Lessons from the PNB Housing Finance fiasco

On June 21, the Securities Appellate Tribunal (SAT) allowed PNB Housing Finance Limited (PNB Housing) to go ahead with the EGM of June 22, thereby allowing shareholders to vote on the resolution of the preferential allotment of shares to a select set of investors but keep the results in a sealed envelope.

The genesis of the current fiasco started on May 31, when the PNB Housing board approved raising of funds through a preferential issue of shares and share warrants worth Rs 4,000 crore to Carlyle, General Atlantic and Salisbury Investments, an entity owned by Aditya Puri.

The price of the preferential issue of shares and share warrants was fixed at Rs 390 per share, which was only Rs 6 higher than the floor price under the SEBI Issue of Capital and Disclosure Regulations (ICDR). For the share warrants issue of Rs 800 crore, only 25 percent is needed to be infused on allotment, the remaining to be infused within 18 months. Through this preferential issue, PNB Housing was also ceding management control to Carlyle and the persons acting in concert (PAC).

However, the objections to the transaction were that there was a violation of the Articles of Association, and; that the preferential issue of shares was unfair to minority shareholders as only 15 percent of current shareholders were largely impacted, and a rights issue would have been better.

The SEBI’s June 18 letter to the company stated: “The current resolution bearing item no. 1 (Issue of Securities of the company and matters related therewith) of EGM notice dated May 31, 2021 is ultra-vires of AOA and shall not be acted upon until the company undertakes the valuation of shares as prescribed under 19(2) of AOA, for purpose of preferential allotment, from an independent registered valuer as per the provisions of applicable laws. The said report shall be considered by the company’s board while deciding on the preferential issue of shares and warrants.”

Here SEBI is merely pointing out that the compliance with regulations matters. It is surprising that the lawyers to the PNB Housing transaction missed out the provision in the Articles of Association where an independent registered valuer needed to have been engaged.

In August, the PNB Housing board approved a fund-raise of Rs 1,800 crore through rights issue or preferential issue. While PNB Housing seemed to be on the lookout for raising Rs 1,800 crore, it is surprising that the company chose to raise Rs 4,000 crore capital.

While a rights issue ensures that all shareholders get to exercise their pre-emptive right, preferential allotments to promoters or external shareholders is prevalent among Indian companies. Also, attracting other strategic or financial bidders may have proved difficult as Carlyle was already an existing investor with a significant shareholding. However, the Board of Directors of PNB Housing owed it all shareholders to ensure that maximum value was extracted when control was being given out.

The pricing of the preferential allotment left much to be desired. While the SEBI ICDR regulations prescribes a floor price, the preferential allotment was done at a price only marginal higher than the floor price. Additionally, the preferential allotment was being made while control of the company was also being ceded. The company did not seek a control premium from the investors. Not only was Carlyle and PAC getting to be in control of the company, but it was also not infusing all the funds upfront.

PNB Housing was not the first instance where the company and minority shareholders got an unfair deal when change of control took place. Similar change of control with a preferential allotment of shares happened in the case of CG Power, where Tube Investments Limited was an investor and took control of the company late last year. CG Power did not get an independent valuation done, and Tube Investments was exempted from an open offer though there was change of control. Even the SEBI ICDR floor price calculation of six-month high-low average price was not applied citing exemption under Section 164(1). Much like the PNB Housing stock, the CG Power stock price ran up almost three times ahead of the imminent change of control, thus bringing to question whether the right valuation was undertaken, whether the company could have raised more funds for similar dilution of minority shareholders, and whether the board was in a rush to get a new investor with KKR in a rush to exit.

The way forward seems to be for PNB Housing to revisit the pricing of the preferential allotment of shares by getting a proper valuation done that includes a control premium, and structure it in a manner where all funds are infused upfront.

Though not a public sector enterprise, it was felt that the PNB Housing preferential allotment was selling out by PNB at low valuations. The beneficial interest of the Government of India in PNB Housing was only 25.08 percent (PNB holds 32.6 percent in PNB Housing and the Government of India holds 76.87 percent in PNB) and would be reduced to 15.60 percent after the preferential issue.

The larger lesson is that all promoters should work towards enhancing the value of companies ahead of any change of control, if not at any point of time. Also, all transactions should be undertaken in a very transparent manner. Many public sector banks and NBFCs have been trading at lower than the book value, as investors believe that the book value does not represent the true picture of the assets of the banks and NBFCs.

While in many transactions it may not be able to please all sections of investors and market participants, the company and the board owe it to shareholders to conduct the entire process in a transparent manner in the quest to extract maximum value.