When an unlisted company merges with a listed entity, both sharing the same promoter

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group, there is a high risk of minority shareholders getting short-changed. The problem with such mergers is that there is no financial information when it comes to unlisted entities — which leaves room for misinterpretation and can result in losses for minority shareholders.

A number of promoters have increased their holdings in listed companies by more than the permissible limit specified by the Securities and Exchange Board of India (Sebi) in a financial year but have escaped the mandatory public offer to minority shareholders. This has been made possible through the merger of a non-listed company, owned by the promoters of a listed company, through a swap ratio that is often tilted in favour of the unlisted entity.

One such example is the proposed merger between Bombay Stock Exchange (BSE)-listed Srei Infrastructure Finance and Quippo Infrastructure Equip-ment with effect from April 1, 2010. While company officials say the merged entity will have increased net worth (read greater access to capital) and synergies in business — the Street could not ignore the fact that promoters’ holding in the merged entity is set to go up from 30 per cent to 46 per cent. Since January 28 (the day of announcement), the Srei Infra stock has tanked 19 per cent, while the broader market has corrected 3.2 per cent.

While a higher stake in an unlisted entity and better valuation ascribed to it by valuers cannot be overlooked, minority shareholders absolutely have no exit option in such a deal (other than selling shares in the open market).

In the past few years, many such proposals surfaced. Examples include proposed merger of Lok Shelters and Lok Housing; Kalpa-

taru (unlisted real estate firm), JMC Projects and Kalpataru Power Transmission; Samruddhi Cement and UltraTech Cement; Ahmed-nagar Forgings-Amtek India and Amtek Auto; Maytas Properties, Maytas Infra and Satyam Compu-ters; and the five-way merger of Summit Securities, Brabourne Enterprises, Octav Investments, CHI Investments and RPG Itochu.

While their mere mention does not suggest foul play, all these merger proposals met with tepid or fierce resistance from investors.

A look at stock price movements shows all these listed entities underperformed the benchmark Sensex by up to 15 percentage points in the six-month period or till date since the announcement.

When companies are merged, the swap ratio is fixed after valuation reports are complied (conducted by independent agencies) and a merchant banker adjudges its fairness. But Sebi does not have a prescribed valuation procedure for unlisted firms.

“For valuation of unlisted firms, revenue, profit, market share, industry, growth prospects, competitive scenario and management are considered. Accepted set of valuation methods are based on discounted cash flow, comparison with listed companies and historic transaction multiples, among others. Discounts/adjustments are made to give a real picture,” executive director of corporate finance at KPMG KV Ramanand said.

But valuation methods are always a source of concern. When the RPG Group recently decided to merge four listed companies — Summit Securities, Brabourne Enter­prises, Octav Investments and CHI Investments — with RPG Itochu, a 100 per cent subsidiary of RPG Enterpri­ses, questions were raised over the ‘fair value’ valuation procedure adopted, resulting in alleged loss of value to minority shareholders.

Jagannadham Thunugun­tla, equity head of SMC Capitals, said minority shareholders should look at ‘shareholder friendliness’ of a promoter/management when such mergers happen. “Shareholders’ value creation should be the ideal purpose of such mergers. There is little you can do as a minority shareholder if a transaction (where they feel their interest is being overlooked) apart from staying away from voting,” he said.

While corporate governance issues came to the fore with the Satyam-Maytas Properties-Maytas Infrastructure merger proposal (which got derailed), foreign institutional investors have always managed to get a whiff of such moves that result in shareholder value being hampered.

In a recent conference call after the Srei-Quippo reverse merger plan was proposed, analyst Nick Van Broekhoven of Belgium-based Value Square asked how the merger is going to create value for shareholders as the book value will drop post-merger.

Saurabh Mukherjea, equity head of Noble Group (India), the India arm of a British investment bank, says shareholders should pay attention to what size and valuation the unlisted company is being given. “All companies in India have to submit their financial results to the registrar of companies. If the data has been submitted, shareholders can find the profit and revenue numbers from the registrar of companies. While there is scope for promoters to manipulate, vigilant investing will reduce that to a large extent,” he said.

High courts have also played an effective role in mergers or schemes of amalgamation that come to them for approval. Last year, the high court of Punjab & Haryana threw out Amtek Auto’s proposal for merger with Amtek India, Ahmednagar Forgings, Amtek Ring Gears, Amtek Crankshafts India and Amtek Casting.

The scheme was dismissed on account of changed circumstances as regards to “valuation of shares and decline in turnover and profits”. The court held that it would be impermissible to order the scheme proposed on the basis of valuation done in 2007.

But all such mergers need not be looked at with suspicion. Smaller and unlisted companies, when they get merged with large and listed players, improve growth prospects as well as transparency. “The combined entity may have a far higher net worth and leveraging capability,” said Avinash Gupta, assistant vice-president (equity research) at Bonanza Portfolio.