Preferential Allotments

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: With the stock market expected to remain choppy as we approach the year-end, it would be a good time to re-visit valuation strategies and prepare for the New Year well in advance. Now, the conundrum here is to know at what price to get into any particular stock, especially when the market is in the ‘over-valued’ zone.

One unique way of beating this confusion is to use the preferential allotment route. Confused! Don’t be. Preferential allotment is a way of infusing fresh equity in the business by issuing shares or warrants to the specified entities at specific prices to a promoter or promoter group or a person acting in concert (PAC) or institutional players. And this could be a strong tool that investors can use to identify investing opportunities.

The basic reasoning is that if the promoter is pumping in money into the business, they must be confident of its prospects. And when other institutions pick up preferential shares, this also adds to the confidence factor. Moreover, often enough, promoters and institutions have access to more information than available to the lay investor and hence their decisions are well thought of. This can be piggybacked to make gains (see table for evidence).

Changing guidelines

It is the change in guidelines that has made this opportunity to be a viable tool. Earlier, guidelines were seen to be restrictive in nature and did not encourage companies to opt for the preferential allotment route.

In the early 90s, the regulations on preferential allotment were very stringent. As per the first Sebi takeover code in 1994, after the preferential allotment, the allottee had to go through a mandatory open offer to the public. This rule made the preferential route a bit averse for them. Due to this, preferential route was out of favour.

Later, Sebi set up a committee under the chairmanship of Justice Bhagwati, which recommended exempting the need to make an open offer. The rationale was that infusion of capital into the company was in general interest of all shareholders. And then in 1997 the takeover code came into being and allotment via the preferential route was exempted from making open public offers. Shareholders could also send in their approvals through a postal ballot.