Open Offers- What to do

KEEP YOUR OPTIONS OPEN

Sandeep Singh

Posted online: Monday , September 24, 2007

Over the next five days, non-promoter shareholders of Essar Steel, India’s fourth-largest steel company by sales, have a decision to make. The company’s promoters, the Ruias, who hold 87.1 per cent of Essar Steel’s equity, want to buy the balance 12.9 per cent from the public, and delist the company. As per delisting rules, the Ruias have set the floor price at the stock’s six-month average price, Rs 38. Shareholders can accept the offer; or they can quote their price through a formal process on the stock exchanges; or they can wait and watch.

It’s a choice that shareholders of DLF and Bharti Airtel in their previous incarnations had to face. It’s a choice that shareholders of Deccan Aviation are currently facing, in a different context. With India Inc getting bigger and broader, and seeing more large equity investments, mergers and acquisitions, the number of open offers is only bound to increase. How should you respond to such buyout propositions?
What are open offers?There are two reasons why an open offer is made. One, the ‘takeover code’ is triggered. If any investor buys more than 15 per cent of a company’s equity, by law, it has to offer an exit option to other shareholders for at least 20 per cent of the company’s equity. In recent times, for example, UB Group’s acquisition of Deccan, Blackstone’s purchase of Gokaldas Exports.Two, the promoters want to delist their company’s shares. It could be because they don’t want to share the fruits of their business with others or because they don’t want public scrutiny or because they think their shares are undervalued. This delisting intent is most active among multinationals, many of which were forced to list in the seventies under Fera (Foreign Exchange Regulation Act).
What are your options?The rules related to takeovers and delisting have set guidelines for the open offer price. It’s the six-month average share price. Says Kamlesh Gandhi, country head-investment banking, Religare: “Six-month average is fair. One year is too long, as many more factors can influence price. Two weeks is too small and open to manipulation.” If a stock is not traded frequently, besides price paid by the acquirer, other financial parameters like book value and PE ratio also come into play.
As an investor, you don’t have a say in the open offer price. You can take it or leave it. However, in case of delisting, the rules empower you to influence the exit price. Companies wanting to delist have to go through a reverse book-building process on the stock exchanges. As the name suggests, it’s the book-building process used to price IPOs (initial public offers) in reverse. Rather than quote a price you are willing to buy the shares at, you quote the price at which you are willing to sell. Starting from the offer price, the price at which 90 per cent of shares tendered in can be accepted is called the exit price. However, the choice to offer it or not lies with the promoters.
Reverse book-building is intended to give investors a say in setting the price. More often than not, it throws up a higher price than the floor price. For instance, Essar Shipping, another company of the Ruias, went in for a reverse book-building exercise in March. Against the floor price of Rs 31.62, the exit price was set at Rs 50, and even then only 61 per cent of the balance shares were tendered in. Similarly, in January, Eicher offered a floor price of Rs 150, but the reverse book-building process threw up an exit price of Rs 265.
What should you do?If you go by performance records over the last four years, the verdict is split. Roughly, in half the cases, investors have done better than the market by accepting the open offer. In the other half of cases, they would have done better had they availed off the open offer, and simply reinvested that money in the market (See box: Not an open and shut case).
In general, investor participation in open offers is low. For instance, in 2006-07, 90 companies came out with takeover-induced open offers.
Of these, 54 were subscribed less than 10 per cent, and 73 less than 50 per cent. Holcim got barely 0.15 per cent of Gujarat Ambuja in its open offer in April 2006. Says Gandhi: “Subscription levels are low, as investors mostly feel if someone is buying a stake, good things must be happening to the company.” But as the subsequent share performance shows, that may or may not be true.
The decision to tender in your shares should be based on the company’s business prospects. If it’s a takeover, says Gandhi, “I give maximum weightage to the new management and the purpose of the acquisition.” Adds Ashok Jain, chairman and managing director, Arihant Capital: “There is no correlation between the open offer price and future stock performance. It’s a qualitative issue that depends on the company’s future performance.” So, for instance, the call that Deccan shareholders have to make today is whether the company will turn profitable under the stewardship of Vijay Mallya.
Since it draws from the market price, the offer price generally represents the current value of a business. This may or may not be a fair representation. Also, you hold the stock keeping the company’s future in mind, which the offer price may not capture. So, if you think the business is promising and price is less than what your company is worth, stay on.
If you feel the price being offered is more than its worth, tender your shares. Says S.N. Lahiri, senior vice-president (equity), DSP Merrill Lynch Mutual Fund: “Sesa Goa, for example, is in the iron ore business, which has lots of potential. Prices of iron ore have increased by 25-30 per cent in recent times. I don’t see many investors applying to this one.”
The one situation where an additional variable enters the picture is delisting. If the promoters control more than 90 per cent of the company’s equity, they can delist the shares. You can still hold on to your shares, but you will find it difficult to sell. That doesn’t mean when a promoter makes an open offer with the intention of delisting, you should tender in your shares.
Under Sebi regulations, even if a company’s shares get delisted, you can sell your shares to the promoter at the open offer price for six months from the date of delisting. Beyond that, it is up to the promoters to accept — and that’s a risk. Keep that in mind when faced with an open offer or delisting buyout.