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An introduction to open offers

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Shanthi Venkataraman

There has been a string of open offers in recent months, on the back of a wave of takeovers and stake hikes by the promoters of India Inc. The stock prices of companies for which offers have been made have also zoomed.

Just what are open offers? How are they triggered? How do stocks behave in response to open offers? Read on to find out.

Warning. Some of what you are about to read might seem a bit like regulatory mumbo-jumbo. Here goes.

When there is a takeover, or a substantial quantity of shares or voting rights being acquired, regulations require the acquirer to provide an exit option to the target company’s shareholders, as there is a change in control of the company. The acquirer makes an open offer to buy shares to the extent of 20 per cent of the share capital from the public, at a particular price, during a defined time period. A public announcement is made to this effect, providing details such as the background of the acquirers, the justification of the offer price and the intentions and plans of the acquirer.

Triggers for open offers

Open offers can be voluntary. For instance, a promoter may wish to increase his stake in the company. According to SEBI regulations, promoters holding more than 55 per cent of the capital can increase their stake only by making an open offer to the public. If they hold less than 55 per cent, they can add up to 5 per cent a year to their stake, after making suitable disclosures to the stock exchanges. If they wish to acquire more than 5 per cent in a year, then too, an open offer will have to be made.

Most open offers are, however, triggered when a new acquirer buys a significant stake into a company and his shareholding in the company crosses the 15 per cent threshold limit stipulated by SEBI. In this case, an open offer has to be compulsorily made, barring a few exceptions, and involves a hefty cash payout. This is why acquirers who have a purely investment or financial interest in the company try to maintain their stake at below 15 per cent levels. It is also why the open offer route is rarely used for complete 100 per cent buyouts.

Offer price

The price at which the acquirers buy shares from the public will be based on parameters such as the rate at which shares are acquired from promoters, the price at which shares have been allotted to the acquirers in the six-month period preceding the offer and the stock price behaviour in weeks preceding the offer, whichever is higher.

Confused? Essentially, you can expect the offer price to be at least equivalent to the market price before the offer, or higher. If the acquirer is keen on garnering a higher stake in the company, he is likely to price the offer at a significant premium to the current market price, to induce most shareholders to tender their holdings.

Stock market response

So how does the stock market typically respond to an open offer? While the acquirer is busy complying with regulatory norms, the stock market is busy digesting the idea of a change in control of the company. There is usually an interlude between the time the public announcement is made and the actual offer period. The behaviour of the stock during this period has an immediate bearing on the success of the open offer. Here is how.

The usual response to an offer, especially if the offer price is at a premium, is a sharp run-up in the stock price. Say, an open offer is made for a stock at Rs 125 and its current market price is Rs 100. Who can pass up the opportunity to make a quick 25 per cent gain? A spurt of buying immediately leads to a stock run-up to near Rs 125 levels.

Great expectations

But sometimes the market sees benefits beyond the premium, in this case 25 per cent. It might expect the new management to pump in more money, re-structure operations, help a loss-making company turn around or a small company scale up operations.

The market may expect an ultimate merger with the acquiring company, which could mean a better valuation. Given these expectations, it is only natural that the market price jumps way beyond the offer price.

This has been a recurring phenomenon with a majority of recent offers: Reliance Capital’s offer for TV Today, Kingfisher’s offer for Deccan Aviation, or the promoter’s offer for Tata Investment Corp.

If the market price shoots up beyond the offer price, the acquirers would have to revise the offer price upwards, if they wish to acquire a higher stake.

Alfa Laval, for instance, had to revise its offer price upwards by nearly 50 per cent after its first open offer price of Rs 875 was rejected by shareholders. But with expectations that the Swedish parent would ultimately de-list the Indian subsidiary, even the higher offer price has not found many takers.

Low acceptance ratio

Sometimes, however, the stock price may not run up even if the offer price is at a premium to the current market price. For instance, private equity player Blackstone made an offer of Rs 275 per share to shareholders of Gokaldas Exports, a significant premium to the then prevailing offer price.

Textiles stocks have also been out of favour, as a strong rupee has been hurting off-take and margins of garment exporters. There is, therefore, a good incentive to tender shares to the offer. However, the stock price continues to trade below the offer price.

Here is where the acceptance ratio comes into play. The acquirer offers to buy only 20 per cent of the shareholding. Therefore, if the public shareholding is say 40 per cent, and almost all shareholders accept the open offer, the acquirer will only buy a part of the shares tendered.

That is, you might be able to tender only a part of your holdings to the offer and will have to offload the remaining in the open market. In this case, the company will accept only one of every two stocks tendered. This is known as the acceptance ratio.

So if the acceptance ratio is low, chances are the premium between the offer price and the current market price would never be bridged.

No easy choice

Clearly, there are several factors that influence the stock during an open offer, making the decision to tender shares to the offer no easy choice. Of course, when the stock price runs up ahead of the offer price, your decision is made simpler.

In other instances though, you have a window of opportunity to make a quick gain. Your own expectations from the new management, your investment horizon and target return would ultimately determine your choice.

(This article was published in the Business Line print edition dated December 16, 2007)
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