[Reet Balmiki is a 4th-year B.A., LL.B. (Hons.) student at NALSAR University of Law, Hyderabad]
Introduction
Share repurchases, commonly referred to as buy-backs, have become a strategic and pliant mechanism serving myriad purposes and facilitating endurance for corporations in vulnerable situations. The Companies (Amendment) Act 1999, characterised by the radical structural reforms to the Indian economy in 1990s, laid the departure from the strict adherence to the Capital Maintenance Rule, and first-envisaged buy-backs as a market exigency.
In 2022, 58 buy-backs amounting to INR38,735 crore were offered marking a jump of over 170% in the total value of buy-back offers. In this light, the focal point of the article is the buy-back by the fintech company One97Communications, the parent entity of Paytm [“the Buy-back”], announced in December 2022. The Buy-Back has invoked several mixed reactions among investor-shareholders, advisory firms, the regulators and other stakeholders. Through a theoretical analysis of buy-back in light of two perspectives, the article seeks to critique the route of the Buy-back in light of recent Amendments.
Paytm, an Indian multinational financial technology company, founded in 2010 by Vijay Shekar Sharma under its parent company One97 Communications, specializes in digital payments, financial services and offers microloans to merchants, credit and bill payment services, retail brokerage products etc. It is registered on the Indian stock exchanges (NSE and BSE) through its parent and issued amongst the largest Initial Public Offer in November 2021 raising INR18,300 crores.
On 13th December 2022, the Board of Directors of One 97 Communications unanimously approved the buyback of fully paid-up equity shares at a maximum price of INR810 per share. The Company cited the objective of the Buy-back as improving shareholder-value and indicating a sign of confidence of ‘a clear path to deliver cash flow profitability.’ Further, the Board opined that the ‘surplus liquidity’ of the company can be productively applied to the Buy-back.
The total amount earmarked for the buy-back was INR850 crores with the maximum buy-back size being 6.67-6.97% of the total paid-up equity capital and free reserves of the Company. At the indicated price and size, the equity shares proposed to be bought back represented approximately 1.62% of the paid-up share capital of the Company. The aggregate maximum amount of the Buy-back being less than 10% of the total paid-up equity capital and free reserves, the Company required only a Board resolution to be passed to as per Section 68(b)(2) of the Companies Act 2013 [“the Act”] and proviso to Regulation 5(i)(b) of Securities and Exchange Board of India (Buy-back of Securities) Regulations, 2018 [“2018 Regulations”].
The Buy-back, having commenced on 21st December 2022, resulted in a buyback of 1 crore 55 lakh Equity Shares amounting to INR849.83 crore (99.98% of the maximum buy-back size). The Company opted for the Open Market route of buy-back through stock exchange method owing which the price of the equity shares bought back was determined on the basis of the price quoted at the stock exchange. According to their regulatory filing, the highest price paid during the Buy-back was INR702.65 per equity share, while the lowest being INR543.93 per equity share.
The Buy-back was announced less than one month subsequent to the lock-in period for the pre-initial public offering investors ended resulting in alterations in the shareholding structure. China’s Alibaba Group completely exited the Company by selling its 6.26% stake in two tranches, sold through a block deal at INR642.74 per share. However, with the Paytm shares oscillating at their life-time lows, several investors like Ghisallo Master Fund LP and Morgan Stanley Asia have also been attracted to invest in the Company.
A bare understanding of the Buy-back paints a black and white picture resulting in a conclusion of full-compliance with legal rules by the Company. This article diverges from such interpretation and attempts a comprehensive decoding of the process, method and motivations of the Buy-back and its repercussions on stakeholders.
This segment analyses two major contentions of the Buy-back (1) unravelling the motivations of the Buy-back and tracing its true beneficiaries, and (2) evaluating the viability of Open Market (through stock exchange) route in contrast to the Tender Offer route.
With Paytm’s share value having faced an exorbitant decline, the Company sought to utilize the Buy-back as a means to instil shareholder confidence in the Company’s strong financial position and liquidity in the near future. Being a loss-making company, Paytm sought to improve its earning per share value through the Buy-back by depicting management’s confidence over the prospects of the Company to justify a higher market value of shares. This is popularly referred to as the Signalling Hypothesis which aims to reduce information asymmetry about the Company’s internal position which may improve market valuations. However, the strength of the signalling largely depends on the selection of the buy-back route. The open market route chosen by Paytm, being defined by its volatile price, buy-back size, premium per shareholder, was less likely to send a strong signal.
Another reason quoted by Paytm, is that ‘surplus liquidity’ will be productively applied as returns to its shareholders. This stems from the Free Cash Flow hypothesis which seeks to reduce agency conflicts over misutilization of free cash by managers through unprofitable investments. A productive alterative devised is to distribute the free cash to shareholders either as dividend or share buyback, also reducing the possibility of investing in suboptimal projects. However, in Paytm’s case, two aspects raise concerns. First, that Paytm is a loss-making entity and the ‘surplus’ proceeds do not flow from operating business profits. Second, owing to the Open Market route, even the maximum share price for the Buy-back (INR810) would not avail the IPO shareholders who entered at a much higher share-value (INR2,150). Therefore, the claim of a loss-making company having ‘surplus liquidity’ to redirect funds from its operations, along with the inconsistency between the claimed motivations of the Buy-back and the route chosen, raises scepticism among shareholders.
Despite these concerns, the Buy-back would result in an improved valuation of the remaining shares by reducing Paytm’s outstanding shares. While the viability of the buy-back route remains contested, the strategic value of the Buy-back cannot be understated. The Buy-back was introduced in a timely manner, just a month after the lock-in period of the major investors ended. Further, it avails the investors an opportunity to dispose their shares in a tax-effective manner and also ensure repurchase at the current market rates or higher.
However, a nuanced understanding of the specific shareholder beneficiaries in imperative at this juncture. The Buy-back being priced at INR810, remains a highly unattractive opportunity for IPO investors as it is at a discount of 62% of the IPO price (INR2,150) in November 2021. Further, the miniscule size of the Buy-back (over 1%) indicates that very few shareholders are actually benefiting from this move. The investors in the November 2021 IPO issue largely comprised of retail investors who had lost around 67% of their investments at the time of the Buy-back. These factors indicate that the focus-beneficiaries for the Buy-back were the Institutional Investors i.e. pre-IPO investors, for whom this Buy-back was an attractive and beneficial exit opportunity.
Having undertaken a preliminary analysis from the commercial and theoretical lenses in the previous section, this section proceeds to a legal analysis of the buy-back mechanism. Regulation 4 (iv) of the 2018 Regulations provides three major methods of buy-back (1) Tender offer route (2) Open Market through book-building process and (3) Open Market through stock exchange. In the Tender Offer route, the company buys-back the shares through a letter of offer from existing shareholders at a fixed price on a proportional basis. In the Book-building route the shareholders determine the exit price through a bidding process where the floor price and ceiling price if predetermined by the Merchant Banker. In the Stock Exchange method, the company can buy-back its shares on nationwide trading terminals wherein the maximum price is fixed by the company and the final buy-back price fluctuates as per market valuation.
Paytm opted for an Open Market through stock exchange method of buy-back resulting in the buy-back price being determined based on the grossly undervalued rates when compared to the IPO issue of November 2021. Further, the buy-back price was not fixed, rather it fluctuated as per market demand. Therefore, while the Buy-back offers a premium of around 52% over the undervalued market rate, it is still at a discounted rate to the initial valuation during the IPO. Moreover, as the shares can be bought at any price below INR810 in the stock exchange route, the Buy-back announcement failed to persuade investors resulting in a continued decline in the share value. An inevitable question to be answered then is whether the Tender Offer route would have been a viable fit for Paytm’s buyback objectives.
Among the major objectives of SEBI is to ensure investor protection and facilitate smooth and fair functioning of the stock-market in a manner that does not prejudice the interest of the small-scale retail investors. As depicted in the case of Paytm Buy-back, the perils of the stock exchange route of buy-back can be exploited to rig the entire buy-back process and restrict its benefits from retail investors.
This segment transgresses beyond the shareholder-centric analysis of the Buy-back, and examines its repercussions through a broader lens. Opting for a share repurchase is a strategic decision concerning the utilization of the company’s monetary funds. One set of significantly impacted stakeholders by a company’s buy-back decisions are its creditors.
The creditors entrust the company and extend monetary support under the reassurance of the financial soundness of the company. They are, thus, direct stakeholders in terms of the utilization of surplus liquid cash of the company. It becomes imperative that the rights and interests of a company’s creditors be adequately protected while deciding the company’s power to buy-back its shares. This principle is supported by the Capital Maintenance Rule enshrined under Section 67(1) of the Act, which necessitates that the company must maintain its capital intact as a general rule with the aim to guarantee repayment to its creditors. This Rule, laid down in the landmark case of Trever vs Whitworth, is based off the fundamental duty of a corporate to not diminish its liability towards its creditors by diminishing/reallocating surplus capital. Therefore, buy-backs are allowed only as an exception to the general rule of capital maintenance provided it meets the required conditions. It is also in furtherance of this principle that, Section 68(2)(d) requires that the debt-to-equity ratio of a company be 2:1 and Section 68(6) mandates a declaration of solvency to be filed with SEBI.
As per Paytm’s Annual Report for March 2021-22, its Debt-to-equity ratio is 0.02 due to the capital raised in 2021, however, the Company continues to have a total debt of INR2.04 million. Further, the Company having consistently been in losses has also faced a massive drop in share value, which raises concerns over its future solvency. It is essential that the model of buy-back adopted by Paytm in its current conditions be evaluated without considering Paytm’s chances of recovery. Rather what is to be considered is that even if such a Buy-back strategy does not negatively impact itself, it still puts the investors and creditors at a serious risk by setting a precedent capable of devastatingly impacting the stakeholders. A relatively mid-sized firm, if allowed to undertake a buy-back in similar conditions may not be able to recover, thus inflicting an uncalled-for risk on its investors. Therefore, the concern here is whether Paytm should have been allowed to reallocate its surplus cash in light of its existing debt and prolonged business losses, or should the Buy-back have been restricted by SEBI.
A related concern remains the very source of the funds utilized for the Buy-back. Section 68 read with the 2018 Regulations provide for three sources for funding a buy-back (1) company’s free reserves (2) securities premium account and (3) proceeds of issue of any other kind of shares or other specified securities. As per Paytm’s public announcement of the Buy-back, the Company utilized its cash and bank balances, liquid investments and cash accruals to fund the Buy-back. There were serious suspicions over the loss-making Company’s claim to utilize INR9,182 crore as cash in hand to fund the Buy-back. The source of this surplus cash cannot be its operative profits, therefore Paytm resorted to utilize the funds raised from investors prior to the Buy-back. This is quite unsettling for its stakeholders as it deviates from the rationale of incentivizing shareholders through surplus by merely reallocating money raised from one shareholder/creditor as premium to other.
All in all, the Paytm Buyback serves a crucial purpose in depicting the need for academicians, practitioners and the market Regulator to transgress beyond shareholder considerations to determine the viability of a buy-back. This would result in the source of funds and history of loss-making being recognized as threats to the financial health of the business. SEBI must secure the interests of creditors by ensuring that deviations from Capital Maintenance Rule are strictly prohibited when they threaten the very financial soundness of the Company and their ability to repay their liabilities. In the case of Paytm Buyback, considerations over the utilization of surplus cash accumulated not from its profits, rather from other investors money raise severe concerns which could only be addressed through a stakeholder-centric analysis.
Alternative to the Buy-back strategy
As opposed to the Open Market method, had Paytm opted for the Tender Offer route, the likelihood to achieve its Buy-back objectives of gaining investor confidence, reviving its market value and fairly utilizing its resources to incentivise investors would have increased. The Tender Offer route is a more flexible and fair process which favours all shareholders by even allowing the retail investors an equal opportunity to participate and benefit from the buy-back. Moreover, the shares are bought back on a proportional basis rather than all or nothing basis. There also exists an additional safeguard under the Proviso to Regulation 6, mandating a 15% reservation for retail shareholders which is absent in the stock exchange route. The most prominent advantage of the Tender offer route over the Stock Exchange route is the fixed-price of the buy-back offer. All these safeguards ensure a level playing field for all investors and allow for the benefits of the buy-backs to truly reach the investors. Had the Paytm buy-back followed this method, it would have been successful in gaining the confidence of retail investors because (1) the 15% reservation would ensure their access to the Buy-back and provide a short-term gain opportunity, (2) the price could be fixed by the investors resulting in a higher premium value as compared to stock exchange route and (3) it would truly indicate the Company’s confidence over its business strategy by allowing a quick exit opportunity to all shareholders.
Adhering to its larger policy objective and recognizing the shortcomings of the stock exchange route, SEBI has introduced Amendments to the 2018 Regulations in 2023. The Amendments incentivise the Tender Offer route and impose further safeguards in the Stock Exchange route. One major overhaul is the gradual phasing out of the stock exchange route of buy-back by 1st April 2025. This is being done by imposing a limit on the quantum of the buy-back permitted which is currently 15% of the paid-up capital and free reserve. The same shall be reduced to 10% from 31st March 2023-24 and to 5% from 31st March 2024-25. Simultaneously, SEBI has also imposed restrictive measures on the stock exchange route including the creation of a separate window, under Regulation 16, by concerned stock exchange for the buy-back period ensuring better monitoring by the regulators. An amendment is brought to Regulation 15 which raises the percentage of amount to be utilized from the amount earmarked for buy-back from 50% to 75%.
Complementing this, several barriers have been removed making the Tender offer process more efficient and desirable. In order to make the process timely and less cumbersome, the requirement of associate review by SEBI approval through a draft letter of offer has been discarded. The Amendments also give the Board of Directors more flexibility to increase the buy-back price and number of securities without altering the aggregate size of the buy-back. Overall, the 2023 Amendments have streamlined the Stock Exchange route of buy-back by making the process robust, efficient and shareholder-friendly; and also revamped the process under the Tender Offer route of buy-back.
The case of Paytm Buy-back, has raised concerns and invoked debates from various perspectives. It has presented an unordinary situation where a loss-making company with undervalued marker shares, had attempted to secure its interests and improve shareholder confidence. The Buy-back raised wide-ranging questions from the very source of the funding to the rationale behind the Buy-back route and its eventual beneficiaries.
This piece suggests that the case of the Paytm Buyback is an exemplar of the shortfalls in the Open Market through Stock Exchange route, which have triggered the 2023 Amendments. The policy overhaul for a gradual phase-out of the Stock Exchange route is a welcomed decision with the current trend of increasing buy-backs. It is concluded that the Tender Offer route would have closely aligned with Paytm’s buy-back objectives, and improved investor confidence in the Company. It would also provide a level-playing field for all shareholders and must be preferred.
This piece also emphasizes the exigency for a stakeholder-analysis for buy-backs to evaluate their viability. In doing so, it invokes a purposive application of the Capital Maintenance Rule to secure the interests of creditors by preventing reduction of capital when it can result in serious encroachment over creditors rights.
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