The Buyback OptionIn October 2000 Royal Philips Electronics of Netherlands (Philips) the Dutch parent of Philips India Limited announced its first offer to buyback the shares of its Indian subsidiary The open offer was initially made for 23 of the outstanding shares held by institutional investors private bodies2 and the general public The offer was made at Rs105 a premium of 46 over the then prevailing stock market price With this Philips became one of the first multinational (MNCs) companies in India to offer buyback option to its shareholders

Soon after the buyback option was offered by several multinational companies (MNCs) to increase their stake in their Indian ventures Some of these companies were Cadbury India Otis Elevators Carrier Aircon Reckitt Benkiser etc Fund managers which held these companies stocks felt that allowing buyback of shares was one of most favorable developments in the Indian stock markets It provided a much needed exit option for shareholders in depressed market conditions Buyback by the company usually indicated that the management felt that its stock was undervalued

This resulted in an increase in the price bringing it closer to the intrinsic value and providing investors with a higher price for their investment in the company

However critics of the buyback option claimed that large multinationals had utilized the buyback option to repurchase the entire floating stock from the market with the objective of delisting3 from the stock exchange and eliminating an investment opportunity for investors Moreover most MNCs that offered buyback option reported a steep decline in the trading volumes of the shares of their Indian ventures The declining liquidity of these shares prompted critics to say that the Government of Indias attempt to revive capital markets by allowing buyback of shares had failed

The Buyback ActThe buyback ordinance was introduced by the Government of India (GOI) on October 31 1998 The major objective of the buyback ordinance was to revive the capital markets and protect companies from hostile takeover bids4 The buy back of shares was governed by the Securities and Exchange Board of Indias (SEBI)5 Buy Back of Securities Regulation 1998 and Securities and Exchange Board of Indias (SEBI) Substantial Acquisition of Shares and Takeover Regulations 1997

The ordinance was issued along with a set of conditions6 intended to prevent its misuse by companies and protect the interests of investors According to guidelines issued under SEBIs Buy Back of Securities Regulation 1998 a company could buyback its shares from existing shareholders on a proportionate basis7 Through tender offer

bull From the open market through the book building process8 or the stock exchangebull From odd lot holders9

The ordinance allowed companies to buy back shares to the extent of 25 per cent of their paid up capital and free reserves in a financial year The buyback had to be financed only out of the companys free reserves securities premium account or proceeds of any earlier issue specifically made with the purpose

of buying back shares The ordinance also prevented a company that had defaulted in the repayment of deposits redemption of debentures or preference shares and repayment to financial institutions from buying back its shares Moreover a company was not allowed to buy back its shares from any person through a negotiated deal whether through a stock exchange spot transactions 10 or any private arrangement

The buyback of shares was allowed only if the Articles of Association12 of the company permitted it to do so The ordinance also required the company to pass a special resolution at a general meeting and obtain the shareholders approval for the buyback In addition companies were not allowed to make a public or rights issue of equity shares within a period of 24 months from the day of completing the buyback except by way of bonus issues and conversion of warrants preference shares or debentures

The ordinance did not lead to increased buyback activity by multinational companies In the financial year 1999-2000 only six MNCs came out with buyback offers and in the year 2000-2001 only eight more companies offered to buyback shares According to the analysts the low level of buyback activity in 1999 and 2000 could be attributed to the fact that buyback regulations were very elaborate and discouraged companies from making use of buyback option (Refer Exhibit I for the buyback process and Exhibit II for methods of buyback) The lack of interest in the buyback option could also be the result of SEBIs restrictive regulations

Some companies complained that the process of buyback was delayed because the law required them to obtain shareholder approval for offering a buyback SEBI guidelines prevented companies from raising fresh equity to finance their projects It also prohibited any subsequent buyback offer by the same company once it had made one for a period of two years These complaints and the need to revive the stock markets after the September 11 2001 terrorists attacks in the US forced the government to make amendments to the buyback ordinance

Buyback Offer by MNCsIn the financial year 2001-2002 twenty MNCs made buyback offers Some of the well-known MNCs which offered to buy back their shares were Philips India Limited (Philips) Cadbury India Limited (Cadbury) Britannia Industries Limited (Britannia) Carrier Aircon (Carrier) and Otis Elevators (Otis) All these companies made open offers for the non-promoter shareholding in their Indian subsidiaries To buy back shares Cadbury paid Rs 9 billion Philips Rs 2 billion and Carrier Otis and Reckitt Benkiser all paid over Rs 1 billion (Refer Table I for MNC buybacks)

According to analysts the increased buyback activity by MNCs was due to three reasons They felt that the share prices of most MNCs were under priced and did not reflect the true value of the company Moreover the buyback of shares allowed MNCs to convert their Indian ventures into wholly owned subsidiaries (WOS)13 It also allowed them to delist the shares of these ventures from the stock markets and thus protect them from the volatility of the stock markets (caused by scams and other market manipulations)

Table IMNC Buyback Offer Details

Issuer Method Opening Date

Closing Date Price

of Shares offered for Buyback

Philips India Limited Open Offer 13-Nov-00 12-Dec-00 Rs 105 4900

Philips India Limited Open Offer 21-Nov-01 ----------- Rs 105 1734

Cadbury India Limited Open Offer 13-Dec-01 Mar-02 Rs 500 4900

Carrier Aircon Open Offer 2-Jul-01 31-Jul-01 Rs 100 4900

Otis Elevator Open Offer 18-May-01 9-Jul-01 Rs 280 3110

Otis Elevator Open Offer 18-Oct-02 16-Nov-02 Rs 320 1938

Reckitt Benkiser Open Offer 14-May-02 13-Jun-02 Rs 250 4900

Britannia Open Offer Sep-01 ---------- Rs750 4900

Analysts also felt that MNCs had used the buyback of shares as a method for distributing surplus cash 15 to their shareholders Buyback also acted as a tool for creating wealth for the shareholders The buyback of shares improved a companys return on equity (ROE)16 and this improvement would ultimately be reflected in a higher price earning ratio17 Buyback by the company usually indicated that the management felt that the stock was undervalued It resulted in an increase in stock price bringing it closer to the intrinsic value For example when Philips announced its first buyback offer at a maximum price of Rs105 in October 2000 its shares were trading at around Rs 60 The buyback announcement resulted in an increase in the share price to Rs 90 even before the buyback offer opened on November 13 2000 Hence the buyback offer gave shareholders an exit option that paid them a premium over the pre-buyback share price However in spite of the benefits of buyback a section of analysts and investors felt that it was being misused by MNCs

Investor GrievancesAnalysts felt that the buyback option may be misused by MNCs to increase their equity stakes in their Indian ventures escape public scrutiny and accountability and prevent them from the Indian regulatory environment Moreover the option to convert their Indian ventures into wholly owned subsidiaries and delist their shares from the stock markets provided MNCs with complete control over their Indian ventures allowed them to repatriate profits and make more independent investment decisions

A section of investors felt that government regulations must have provided them with a choice However minority shareholders claimed that they had no option and were forced to sell their shares once MNCs bought back shares from the majority shareholders For example because Life Insurance Corporation (LIC) and the General Insurance Corporation (GIC) who together held a 21 stake in Philips surrendered their shares when Philips made its first buyback offer the minority shareholders were forced to surrender the remaining shares when Philips made a second offer in November 2001 (Refer Table II)

Reportedly investors feared losing an exit option in case the shares get delisted Moreover during the second offer the trading volume of shares fell to less than (on an average) 500 shares per day since December 2001

Table IIShare Holding Pattern in Philips India Limited

Share Holding Pattern as on ()

30062002

31032002

31122001

Foreign Promoters 9234 9147 8286Institutional Investors 007 007 085

Private Bodies 014 018 149General Public 74 822 1467

Source wwwindiainfolinecom

Similarly when Cadbury made a buyback offer public shareholding fell from 2667 to just 732 within six months after the majority shareholders surrendered their shares (Refer Table III)

Moreover in this case investors felt that the premium offered by Cadbury Schweppes the UK based parent company of Cadbury was low The offer was priced at Rs 500 which represented a premium of 24 on the average high and low prices over the past 26 weeks prior to the offer However Cadburys stock had been trading at prices in excess of Rs 500 in 1999 and 2000 (Refer Table IV) with an average PE multiple of 60 in 1999 and 54 in March 2000 Moreover Cadburys third quarter (October to December 2001) sales had increased by 112 compared to the same period in 2000 while its profits had increased by 52 Hence investors felt that the price offered for the buyback had not taken into consideration the future potential profits of the company and was not attractive to shareholders who had been holding their shares for a longer term

As a result of depressed stock market conditions investors (in most cases) received a low buyback price The price at which the open offers were made by MNCs caused great concern to both investors and regulators (Refer Exhibit III for details of pricing parameters of open offers)

Table IIIShare Holding Pattern in Cadbury India Limited

Share Holding 3006200 3103200 3112200

Pattern as on () 2 2 1Foreign Promoters 9025 5100 5100Institutional Investors 010 022 2036

Private Bodies 225 3318 171General Public 732 1546 2667

Source wwwindiainfolinecom

In many cases minority shareholders had expressed their opposition to the use of discriminatory pricing by MNCs for buying back shares For example Otis Elevators bought back 239 of the equity stake from the Mahindra group at Rs375 per share in October 1999 but made a buyback open offer for only Rs 280 for the remaining 31 of the shares held by the Indian public in May 2001

Table IVShare Prices on First Open Offer by MNCs

Company Name

Maximum Offer Price

Price on

Buyback Date (BD)

Premium offered18

Price 1 year prior to BD

Price 2 year prior to BD

Price on1-Jul-02

Philips 105 905 46 110 148 103Cadbury 500 483 590 589 566 493Carrier Aircon 100 98 53 88 218 99

Otis Elevator 280 175 4140 315 306 287

Reckitt Benkiser 250 245 5 211 190

5 235

Source wwwmyiriscom

Analysts also felt that the buyback option was not beneficial for small investors Allowing MNCs to delist their shares from the stock market would deprive Indian shareholders of good investment opportunities For example in few companies including Philips Carrier Reckitt Cadbury and Wartsila the promoters stake had almost crossed 90 (Refer Table V) Though these companies had not delisted their shares from the stock markets there was hardly any trading in these companies stocks

Table VShareholding Pattern as on 3062002 (In )

Name Foreign Promoter

Institutional and Other Investors

General Public

Philips India Limited 9234 026 74

Cadbury 9025 243 732Carrier Aircon 9116 - 884

Otis Elevator 8062 921 1018Reckitt Benkiser 8284 123 1593

Wartsila 8813 637 549

Source Indiainfolinecom

Carrier Aircon has also made its final offer to acquire the remaining 884 of its stock The offer opened on September 9 2002 and would close on March 7 2003

The foreign promoter Reckitt Benkiser had acquired 8727 of Reckitt Benkiser India Limited shares by September 2002 It had already made an open offer for the remaining 1273 in August 2002

Analysts argued that like China and Indonesia India must revert back to a system that prevented multinationals from delisting their shares from the stock exchange by prescribing a minimum amount of floating stock The buyback by MNCs not only affected the small shareholders it also had an impact on the stock exchanges The buyback of floating stock resulted in a decline in the trading volumes For example the Delhi Stock Exchange was badly affected as MNCs accounted for more than 90 of the volume traded and 85 of the listing fees earned by the exchange before the buyback act was introduced Given the negative impact of the Buyback Act market observers felt that the act had failed to revive the capital markets

Buy or Not to BuybackThe dilemma that faced small investors in India was whether the buyback option along with the SEBI guidelines actually protected their interests and offered them an exit option at a fair price or was it a tool that provided them with no options allowing large MNCs to gain complete control of their subsidiaries

Investors felt that the regulations framed by SEBI did not have provisions for preventing good stocks from delisting Moreover the buyback price which was determined using the parameters specified in the SEBI Takeover Code did not consider the future potential of the stock (Refer Exhibit III for details of pricing parameters of open offers) They felt that SEBI should have looked at various financial parameters such as future cash flows value of brands and the value of fixed assets to determine a pricing

formula for open offers which ensured that investors who had been holding the stock for several years received a fair price for their investment

Questions for Discussion1 What were the objectives of the buyback ordinance issued by the Government of India in

1998 Describe the salient features of the buyback ordinance Why did MNCs want to buy back the shares of their Indian ventures Explain

2 The depressed stock markets in India are being utilized by several large MNCs to increase their stake in their Indian subsidiaries through the buyback of shares Explain in detail the different methods of buyback available to an organization

3 According to minority shareholders MNCs had misused the buyback option Explain the various grievances of minority shareholders regarding the buyback of shares

4 Do you think stringent measures should be introduced to protect the interests of small investors What should SEBI do to safeguard small investors interests and resolve their grievances

References

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India1htm

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India-8htm

• The Buyback Option
• The Buyback Act
• Buyback Offer by MNCs
• Investor Grievances
• Buy or Not to Buyback
• Questions for Discussion

Pattern as on () 2 2 1Foreign Promoters 9025 5100 5100Institutional Investors 010 022 2036

Private Bodies 225 3318 171General Public 732 1546 2667

Source wwwindiainfolinecom

In many cases minority shareholders had expressed their opposition to the use of discriminatory pricing by MNCs for buying back shares For example Otis Elevators bought back 239 of the equity stake from the Mahindra group at Rs375 per share in October 1999 but made a buyback open offer for only Rs 280 for the remaining 31 of the shares held by the Indian public in May 2001

Table IVShare Prices on First Open Offer by MNCs

Company Name

Maximum Offer Price

Price on

Buyback Date (BD)

Premium offered18

Price 1 year prior to BD

Price 2 year prior to BD

Price on1-Jul-02

Philips 105 905 46 110 148 103Cadbury 500 483 590 589 566 493Carrier Aircon 100 98 53 88 218 99

Otis Elevator 280 175 4140 315 306 287

Reckitt Benkiser 250 245 5 211 190

5 235

Source wwwmyiriscom

Analysts also felt that the buyback option was not beneficial for small investors Allowing MNCs to delist their shares from the stock market would deprive Indian shareholders of good investment opportunities For example in few companies including Philips Carrier Reckitt Cadbury and Wartsila the promoters stake had almost crossed 90 (Refer Table V) Though these companies had not delisted their shares from the stock markets there was hardly any trading in these companies stocks

Table VShareholding Pattern as on 3062002 (In )

Name Foreign Promoter

Institutional and Other Investors

General Public

Philips India Limited 9234 026 74

Cadbury 9025 243 732Carrier Aircon 9116 - 884

Otis Elevator 8062 921 1018Reckitt Benkiser 8284 123 1593

Wartsila 8813 637 549

Source Indiainfolinecom

Carrier Aircon has also made its final offer to acquire the remaining 884 of its stock The offer opened on September 9 2002 and would close on March 7 2003

The foreign promoter Reckitt Benkiser had acquired 8727 of Reckitt Benkiser India Limited shares by September 2002 It had already made an open offer for the remaining 1273 in August 2002

Analysts argued that like China and Indonesia India must revert back to a system that prevented multinationals from delisting their shares from the stock exchange by prescribing a minimum amount of floating stock The buyback by MNCs not only affected the small shareholders it also had an impact on the stock exchanges The buyback of floating stock resulted in a decline in the trading volumes For example the Delhi Stock Exchange was badly affected as MNCs accounted for more than 90 of the volume traded and 85 of the listing fees earned by the exchange before the buyback act was introduced Given the negative impact of the Buyback Act market observers felt that the act had failed to revive the capital markets

Buy or Not to BuybackThe dilemma that faced small investors in India was whether the buyback option along with the SEBI guidelines actually protected their interests and offered them an exit option at a fair price or was it a tool that provided them with no options allowing large MNCs to gain complete control of their subsidiaries

Investors felt that the regulations framed by SEBI did not have provisions for preventing good stocks from delisting Moreover the buyback price which was determined using the parameters specified in the SEBI Takeover Code did not consider the future potential of the stock (Refer Exhibit III for details of pricing parameters of open offers) They felt that SEBI should have looked at various financial parameters such as future cash flows value of brands and the value of fixed assets to determine a pricing

formula for open offers which ensured that investors who had been holding the stock for several years received a fair price for their investment

Questions for Discussion1 What were the objectives of the buyback ordinance issued by the Government of India in

1998 Describe the salient features of the buyback ordinance Why did MNCs want to buy back the shares of their Indian ventures Explain

2 The depressed stock markets in India are being utilized by several large MNCs to increase their stake in their Indian subsidiaries through the buyback of shares Explain in detail the different methods of buyback available to an organization

3 According to minority shareholders MNCs had misused the buyback option Explain the various grievances of minority shareholders regarding the buyback of shares

4 Do you think stringent measures should be introduced to protect the interests of small investors What should SEBI do to safeguard small investors interests and resolve their grievances

References

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India1htm

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India-8htm

• The Buyback Option
• The Buyback Act
• Buyback Offer by MNCs
• Investor Grievances
• Buy or Not to Buyback
• Questions for Discussion

Name Foreign Promoter

Institutional and Other Investors

General Public

Philips India Limited 9234 026 74

Cadbury 9025 243 732Carrier Aircon 9116 - 884

Otis Elevator 8062 921 1018Reckitt Benkiser 8284 123 1593

Wartsila 8813 637 549

Source Indiainfolinecom

Carrier Aircon has also made its final offer to acquire the remaining 884 of its stock The offer opened on September 9 2002 and would close on March 7 2003

The foreign promoter Reckitt Benkiser had acquired 8727 of Reckitt Benkiser India Limited shares by September 2002 It had already made an open offer for the remaining 1273 in August 2002

Analysts argued that like China and Indonesia India must revert back to a system that prevented multinationals from delisting their shares from the stock exchange by prescribing a minimum amount of floating stock The buyback by MNCs not only affected the small shareholders it also had an impact on the stock exchanges The buyback of floating stock resulted in a decline in the trading volumes For example the Delhi Stock Exchange was badly affected as MNCs accounted for more than 90 of the volume traded and 85 of the listing fees earned by the exchange before the buyback act was introduced Given the negative impact of the Buyback Act market observers felt that the act had failed to revive the capital markets

Buy or Not to BuybackThe dilemma that faced small investors in India was whether the buyback option along with the SEBI guidelines actually protected their interests and offered them an exit option at a fair price or was it a tool that provided them with no options allowing large MNCs to gain complete control of their subsidiaries

Investors felt that the regulations framed by SEBI did not have provisions for preventing good stocks from delisting Moreover the buyback price which was determined using the parameters specified in the SEBI Takeover Code did not consider the future potential of the stock (Refer Exhibit III for details of pricing parameters of open offers) They felt that SEBI should have looked at various financial parameters such as future cash flows value of brands and the value of fixed assets to determine a pricing

formula for open offers which ensured that investors who had been holding the stock for several years received a fair price for their investment

Questions for Discussion1 What were the objectives of the buyback ordinance issued by the Government of India in

1998 Describe the salient features of the buyback ordinance Why did MNCs want to buy back the shares of their Indian ventures Explain

2 The depressed stock markets in India are being utilized by several large MNCs to increase their stake in their Indian subsidiaries through the buyback of shares Explain in detail the different methods of buyback available to an organization

3 According to minority shareholders MNCs had misused the buyback option Explain the various grievances of minority shareholders regarding the buyback of shares

4 Do you think stringent measures should be introduced to protect the interests of small investors What should SEBI do to safeguard small investors interests and resolve their grievances

References

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India1htm

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India-8htm

• The Buyback Option
• The Buyback Act
• Buyback Offer by MNCs
• Investor Grievances
• Buy or Not to Buyback
• Questions for Discussion

formula for open offers which ensured that investors who had been holding the stock for several years received a fair price for their investment

Questions for Discussion1 What were the objectives of the buyback ordinance issued by the Government of India in

1998 Describe the salient features of the buyback ordinance Why did MNCs want to buy back the shares of their Indian ventures Explain

2 The depressed stock markets in India are being utilized by several large MNCs to increase their stake in their Indian subsidiaries through the buyback of shares Explain in detail the different methods of buyback available to an organization

3 According to minority shareholders MNCs had misused the buyback option Explain the various grievances of minority shareholders regarding the buyback of shares

4 Do you think stringent measures should be introduced to protect the interests of small investors What should SEBI do to safeguard small investors interests and resolve their grievances

References

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India1htm

httpwwwicmrindiaorgfree20resourcescasestudiesBuyback20of20Shares20by20MNCs20in20India-8htm

• The Buyback Option
• The Buyback Act
• Buyback Offer by MNCs
• Investor Grievances
• Buy or Not to Buyback
• Questions for Discussion