In 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 bodies and the general public. The offer was made at Rs.105, 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 delisting 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 India's attempt to revive capital markets by allowing buyback of shares had failed.
THE BUYBACK ACT
The 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 bids. The buy back of shares was governed by the Securities and Exchange Board of India's (SEBI) Buy Back of Securities Regulation, 1998, and Securities and Exchange Board of India's (SEBI) Substantial Acquisition of Shares and Takeover Regulations, 1997.
The ordinance was issued along with a set of conditionsintended to prevent its misuse by companies and protect the interests of investors. According to guidelines issued under SEBI's Buy Back of Securities Regulation, 1998, a company could buyback its shares from existing shareholders on a proportionate basis :
Through tender offer.
• From the open market, through the book building process or the stock exchange.
• From odd lot holders .
THE BUYBACK ACT Contd...
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 company's 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, or any private arrangement.
It also allowed the promoters of a company to make an open offer (similar to an acquisition of shares) to purchase the shares of its subsidiary. This allowed foreign promoters to utilize their surplus funds and make an open offer to acquire a 100% stake in their Indian subsidiaries.
The buyback of shares was allowed only if the Articles of Association 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 SEBI's 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.
The government made amendments to the buyback ordinance in October 2001, relaxing the buyback norms. The new amendments allowed the promoters of a multinational company to make an open offer to purchase up to 10% of its equity without making a public announcement. This purchase just required a mere approval from the board of directors. However, a public announcement and shareholder approval were necessary for any offer above 10%. The amendments also reduced the time limit for issuing fresh shares from 24 months to 6 months. These two changes were incorporated into the buyback ordinance, which was passed by the government in December 2001 (and subsequently became the Buyback Act).
The amendments in the buyback ordinance coupled with depressed stock market conditions saw an increase in buyback activity. MNCs (through the open offer route) regarded the buyback option as an opportunity to raise their equity stake in their Indian ventures.