisting Regulations, for a period of one year from the date of completion of open offer.

Some loopholes need to be closed

Similar to the uncertainty on how PACs are defined, SEBI is reviewing the provision related to the creeping acquisitions. The issue raised is mainly to tackle the situation of acquiring 5% stake in a financial year. A leading business daily reported that the new takeover code creates a strange situation wherein an entity can acquire 10% in a period of two days (as per the report, an entity can acquire up to 5% stake without triggering an open offer)- by acquiring shares on March 31 and April 1 of two different financial years. A clarification on the same is expected soon.

Acquisition of control

Next point we would like to touch upon is the acquisition of 'control'. The revised takeover code has exempted companies looking at gaining control by one acquiring substantial shares (when an acquirer acquires "substantial quantity of shares or voting rights" of the target Company) through a special resolution by postal ballot process. Now, any change in control of the listed company shall be only after the open offer.

Offer Price

With this, we come to the point of offer price calculation. The offer price shall be the highest of the negotiated price, volume weighted average price (product of the number of equity shares bought and price of each such equity share divided by the total number of equity shares bought) of the last 52 weeks prior to the public announcement, highest price payable or paid in the last 26 weeks before the public announcement or the volume weighted average market price (product of the number of equity shares traded on a stock exchange and the price of each equity share divided by the total number of equity shares traded on the stock exchange) of 60 trading days prior to the public announcement.

Good for minority shareholders?

While the revised takeover code has its set of issues that still need to be resolved, on an overall basis the code is good for public shareholders. A key change in the revised code is the abolition of a non-compete fees. This is a welcome move for the minority shareholders as the new rule does not allow the promoters/sellers to receive a consideration, a non-compete fee or a control premium or otherwise. In fact the same shall be priced into the offer price, thereby giving all shareholders the highest of the offer price offered.

Devanshu Sampat

Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.

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