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Motilal Oswal

By Motilal Oswal 28-Jun-2010 | 16:03

The idea of a minimum level of public shareholding in listed companies is not new. Until the early 1990s, promoters of listed companies were not allowed to hold more than 40% of the paid-up capital. This was relaxed to allow up to 90% promoter holding. The latest amendment requires a minimum public float of 25% in listed companies, irrespective of what requirements applied to them at the time of their initial listing. Listed companies where promoter holding exceeds 75% have to sell down to the public, diluting 5% per year until the stipulated minimum public float of 25% is achieved.

At a conceptual level, such a requirement is laudable. Among the long-term advantages of a higher public float are increased market depth, enhanced liquidity, better price discovery, and improvement in corporate governance. When companies sell down to meet the enhanced minimum public float, it should result in a more dispersed shareholding, lowering opportunities for collusive market action. The resultant increase in liquidity would enable small investors to buy or sell shares at prices that are discovered in a fair manner. Reduced ownership concentration also encourages good governance.

At a more pragmatic level too, there would be significant long-term benefits. A higher public holding would increase the free float market capitalization of the Indian market. As a result, India’s weightage in the globally tracked free-float-based emerging market indices would increase. This, in turn, should lead to a rise in the quantum of foreign inflows allocated to India. Many global funds mirror the index weightages while deciding on their country allocations. With India’s free float market capitalization increasing, the India allocations of several FIIs would go up.

With higher public float in large entities such as MMTC and NMDC, the composition of the Indian/regional market indices could undergo a change. One of the eligibility conditions for a stock to be included into the Nifty (or the MSCI) is that it should have a minimum free float of 10%. Higher public float would not only raise the free-float-based market capitalization of the indices themselves, but would also make them more representative through the inclusion of new stocks.

Government-owned companies would account for bulk of the issuances to comply with the new minimum public float norm. If the government chooses to bring down its shareholding in 29 listed companies where it owns over 75% through stake sale, it could raise more than Rs 120,000 crore over the next five years. This would help the government to consolidate its fiscal position further after raising over Rs 100,000 crore from the auctions of 3G and BWA spectrum. Stake sale in MMTC (government holding: 99.3%), NMDC (government holding: 90%) and NTPC (government holding: 84.5%) alone would help raise over Rs 70,000 crore.

However, the requirement of higher public float is not trouble-free. There would be a glut of issuances to meet the new guidelines. In the near term, the incremental equity issuance is likely to create an overhang in the secondary market. To comply with the new norm, companies would have to raise over Rs 150,000 crore. This is three times the average of Rs 50,000 crore raised annually through equity issues including IPOs. Not only will companies/promoters seeking to comply with the new guidelines find it difficult to do so, companies with genuine need for capital too might find it difficult to raise resources.

Given the ongoing global financial crisis, this is not the best time to have introduced this norm. It might have been more sensible to wait for the global crisis to subside for good. But then, there always are some not-so-desirable fallouts and some pain associated with any change. Promoters do not need to bring down their holdings at one go. Staggered dilution would help take away some of the pain, though the valuations realized may still not be in line with promoters’ expectations. The guideline of 5% dilution per year gives most companies three years and some government-owned companies five years to comply. If this were revised to 2-3% dilution per year, it could make things easier.

Another fallout might be that some companies with low public float would choose to buy back the small portion of shares in public hands and go private. However, in my view, there would be very few such instances. If some companies do choose to go private because a larger public float exposes them to greater public scrutiny, shareholders are better-off not owning shares in such companies. The Indian capital markets have come of age. A listing on Indian bourses is not just about raising money but perhaps more significantly for enhancing brand value – the recent ADR issue of Standard Chartered Bank is a case in point.