Widening Gap

The provisions relating to buy back of shares have significant implications, especially on the Takeover Code.

The provisions relating to buy-back of shares have significant implications, especially on the Takeover Code. Logically, therefore, the two statutes need to be read in alignment.

Buy-back of shares requires prior approval of shareholders through a special resolution. But buy-backs requires potential sellers not to vote on special resolution. A company proposing buy-back cannot issue any new shares ( excluding bonus ) for a period of 12 months after the buy-back. Post buy-back debt equity should not be more than 2:1. Buy-back of treasury operations requires that such shares cannot be re-issued before 24 months without suspension of voting rights.

 

In case any person, group etc., aquires 95 percent of a companys shares through buy-back, takeover or otherwise (with the company getting de-listed,resultantly) residual shareholders will be required to sell their shares to the various holders holding the 95 per cent stake at a price based on SEBI guidelines.

Buy-back is a preventive defence mechanism available to promoters of a company having low holding. A secondary market buy-back at attractive prices would be an ideal method of mopping up floating stock and shoring up promoter holding. A promoter enhancing his holding is a good sign for all shareholders since it is evident that he foresees value for his holding in future. The advantage in a buy-back is that this is possible at the companys cost without promoters having to dip into their pockets. This would be unfair if full disclosure is not made to non-management shareholders about the implications of the buy-back to enable them to make an informed sales decision.

The Takeover Code exempts prefrential offers from the provisions of triggering an open offer in case full disclosure is made about the price of the proposed allotment, the identity of such persons, implications of the changes in the Board of Directors and changes in shareholder pattern. Therefore, buy-back provisions also need to provide for disclosures. The notice for a special resolution for buy-back must be sent to stock exchanges for their notice boards. Details such as justification of the price, promoters holding prior to buy-back, promoters participation in buy- back, post buy-back holding (in case it is accepted to the extent proposed), the possibility of any change in management and control must be disclosed.

The buy-back provisions provide for aquisition of residual shares where the promoters holding is 95 percent or more while the Takeover Code talks about 90 percent. The holding of 90 percent is more appropriate and the same needs to be adopted in the buy-back provisions.

Buy-backs can be used to their advantage by a promoter group facing a greenmail threat in a takeover. In a greenmail threat, the promoters are forced to buy-back shares of a predator at fancy price to ward off a takeover threat. Buy-back would open up a convenient way to implement greenmail at company expense. This would also encourage predators having no interest in running companies to acquire shares and subsequently to sell them to the company at a neat profit. This should not be encouragd. The Takeover Code should stipulate that buy-back by a company should not be permitted for a period of time, say 24 months, from a person having made an open offer.

Buy-back for the purpose of treasury operations and re-issue of shares after 24 months is possible. This could be used by promoters for enhancing their holding in the medium term. In the absence of suitable provisions, the re-issue could be to promoters at attractive prices. To avoid this scenario, buy-back provisions should provide for an open and transparent mechanism of re-issue like going through the prefrential offer route or an open bidding process or public offer.

Buy-back has significant implications on the companys balance sheet. Lenders and creditors are immediately affected since it increases the debt equity ratio, reduces available funds and affects current ratio. Therefore, a company proposing buy-back must be financially viable and liquid. Not all companies wishing to shore up its promoters holding should be permitted buy-back. Just having a post-issue debt equity of 2:1 is not adequate. Additional financial benchmarks need to be stipulated, like a five year track record of profits, free reserves three times of equity, healthy post buy-back current ratio of 2:1,etc.

Sidharath Kapur is senior vice president, investment banking, Apple Finance.The views expressed here are the personal views of the author and not necessarily those of the organisation he represents.