The Hindu Business Line : Colour Chem open offer and asset valuation

THE recent Supreme Court decision on Colour Chem's open offer prima facie appears to go against the basic idea of asset valuation. Asset price is the discounted future value of cash flows. A person buying the asset is, hence, entitled to all cash flows in the future as well as those already embedded in the asset price. By that logic, investors who bought shares of Colour Chem after 1998 should be entitled to the 10 per cent interest that the Supreme Court has directed Clariant International (the acquirer) to pay.

But the apex court has decided that only those investors who held the shares since 1998 would be entitled to the interest. The rationale is this: Interest payment is a compensation to the shareholders for the delay in the payment of the open offer price. Investors who bought shares after 1998 could not have tendered to the offer price had it been made on time. They are, hence, not entitled to interest compensation. This argument does not appear fair. Here is why.

Asset valuation: In the case of Colour Chem, the underlying cash flow primarily represents the open offer price and the interest payable by the company. Now, assume that the company proposes to buy the entire public holding through the open offer. The actual offer was made in May 2003. Those who sold the shares between 1998 and May 2004 obviously did not want to subject their portfolio to the cash flow risk. After all, the case was pending with the Supreme Court and none could have predicted the verdict.

This uncertainty in the cash flow led to the stock trading at a substantial discount to its cash flow price (open offer price plus interest). Note that the market was assigning a certain probability to the event. Whether the probability was high or low is not relevant to the issue at hand. So, those who bought the shares between 1998 and 2004 were paying a probability-adjusted discounted value of the open offer and interest-related cash flows. This is similar to an investor buying a stock that carries dividend.

In such a case, setting a record date in 1998 is unnecessary. After all, only the current shareholders will have to receive the entire cash flows. So, the company might as well set a prospective record date and pay the open offer price and interest to the shareholders on that date.

Present case: It may be argued that the same logic cannot be used for the current situation. The reason is that the public holding in Colour Chem constitutes nearly half of the paid-up capital. The open offer, on the other hand, is for only 20 per cent of the capital. So, the company cannot decide which shareholders will tender to the open offer.

True, it cannot. But remember, the market would have valued Colour Chem's stock as a combination of two events: Uncertainty about the cash flows and uncertainty about the acceptance of the shares tendered. The investors who bought the shares between 1998 and 2004 would have paid a market-consensus probability estimate of these cash flows. So, the buyers should be entitled to the open offer and the interest payment.

Such a situation benefits the company and respects the SEBI directive as well. What if more than 20 per cent of the public held their shares since 1998? The company's interest payout will be higher. On the other hand, what if less than 20 per cent of the public held their shares since 1998? The SEBI directive is violated in spirit; for, the compensation is not made to all the shareholders who would have tendered to the open offer.

Under the circumstances, it is best that the acquirer allows all shareholders to tender to the offer. Only those shares that are accepted by the acquirer will carry interest. That is the risk the buyers exposed themselves to when they bought the shares. It is, hence, fair.

(Feedback can be sent to bvenky@thehindu.co.in)

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