Wednesday, May 09, 2012

Escorts merger - sleight of hand...?

Kudos to investor activism in Escorts merger...

Let me elucidate it with an easier example.  Let's say I, you and 48 others own a company -XY Farms Ltd.  Imagine I and you hold 5% shares each and 48 others own the remaining 90%.  Some time later,  to help sell the products of the company, we set up a retail store - XY  Retail Pvt. Ltd -  in a nearby city, using the company funds.  In this case, XY Retail is a subsidiary of XY Farms ( Parent Co. or Holding Co.).  As such, I, you and 48 other shareholders have identical interests in both the companies.

A few years later, I and you feel that our shareholding in XY Farms Ltd. is only 10% put together and worry that if a few shareholders from the minority get together, they can throw us out of the management control using their collective voting power far in excess of 10% that I and you hold.. So the option before us is to buy out some of those shareholders and boost our stake in the company.  But what if nobody wants to sell..?

So we storm our brains and come up with an idea. Since XY Retail is a subsidiary of XY Farms, why keep both companies as distinct entities...?  Let's merge the two and run the business of XY Retail as a division of XY Farms instead of as a separate company, with a separate management.  It helps reduce  many functional overlaps in accounting, inventory, sales etc., that consume capital. 

All corporate actions should be seen in the light of how it helps increase the shareholder value.  Here since XY Retail is 100% owned by XY Farms, the parent company need not `pay' any consideration to merge it back with it. Only regulatory approvals need be obtained and accounting entries passed to validate the transaction.

Here is where Escorts Ltd., tried to play foul.  While it seeks to merge its 100% subsidiary with itself, it wants to allot shares as "consideration" to its subsidiary that will eventually merge with itself and cease to exist. And then it wants to transfer those shares (treasury stock) into some company owned Trust, controlled by Trustees that include CFO of the parent company.  This arrangement is a foul since it leaves out the minority shareholders (who are also part owners of the subsidiary and therefore entitled to the proportionate treasury stock) without any say on how to administer the treasury stock. 

Proxy advisory firm IIAS has called the bluff... Let's hope the institutions vote against this proposal in the interest of upholding shareholder democracy.


Raghu Babu G said...

you have put it very lucidly. let us hope this activisim helps promoters to rethink on these kind of structures.

Krish said...

Thanks Raghu...welcome to my reader base.