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Sunday, April 26, 2009

Investment Strategy: Waiting to exit

Many MNCs are likely to opt for delisting to come out of the regulatory purview:-

On 25 March 2009, Switzerland-based pharmaceutical multinational Novartis declared its intention to raise its equity stake in its Indian subsidiary from 50.9% to 89.93% by acquiring a 39% stake from the public shareholders. Novartis is offering Rs 351 per share, which is at a 27% premium compared with its previous day closing of Rs 275.6 per share. The parent company would have to spend Rs 440 crore on the acquisition. The question is: Why is Novartis is making a voluntary open offer?

According to the public announcement made on 27 March 2009, the parent company wants to consolidate its holding in the Indian subsidiary for more flexibility to organise its commercial and financial activities in India. The public announcement further states that Novartis wants to ensure that the public shareholding in the subsidiary does not fall below the minimum level of public shareholding required to be maintained under the listing agreement with the Bombay Stock Exchange (BSE). Interestingly, it also mentions that the annualised trading turnover in the shares of Novartis India on the BSE is less than 5% of the total number of listed shares. Thus, the shares are deemed to be infrequently traded on the BSE in terms of the explanation (i) of Regulation 20(5) of the regulations. Even if Novartis manages to acquire 39% in the company through the open offer; the stock would have just 10% free float in the market, adversely impacting price discovery.

The Swiss company owns almost 51%, which is more than sufficient for operational and strategic flexibility. In what way will the parent get additional leverage by taking the equity stake a tad below 90%? It seems Novartis India could be heading for delisting in near future but may not want to go through reverse book building as the price discovery in this process is shaped by the shareholders. This could be at a substantial premium to the floor price (the average of the trailing 26-week high and low). The company has to either accept the price at which a majority of the shareholders offer their shares or reject the process outright. In buyback, the price is decided by the company and it can accept whatever shares are offered.

In August 2009, country's largest mutual fund house Reliance Mutual Fund, with an equity stake of 4.28% end June 2008, expressed concerns about the management of surplus cash by Novartis India. The fund questioned Novartis's investment of around Rs 340 crore in group companies through inter-corporate deposits (ICD) when surplus cash could have been invested in high- yielding instruments or returned to the shareholders through dividend or buyback of shares if the business did not need the cash. Interestingly, the fund has increased its exposure to Novartis India by over 70 basis points to a 4.99% equity stake end December 2008.

MNCs with operation in India and also listed on the domestic stock exchanges largely remain indifferent to investors. Stock prices, in most cases, remain range bound, with limited action and euphoria witness on the counter. There are many reasons for this. The parent has enough cash to support and grow its Indian operations so the Indian subsidiary is not bothered about stock-market performance. Why, therefore, have a listed subsidiary, which entitles following rules and regulation apart from disclosing financial information and remaining answerable to the investor community? Incidentally, Novartis India is the only listed subsidiary of Novartis.

To begin with, MNCs listed their Indian operations under pressure from the Indian government. In 1977-78, the Union government, using the Foreign Exchange Regulation Act, 1973, directed foreign companies operating in India to dilute their equity stake below 40%. Exemptions were provided at the government's discretion. The condition for exemption included exports or being in a high-tech industry. Responding, a few multinational companies exited India. These included Coca-Cola and IBM. Many MNCs preferred to list their shares on the stock exchanges. These comprised pharmaceutical companies such as Abbott Labs, Burroughs Wellcome, E Merck, Eskayef, Fulford, Hoechst, May & Baker, Organon, Parke Davis and Wyeth.Subsequently, many companies were delisted due to industry consolidation. For instance, Burroughs Wellcome went offline owing to its amalgamation with GlaxoSmithkline Pharmaceuticalsin March 2005.

Launching initial public offerings (IPOs) was a smart move. Despite the 40% cap, MNCs did not lose control as post-listing shareholding remained scattered. HUL, the erstwhile Hindustan Lever, came out with an IPO in 1977-78. HUL issued shares at Rs 16 per share and the market capitalisation at that point worked out to Rs 35 crore. The current market capitalisation of HUL is around Rs 55000 crore — an appreciation of over 1,550 times. HUL is also known for innovative ways of rewarding shareholders besides paying generous dividends on a regular basis.

A growing number of MNCs opting for delisting is not in the interest of retail investors. A delisting proposal boosts the stock and, thus, the buyback price to be discovered by book building. But, in the long run, investors lose quality stocks.

In the past many high-profile companies had opted for delisting. These included Reckitt Benckiser India (makers of Dettol, delisted in May 2003), Cadbury (January 2003) and Philips India (February 2004). The high profile MNCs that would be
going offline or in the process of de-listing their shares or substantially increase their equity stake in the company include:

Matrix Laboratories: Mylan Inc. is in the process of delisting Secunderabad-based pharmaceutical company Matrix Laboratories. The company held its extraordinary general meeting on 30 April 2009 to approve the delisting offer. The objective of the delisting is to enhance flexibility in managing its global technical and commercial operations platform.

BASF India: Germany-based BASF SE, parent company of BASF India, came out with open offer in July- August 2008 to increase its shareholding to 75% from 52.69% in BASF India. At the end of the open offer, BASF SE managed to acquire an 18.49% equity stake in BASF India, taking its total shareholding to 71.18%. According to the public announcement, "BASF SE plans to extend its market position in the growing Indian chemical sector. To this extent, a larger shareholding in BASF India will support the parent's efforts in developing the businesses effectively".

Alfa Laval (India): Sweden-based Alfa Laval AB came out with an open offer between November 2008 and January 2009 to increase its equity stake in Alfa Laval (India) by 13.26% to take it to 89.99% from 76.73%. At the end of the open offer, Alfa Laval AB managed to acquire a 12.04% equity stake, which took its holding to 88.77%. As per the offer document, "the parent company wishes to consolidate and enhance its stake in the subsidiary to justify greater commitment and support from the promoter group, in terms of resources and knowhow".


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