Docomo case: Govt sends wrong signals

That various arms of the government are working at cross-purposes was once again apparent in the manner in which the NTT Docomo’s proposal to exit its Indian venture was handled.

Even as the Prime Minister is intent on inviting foreign investors to set up a manufacturing base in India to help boost the sagging investment cycle, the finance ministry recently turned down the proposal of the Japanese telecom company to divest its stake in Tata Teleservices Ltd.

The rejection is ludicrous on many counts. One, the price at which NTT Docomo is proposing to sell its stake is 50 per cent below its cost of purchase. That is, it is exiting its investment with a big loss. Two, Tata Sons, the buyer, has expressed its willingness to buy the shares to meet its contractual agreement. And finally, the Reserve Bank of India had given its in-principle approval to the deal in January this year.

It is apparent that the finance ministry is playing strictly by the book.

Since the existing regulations allow put options (the clause allowing the foreign investor to sell the shares back to the company at a specified date in the future) in foreign direct investments only if the shares are sold back at fair value, it could have rejected the NTT Docomo deal since the shares were being sold at a price above the fair value.

But aren’t foreign investors justified in seeking protection against loss through insertion of such clauses? As long as the put option clause does not promise assured returns there appears to be no real ground for objection.

NTT Docomo had acquired 26.5 per cent stake in Tata Teleservices Ltd between 2009 and 2011 for ₹13,070 crore. Under an agreement signed between the two companies in 2009, Docomo could sell its entire stake in TTSL by December 2014. Tatas had to find a buyer for these shares, else they had to buy them back from the Japanese company at half the amount invested — ₹7,250 crore. NTT Docomo announced its plans to exit the Indian venture in April 2014 as the Indian company had failed to achieve certain performance targets. Since a buyer could not be found for these shares, Tata Sons had to buy the shares at ₹58.05 a share according to the 2009 agreement.

The value of shares of TTSL, as valued by an independent consultant, was ₹23.34 a share towards the end of last year. The objection of the finance ministry was that the deal was being done at ₹58.05; more than double the fair value.

The debate on whether an FDI made with put options clause in the agreement should be treated as equity or debt has been raging for a while now. The government had earlier held that a put option that promised a certain return to the foreign investor should be treated as a debt or a fixed income investment. It was, therefore, held that it should be treated as external commercial borrowing and not FDI.

In 2011, the department of industrial promotion and policy issued an order stating that shares issued to foreign investors along with a put option would not be considered as FDI. But this order was withdrawn in a month’s time following vociferous protests from companies. In January 2014, the RBI issued a circular that allowed companies to introduce put options in equity shares issued to a foreign investor under FDI. But the buy-back of shares was allowed only at the fair value determined at the time the option was exercised. In listed companies, the traded price was to be the buy-back price. Unlisted shares had to be valued based on the return on equity as per the latest audited balance sheet.

The RBI, however, appears to be taking a more flexible approach towards such deals.

While accepting Tata Sons’ proposal to buy NTT Docomo’s stake in January, it had stated, “The larger issue here is of a fair commitment in the contracts in relation to an investment and a downside protection of an investment, rather than an assured return. Besides, our strategic relationship with Japan in recent times in relation to FDI flows is also a matter to be kept in view. In future, in all such cases, similar principles shall be applied.”

In its monetary policy statement of February, 2015, the RBI went one step further and appeared ready to even accept an embedded option to buy back shares at an assured return that was at a discount to the sovereign yield curve, “in order to offer the investor some protection against downside risks”. The central bank has promised to issue guidelines on these, soon. Such policy flip-flops that cause uncertainty in the minds of foreign investors are avoidable.

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