Personal Finance: Money Minder's Mailbag: Open Sesame!

With takeovers becoming a strategy for growth, I notice that the price offered by the predators is good considering the present market scenario. But is the open offer always higher than the price quoted on the stockmarket?

Dear Reader, your observation is correct. It certainly is a period of takeovers. And yes, you are right about pricing. When an open offer is made, the proposing company always offers to buy shares at a price higher than what is being quoted on the bourses. The logic is simple: the offer has to be sugar-coated so that the investors bite it. For, if the offer is the same as the listed price--or just slightly higher--the investors wouldn't be interested in selling their stake. An offer price is mostly at a 30 to 40 per cent premium on the market price.

But there are exceptions: it could be less, or even more as in the case of the India Cements' bid for Raasi Cement. India Cements made an open offer of Rs 300 a share when the market price the preceding day (February 25) was Rs 174. That translates into a premium of around 72 per cent. Generally, the minimum offer price is the average of the weekly highs and lows of the closing prices of the shares of the target company during the 26 weeks preceding the date of the public announcement. If the shares are traded infrequently, the price has to be approved by the Securities & Exchange Board of India (SEBI).

Doesn't that mean a substantial gain for me? After all, I can get a higher price than what is being quoted on the markets. And, since the prices invariably start declining once the offer closes, shouldn't I cash in on the offer?

Dear Reader, when an open offer is made, the share price starts inching up towards the offer price. And if the offer has been anticipated even before it is actually made, the share price will have started its climb before the offer itself. In fact, a sudden spurt in the trading volumes of a scrip, or unusual upward swings in its price, are considered portends to a possible takeover bid (and, ergo, an open offer). You're right in that once the open offer is concluded, the share price normally shows a downtrend. So, in a way, the answer is yes, the investor would benefit by selling when the open offer is made. But, let me emphasise, it needn't always be the case.

Why do you say that? There is no possible reason for the share price to move northward after the offer closes. In fact, I would say this is the only time when minority shareholders can reap substantial gains by selling their holdings

Dear Reader, there are two ways of viewing this situation. If you are desperately in need of money, it makes sense to sell your share at a price that is higher than what you would have got under normal circumstances. But has it ever occurred to you that you could get a good price even if you held on to your scrip for a longer duration? Logically speaking, the price of a scrip may show a sudden downtrend in the aftermath of an open offer, if you compare it with the offer price.

But, if you hold on to the scrip for a year or two, the price could show a good appreciation. It is obvious that a company won't make a takeover bid when the market is booming and the share prices are at a peak. So, even if there is a premium on the market price, there is no telling that the price will not rise by a larger extent later. But this, of course, would depend solely on the company's performance.

So what you're trying to say is that it makes better economic sense to hold on to the scrip as a long-term investment?

Dear Reader, yes, but that, again, is not a hard-and-fast rule. If the track-record of the company isn't encouraging, it makes sense to sell. If a company is sick and is saddled with Non-Performing Assets, lacks financial resources or competitiveness, and needs to undertake extensive research to sustain growth, it makes sense to move out. In fact, it will be foolish not to do so.

But if the acquirer plans to infuse sound management practices, or large doses of capital--as the case may be--in the target company, it may well turn around. A takeover bid is generally understood to imply the acquisition of shares carrying voting rights in a company in a direct or indirect manner with a view to gaining management control. In a situation like this, even if the share shows a downturn immediately after the bid, the price can rise to an even higher level later.

But always look at the average share price of the company before the open offer was made. Then, if the offer seems hyped-up, you should sell. But if you still feel the price doesn't reflect the actual value of the scrip, and you expect an appreciation in the years to come, it would make sense to hold on to it.

Does that mean there are other factors to be considered too? For instance, if the company that I have invested in is known to make bonus issues, shouldn't I consider that as a factor?

Dear Reader, you do so at a risk. Usually, it's the transnationals which give bonuses since that increases the absolute shareholding of the parent, and helps in repatriating larger dividends back home. But bonuses have to be declared from free reserves, and, so, only companies with high reserves do that. Sure, the company may have a policy of issuing bonuses every three years, and the open offer could be made at a time when a bonus is due. But that may not be reason enough to hold on to the scrip since, post-takeover, the bonus policy may be done away with.

However bizarre it may sound, can there be a situation in which the price of a scrip goes up after an open offer?

Dear Reader, that is unlikely although not impossible. For instance, let us say Company A, which has a high Price-to-Earnings ratio (p-e), makes an open offer for Company B with a low p-e. In that case, the shareholders of Company B may not want to sell their shares because they would expect that post-acquisition, the p-e of Company B would move closer to that of Company A. That's a situation where the post-acquisition price could be much higher than the offer price.

I get your point. Let's say I go by your earlier logic, and hold on to the scrip on the ground that a substantial appreciation is likely in the years to come. In that case, won't I be losing out on short-term profits by forgoing the opportunity to sell if the offer price is really high?

Dear Reader, of course you will. You should hold on to your scrip only if you want it to be a long-term investment and you are certain that the price will appreciate beyond the price being offered. However, if you still want to reap short-term profits, you could sell when the offer is made and buy back the same shares for holding once the offer closes and the price shows a downturn. This way, you would make a profit from the high offer rate and be able to hold the scrip as a long-term investment as well. But if it's a hostile takeover bid, don't sell immediately. Wait for the counter-offer.

Are you saying that, in a hostile takeover, I will, probably, get more than one option to choose from. But then, how long should I wait till I decide to sell?

Dear Reader, if it is a hostile bid, it makes sense to hold on to your scrip till the final price is stated. When an acquirer company makes an offer, it is required to make a public announcement in at least one English national daily, one Hindi national daily, and a regional language daily at the place where the registered office of the target company is located and at the place of the stock exchange where the shares of the target company are most frequently traded. The offer has to remain open for 30 days.

Once an open offer is made, the target company may decide to come out with a counter-offer to buy its own shares. If that is the case, it will make an announcement stating its plan. So, be on the lookout. The counter-offer will be higher, and the war will continue. Once the final bid is made and there are no counter-offers, it is time to sell. But if it is a friendly takeover bid, the price will remain unchanged since there will be no counter-offer. Hence, you will have no choice but to sell at the price being offered. The same would apply if the offer is by the promoters themselves wanting to increase their stake.

But how will I know if there is going to be a counter-offer or not? How many counter-offers can there be? What is the time-frame for such offers?

Dear Reader, technically, a company can make just one open offer and one counter-offer. The counter-offer has to be made within 21 days of the public announcement of the first offer. So, it will happen even before the offer is actually open. Usually, the gap between the public announcement and the opening of the offer is around 45 days. But it can't exceed 60 days.

Consider India Cements' bid to acquire Raasi Cement. The public announcement was made on March 2, 1998, but the offer opens on April 15, 1998, for a month. So, Raasi Cement will have to make a counter-offer within 21 days of India Cements' public announcement. That will leave India Cements a choice to revise its bid, but it will have to do so within 14 days of Raasi Cement's public announcement. And then, Raasi Cement could again counter within seven days. So, if there are no more offers within the specified time-frame you know what the final price is.

I would like to know what I must do to avail of an open offer. Do I just approach my stockbroker?

Dear Reader, no. You cannot approach your broker or the company registrar in such a situation. You will have to send your shares to the manager of the issue, which will be the merchant banker.

First, the acquirer has to ensure that the letter of offer is sent to all shareholders of the target company whose names appear on the register of members of the company as on the date mentioned in the public announcement. Those who hold shares but are not registered shareholders are also eligible to participate in the offer. These shareholders have to send an application to the merchant banker along with proof of ownership (contract note). Incidentally, the target company has to furnish the acquirer with a list of shareholders, warrant holders, and debenture holders, as well as those whose applications for registration of transfer of shares are pending with the company.

But I don't understand why a company has to make an offer at all. Can't it just pick up the shares from the stockmarket?

Dear Reader, in India, an entity can accumulate only up to 5 per cent of the equity capital of a company without making any disclosures. But once the figure is 5 per cent, or more, a disclosure has to be made to sebi, the stock exchange concerned, and the board of directors of the company in question. And once it touches 10 per cent, acquisition of more shares must be through an open offer. Even a promoter wanting to raise holdings in his company has to make an open offer if he already has a 51 per cent stake in it.

Besides, it may also make better economic sense to come out with an offer. Let's take the case of Sterlite Industries (Sterlite) wanting to buy into Indal. Now, Indal has a low floating stock; only 9 per cent is held by the public. If Sterlite were to try and pick up a 5 per cent stake, there is no doubt that such moves would have sent the price of the Indal scrip soaring. Sterlite would, thus, have ended up paying much more than the Rs 90 it has offered.

If a single entity holds such a large portion of the stock, won't it affect the liquidity of my scrip?

Dear Reader, you do have a point. If the floating stock is reduced drastically, liquidity may be affected adversely. With trading being thin, it is likely that the investor will not be able to exit easily since the option to sell will be limited and the quotes fewer. But the extent of the problem will depend on the company in question. If it's a huge company with a large floating stock, there shouldn't be too much of a problem. Otherwise, the problem is for real.

WHAT THE TAKEOVER
CODE ENSURES FOR YOU

The acquirer sends the letter of offer to all shareholders (including non-resident Indians) of the target company
The acquirer informs all warrant holders/convertible debenture holders who can exercise their option within the offer period
The target company gives the acquirer a list of all eligible shareholders / warrant holders / convertible debenture holders
The date of opening of the offer is not later than the sixtieth day from the date of the public announcement
The offer to acquire shares from the shareholders remains open for a period of 30 days
The acquirer completes payment to all shareholders who have accepted the offer within 30 days from the offer closure date