Interesting time for investors

The decision that listed firms must have 25 per cent public shareholding is going to be an important factor to consider for investors while valuing a company

The diktat that all listed companies must have 25 per cent public shareholdings will cause tectonic shifts in the structure of India's stockmarkets over the next few years. There have been very few policy changes to compare with this in terms of long-term impact.

One was the 1970s decision that all foreign companies operating in India must have local listings. Coupled to the Controller of Capital Issues' (CCI) regulations about IPO price-caps, that created an opportunity for Indians to buy cheap into MNC blue chips.

The second policy change with similar impact was the abolition of CCI in the early 1990s. That created incentive to list. It gave an army of fraudsters access to the primary market. On balance, the economy gained and so did investors. One Infosys after all, compensates for many MS Shoes.

The new policy has multiple implications. Consider closely-held desi blue-chips like DLF and Wipro as well as MNC-controlled entities like Fairfield Atlas, AstraZeneca Pharma, Gillette India, Oracle Financial Services, Alfa Laval, Novartis, etc.

A company can delist if the promoters hold over 90 per cent. Or it can dilute down to 75 per cent.

The choice for promoters with stakes between 75-90 per cent is simple: delist or dilute. Which way they swing will differ case-by-case.

Either way, huge sums are required. At current market price for instance, Wipro (where the promoters hold around 80 per cent) needs to sell shares worth around Rs 4,700 crore to dilute to 75 per cent. Alternatively, the promoter must spend at least twice that to delist by buying out 10 per cent – and any open offer will trigger a bidding war. Other companies face similar decisions. In aggregate, a lot of money will go into restructuring. The MNCs will probably try to delist because they never wanted to list anyhow.

Whether the cash comes from promoters (delistings) or investors (in dilution) doesn't matter in the larger context. It means less resources for other activities. This may cause some deceleration in new investment. The policy also raises the cost of capital (or raises fears of losing management control) for corporates, who rely on pledging shares but that's a relatively less acute problem.

In the short run, a buyout can create a windfall for existing shareholders. In the long run, a well-run profitable company delisting creates a “vacuum” in the stock market. Minority investors cannot participate in any further wealth creation.

Market analysts must now reckon with the creation of more entities like J&J (cosmetics), Hyundai (automobiles) or Nestle. These are unlisted market leaders. The valuation of other companies in the same space becomes more difficult when there are major unlisted players around. Issues of corporate governance may arise – it is much easier to perpetrate fraud with unlisted companies.

It is an open question what a minority shareholder faced with a delisting open offer should do. Should he sell for the best price? Should he stay in, hoping for long-term dividend income and perhaps, another later offer? A minority shareholder has few exit options in an unlisted company. Then again, GoI policy might change, or the company may relist, ala DLF.

The other side of the coin is, what does an investor do if there's an FPO or rights issue with promoters selling stakes. This is guaranteed to happen in many companies. Dilution can lead to a drop in share value. So, does he put more money into the company or sell? Again, a difficult decision and the answers will differ case-by-case.

For new listings, if the post-issue capital (at offer price) is above Rs 4,000 crore, the company can start with a 10 per cent public offer and comply with the 25 per cent public shareholding requirement by increasing public shareholding at least 5 per cent every succeeding year.

The space for smaller IPOs (in terms of either stakes or cash) therefore, disappears. Any IPO has to consider a higher dilution threshold since investors will hold off if they think a second issue is going to be lined up. This means larger IPOs. It could mean relatively smaller businesses are choked off. What it could do to entrepreneurship is anyone's guess since India Inc. is permanently capital-starved.

There are no immediate recommendations on the basis of this new policy, of course. But it adds another variable that investors must take note of. It will have to be borne in mind when making any valuations whatsoever.