Commercial and legal impact
In the previous part of this publication, we had set out an overview of the current market scenario and economic slowdown across key global markets, in view of factors such as global economic concerns, the COVID-19 pandemic as well as India-specific concerns such as the collapse of Yes Bank and pressure on Indian industries. We now evaluate the commercial and legal impact of these events on capital market transactions and highlight the key commercial and regulatory considerations for companies considering such transactions.
Key commercial and corporate arrangements
For listed companies and companies looking to list, a market downturn of this scale has a direct impact with overarching long-term consequences. Key concerns for listed companies at this time will include determining “material” events that require disclosure under the applicable SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, ensuring compliance with the SEBI (Prohibition of Insider Trading) Regulations, 2015 and their code of conduct, particularly to plan their trading by persons with access and make allocation decisions more efficiently. Read here about how to prevent insider trading during the current situation due to COVID-19. It will also be important for them to assess the impact of the significant loss their ongoing business and operations, existing contractual obligations including debt repayment, as well as, future fundraising plans. A potential impact on share price may also follow from the release of companies’ annual financial results, showing the impact of the economic slowdown and likely result in companies missing performance forecasts. The question to analyse is whether the market capitalisation of the company today reflects the above issues and factors in the company’s preparedness for such events or is there more than what meets the eye?
For companies in the process of listing, timing is more important than ever. Various disclosures now need to be considered, including the implications of a global economic slowdown on their financial performance, the planned use of proceeds from the issue and delays in listing that could lead to defaults in existing contractual arrangements. There is of course the important challenge of being able to compare with past periods which is now near impossible given the impact of this pandemic. Explaining any growth story considering the reduction of business during this period is likely to be very challenging, and analysts will struggle to build accurate models given the data they have. This would be especially true of new or nascent businesses.
Impact on capital markets
The most obvious impact of the downturn on capital markets has been the reduced investor interest, and hence, limited options for fundraising. With limited to no investor appetite, coupled with travel restrictions and lockdowns, companies have had to defer road shows and marketing of security offerings. Several companies have recently decided not to proceed with their IPOs due to the market volatility, including Antony Waste Handling Cell Limited in India, and LS Eve Korea and Indonesia’s Lion Air Group overseas. Other routine capital market transactions, such as QIPs and preferential allotments, which have pricing mechanisms directly linked to share prices in preceding weeks, have also taken a backseat. There has been a significant slowdown in offerings, on both equity and debt fronts, with key sectors such as infrastructure, manufacturing, tourism, transportation and hospitality bearing the brunt of the impact.
On the other hand, with decreasing share prices, Indian companies, like Sun Pharma, have announced buyback of their shares from public investors in a bid to consolidate promoter shareholding, while providing returns to investors and keeping up their confidence.
Specific considerations for securities offerings
For companies looking to access equity or debt markets in the near future, some of the key areas and questions to focus on are:
- Reason for the offering – Objectives of security offerings range from internal factors such as for shoring up capital and working capital, refinancing or repayment of existing debt, expansion of business operations or financing acquisitions, to external driving forces such as providing existing investors an exit, and in some cases, compliance with sector-specific regulatory requirements, such as small finance banks with prescribed timelines to undertake public offerings. Companies who see more opportunities may approach early on and then expand with the aim to do well and there maybe companies who have suffered tremendously and this is imperative for their survival.
Current market conditions may also see some companies re-evaluate the timing and/or size of planned transactions, and, depending on the requirements driving the offer and possible alternate sources of funding, decide to defer or withdraw. Where offers are driven by investors, lenders or for regulatory reasons, such decisions would need to be made in consultation with, or with the prior approval of such parties.
- Financial conditions – Companies have had to adjust their financial allocations, including allocating part of their cash reserves for current business and corporate obligations, such as outstanding payments to lenders, third parties and employees. The impact of such adjustments and financial rebalancing on an issuer’s future financial performance and prospects will play a role in investors’ decisions and will need to be thought through carefully.
- Due diligence process – Diligence exercises will need to have a comprehensive set of questions and assessments regarding the current and anticipated impact of the market downturn, and specifically, the COVID-19 pandemic, on various aspects of the company, including business or production levels, supply chains both for production and sales’ networks, access to raw material, regulatory and commercial compliance, and financial obligations. Companies may be asked for revised projections and internal audits to assess any potential qualifications. Potential delays in regulatory filings, loan repayments, renewal of contracts or licenses could result in highly qualified diligence findings, adding to the risk profile to be highlighted in offer and marketing documents.
- Offer documents and disclosures – Additional disclosures will need to be included in offer documents, particularly to highlight the risks and effect of the current market scenario and COVID-19 on the company’s business, financial condition and results of operations. The actual and perceived impact on business and financial results, trends and uncertainties, to the extent ascertainable, should be included in the management’s analysis of the company’s financial condition. Where projections of future financial performance are included in offer documents, the process of determining and preparing such projections could be complicated by current economic conditions. Further, adequate disclosures on measures and strategies to mitigate losses or steps taken to ensure continued commercial and regulatory compliance, including amendments, extensions or waivers taken in respect of agreements, licenses or approvals will be required.
Companies which have already filed draft offer documents with SEBI are bound by prescribed timelines to complete subsequent actions in the listing process. Observations issued by SEBI on such draft offer documents would lapse within 12 months, forcing such issuers to re-file their documents when markets revive and adding significantly to the offering costs. If companies re-evaluate the objects for raising capital, which increases the estimated issue size or estimated means of finance by more than 20%, a fresh draft offer document would need to be filed. Similarly, a fresh filing will also be required for any change of more than 20% of the estimated fresh issue size and/or more than 50% of the estimated size or number of shares being offered for sale.
Should a company successfully manage to find an alternate source of funding, for instance, through a strategic sale or partial/ full acquisition, it may need to formally withdraw the draft offer document filed with SEBI. For companies pulling out after filing the red herring prospectus, intimations to SEBI, Registrar of Companies and any sector-specific regulators, existing investors, lenders and public communication will need to be made. In all instances of withdrawal, offer expenses incurred to date will likely have to be paid by the company (unless otherwise agreed), as opposed to the typical practice of allocating a portion of the offer proceeds towards various expenses and selling shareholders bearing a proportion of the costs in a successful listing.
- Existing shareholding and financing arrangements – Delays in or breaches of timelines for investor exits and minimum required returns typically included in shareholder agreements could lead to events of default under such agreements. Similarly, borrowers may struggle to comply with covenants in their existing financing agreements. Parties may in such situations have to negotiate a commercially acceptable solution or moving to adversarial proceedings.
The immediate impact of the global economic downturn is a slowdown in companies accessing the capital markets. Key measures by the central and state governments and regulators have been initiated to tackle the current meltdown, however, with immediate relief to provide liquidity and monetary stimuli being the focus, it remains to be seen how these play out in the long term.
Significant relief packages, reduced penalties and extended timelines for certain tax payments and reporting, relaxations from regulatory compliance, aggressive interest rate cuts and moratoriums on repayments, while helpful in keeping entities afloat during this downturn, may not help reduce the lasting impact on the business and financial and operating conditions of companies or their ability to raise funds through public offerings or other capital markets transactions. These new challenges and significant costs for companies, going forward, offering structures and disclosures in offer documents may look quite different from present constructs.