Ban preferential allotments


Director, Banyan Tree Advisors

December 20, 2011

By allowing preferential allotments at almost ridiculous prices Sebi is guilty of leaving minority shareholders in the lurch.

THE STOCK market here is strangely reminiscent of George Orwell’s Animal Farm – all investors are certainly equal, but some appear more equal than others. Take, for instance, the pampered institutional investors. Everything in the market
seems to be made easy for this tribe. Even Sebi (the Securities and Exchange Board of India), whose mandate is to protect the interest of retail investors, frames its regulations in tune with the demands and desires of institutional investors.

I was looking at the list of stocks that have outperformed all others in the past year and a half (when the Sensex peaked) and one stock grabbed my interest: HDFC.

Over this period, HDFC is up almost 70 per cent; comparatively, the BSE Sensex is down about 35 per cent over the same period. Digging into the reasons for this superlative outperformance, I found that while there were a number of factors
(strong demand for housing, tax benefits for the sector, defensive qualities) that could be responsible for this, many of these were shared by other players, who have not performed half as well. It struck me that perhaps the biggest reason for
the stock’s sterling performance is this: when Standard Life (with which HDFC entered into a tie-up and entered the insurance industry) wanted to increase its stake in the company, HDFC did not make a preferential allotment at the 26-week average price; it asked Standard Life to buy the shares from the secondary market.

This, I believe, is a landmark move and reflects the shareholder-friendly attitude of the HDFC management. Why should any investor be made a preferential offer? I could not come up with a satisfactory answer except that companies that want large institutional investments need to pander to these investors’ whims and fancies.

The principle that the regulator and the management of a company need to keep uppermost in their mind is that all shareholders are equal and no one should get preferential treatment over others. It is the regulator’s job to ensure that this happens. Often, preferential allotments are made by unscrupulous managements who rig up share prices and then offload these shares to mutual funds/foreign institutional investors. In these times of low share prices, we could be subject to the reverse. Managements can make preferential allotments to themselves or their friends at ridiculously low prices and offer to buy back shares from small holders. A small shareholder, faced with the prospect of delisting of the
company’s shares, has no choice but to sell to the promoters. Recently, Otis bought back its equity at Rs 280 per share. But in 1999, the same company bought back M&M’s share of its business at Rs 360 per share. Otis got round the Sebi regulations because there was a significant time gap between these offers.

But is justice being served here?

We are now likely to see a spate of buybacks, often at prices that are not fair to minority shareholders, and more delistings. I remember the case of Bharti Telecom; despite owning assets that were probably worth Rs 500 per share or
more, the company offered only Rs 96 per share to its minority shareholders. The promoter group already owned about 90 per cent of the shares, so the minority shareholders had no say in the price on offer. Note that Bharti Telecom is the
parent company for all of the Bharti group’s telecom ventures. I recently read that the group is targeting revenues of $1 billion; Bharti Telecom, however, was offered a valuation of only Rs 160 crore ($40 million) for the company. That is
nothing but a crying shame.

It is quite clear that Sebi’s regulations on buybacks and offer prices fall way short in protecting minority shareholders’ interests. Enlightened regulation would give minority shareholders the same rights as the management of the company or its institutional interests. To make it fair, the minority shareholder should be given additional rights since he does not have the clout that the other two categories of investors seem to have. I would suggest the following:

All preferential offers (to buy back or sell shares) should be accompanied by a put and call option to all investors. This will allow them to either sell their shares or buy more shares (in proportion to their holdings) at the same price that’s offered to institutional investors.

Delisting of a company needs to be made much more stringent, as minority shareholders are often forced to offer their shares for fear of not having an exit option. No company promoted by the same group should be allowed to access
the capital market for the next three years.

Only if such proposals are executed can we hope to get a fair deal for the minority shareholder, who, after the battering he has received in the stock market over the past 10 years, has probably abandoned this investment avenue for good. Mr
Mehta, are you listening?