Target buybacks and delisting to make money in shares

Generally, investors tend to make more money in a bullish market than in a bear market. But, if the bearish trend persists for long, one wonders how to make money? It is like the metaphor: “When the going gets tough, tough gets going.”

Should investors look out for a broker who could buy them some stocks selectively merely because those companies are likely to delist and can make short-term gains reacting to the delisting talk? “At times, it does make sense to invest in such a company, as there is good potential for an upside. But while doing so, the investor should make sure that the fundamentals are also in place and valuations are not expensive,” says Angel Broking Vice-President (Research - Banking) Vaibhav Agarwal.

Usually it is high quality MNC stocks on which such kind of recommendation is given, says Agarwal, where corporate governance standards are impeccable.  

Delisting plans

Let’s face it. Investors often get swayed by immediate gains, especially rise in share prices on reports of company’s delisting plans. For example, the recent case of UTV Software Communications where the speculation of a possible delisting move started doing the rounds, with news reports appearing in early June, the stock started inching up. It grew over 30 per cent from Rs 665 on June 3, 2010, to Rs 950 on July 26, when The Walt Disney Company has formally announced its plan to delist at Rs 1,000 per share.

Though the Securities & Exchange Board of India (Sebi) lays down the criteria for fixing the minimum price below which the promoter cannot buy, it is silent on the maximum price. The pricing tussle also results from the regulatory requirement that any company seeking to delist must buy back more than 90 per cent of its total shares.

As such, the current bearish market has come as a blessing for some companies and promoters. So much so that foreign institutional investors (FIIs) sold sizeable number of equities of domestic companies from January mainly to the promoters of these companies who are looking to buy shares cheap before the new takeover code kicks in from the last week of October, making such purchases dearer.

As per the Sebi data, FIIs being the key drivers of Indian markets have sold shares worth Rs 2,595 crore till September 23, this calendar through primary market deals such as delistings, buy-backs and open offers net of buying in initial public offerings and other transactions. In the corresponding period last year, they had invested Rs 38,925 crore in primary market deals.

 At the same time, the 30-unit popular Sensex of BSE has lost 22 per cent since January, mirroring the fall in global markets in the wake of a threat of a double-dip in the world’s affluent economies.  So, domestic companies and their promoters are making the most of this fall by buying shares from FIIs at low prices.  Some companies have opted for buy-backs and even delisting with an aim to re-list when the markets turn bullish again.

Buy-back has caught the fancy of the government too, which plans to ask cash surplus PSUs to buyback their shares to mobilise more resources. Among the PSUs that have the wherewithal to buyback government shares include ONGC, SAIL, NMDC, NTPC, Oil India, BHEL and MMTC that have strong cash balances and may qualify for a buyback option.

For one, a buyback improves revenues to the Centre immediately. Simultaneously, the shrunk paid up equity base also improves the earnings per share of the PSU, allowing for a fresh float in future at a higher price. Top executives of FIIs operating in India aver there is a significant rise in the number of open offers, buy-backs and delistings. “FIIs are offloading their stakes through these non-secondary offers,” said U R Bhat, managing director of Dalton Capital Advisors (India) adding: “There is an arbitrage between secondary market and buy-backs and delisting. Promoters are capitalizing on the fall in share prices by buying shares back from investors.” 

Companies with 75-90 per cent promoter holding will most likely increase their stake and go for de-listing, says Bhat adding: “They can relist again when the markets rise. There are 214 such listed firms.” In the first eight months of calendar 2011 period, 30 companies applied for delisting with stock exchanges, 64 firms applied for open offers with Sebi and at least 42 firms followed the buy-back route, according to Prime Database, a Delhi-based primary market tracker.

Eight firms have already delisted their shares valued at a total Rs 3,057.62 crore and there have been 17 buy-backs valued at Rs 5,283.96 crore, according to Prime Database. Nirma Ltd (Rs 379.84 crore), Binani Cement Ltd (Rs 81.7 crore) and Atlas Copco (India) Ltd (Rs 502.6 crore) are some of the companies that are in the process of delisting their shares. In comparison, calendar year 2010 saw nine delistings valued at a total Rs 948.26 crore, while 12 companies bought their shares back worth Rs 1,229.40 crore.

Takeover code trigger

The market has turned bearish at a time when the new takeover code is set to be implemented. Effective from October 22, 2011, the new takeover code requires an acquirer to buy at least 26 per cent shares in an open offer as mandatory and the trigger for such an offer will be 25 per cent. Currently, the trigger is 15 per cent and the mandatory open offer is for at least 20 per cent. So, the new norms will make it relatively difficult for companies to opt for delisting.

Currently, if an acquirer’s share purchase following an open offer leads to a fall of public shareholding below 25 per cent, it can either pare its stake to 75 per cent within the next 12 months or choose to delist the company by reducing the public holding at least 10 per cent.

Under the new norms, the buyer’s right to delist a company in such a manner has been revoked. The new norms require such an acquirer (with more than 75 per cent stake) to dilute its stake to 75 per cent within 12 months from the date of the open offer. Only after that it can opt for delisting the company, making this a relatively cumbersome process. Usually, open offers are made at a premium to the prevailing market price of shares. With the market in a bear phase, several stocks are trading either close to their fair valuation or below. So, while offering a premium to the prevailing market price for buying shares through an open offer, an acquirer not only gets management control at a low cost, but also holds the prospects of booking profit when the markets turn bullish.

“Open offer tenders are always higher in bear-market phases. A lot of companies, mostly multinational ones, which have low public shareholding are said to have plans to delist from the Indian bourses,” said Edelweiss Capital President (wholesale capital market) Vikas Khemani. 

Buy-back offers of Reliance Infrastructure (Rs 1,000 crore), Zee Entertainment Enterprises (Rs 700 crore) and Deccan Chronicle Holdings (Rs 270 crore) are currently on.

A company can buy back its shares to the extent of 25 per cent of its paid-up capital and reserves with a shareholders’ resolution and up to 10 per cent without any resolution as per the Companies Act.

Firms go for buy-backs when the share price is undervalued or an eventual delisting is intended. They buy shares from shareholders and extinguish them. Some companies, especially those with foreign promoters or MNCs, resort to buy-backs to eventually delist from Indian bourses.

Some times, buy-back is preferred by companies to make their equity attractive as it reduces the number of outstanding shares and increases its earnings per share (EPS).

This is happening globally and not specific to India. Firms with less than 25 per cent public holding, which have been waiting to voluntarily delist, have got an opportunity to do so cheap with their stocks trading low.

Of course, there is a downside too. Stocks may crash if the delisting plans by promoters do not materialise, points out SMC’s Thunughutla adding: “If Walt Disney is not able to buy 90 per cent outstanding shares (of UTV Software), the plan will fail and there is a good chance that the stock will collapse.”