Fending off hostile raiders -- Whining corporates may stifle the takeover market

Krishnan Thiagarajan

The purpose of the (Securities and Exchange Commission's) regulatory scheme should be neither to promote or deter takeovers; such transactions and related activities are a valid method of capital allocation, so long as they are conducted in accordance with the laws deemed necessary to protect the interest of shareholders and the integrity and efficiency of capital markets.

Takeovers should be allowed to take place. For this reason, the committee does not encourage or discourage, or evaluate the merits of, takeovers. -- Report of the blue-ribbon SEC Committee on Takeovers comprising 17 Wall Street takeover experts, submitted in 1983, during the early days of the wild corporate raids in the US.

In 1983, political and public pressure was brought to bear on the SEC to regulate the hostile takeovers that were spreading their tentacles in the US. Later, in 1985, at the height of the takeover wave, nearly 50 Bills were introduced in the US Congress to regulate corporate acquisitions aimed primarily at protecting the target companies from hostile raiders.

However, both in 1983 and 1985, the SEC consistently advocated the `free-market' ideology and promoted liquidity and efficiency in the stock markets by creating conditions for a vibrant market for takeovers. Although the manipulative and abusive takeover practices fuelled by the Michael Milken junk bond machine proved a major embarrassment for the SEC, its fundamental doctrine of a regulator remaining an `umpire' in takeover battles still has enduring appeal.

In India too, the recent acquisition of a 14 per cent equity stake in Bombay Dyeing by Mr. Arun Bajoria and the open offer made by AH Dalmia and associates for GESCO Corporation have raised cries of `protection' from the incumbent owners/promoters (these are mainly family-owned businesses).

As a result of the pressure on SEBI by several vested interests -- the political establishment, the Chambers of Commerce and family-owned business peers -- over the past month, it has appointed a Committee headed by Justice P. N. Bhagwati to review the provisions of the Takeover Code. Instead of enforcing the implementation of specific provisions of the Code and tweaking a few others, the powerful lobby raised several non-issues in the proposals before the newly constituted Committee.

G>Mercifully, from SEBI's stand thus far, it appears that it favours hostile takeovers and seems to endorse the view that they are good for the economy. In India, corporate takeovers are probably the only way to solve the `free-rider problem' -- where the owners of a company are not acting in the best interest of the shareholders -- but dispersion of corporate ownership has failed to discipline them.

Corporate takeovers alone can police management conduct in widely-held public corporations. Moreover, they help identify undervalued assets and permit shareholders to realise the true value of their investments. Third, successful takeovers help realise efficiencies by reallocating capital and corporate assets to more high-value uses; enabling merger partners to generate joint operating efficiencies and providing companies access to financial, management and other resources not otherwise available.

Based on the Committee meeting earlier this month, Business Line analysed the relative merits and demerits of the proposals considered (most of the proposals are to be finalised in December, after consultation with investor associations/corporate fraternity).

Three-stage disclosure

The P. N. Bhagwati Committee proposes to recommend disclosure at three stages -- 5 per cent, 10 per cent and 14 per cent of equity -- vis-a-vis the current requirement at the 5 per cent level. Corporate India has pushed for this disclosure claiming it will provide greater transparency (and if the takeover bid succeeds, a higher price) in takeover transactions for the general public. By introducing a three-stage disclosure mechanism, the target company management could try indirectly stifle the `market for corporate control' in three ways.

First, by making disclosure mandatory especially at the 10 per cent and 14 per cent levels, the target company aims to make the cost of acquisition high (even prohibitive) for the acquirer. At these levels, speculative interest is likely to drive the price expectation way beyond the levels the acquirer may have in mind.

Second, while the acquirer has to make his intention known to the target company, the latter can conserve its resources till the 10 per cent level and test the seriousness of the hostile raider before entering the market. The target company can also drive the acquisition price to higher levels through `market operations', making the acquisition as unattractive as possible for the acquirer.

Finally, even with a single-stage disclosure, say at 5 per cent, the target company has adequate safeguards in place to mount a takeover defence against the hostile acquirer, such as creeping acquisition, making a competitive bid, a white knight rescue, a buyback and even a preferential offer.

Even in the US market, where the takeover market is fairly mature, the various Committees have only actively solicited for a `lower threshold' of disclosure, and never multi-stage disclosure. Under Rule 13D of the Williams Act, as soon as an acquirer has accumulated 5 per cent of the target company's stock, he has to disclose the size of his holdings to the company and the SEC. To place the target company on guard, these companies have been demanding the lowering of the disclosure threshold to 1 per cent, unlike in India, where the demand is to raise it to higher levels.

In India too, instead of making the disclosure at the 5, 10 and 14 per cent levels, stringent disclosure practices need to be in place on the lines of the recommendations made by the Takeover Committee. As soon as the 5 per cent threshold is reached, the acquirer must be called upon to notify the target company, its regional stock exchange, the BSE, the NSE (and even SEBI, though this has not been recommended) which must put this information on their web sites to provide for widest possible dissemination.

Creeping acquisition

After the high-profile takeover battle by Sterlite Industries for Indian Aluminium, the pressure lobbies forced SEBI to raise the creeping acquisition limit from 2 per cent to 5 per cent. After the recent hostile takeover attempts in Bombay Dyeing and GESCO Corporation, there is a clamour for raising the limit yet again. Now, the Takeover Committee is deciding whether to scrap the creeping acquisition limit of 5 per cent altogether and introduce the concept of `lock-in' for acquisitions beyond the 5 per cent limit.

Both the courses of action may be undesirable from the point of view of creating a vibrant market for corporate control. First, the companies that are now the targets of takeover -- Bombay Dyeing, GESCO Corporation, Ballarpur Industries and Jaiprakash Industries -- have performed poorly by the yardstick of delivering shareholder value. Though they have been sitting on huge investments or liquid cash (Bombay Dyeing had investments in the Unit Trust of India worth Rs 346.50 crore as of March 31), they have never contemplated a buyback programme or any progressive measure aimed at enhancing shareholder value.

Second, it is moot point, whether the existing creeping acquisition limits of 2 per cent between 1997 and 1998 and 5 per cent thereafter have been completely used by the existing promoters/companies to consolidate their holdings. If this ceiling itself has not been utilised over the past three years by most of the existing promoters, why are they crying themselves hoarse over scrapping the creeping acquisition limit?

Even if the lock-in provision is introduced, it can pertain only to new additions of equity from the open market. The promoters can still sell existing holdings at any price they think proper (as the Tatas did in unloading their equity stake in ACC to Gujarat Ambuja Cements, leaving the minority shareholders high and dry).

Moreover, by allowing incumbent managements to perpetuate their ownership by creeping acquisition, the promoters can time their purchases by acquiring shares in small lots at low price levels or at least manipulate market prices before acquisition. This could prove detrimental to minority shareholders in the long run.

Finally, the creeping acquisition limit of 5 per cent makes sense because, while an acquirer has to buy up to 15 per cent equity through the open market, the promoters, who already have significant holdings in the company, can shore up their equity much faster to foil a takeover bid.

Even assuming a hostile takeover bid is launched against a company, the target company can enhance its equity holdings through almost half a dozen routes. It can do so through a combination of buyback of shares, preferential allotment of shares, a counter-offer or the creeping acquisition route. The argument that scrapping the creeping acquisition limit would neutralise all the risks for a target company in a hostile takeover is specious and hardly credible.

Outright acquisition of 51 or 100 per cent

There is a growing demand among sections of Corporate India for an outright acquisition of 100 per cent equity, or at least 51 per cent, when an acquirer crosses the 15 per cent threshold. The Takeover Code now calls only for a minimum offer of 20 per cent for an acquirer crossing the 15 per cent threshold. Though prima facie, this suggestion has merit, the pros and cons have to be debated at greater length before it is introduced.

Let us first consider the points in favour of a mandatory 100 per cent or 51 per cent acquisition (with some attendant comments) as it stands today:

*In the case of a minimum offer size of 20 per cent, while the promoters can sell their entire equity stake in a friendly offer, the minority shareholders have to be satisfied with a proportional acceptance of equity shares by the acquirer. The proportional acceptance leads to shareholders being saddled with shares in companies whose prices fall sharply after the takeover bid. Even in a hostile offer, the minority shareholders may be constrained by this low minimum offer requirement of 20 per cent.

*The minimum offer size of 20 per cent does create scope for frivolous offers. However, this is balanced to a large extent by the escrow mechanism, which has kept at bay several non-serious bidders.

*The `nuisance value' attached to a minimum offer of 20 per cent (that is, with an equity stake of, say, 35 per cent or lower) is significantly high. But that is the price one has to pay for corporate democracy. And even these cases can be observed only in those company managements which have been woeful in delivering shareholder value and probably deserve a takeover bid.

At the same time, the points going against the 100 per cent acquisition are:

*In a country like India, where financing options from banks or alternate sources are virtually absent, a 100 per cent acquisition will make a takeover offer too onerous for an acquirer. So, strictly, the UK City Code on Takeovers, which provides for 100 per cent acquisition, or the Williams Act of the US may not be strictly applicable in India. Making the takeover offers too onerous may end up killing the takeover market in India, leaving it open to cash-rich Indian and foreign companies.

*The requirement of 100 per cent acquisition by a bidder in a target company in which a good chunk of equity is with financial institutions (FIs) may prove a non-starter and discourage the growth of the takeover market. FIs have been either neutral observers or have favoured incumbent managements in takeover battles. Unless they become active participants, lending transparency to the takeover process (being aware of the internal workings of the target company), the market for corporate control will never take off.

*If a 100 per cent acquisition is felt desirable by the Takeover Committee, it can be introduced only with adequate checks and balances. In hostile takeovers, in order to encourage genuine bidders, the bidder must be allowed to retract his offer if it fails to generate the required number of acceptances. At the same time, to ensure that the bidder does not destabilise existing managements, the Code must indicate the minimum level of acceptance of offer (say, 20 per cent) by bidders, even where it fails to generate the desired response.