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Regulatory issues pose hurdle on buyback route

Deal value down 75% in 2012 till now, compared with 2011 figures

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Uncertainty around arrangements has put private equity (PE) firms, struggling to exit their investments, in troubled waters. The number of buybacks so far this year has halved compared with 2010 numbers, and the value of these deals has declined about 90 per cent.

This year, nine such deals accounting for $79 million have been recorded. In 2009 and 2010, the buyback route was a favourite among PE investors: 15 buyback deals, worth $535 million, were recorded in 2009, while 23 deals, worth $1.5 billion, were carried out in 2010. Last year, 21 buybacks deals were recorded, and these amounted to $317 million.

Most private investments have a put-on or a pre-agreed buyback clause in the shareholders’ agreements. Through this option, investors’ stakes are bought back by promoters at a pre-determined price, offering investors an assured exit irrespective of market conditions.

Buyback exits from 2009-12 year-to-date
Year Deal  volume Deal value ($ mn)
2009 15 534.66
2010 23 1,515.32
2011 21 317.47
2011 9 78.72
Total 68 2,446.17
Source: VCCedge

However, in October 2011, the Department of Industrial Policy and Promotion (DIPP) issued an order that any equity instrument with an option of assured returns — such as buyback, put or call — would not be eligible for foreign direct investment and would be considered debt instruments. These would have to comply with external commercial borrowing guidelines, the order added.

“Going by recent trends, PEs are not able to use the buyback route for exits,” said Aakash Choubey, partner Khaitan & Co. “This is largely due to the fact that in certain cases, buybacks may be regarded by the regulator as put options and would, therefore, be unenforceable. Also, there is challenge of meeting (Reserve Bank of India) pricing requirements, as well on those on buyback.”

TOP FIVE BUYBACK EXITS from 2009-2012 year-to-date
Date Target Seller Exit value ($mn)
Apr 10 DLF Assets  Symphony Capital Partners 694.30
Nov 09 DLF Assets  DE Shaw Composite Investments  470.00
Feb 10 Aamby Valley  Siva Ventures  323.00
Sep 10 L&T Infrastructure  India Development Fund 165.00
Dec 11 Redington 
Gulf Opportunity Fund I 113.00
May 12 Panchshil Real Estate**  North Cove Partners 54.79
Jun 12 KUL Ecoloch India Opportunities Portfolio* 12.90
Aug 12 Lalith Gangadhar 
Kotak Alternate Opportunities 
*Also includes ICICI Prudential PMS Real Estate Securities Portfolio Series 1; ** Also includes Yerwada Tech Park

RBI pricing guidelines state that if buyback is carried out by an unlisted company, the buyback price cannot be more than the price arrived at by the discounted cash flow method.

In case of listed companies, the pricing has to be compliant with the Securities and Exchange Board of India’s pricing norms.

had withdrawn the order after a month, following stiff opposition. But uncertainty still looms over the put option clause. The other exit route of initial public offerings are not favoured now as market conditions are dismal.

RBI has also started scrutinising transactions in which the foreign investors try to exercise the put option. The central bank mandates that the option fulfil external commercial borrowing rules. considers it as a futures contract, which can be traded only at an exchange, and not between a company and its shareholders. The economic slowdown has also led to promoters refraining from signing buyback deals.

Shefali Shah, senior executive director and head (financial sponsors group), Kotak Investment Banking, said, “While valuations may be compelling for companies for buybacks, most companies would prefer to conserve cash in the current environment.” They would prefer to use cash on the balance sheet to build assets, rather than give it away in the markets, she added.

However, experts said the Bombay High Court’s recent verdict in the MCX Stock Exchange-Sebi case could encourage buyback transactions. In March, a division bench of the court had stated buyback arrangements couldn’t be held illegal on the grounds that they were forward contracts.

“Given the state of capital markets and the number of companies we have seen being listed in the last few quarters, any further regulatory challenge to exit through the buyback route would dampen investor sentiment,” Choubey added.

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