[Shalin Ghosh is a 3rd year B.A., LL.B. (Hons.) student at Maharashtra National Law University, Mumbai]
Indirect acquisitions involve an acquirer obtaining control in the target company by taking over an intermediary entity which already holds a controlling stake in the target. This transaction structure does not result in any change in the target’s public shareholding. However, such acquisitions are nevertheless covered under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Code’). Accordingly, an acquirer undertaking an indirect acquisition is bound by the mandatory open offer obligation and the applicable valuation and pricing guidelines prescribed under the Takeover Code.
In December 2024, the Securities Appellate Tribunal (‘SAT’) passed an order in Pegasus Holdings III, LLC v. SEBI setting aside an order passed by the Securities and Exchange Board of India (‘SEBI’) which appointed an independent valuer to determine the fair value of the target company’s shares. In doing so, the SAT upheld the offer price suggested by the acquirer while holding that SEBI incorrectly exercised its power to appoint a valuer under regulation 8(16) of the Takeover Code.
This post critiques the SAT order by making two arguments. Firstly, it argues that the offer price determination by the acquirer suffers from glaring procedural irregularities and that it also failed to account for the specific commercial intent underlying regulation 8(5) of the Takeover Code, which governs the offer price in indirect acquisitions exceeding 15% of the value of the target entity. Secondly, it contends that SEBI was well within its power to appoint an independent valuer in the present case and that the SAT order, in quashing SEBI’s directive, ignored certain settled principles in this regard.
Background and Decision
The narrow facts relating to the case are that Pegasus Holdings III LLC (‘Pegasus’) sought to acquire Tenneco Inc., representing its global business of which Federal Mogul Goetze (India) Ltd (‘FMG’), a listed entity, was a part. It was undisputed that the proportionate net asset value (‘NAV’) of FMG was more than 15% of the consolidated NAV of Tenneco Inc.’s global business. Accordingly, Pegasus ascribed a value of INR 275 for every share of FMG in furtherance of regulation 8(5) of the Takeover Code, which requires the acquirer to advance an offer price in case the proposed acquisition meets the stipulated NAV thresholds. The suggested offer price was at a premium to the 60-day volume weighted average price (‘VWAP’) of FMG’s shares which stood at INR 236. This valuation was not accepted by SEBI. Consequently, the regulator appointed an independent valuer under regulation 8(16) of the Takeover Code to determine the true and fair value of FMG’s shares, which was challenged by Pegasus.
The majority opinion of SAT began by noting that regulation 8(16) applies only to scenarios where the price determination of a target company’s shares is unfeasible, either because its scrips are not traded frequently (as provided under regulation 8(2)(e)) or because their price cannot be determined using any of the pricing parameters outlined under regulation 8(3). It went on to observe that as FMG is a listed entity whose shares are traded frequently, the applicability of regulation 8(2)(e) was not attracted in the present case.
According to the majority, regulation 8(3) was also inapplicable to this dispute as Pegasus had chosen to value FMG’s shares basis their VWAP as it stood 60 days prior to the primary acquisition. Resultantly, the tribunal concluded that SEBI’s exercise of its power to appoint an independent valuer under regulation 8(16) was incorrect due to the inapplicability of the two provisions in determining the offer price in the present case. However, it is the dissenting opinion that raises certain relevant concerns regarding the majority’s reasoning, which will be highlighted and explored in the foregoing analysis.
Analysis
The price determination undertaken by Pegasus is in the teeth of applicable pricing guidelines under the Takeover Code. Regulation 8(3) prescribes six methods for an acquirer to ascertain the offer price in case of an indirect acquisition. The first five methods refer to various parameters like the 60-day VWAP, the negotiated price and the actual scrip price as benchmarks to ascertain the offer price. The sixth method, which in turn refers to the valuation procedure described under regulation 8(5), concerns offer price determination when the size of the target entity exceeds 15% of value of the primary acquisition.
Regulation 8(5) provides that an acquirer, in such acquisitions, must compute and disclose the share price taken into account by it for the purposes of the acquisition, along with a detailed description of the methodology employed for such computation. Most importantly, the acquirer must determine the offer price by selecting the highest value among those calculated using the six specified methods.
The offer price suggested by Pegasus was based on the 60-day VWAP of FMG’s shares, which is only one of the six valuation parameters provided under regulation 8(5). The determined offer price did not represent the highest value obtained after independently comparing all prices calculated under the six distinct valuation methods, as mandated by regulation 8(3) of the Takeover Code. The majority’s view that a valuation can be dispensed with merely because the share price of a target entity is capable of being ascertained basis the 60-day VWAP also fails to factor in the mandatory nature of the provision.
Pegasus’s price determination also failed to appreciate the commercial intent underpinning regulation 8(5) of the Takeover Code. As the dissenting opinion pertinently notes, regulation 8(5) seeks to factor in certain special transaction structures where the underlying NAV/proportionate sales turnover/proportionate market value capitalization, as the case may be, as a percentage of the overall entity under acquisition is significantly higher. This may not accurately be reflected by only accounting for the market valuation of the shares. This commercial objective was also spelt out in the recommendations of the Achuthan Committee Report which formed the basis for the Takeover Code. The committee was of the opinion that assigning a value to the target company was crucial in situations where the company constituted a significant part of the primary transaction and influenced the negotiations for such transactions, as it ensured the determination of a fair offer price.
In the present case, Pegasus merely presented the valuation in ‘per share’ terms by dividing the total valuation of the company with the total number of shares. It is a common commercial practice to express valuation estimates of a company on a ‘per share’ basis. Even if the acquirer argues that ascertaining the valuation in this manner justifies compliance with regulation 8(5), it cannot be inferred that the purpose of the provision—which specifies valuation guidelines for certain special transactions—is to merely require a basic computation of the target company’s share value.
The majority holding that SEBI’s appointment of an independent valuer in the present case amounted to an improper exercise of its power under regulation 8(16) is also misplaced. The Supreme Court in G.L. Sultania v. SEBI made certain important observations regarding adhering to the valuation procedure while determining the offer price in acquisitions. In that case, the mandatory open offer obligation was triggered under the erstwhile Takeover Code, 1997 after a 40% equity sale of the target company pursuant to a family settlement. The dispute primarily revolved around contesting estimates about the true and fair value of the target company’s shares which were infrequently traded.
The Supreme Court made certain instructive observations regarding regulation 20(15) of the erstwhile Takeover Code, which is substantially similar to regulation 8(16). This provision outlined valuation guidelines for shares of companies that were infrequently traded. The Court observed that an acquirer must mandatorily consider every parameter laid down in the provision in all cases as they are basic and essential to a fair valuation. It added that if the valuation report discloses that any of the prescribed parameters is not considered, then the valuation report shall stand vitiated for that reason.
The Supreme Court also highlighted that SEBI is not bound to accept the offer price if it does not reflect the true value of the scrip determined in terms of regulation 20(5), reiterating that it may object to the offer price and order an independent valuation if the regulator feels that the estimate has not been determined fairly factoring in all the parameters. While the facts might be different to the extent of the liquidity of the target company’s shares, the Court’s observations regarding fairness in conducting valuations remain relevant.
In the present case, Pegasus failed to consider all the relevant parameters under regulation 8(5) and also did not include a detailed methodology explaining the computation of the offer price, as required under the provision. Considering the Supreme Court’s observations in G.L. Sultania, SEBI reserved the right to order an independent valuation under regulation 8(16) to ascertain the true and fair value of FMG’s shares. Given that an inadequate valuation deprives investors of a fair exit opportunity and works against their interests, SEBI’s power to order an independent valuation may also be located in its inherent powers provided under sections 11(1) and 11B of the SEBI Act, 1992. In the matter of Linde India Ltd., SEBI, exercising its inherent powers, ordered an independent valuation with a view to protect investor interest, (albeit in a case involving valuation of related party transactions concerning allocation of the entity’s future businesses) where the entity failed to provide any valuation to its shareholders.
Conclusion
The SAT’s order sets a wrong precedent and can be misused by acquirers who may dispense with valuations in indirect acquisitions by merely using the 60-day VWAP as a benchmark to determine the offer price, bypassing the complete procedure under regulation 8(3) of the Takeover Code. The order may also result in public shareholders not obtaining a fair exit in cases of change in control due to arbitrary price determination. A dissenting opinion provides only limited relief due to the possibility of varied interpretations. Ideally, the order should either be set aside on appeal or regulation 8(16) amended to enable SEBI to appoint an independent valuer beyond cases specified in regulations 8(2)(e) and 8(4), thereby ensuring fairness in valuation.
– Shalin Ghosh
