New Pricing for Preferential Allotments: Getting on the Funding Train

The SEBI Board in its meeting held on June 25, 2020, has approved  providing listed companies with a time-bound temporary option of undertaking preferential allotments at a possibly more investment-friendly pricing, by choosing to utilise the higher of the two weeks or the 12 weeks formula price (i.e. based on the average of the weekly high and low of the volume-weighted average price quoted on the stock exchange – the pricing formula) instead of the existing norm of higher of the two weeks or the 26 weeks formula price. Given the current market conditions, which has seen a significant stock price drop since the second half of March, 2020, this option is bound to result in lower and arguably more favourable pricing for potential investments.

However, this additional option comes with a mandatory lock-in period of three years for such allotments as opposed to the one-year lock-in that currently applies to non-promoter allotments or promoter allotments in excess of 20% of the capital of the company when based on the 26 weeks pricing formula. The amendments to the SEBI ICDR Regulations, incorporating this option, are expected shortly and will remain in effect until December 31, 2020.

The extant pricing norms, based on the 26 weeks formula price for preferential allotments, have been a part of various SEBI regulations for over twenty years and have survived various events affecting the securities’ markets, including the 2008 financial crisis, as well as the more recent debt crisis. The only relaxation provided by SEBI in this regard was in August 2008, when it allowed up to five qualified institutional buyers to be issued shares using the pricing formula based solely on the two weeks look back period.

Therefore, the new pricing option can be said to be a fundamental change as it is the first pricing relaxation offered by SEBI in many years for preferential allotments to promoters of listed companies and for strategic investors.

Until now, given the unfavorable or likely higher pricing offered by the 26 weeks formula in the current market conditions, the preferred option for consolidation of promoter shareholding was by way of rights issues, given that it allowed/ allows free pricing. However, there are other upsides and downsides to rights issuances, for example, while the uncertainty related to shareholder approval not coming through is not there, the impact on timelines due to regulatory review process (in instances where applicable) and possible uncertainty linked to minimum subscription requirements have to be weighed. Thus, the new pricing norms may make preferential allotments to promoters another viable option for consolidating their shareholding. However, the balancing act that boards of listed companies will have to manage will be from a governance standpoint, given that globally, rights issues are considered a fairer capital raising avenue, especially in depressed markets, as compared to preferential issuances.

Additionally, we believe that the new pricing option will also give a boost to control acquisitions as it bridges the gap between the floor price for preferential allotments and open offer floor price (which is based on the volume-weighted average market price for the previous 60 trading days). Of course, while the formula for calculating floor price for preferential allotments is different from that of the open offer floor price, given that both now cover almost the same lookback period, it is expected to significantly reduce the disparity in price and allow for more commercially viable control acquisitions, involving preferential allotments. In the current scenario of cash crunch and liquidity concerns, we expect to see more control transactions by way of primary issuances and this alignment in pricing is bound to make deals more attractive for acquirers.

Another interesting aspect coming out of this alignment in floor price for preferential allotments and open offers is the potential for it be a takeover defence. While hostile takeovers are not common in the Indian market due to inherent regulatory and cultural poison pills available to Indian companies (or may we say the Indian promoters), this revision in the pricing framework allows a company to launch its own takeover defence by making a significant preferential allotment to a friendly acquirer in the face of a hostile acquirer proposing to acquire significant stake in the company at the open offer floor price. Given the pricing alignment, this option now is more viable, when compared to the 26 weeks look back period as it would make such white knight defence much more expensive when compared to the hostile acquisition through secondary stake acquisitions.

Given the above, we believe that the new pricing option for preferential allotments is a welcome relief and is expected to give a significant boost to funding of listed companies. By increasing the lock-in period, it proposes to nudge companies towards long-term capital, whether through promoters or strategic investor consolidations. While the optionality is currently proposed to be valid only till the end of the current calendar year, subject to market conditions and exercise of the new pricing option leading to better market dynamics, increased deal making and positive impact, we will not be surprised if the regulator chooses to extend the same for a longer period.