SEBI steps in to de-stress the stressed, but are the measures taken by the regulator good enough?

With the stock markets volatile and investor community uncertain, primary investments in listed companies have stagnated.

By Ashraya Rao, Saswat Subasit, and Suditi Surana

With the stock markets volatile and investor community uncertain, primary investments in listed companies have stagnated. The COVID-19 crisis and the lockdowns have left companies in need of working capital and unable to service their existing debt obligations. While various listed entities are considering capital raise through rights issue (including the biggest ever Indian rights issue of Reliance Industries Limited), the feasibility of this funding route is linked to the shareholders’ ability to participate, most of whom are likely to be cash strapped or conservative. Further, for primary investment to be available for raising capital, the pricing regime for preferential allotment has become a hindrance.

SEBI to the rescue

Taking cognizance of the grim situation, SEBI has recently introduced a slew of measures to facilitate capital raise by listed entities by relaxing various requirements and timelines. Further, SEBI has recently issued a consultation paper on ‘Pricing of Preferential Issues and exemption from open offer for acquisitions in Companies having Stressed Assets’ (Consultation Paper). The Consultation Paper proposes: (i) relaxation in pricing for preferential allotment; and (ii) exemption from open offer obligations under the Takeover Code. We have analysed the proposed amendments and if they are likely to achieve the desired end results.

Applicability:

The relaxations are proposed only to ‘stressed’ companies. To qualify as ‘stressed’, a listed company needs to satisfy 2 of the following 3 conditions:

• Disclosure of defaults on payment of interest / principal amount on certain loans and debt securities for 2 consecutive quarters;
• Existence of inter-creditor agreement Reserve Bank of India’s directions; and
• Downgrading of credit rating of the company’s listed instruments to “D”.

SEBI seeks to provide protection to certain types of companies and situations but the relaxation appears to be reactionary ( considering IL&FS, Jet Airways and Yes Bank). However, the current pandemic is a black swan event which has impacted almost all sectors. Therefore, while the objective criteria for identifying ‘stressed’ entities is appreciated, many cash starved listed companies (which do not qualify as ‘stressed’) may miss out on the opportunity of raising capital from investors (domestic and foreign) at the relaxed pricing requirements.

Proposed relaxation of pricing guidelines

In the current market, where stock prices have fallen and companies are unable to service their debt or other associated obligations, mandating the issue price at the higher of 2 week or 26-week VWAP, may not reflect the true financial condition or fair valuation of the company.

In order to resolve this, SEBI has proposed that preferential allotments undertaken by ‘stressed’ listed entities may be priced only looking at the 2 weeks VWAP.

This welcome move allows ‘stressed’ entities to attract primary investments at current market price, including distress capital from investors willing to take minority positions.

Exemptions from open offer obligations

Regulation 3(1) of the Takeover Code requires a person acquiring 25% or more of shareholding in a listed company to make an open offer for atleast 26% share capital. This offer is intended to provide the public shareholders with an opportunity to exit at the acquisition price.
The Consultation Paper proposes to relax the above requirement of making an open offer for a ‘stressed’ listed entity, with certain riders.

The open offer obligations under the Takeover Code are huge deterrents to potential investors as substantial cash commitment is required. While Takeover Code already exempts acquisitions pursuant to IBC resolution plan or lenders converting their debt into equity under RBI debt restructuring schemes, the proposed exemption for ‘stressed’ entities is wider and will cover companies in pre-insolvency and pre-debt restructuring stages.

However, while an investor may acquire substantial shareholding, it would still have to make an open offer if it acquires any ‘control’. This may continue to act as a deterrent considering the ambiguity around what constitutes ‘control’ and lack of adequate guiding principles to determine these rights. Nevertheless, considering the combined relaxation of pricing requirements and open offer exemption, with some structuring, ‘stressed’ entities should attract minority foreign investments.

Conditions for applicability

Intending to safeguard public shareholders and prevent misuse, SEBI has proposed the following additional conditions:

• The exemptions would only apply to preferential issue to non-promoters;
• The issue and open offer exemption should be approved by the majority of non-promoter group shareholders;
• The use of issue proceeds should be disclosed in the explanatory statement for shareholders’ meeting and be monitored by a monitoring agency; and
• The issued securities will be locked-in for 3 years.

The requirement of obtaining majority of minority approval appears to have been brought in to balance the exemption requirements and public shareholder interest. However, investors may be wary because it brings uncertainty in deal closing. Many questions remain if the minority vote is not achieved, including if the investor will be allowed to walk away.
Further, promoters will not be able to increase their commitment and pump in additional capital at the current price.
With debt continuing to be expensive and difficult to obtain, it remains to be seen if the above amendments along with the proposed ordinance to suspend the insolvency proceedings will attract new investors (friendly as well as hostile) and result in increased third party funding into Indian listed companies.

Further, the current situation may pave the way for opportunities for distress and hostile M&A. While these distress or hostile deals are common in the west, investors have faced a conundrum of issues in India, while evaluating such deals or assets. These issues are primarily linked to risky assets, performance quality, available dry powder and more importantly, the pricing regime prescribed by SEBI. With the fall in share prices combined with companies in dire need of working capital, SEBI’s pricing relaxations may also result in a rise in hostile and distress takeovers in the coming days.

(Ashraya Rao is a Partner at Khaitan and Co, Saswat Subasit is a Principal Associate at Khaitan and Co, and Suditi Surana is a Senior Associate at Khaitan and Co. The views expressed are the author’s own)