Open offers -- The preferred route

Suresh Krishnamurthy

WHAT factors dictated the particular route companies adopted in 2000 to acquire businesses? A review of the M&A activity suggests that share price valuations were the crucial deciding factor.

Clearly, the economic laws are structured in a manner favouring the open-offer route. The court clearances required for effecting a merger, and the stamp duties attracted in the sale of an asset act as disincentives to acquisition through these two routes. However, an open offer comes with the `burden' of a relatively higher degree of transparency.

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Still, as the higher number of open offers suggests the disclosure stipulation has not been a crucial factor. Among the methods companies adopted in 2000 to expand their businesses non-organically, acquisitions through open offers and mergers figure prominently. The sale-of-assets route, judging by the number of deals put together, was the least preferred.

More than anything else, stock price valuations of the acquiring company had a strong role to play in the route used for the acquisition. Companies whose stocks commanded quite good valuations opted for the merger route while others adopted for the open offer route. The asset sale route was primarily used to sell divisions and intangible assets, mostly by healthcare companies.

In a way, the acquisition route has a definite correlation with the sector to which the company belongs. Technology sector companies, whose earnings are valued at a higher multiples than the market average, took the merger route to expand non-organically, while others traditionally valued at lower multiples stuck to the open offer route.

This pattern is also not surprising considering the valuations both these sectors commanded in the bourses in the early half of 2000. Since a technology company was generally valued at quite a high price-earnings multiple, companies would have been hard-pressed to offer cash to make an acquisition. For example, in the Mphasis-BFL merger, other than through the issuance of stock it would have been practically impossible for BFL Software to pay the value of the deal, which was close to Rs 727 crore.

In contrast, the share prices of non-technology companies which were beaten down to lower levels were acquired through the payment of cash. For example, the acquisition of substantial stakes in DLF Cement, Indian Aluminium and BSES were made by the acquirers -- Gujarat Ambuja, Hindalco and Reliance Industries respectively -- using cash.

These companies may have been reluctant to issue fresh shares, feeling their share valuations (of Gujarat Ambuja, Hindalco and Reliance Industries) did not completely reflect their fundamental strengths.

Since the open offer route makes a heavy demand on the cash resources, rarely do companies come out with an open offer to effect a complete buyout. Target companies in an open offer more often remain separate legal entities even after the acquisition of a substantial stake by the acquiring companies. The mergers of these target companies can, however, be expected in due course. When the stock price of the acquiring companies and the target companies stabilise to levels the management feels comfortable with, a merger will most likely materialise.

Stringent disclosure norms

Thedisclosure requirements in a merger are far less than that in an open offer. On the face of it, a merger or open offer makes no difference for an investor if the valuation of the deal remains unchanged. Under both mergers and open offers, investors would get either cash or cash equivalent (stocks).

However, the disparity in information disclosure has ensured that even in a merger involving two unrelated parties, the shareholders or the stock market have been offered very little in terms of meaningful information. An investor or a prospective investor has necessarily to wait for the annual report (at the end of the year) to discover the real impact of the acquisition.

Interestingly, this lack of timely information does not improve even if the Indian companies have listed their securities in overseas markets. In the case of Silverline Industries, which came out with a stock-cum-cash deal to acquire SeraNova Inc. of the US in October 2000, the filing with the Securities Exchange Commission of the US was made after a delay of more than a week, and did not contain any information in addition to that contained in the press release issued on the day of acquisition.

More important, the disclosure requirements for the open offer in themselves do not serve the purpose of bringing out into the open the information necessary for a shareholder to make a decision. For example, the existing guidelines require the acquirer in an open offer to give the reasons for making an open offer. Almost all companies summarily deal with this requirement in three or four lines. These statement do not provide any information other than the obvious, and in the process completely dilute the value of the disclosure requirement.

The regulatory requirements for open offers have indeed added value to shareholders in the past few years. However, as is inevitable, offers are becoming increasingly complex to evaluate in the absence of detailed information. In this backdrop, disclosure norms need to been tightened further.

In addition, a merger needs to be viewed at par with an open offer. Accordingly, the statutory disclosures applicable for open offers also need to be made mandatory for mergers. In fact, if the sale-of-asset route is used to transfer the entire business of the company, then too such mandatory disclosures need to be made applicable to shed more light on the transaction. Unfortunately, SEBI has not made much progress on the disclosures front.