Reverse Book Building The Pros & Cons

Will reverse book-building ensure fair play?

THE EFFICACY of reverse book-building as a means to ensure fair play for small investors of a
company exiting from Indian stock exchanges has come into sharp focus recently. The move by
Hewlett Packard (HP) to get its Indian subsidiary Digital Globalsoft delisted through reverse bookbuilding for buying back residuary holdings provides an opportunity to discuss the pros and cons of
this process. The Securities and Exchange Board of India had issued the SEBI (Delisting of Securities)
Guidelines, 2003 which would make this process mandatory for all such cases.
"Reverse book-building allows shareholders to tender their shares at a price of their choice and the
acquirer the freedom to accept or reject the offer,'' says A. Murugappan, Joint Head, Investment
Banking, M & A Advisory, ICICI Securities (I-Sec). The SEBI guidelines have ushered in a new
regulatory framework and should have a far-reaching impact on delisting activity.
The reverse book building process as required under the guidelines will utilise the trading system
network of the stock exchanges now used in Initial Public Offerings (IPOs). The acquirer determines
the floor price for his offer based on the average prices for 26 weeks (daily high & low prices of the
stock) preceding the date of public announcement. Shareholders are then allowed to tender their
shares at or above the floor price.
The SEBI has stipulated that there will be no cap or maximum price. Once the book building is
completed, the final price will be determined as the price at which the maximum shares are
tendered. While this provides the shareholder an opportunity to determine the price, the acquirer
has the right to accept or reject the price so discovered. In case the acquirer accepts the price, all
shareholders who bid at or below the discovered price will receive the discovered price for their
holdings.
In the current rising market conditions, the floor price based on the 26-week average will be lower
than the current market price and hence will not serve as a useful benchmark for the investor.
While the shareholders have the flexibility to tender their shares at any price, they also run the risk
of their shares not getting accepted if the acquirer finds the price unattractive. Unlike under the
Takeover Regulations where the acquirer has to acquire all the shares tendered in the offer
(regardless of crossing the delisting limits) at the offer price he has determined, under the new
guidelines, the acquirer has the right to accept or reject the price as determined through the
reverse book building process.
Further, if the price is rejected, the acquirer will not acquire any shares tendered under the offer
and all shares will be returned to the shareholders. Thus it is essential the shareholders get some
indication about the level at which the acquirer is willing to buy out the shares to avoid making this
process a fruitless exercise. Not only this, there is a bigger risk of speculators spreading false
information in the market and increasing the share price to unrealistic levels and selling the stock
to small investors. The absence of any guidance can lead to the creation of a false market which
will ultimately be detrimental to the shareholders, as they may buy shares in the market at high
prices only to realise that these may not get accepted when they tender in the offer. This will
result in a sharp fall in share prices. Interestingly, in IPOs the SEBI has now allowed for indication of
a price band instead of a floor price. Moreover, if the deal size is small, speculators could corner
stocks and drive the price up for the delisting.