Barbarians At The Gate?

MAKING the impossible, possible. That's what the draft code for takeovers presented by the Bhagwati Committee on August 28 has just done. Obstructed by political pressures, archaic guidelines, lack of transparency and general disapproval of takeovers among the public, hostile acquisitions were rarely successful, apart from being a nightmare for both parties, where underhand deals and bullying tactics were the norm rather than the exception. The draft code—scheduled to be notified by end-December—aims to change all that. 

Based on the principles of transparency, equality and opportunity for all shareholders, the draft code has been widely acclaimed. "It has been very well drafted," says Atul Chopra, managing director, projects, Brisk Capital Market Services. And a first glance at the draft was enough to convince analysts that the era of hostile corporate takeovers—the cause behind many corporate dramas in the West—was just a notification away.

 At the same time, Justice P.N. Bhagwati has managed to do what no transnational corporation (TNC) could: give closely-held, family-owned companies with low holdings—be they mismanaged or well-managed—the jitters. For, they are expected to be the prime targets in most instances of hostile acquisitions, courtesy the low holdings of the promoters. This fear is expected to compel slothful companies to shape up, otherwise they might be forced to ship out. But the draft code also provides an escape route to these companies, since it permits consolidation of holdings to build a defence against possible takeover threats.

Family-owned companies apart, Chopra expects a different kind of corporate to be as much under the gaze of merger and acquisition (M&A) experts: those involved in infrastructure projects. Thanks to the high capital cost and the scarcity of capital, the promoter in most of these instances is forced to retain a minority shareholding, giving up the rest to venture capitalists or a consortium of financiers, who today are, more often than not, unwilling to offer the right of first refusal of their shares to the promoter. This, says Chopra, offers scope for a hostile takeover, in case the financiers or venture capitalists want out of the project when it's listed on the bourses—whichis usually when the gestation period is nearing completion and it's time for the returns to trickle in. "While the promoter will bear the construction risk, the rewards will go to the acquirer," he says.

 But there are others who view the scenario differently. Says Ashwajit Singh, president, Allianz Capital and Management Services Ltd: "Why should we stick to companies we have promoted? Theacquirer may bring in new ideas and add value to the product, and at the same time, compensate you adequately while acquiring the company you have promoted." He adds that this is something that happens regularly in the West, where promoters are just that: promoters, and not managers of the company.

While family-owned companies with low holdings, small companies with low market capitalisation but strong asset base and infrastructure projects are expected to be the prime target for acquisition experts, there are still a few stumbling blocks peculiar to the Indian environment in the path of M&A experts. For instance, RBI regulations do not permit banks to lend more than Rs 25 lakh against shares. The acquirer is thus left with the option of either circumventing the banking route by raising money through debt issues, FIIs and private equity funds, or to get the bank to borrow money to use as working capital in his company, while he utilises his surplus funds for acquisition. Besides this, other factors, hangovers from pre-takeover days, will continue to haunt for some time to come. For instance, public sector banks might be unwilling to lend funds for takeovers, since they could be accused of favouring one company over another, and if the acquirer happens to be a TNC, the bank's top brass would be unleashing a certain political storm. "This could be a stumbling block," agrees Singh.

DITTO the case with financial institutions (FIs) who have high stakes in a lot of Indian companies. "Hostile take-overs will be next to impossible if FIs hold majority stake in a company and decide not to sell. You'll have to rely on negotiated takeovers in this case," says Singh. Though, of course, if the FIs are unhappy with the management, they might be more than happy to sell. "Whether the draft takeover code is akin to letting a bull loose in the china shop, will only be known once the FIs firm up their views on the issue," says Chopra. Pointing out, that in the past—as a policy—they have preferred to support the promoter rather than the acquirer.

 If FIs decide to sell out to acquirers, the era of takeovers may well and truly be here. "And foreign companies taking over Indian companies will become a more real threat if banks and FIs operate more on the basis of economic fundamentals than political pressures," says Singh. But there is one problem TNCs may face during takeovers if they haven't set up base in India earlier and thus require Foreign Investment Promotion Board clearance to bring in funds. "This will pre-empt the takeover and provide time to build up defences," says Chopra.

 As merchant bankers and cash-rich corporates equip themselves to welcome the takeover era, some have a few reservations about the draft code. "I'd have preferred it if the 10 per cent deposit in the escrow account is brought down for mega corps with high market capitalisation, but a graded and relatively higher limit set for small companies with low market capitalisation," says Singh. He feels it would have been better to dispense with margin requirements on a percentage basis for small companies, and instead setting a minimum limit of Rs 2 crore or Rs 4 crore for these companies. Besides, it is extremely easy to acquire a 10 per cent stake in small companies. "So why should the acquirer activate the takeover code if he doesn't want higher stake?" says Singh. On its part, SEBI has asked the public to send its views and comments by September 20, so that it can finalise the takeover code by the end of the month. Perhaps these reservations will be cleared then.