By Manish Sharma

The UPA government has initiated a major reform move by making it mandatory for listed companies to offload 25 per cent equity for public. Existing listed companies with less than 25 per cent public holding will have to reach the minimum threshold by an annual addition of not less than 5 per cent to public holding. Companies planning to come up with initial offer would, however, have to dilute 25 per cent equity at the outset in case the issue size is just up to Rs 40 billion (US$ 850 million). With around 4,500 listed companies in India, about 180 companies, including 35 PSUs (public sector undertakings), will have to offload equity to meet the new requirement notified by the Finance Ministry. While CRISIL estimates that shares worth Rs. 1.6 trillion will flood the market, Bloomberg data shows that companies may have to sell shares worth Rs. 2.5 trillion (US$ 53 billion) to comply with the new norms.

The issue of public shareholding in a company is a long pending decision and the Finance Ministry officials have been deliberating over this for past few years. Historically, public shareholding has been approved at varied levels time and again. The limit has been changed at 40 per cent, 25 per cent and lastly at 10 per cent, thereby causing inconsistency regarding the required level. The move was deemed necessary in view of inadequate retail participation as around 10 per cent of the population invest in stock market. Thus, a need has been felt for long to broaden the retail investment so as to bring greater level of liquidity and share price discovery, besides making the promoter accountable and protect the interest of minority shareholders to improve corporate governance practices. However, righteous intentions have not been translated into legislative actions.

This time also, there is a negative view prevailing in the market against the proposed policy changes. For instance, while the expression “public” is defined to include persons other than the “promoter and promoter group”, the latter expressions are defined widely. Then, the promoter will not only have to cede substantial control, but also have to account for diluted earnings since the number of outstanding shares goes up. Most companies are not ready for re-rating at this point in time. A lot of companies fear that a follow-on offer would pose the risk of earnings dilution in the near term as it will lead to a situation where companies were forced to raise capital from the market without having any plans to deploy it. On the other hand, a forced expansion that is not in sync with the business cycle of the firm could result in excess capacities.

Also, the government will have to get ready to disinvest substantial stake in a number of its own firms. Around 80 per cent of the estimated funds are likely to be raised by 30 listed government entities. This is unlikely to happen as the disinvestment programme of the government has always been subjected to political scrutiny. Moreover, previous few issues have failed to attract retail investors in droves. Domestic financial institutions bailed out the government repeatedly.

While the Finance Ministry decision is in line with international best practices -- London and Hong Kong exchanges adopt similar threshold of public holding -- the Indian experience needs to be taken into consideration. Indians prefer to invest most of their savings in bank deposits and financial-saving products. Therefore, there are doubts whether the depth of the Indian markets is adequate to absorb the flood of issues that will hit the market post notification. It is hardly surprising that the Finance Secretary, Ashok Chawla, said, “If there is any need for modification or correction or amendment that will be done.” If one read between the lines then some modifications are on the cards.

Indiabiznews, June 19, 2010