While of all us are getting used the to the new normal and are hoping that the worst will be behind us soon, we thought it would be great to share with you (i) our analysis of control premium paid in top takeover transactions of publicly traded companies in the last three financial years, and (ii) our thoughts on the way pricing trends will shape up in 2020 and what regulators should do about the current pricing regime for M&A transactions.
Part A deals with our analysis of ‘control premium’ paid in top 20 control deals (involving tender offers) in each of the last three financial years, aggregating to a total of top 60 control deals. Part B deals with the broad parameters of the way regulatory regime should change to allow pricing flexibility and exemption from open offer so that the regime is more contextual to enable deal making in the current market situation; we call it the ‘Deal Freedom’.
Part A: Last three Financial Years
As dealmakers are aware, for the acquirer as well as the selling shareholders control premium is a significant issue, as giving up control over a business typically commands a premium, making it an expensive proposition for the incoming controller of the target entity. For an incoming controller of a listed target, the premium assumes even more significance as the negotiated price that includes control premium also needs to be mandatorily offered in the tender offer made to public shareholders of the target listed entity, thereby increasing the overall cost of acquisition significantly (as the minimum mandatory tender offer size is 26% of the outstanding share capital).
Pricing Regulations of SEBI and RBI generally prescribe the base price for acquisition of stake in Indian targets. In addition to the general regime, the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (“Takeover Regulations”) provide a special method for calculation of minimum offer price to be paid to public shareholders in a tender offer (which would mandatorily be triggered in a takeover deal). Based on the deals that we have advised on and based on publicly disclosed data of other transactions, our analysis shows that in majority of cases, the acquirer pays a significantly higher price than the ‘base price’ calculated under the Takeover Regulations. We also observe that in some cases either no or significantly low premium has been paid for such acquisitions.
We have given a brief background below of the pricing regime, concept of control premium, followed by analysis of the relevant data.
Overview of Pricing Regime and Concept of Control Premium
An acquirer views the consideration offered by it to the selling shareholders/promoters over and above the market price of listed shares as the control premium of that transaction. Typical parameters of the current general pricing regime for frequently traded companies require the acquirer to pay at least the higher of the 26 weeks/2 weeks market price average. Takeover Regulations also provide the methodology for calculating the minimum offer price/ base price of the shares to paid to public shareholders in the tender offer. The ‘base price’ for a tender offer under the Takeover Regulations is typically the higher of the negotiated price between the parties to the deal or the ‘market price’, which is calculated as the sixty-day volume weighted average price (“VWAP”) of that stock. Any amount paid by the acquirer over and above this market price is considered by deal makers to be the ‘control premium’ for that deal. As per our experience, the negotiated price typically paid by an acquirer to the outgoing promoter is typically way more than this 60-day VWAP.
The following graphs summarise the trends in control premium paid over the base price calculated under the Takeover Regulations in the last three financial years. We have covered (i) highest premium, (ii) lowest premium, and (iii) average premium paid in these top 60 deals:
Trends of Control Premium in FY 2017-18, 2018-19 and 2019-20
Highest Control Premium
The highest percentage of Control Premium i.e. (i) 269.69% in 2017-18 was paid in the tender offer of Econo Trade (India) Limited, (ii) 60.77% in 2018-19 was paid in the tender offer of Trans Financial Resources Limited, and (iii) 123.27% in 2019-20 was paid in the tender offer of Supra Pacific Management Consultancy Limited.
Lowest Control Premium
The lowest percentage of Control Premium, i.e. (i) 3.25% in 2017-18 was paid in the tender offer of Akashdeep Metal Industries Limited, (ii) 0.14% in 2018-19 was paid in the tender offer of Dish TV India Limited; and (iii) 0.75% in 2019-20 was paid in the tender offer of Adani Gas Limited.
Average Control Premium
The average Control Premium paid in the top 20 tender offers, (i) in 2017-18 was 23.70%, (ii) in 2018-19 was 15.45%, and (iii) in 2019-20 was 23.56%. The average Control Premium in the year 2017-18 was higher than the average Control Premium paid in the years 2018-19 and 2019-20, by 34.81% and 0.59%, respectively.
Were there deals in which control premium was not paid?
As per our analysis of the disclosed data, (i) in 2017-18, for 8 out of 20 top deals, (ii) in 2018-19, for 15 out of 20 top deals, and (iii) in 2019-20, for 15 out of 20 top deals, control premium was paid.
Part B: Deals in 2020 and Much Needed ‘Deal Freedom’
Given the current market situation and a possible COVID 19 driven recession, we see a lot of distressed M&A in 2020. Such situations need ‘Deal Freedom’, which primarily encompasses two freedoms, (i) freedom from pricing regime; (ii) freedom from open offer requirement. Since there is no general exemption from the pricing regime, summarised in Part A above or from the open offer requirement, the debate on control premium and price to be paid to takeover companies in extreme financial stress is going to become a tougher one. This is because (a) market price driven regime does not give even a benchmark for discussion on ‘base price’ between the parties; and (b) the acquirer may not want to offer any exit to public shareholders, as such shareholders can continue to hold their stake in distressed entities and make a significant upside if the business is turned around.
This being the case, there is a compelling need to introduce the two exemptions summarised above. The benefit of these exemptions should be given to acquirers irrespective of whether they are Indian or foreign. A recent example of the subtle way in which the regulators accepted this flaw in current pricing regime is the rescue of YES Bank. To bailout this bank, a Scheme was issued under Section 45 of the Banking Regulation Act, 1949, which allowed the acquirers to get equity stake at Rs 10 per share as opposed to following the market price linked regime, which would have required the acquirers to shell out a way higher amount. Acquirers were also not required to make any open offer. Such exemptions allow publicly traded companies to be saved, thereby taking care of the interests of all or most of the stakeholders (including creditors and most employees of such target entities). Such exemptions should not be restricted to government action or government driven bailouts. The reason for this is simple, if there are third party acquirers willing to take a risk call and turnaround the target company as their independent business decision, they should be allowed to do so with a deal freedom, rather than the government using its own funds or restricting the favourable pricing regime for government driven takeovers.
Having said that, as of now, under certain regulations, the lender banks can follow a favorable pricing regime and even have complete exemption from pricing regime for converting debt into equity (in some cases). Till such time a general exemption is provided to third party acquirers (in such special cases), banks might be forced to convert debt into equity and then sell the equity to incoming controller/acquirer, which simply prolongs and complicates a takeover process, as the acquirers who intend to takeover and the banks who have lent to such companies need to resolve other key issues to turn around an ailing business as quickly as possible.
We hope that regulators will amend the law allowing Deal Freedom and assist all stakeholders with a more pragmatic approach to resolution of such gating issues. Broad principles on which this ‘Deal Freedom’ should apply could be based on the following key parameters:
- A target entity should be considered to be under financial stress, triggering an exemption from the pricing regime, when such entity falls within the parameters or similar parameters as mentioned in the Reserve Bank of India’s Circular of June 7, 2019, titled “Prudential Framework for Resolution of Stressed Assets”;
- Since the acquirer is bailing out the target, the open offer requirement should be dispensed with;
- A lock-in (i.e. minimum period of holding of equity stake) of at least three years should be imposed on the acquirer to ensure that the acquirer hasn’t taken any undue advantage of the exemption from pricing an open offer regime;
- As an additional protective measure, all acquirers who are acquiring controlling stake in such companies should be offered immunity from liabilities arising out of past actions of the target company and its management & controllers, since (i) the outgoing promoter will not be in a position to offer indemnity or other contractual protection to the incoming promoter; and (ii) under various laws where the liability is criminal in nature, a contractual protection, if any, offered by the outgoing promoters would be meaningless.
*The author was assisted by Gagan Sharma, Principal Associate and Shweta Pandey, Associate
 Please note that for a foreigner, this is the floor price for both primary infusion of capital in the target as well as secondary purchase from existing shareholders. For a resident, floor price is linked to this market price formula only for primary infusion of capital but not for the secondary purchases.
 A nuance in calculation of base price is that 60-day VWAP is applicable only if the shares are frequently traded. In case the shares are not frequently traded, then certified fair value will be the base price for tender offer as per Takeover Regulations.
 Scheme issued under this provision has an overriding effect on all other applicable laws.