Consolidation Of Shares: How Promoters Use This Murky Path To Delist Undervalued Companies

Did you know that you can delist a company by consolidating shares? Before we tell you how, let us pick up an example — a company called The Indian Card Clothing Company Limited, a card clothing manufacturing company based in Pune. Consolidation of shares is a reverse share split — something which is rarely done.

On August 14, the board of Indian Card Clothing approved a proposal to consolidate the company's entire equity share capital. This would be achieved by increasing the nominal value of each equity share from Rs 10 to Rs 2,000. As a result, every 200 equity shares with a nominal value of Rs 10 each held by a member will be consolidated and re-designated into one equity share with a nominal value of Rs 2,000.

It's worth noting that this is typically done the other way around. Companies like Varun Beverages or IRB Infrastructure often take a share with a face value of Rs 10 and convert it into a share with a face value of Rs 1.

What this means is that the stock price could technically decrease, making it appear more affordable. For instance, a company previously trading at Rs 1,000 might now be quoted at Rs 100, which can make it more accessible to potential investors.

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What Did The Company Say? 

According to Indian Card Clothing, this was done to provide a) exit opportunity to small shareholders at a fair consideration and b) savings for the Company in overhead / administrative costs.

The Core reached out to Indian Card Clothing over email regarding the consolidation of shares and will update this article if the company responds.

“Exit Opportunity to small shareholders” is a phrase that we often see in delisting offers. Now let’s see how this consolidation of shares pans out to be a silent delisting offer to the small shareholder.

Small shareholders in this case are shareholders who hold less than 200 shares of the company. They will not be eligible for consolidation of shares and will not get new consolidated shares because fractional shares can’t be issued in India.

For example if a shareholder holds 150 shares each with face value of Rs 10 per share, such shareholder is eligible for 0.75 new share of face value of Rs 2,000 per share.

Since fractional shares are not allowed, no shareholder shall be entitled to a fraction of a share and all fractional entitlements resulting from the consolidation shall be aggregated into whole shares and the number of shares so arising shall be held by a trustee appointed by the board who shall dispose of the said shares in the market at the best available price.

The balance fractional shares which cannot be aggregated into whole shares ("Unconsolidated Fractional Shares"), shall stand cancelled, and the company shall deposit the fair value of such shares in the separate bank account, which shall further be distributed by the trustee to the corresponding shareholders. The decision of the trustee in this regard shall be final and binding to all concerned.

As of August 25, approximately 8,000 shareholders held less than 200 shares, around 6.5% of the total. These shareholders will not receive consolidated shares and will have the option to exit as mentioned by company in postal ballot

 

Now lets assume the promoter buys unconsolidated fractional shares from the open market. This will increase the promoters share in the company, currently at 65%,. If promoter holding increased to 90% through various options like buying from open market or delisting offer, the company will become eligible for delisting. 

The company’s stock is currently trading between Rs 250 and Rs 270, which is below its book value of Rs 401 per share. This indicates that the shares are trading at discount to its fair value, a situation during which promoters often consider delisting. 

So in this way small shareholders are served delisting offers without going through a comprehensive price discovery process as happens in case of delisting. This raises the question of of whether the amount they receive for their shares is fair. 

Market expert R Balakrishnan, in a column in Moneylife Report,  raised similar concerns about the fair valuation being ascribed to small shareholders when giving them exit oppportunity

Indian Card Clothing - How is it valued?

- Stock trades at around Rs 200-250 as compared to its book value of Rs 400 per share

- Company owns investment property (buildings) in Mumbai’s Powai which is fully occupied

The investment property has a market value of around Rs 126 crore as per valuation exercise done by the company against the book value of Rs 23 crore. This means the current financial position and its book value does not reflect a fair valuation of its assets.

An Easy Way Out

Independent directors and audit committees are required to provide recommendations to shareholders about schemes of arrangement, such as delisting, mergers, acquisitions, and demergers. They consider whether these schemes are beneficial for shareholders. Additionally, an independent valuer provides a valuation report to support their recommendations. 

However, this law does not apply to consolidation of shares, which offers exit opportunities to the shareholders. In absence of such guidance by experts, shareholders have little information and are left in the lurch.

Shareholders have limited protection as the consolidation of shares requires ordinary resolution (delisting requires special resolution by public shareholders) and promoter holds majority stake. So, even if small shareholders vote against the officer, the resolution will still pass. 

When unconsolidated shares are sold through independent trust, they can potentially be influenced by the  promoters, rending the realisation process ineffective for small shareholders. A recently example is the company Nin Tech Systems, which transferred such fractional shares to the managing director who is also promoter of the company.

Previous Such Instances And Corporate Governance Concerns

In the past there have been very few cases of very little and unknown companies that have consolidated their shares. One prominent example is Chemplast Sanmar, a chemical manufacturing company. 

 

In 2012, its promoters offered to delist the company and to provide an exit option to shareholders. They consolidated 5,00,000 shares into one share. In 2015, after successfully delisting, the company again split the share into 5,00,000 shares.

Chemplast Sanmar is the interesting case study as it was delisted in 2012 with a valuation of Rs 1,158 crore and in 2021 it returned to the markets with an IPO with the valuation of Rs 8,500 crore.

The process of reverse split is rare but needs a revised legal framework; something should be at par with delisting. Amit Tandon, MD of Institutional Investor Advisory Services India (IiAS) told The Economic Times, "While it is within the law, this is one more example of 'promoters' using their shareholding to force a decision that is primarily in their interest.” 

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