A few days ago, the Securities Appellate Tribunal (SAT) passed its order in the Reliance Power IPO Case. This is on an appeal from the decision of SEBI (that we had posted about earlier on this blog).
I thank one of our readers who sent in a review of the SAT decision, which I reproduce below:
Rajkot Saher v. SEBI, Reliance Power Limited
Facts: The promoters of Reliance Power Limited (“RPL”) acquired shares at face value through a High Court sanctioned merger 6 months prior to the IPO and by paying for partly-paid shares issued previously to AAA Projects Ventures, i.e., the entity that merged with RPL.
The appellants filed proceedings before SAT to prevent the IPO of RPL primarily because public shareholders were offered 10.1 per cent stake for Rs. 102 billion, whereas the promoters acquired 89.9 per cent stake in RPL by paying Rs. 34.4 billion in the same year. In effect, the promoters acquired 9 times the public shareholders’ stake at one-third the price (during the course of the same year).
The SEBI (DIP) Guidelines require that –
(i) shares acquired by the “promoters during the preceding one year [to an IPO], at a price lower than the price at which they were offered to public, shall not be eligible for computation of promoters’ minimum contribution of 20% unless such acquisition is in pursuance of a scheme of merger or amalgamation approved by a High Court” (Clause 4.6.2);
(ii) the promoters’ contribution in a public issue by an unlisted company shall not be less than 20% of the post issue capital (Clause 4.1.1).
Therefore, the High Court sanction permitted the promoters to factor-in the shares allotted through the merger for calculating of the “minimum promoters’ contribution” prior to the IPO.
The appellants contended that
(a) the High Court was “kept in the dark” about the reason behind the merger during the High Court proceedings;
(b) the partly paid-up shares should be considered as acquired only when they were fully paid-up and not considered as part of promoters contribution. Moreover, the price of these shares should match the price offered to the public shareholders, i.e., Rs. 450 per share;
(c) the post-issue capital should also include the share premium paid by the shareholders and not be limited to the face value of the shares. This would require the promoters to contribute 20 per cent of the face value plus the share premium of Rs. 440.
Decision: SAT held that:
(a) “The share premium account cannot be taken as a part of the ‘post issue capital’ because the provisions of the Companies Act make a clear distinction between the two.”
(b) “The provisions of sections 87 (1)(b) and 110 (2) of the Act clearly show that the holders of the partly paid equity shares of a company are its legal members…. ….these shares were also fully paid by the promoters before 15.1.2008, the issue opening date and this met with the requirements of clause 4.9 of the guidelines. In these circumstances, we cannot agree with the appellants that the partly paid up shares should be considered ineligible under clause 4.6.2 of the guidelines.”
(c) “There is no material before us to say that the order of the High Court was obtained by fraud and, in any case, we cannot go behind the order and hold that it was obtained by keeping the High Court in the dark”.
(d) “The case of the appellants is that the innocent public shareholders were cheated by RPL. We cannot accept this. RPL had furnished all the relevant and detailed information in the Red Herring Prospectus as required by law…..On the basis of the information furnished in the prospectus, the public shareholders had taken an informed commercial decision when they applied for shares in the IPO. In these circumstances, we fail to understand as to how RPL can be faulted after it had furnished information as required by law in the Red Herring Prospectus”.
(1) SAT has (in effect) given its implicit approval to promoters to use partly-paid pre-IPO structures. Partly-paid shares allow promoters to freeze valuations at past date and inject the unpaid portion at the time of an IPO even though valuations would be substantially higher at that time. The partly-paid shares that are later fully paid up would also be accounted for the minimum promoters’ contribution.
(2) The High Court merger route provides another option for the promoters to merge existing promoter group companies at valuations that are far lower than that offered to the public – thereby by giving the promoters a larger stake at lower price.
(3) SEBI will not question the propriety of the High Court’s order and “cannot go behind the order”. Sure enough, a merger of promoter group companies will not be contested in court – but SEBI needs to evaluate whether the target that merges with the “merged entity” should also meet the pre-IPO eligibility criteria and has business case for merger? The pre-IPO merger option could potentially be used to affect valuations, i.e., transferring the merged entity a value substantially higher than its book value.
(4) Is “disclose and get away” the right approach? Although SEBI should not overturn valuations, it must put under the scanner accounting and valuation aspects that may be employed by promoters.