Judgment reserved on offer for sale on stock exchanges

In 2010, the Securities Contract (Regulations) Rules, 1957, were amended to require all listed companies to achieve and maintain a minimum public shareholding of 25% by 5 June 2013. At 30 March 2012, approximately 110 companies in the private sector did not meet this requirement. These companies have two options: delisting of the company, or increasing the public stake through one of the four methods prescribed in clause 40A of the Listing Agreement.

The four methods are: follow-on public offer; offer for sale by the promoters through a prospectus; institutional placement programme; and offer for sale on the stock exchange (OFS). This article examines the OFS method.

OFS process

The OFS is a sale of shares held by the promoters through an auction process. The sale takes place on the floor of the Bombay Stock Exchange, the National Stock Exchange of India, or both, and is carried out through a separate window. To date, the promoters of two companies have used the OFS mechanism – the government of India (ONGC) and the Azim Premji Trust (Wipro).

Promoters that intend to use this process must notify the exchanges at least one clear trading day prior to the opening of the offer, stating the number of shares to be sold and the floor price, which may be submitted in a sealed envelope. The minimum offer size is the higher of 1% of the paid-up capital of the company or ₹250 million (US$4.7 million).

The offer can be kept open for a maximum of one trading day. Bids can be placed through registered brokers of the exchanges and can be modified or cancelled up to 30 minutes before the offer ends. Valid bids at or above the floor price will be accepted on either a price priority basis or proportional basis.

Once the offer is open, the promoters cannot withdraw it, but they can either conclude it or cancel it if they do not get sufficient demand at or above the floor price.

Availability

The OFS route is available only to the promoters of companies that are required to increase their public shareholding to meet the regulatory requirement and promoters of the top 100 companies. The promoters should not have dealt in the company’s shares for the previous 12 weeks.

Anyone who is eligible to trade on the Indian stock exchanges can participate in an OFS. So all resident institutional and retail investors, foreign institutional investors, foreign venture capital investors and qualified foreign investors can participate.

The OFS is the most attractive method available to promoters under clause 40A for several reasons: (1) it can be undertaken in a week’s time, without consents of the target company or regulatory approvals (except for sectors requiring Reserve Bank of India/Foreign Investment Promotion Board approval); (2) no offering circular or prospectus is required – the promoters need only notify the stock exchanges of basic matters such as the stock exchanges on which orders can be placed, the number of shares being offered, the date and time of opening and closing of the offer, floor price, and the allocation methodology; (3) the process costs are low; (4) the OFS is open to the public at large; and (5) the promoters save on long-term capital gains tax as the sale takes place on the stock exchange.

Lacklustre response

Despite the advantages highlighted above, the response to the two recent OFSs was far from satisfactory. This may be partly attributed to the process prescribed by the Securities and Exchange Board of India (SEBI).

A peculiar requirement of the OFS process is that bidders have to place 100% margin money upfront. This means that foreign institutional investors have very short notice to move the funds and retail investors may not have sufficient liquidity for large transactions. These practical difficulties could be avoided by providing more than one trading day’s notice to the potential bidders, which is permitted under the SEBI circular.

Another issue is whether the allocation of shares should be on a proportional basis or price priority basis. Acceptance based on price priority discourages retail investors. The preferred method of allocation will depend on the liquidity and investor demand for the stock in question. It would also help if there is more transparency in the bid process.

Despite the recent experiences of the promoters of Wipro and ONGC, the OFS mechanism is expected to be a preferred method by which promoters will offload their stakes in order to comply with the minimum public shareholding requirement, as it has the clear advantage of simplicity and ease.

Akila Agrawal is a partner and Mukul Sharma is an associate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.