Will PSU share buyback help minority shareholders?


Coal India Limited (CIL), in its annual general meeting (AGM) held on September 18, 2012, sought the approval of its shareholders to pass an enabling resolution to amend its Articles of Association. The special resolution was sought in order to facilitate a potential buy back of its shares. Not surprisingly, the resolution was passed with more than 75% shareholders voting for the resolution. The minority shareholders did not have much say in the matter, given that by Government of India holds 90% in CIL. The amendment was proposed in accordance with a directive from the Department of Public Enterprises and was approved by the Board of the Company on May 28, 2012.


Similar was the case with companies such as NTPC, SAIL and NMDC, which passed similar resolutions in their AGMs between September 18, 2012 and September 21, 2012. The buy backs are aimed at providing an indirect way for the majority shareholder in these companies, the Government of India, to meet its fund raising targets in order to bring down the fiscal deficit.


For more than a year now, low investor appetite and volatile equity market conditions have prevented the government from selling any of its shares in the public market. Most of its disinvestment plans have been in the backburner for more than a year. Hence the government has been mulling share buy backs by cash-rich public sector enterprises as an alternative means to meet its fund raising targets. As of March 2012, four state-owned companies – CIL, NTPC, SAIL and NMDC – had cash balances of more than Rs 1 lakh crores. The Articles of these companies were amended to enable them to buy-back shares from its shareholders, including the Government of India. However, such a move seems to be extremely unfriendly to minority shareholders of these companies.


Share buy backs are an alternative form of paying shareholders. In the absence of any additional investment opportunities with positive net present values; companies use their excess cash reserves to buy back shares. Shareholders deciding to exit the company are paid back in cash at the maximum buy back price (in most cases it is closer to market prices) and the remaining shareholders gain through an increase in their per share value.


But share buy backs differ from dividends in a fundamental aspect. Assume a company where a promoter holds a substantial stake, and this company passes a resolution for both a huge interim dividend payout as well as a share buy back. In case of the dividends, all shareholders, including the promoter gets the same cash payouts regardless of the amount of dividend declared. In case of share buy backs, only the shareholders who decide to tender their shares get the payouts, while the value of the shareholders who continue to remain invested might get affected if excess cash is paid out during the buy back. Hence companies should ideally decide to go in for buy backs when market prices are trading much below their fundamental value.


In the Indian context, promoters use buy backs as a means for stake consolidation. However, as long as promoters do not use buy back as a method to remove the cash out of the company, interest of minority shareholders are not adversely affected. The problem arises when promoters are allowed to sell their shares in a buy back where promoter holds a substantial stake and can pass any resolutions in their favor.


Under the SEBI (Buy Back) Regulations, 1998 Indian listed companies can buy back shares through two different routes:

(i)   Open Market Route, where promoters are not allowed to sell their shares, and

(ii)  Tender Offer Route, where promoters are also allowed to sell their shares and the offer price is fixed.


Further, in accordance with Companies Act, companies can buy back up to 10% of their share capital and free reserves through a simple Board resolution and up to 25% of their share capital plus free reserves through a Special resolution.  Through a notification dated February 07, 2012, SEBI amended the Buy Back Regulations, bringing in changes to the process timeline, public announcement norms and the allotment methodology. The amendment allows for share acceptances in the buy back in proportion to the shares held by individual shareholders as compared to the earlier norm of acceptances in proportion to the shares tendered by the shareholders in the buy back.


The problem with the tender route, particularly in cases where promoter holds a substantial stake, is that the promoter can use this method to remove cash out of the company, with minority shareholders particularly having no say in the matter.


Also, in case of PSU buy backs through the tender offer route, given the discretionary nature of the guidelines related to determination of maximum buy back price, government in its own interest (to meet its fund raising targets) would set the maximum buy back price at higher levels, and this might conflict the interests of the minority shareholders who chose to remain invested. Subsequent amendments on the allotment methodology will also assure the government of acceptances based on their equity holding. In case of the PSU buy-backs, where the government holds more than 85%, the government will be assured of getting a majority of the proceeds at the higher buy back prices as decided by the government, while minority shareholders who chose to remain invested will be adversely affected.


SEBI should review the provisions of the Buy Back Regulations and should not allow any promoter to sell their stakes through the buy back process, particularly if the intention of the buy back is to raise money for the promoters. This will be in direct conflict to the interests of the minority shareholders.


The government should rely more on structural reforms and economic growth to meet its divestment programme targets than making procedural changes to market regulations that are not in the interest of the minority shareholders.


The article can also be downloaded from here: Moneycontrol – September 24 2012


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