What does delisting mean to an investor?
This year, in the Indian equity market, we are experiencing a delisting bandwagon — one after another company is getting delisted from the stock exchange. Early this year, Hindustan Dorr — Oliver and Entegra got delisted and now, it looks like many big companies are also joining the club. In May, Vedanta announced to delist the company’s shares from the stock exchange, and now it’s Adani Power and Hexaware Technologies. In India, the process of delisting of securities for any company is governed by the Securities and Exchange Board of India (SEBI).
Share delisting is the removal of a listed stock from a stock exchange platform by buying back shares from the public, so it can no longer be traded in the secondary market.
Until recently, delisting wasn’t an easy process as investors used to demand a high premium to the current market price, which promoters weren’t willing to offer. However, the situation has suddenly changed following the Covid-19 outbreak and now investors would be ready to offer their shares at a reasonable premium due to uncertainty. It’s a good opportunity for the promoters to raise their stake in the company by buying back the shares from the market at a discounted price.
There are two kinds of delisting:
- Exchange initiated delisting
- Issuer initiated delisting
Exchange initiated delisting
It’s also called involuntarily delisting, where exchange asks the company to delist their shares from the trading platform. All companies seeking a listing of their securities on the exchange are required to enter into a formal listing agreement with the exchange. The agreement specifies all the quantitative and qualitative requirements to be continuously complied with, by the issuer, for continued listing. Companies that fail to meet the minimum standards set by exchange will be delisted by the exchange itself. The agreement is being increasingly used as a means to improve corporate governance. An example of involuntarily delisting is Entegra.
The reasons for involuntarily delisting are:
- Failing to maintain the minimum percentage of public shareholding in the listed companies.
- Failing to maintain the minimum trading level of shares of a company on the stock exchanges.
- If whereabouts of the company, directors, promoters, etc., are unknown.
- Whether the company has become sick or bankruptcy.
- Directors’ track record especially with regard to insider trading, manipulation of share prices, unfair market practices.
Impact on shareholders
Forced delisting by exchanges leaves investors in the lurch as they have no option but to sell at whatever price is decided, which may be less than the actual value of the company.
Issuer initiated delisting
It’s also called voluntarily delisting where listed companies voluntarily opt for permanent removal of securities from the stock exchange. Examples of voluntarily delisting are Vedanta, Hexaware.
Generally, the reasons for voluntarily delisting are:
- Companies opt to delist their securities for eliminating ongoing costs associated with listing (such as annual listing fee, the fee payable to share transfer agents).
- To avoid complicated compliances under listing agreements.
- The management may be seeking greater freedom in decision-making, without having to adhere to tedious compliance rules of stock exchanges and approval of shareholders i.e. more operational and financial flexibility.
- In the case of merger or acquisition.
- It provides operational flexibility and cost savings i.e. the costs of being publicly listed exceed the benefits.
- Companies generally delist when they want to expand or restructure.
Under the following circumstances, delisting is not permissible -
- If the delisting is proceeding after buyback of equity shares by the company.
- If the delisting is proceeding after to a preferential allotment made by the company.
- If three years haven’t passed since the listing of equity shares on a stock exchange.
Impact on shareholders
Voluntary delisting is done through the reverse book-building mechanism. So, it’s a win-win situation for both (promoters as well as shareholders).
The Reverse book building method is the opposite of the book-building method and in this case, the company would only specify a Floor Price (i.e., the minimum acquisition price). There is no price range like we have for initial public offerings. The shareholders are free to place bids at any price as per their valuation.
The floor price is the average of 26 weeks traded price quoted on the stock exchange where the shares are most frequently traded. The relevant date for computing the 26 weeks would be the date of the public announcement.
The final offer price would be the price at which the maximum number of shares are offered and not the price at which the maximum number of shareholders place bids. Example — 1,000 shareholders holding 1000 shares place bids at Rs. 500 per share but 5 shareholders holding 3000 shares place bids at Rs. 525 per share, then Rs. 525 would be selected as the offer price.
A company has to appoint a merchant banker for calculation of fair value i.e. the floor price at which the company would be buying back the shares from the public. Previously, if the ‘offer price’, which was determined through reverse book building was not acceptable, the promoter could only reject the offer price and, consequently, declined to acquire the equity shares from the public shareholders.
Pursuant to the amendment regulations in 2009, the promoter now has a right to make a counteroffer to the public shareholders within two days of the discovery of the ‘offer price’; provided, however, that the price in the counteroffer is not less than the book value of the target company as certified by a merchant banker.
How promoters or shareholders manipulate prices?
- In order to get the floor prices to lower, the promoter may divest stake prior to the delisting to known people or friendly shareholders who can influence the price by bidding less.
- During crises like the global financial crisis (2008), Covid-19, the company can take advantage of the depressed valuation and try to strike a deal with the equity stockholders who are desperate for an exit. The company takes advantage of the undervaluation.
- Sometimes companies also window dress their financial report in order to manipulate share’s fair value.
- Often when a company announces delisting plans or is speculated to be a delisting candidate, investors and brokers push up the stock price to reap short-term gains by forcing the firm to buy back shares from the public at a higher price.
What an investor should do?
Any rational investor should not buy a stock only on the basis of delisting for an investment. The share price will plummet in case the company didn’t go through a successful delisting i.e. holding 90% of outstanding shares. Before investing one should check whether a company is fundamentally strong or not. What’s the economic moat of a business? An investor should compare the offer price to the valuations of peer companies in the industry and consider surrendering the shares if it provides sufficient premiums to these valuations.
What happens when you don’t give back your shares to the company?
Once the company holds 90% of outstanding shares, it can delist from the exchange. In case you haven’t tendered your securities, you end up holding illiquid shares. There would be a few options left with investors:
- You can approach the court for resolution, as minority shareholders of Cadbury move to court back in 2003 as they were not happy with the offer price.
- If you are still holding on to them once the stock is delisted, you would continue to be a shareholder, receive dividends, and retain the right to cast votes at shareholder meetings.
- If you want to unload shares after the delisting, you can do so by tendering them to promoters within one year from the date of delisting. As per regulation, the promoters are required to accept the shares tendered at the same price at which the delisting took place.