Is the sale route better than the merger route?

S. Murlidharan

The merger of Tomco (Tata Oil Mills) with Hindustan Lever Ltd. (HLL) had Tata shareholders feeling shortchanged. Fuelling this feeling was the exch-ange ratio, perceived to be skewed in favour of HLL. Tomco shareholders felt that the exch-ange ratio was arrived at by according a disproportionately greater weightage to future potential earnings and the market quotation of shares of the two companies, thus resulting in negligible weightage for asset value criterion, Tomco’s perceived strong point.

In the next round of restructuring, the Tatas plumped for the sale route in preference to the merger route. That was when Lakme Ltd was sought to be disposed of to HLL. As reported in newspapers, the Tatas could wangle a good price by selling off the assets of Lakme to HLL, which arguably they could not have got had they gone through the merger route—roughly Rs 180 crore was what Lakme reportedly got for its brand name alone and roughly the same amount for its physical assets minus liabilities.

It may be noted that the Tatas plumped for the sale route despite knowing that the income tax law favours the merger route as far as the sellers are concerned inasmuch as under the merger route, neither the shareholders of the merging company nor the merging company itself are liable to capital gains tax.

The aborted Global Trust Bank-UTI Bank merger proposal drew flak from the latter’s shareholders almost for similar reasons except that the controversy had a new dimension—charge of manipulation of market price of GTB shares by its management. It is interesting to note that though Deloitte Haskins & Sells (the merchant bankers appointed for second opinion in the wake of the controversy) had endorsed the exchange ratio of 2.25:1 suggested by SBI Caps, the original merchant bankers, it had opined that the quality of assets has a significant bearing in fixing the exchange ratio.

Primacy should, therefore, be accorded to the quality of assets, whether it is for fixation of exchange ratio or for determining the selling price of shares in a disinvestments exercise. Indeed, the second opinion in l’affaire UTI-GTB, bolsters the case of those opposed to the disinvestment of Balco.

Their principal argument is that future earnings potential, the basis adopted for fixation of the Balco share price, ignores the intrinsic value of the company’s assets. The disinvestments minister, Arun Shourie, has stated clearly that future earnings potential and not the value of assets was the key factor in fixation of the share price. It is not for a moment suggested that the value of Balco assets trotted out in the range between Rs 1,000 to Rs 5,000 crore is correct.

Textbooks and financial pundits swear by the future earnings potential especially in an exercise involving a going concern. They aver that the asset value method has relevance only when the company concerned is sought to be liquidated. A moment’s reflection would show that this need not be so. A seller is likely to set store by what he is bringing to the negotiating table: the assets. Ask the Tatas. Didn’t they plump for the sale route in which what matters is the objective criterion of market value of assets sold? After all, when one talks of future earnings potential, one is treading on the minefield of uncertainty. That there are mathematical models to minimise, if not eliminate, the errors arising out of the element of uncertainty doesn’t put the skeptics at ease.

When hard-headed business houses are more comfortable with the sale route, the proverbial common man too is bound to be more comfortable with it, instead of with future earnings. The common man’s interest is riveted on the ongoing Balco debate as public money is involved. And convincing him is important as public money is involved.

The writer is a chartered accountant