Unraveling The Complex Saga Of Reliance Retail's Equity Share Capital Reduction

A recent move by Reliance Retail Limited (RRL) to reduce its equity share capital has sparked intrigue and left minority shareholders pondering the implications. The episode also highlights the larger risks of investing in the grey market and what could go wrong. Equity share reduction is the process where a company decreases the total amount of its issued and outstanding shares for various reasons such as readjusting the company’s capital structure, returning capital to shareholders, or eliminating accumulated losses.  

Reliance Retail is India’s largest retailer with a network of over 18,000 stores, distributors, and channel partners across more than 7,000 towns. Consumers would know Reliance Retail through several brands including Jio Mart, Reliance Smart, Reliance Trends, Trends Footwear, and JioMart Digital among 50 other international brands which the company has brought into India. ​​Reliance Retail reported a turnover of Rs. 2,60,364 crore for the financial year 2022-23.  

What Is Happening?

It began with the implementation of two schemes by RRL: The Reliance Retail Employees' Restricted Stock Unit Plan 2006 and 2007. These schemes granted eligible employees Restricted Stock Units (RSUs), which, upon exercise, converted into Equity Shares, served as incentives for employees to participate in the company's growth and success.

Reliance Industries Limited (RIL) had received requests from Reliance Retail employees who hold equity shares seeking options to exit and liquidate their holdings. Reliance owns 85% of Reliance Retail Ventures, which in turn holds 99% of Reliance Retail Limited.

Reliance Industries Limited had two options available: 

1. List Reliance Retail Limited that provides liquidity in the market
2. Swapping Reliance Industries shares with unlisted Reliance Retail shares, which would lead to the reduction and cancellation of the corresponding equity share capital. 

In 2019, Reliance chose the latter option, whereby Reliance Retail shareholders would receive one share of RIL for every four Reliance Retail shares held. In this scheme, Reliance clearly mentioned that there is no plan to list the same.

Understanding the Shareholding Structure

To comprehend the intricate dynamics at play, it is crucial to understand the shareholding structure of Reliance Retail. RIL, a listed company, owns 85.06% of RRVL (the rest is owned by  Private Equity investors), which in turn holds a commanding 99.95% shareholding in RRL.

Shareholding Pattern of Reliance Retail 

As on December 11, 2019, when the scheme was issued, the valuation of the Reliance Retail shares in terms of Reliance share:

At that time, due to this scheme, the share price of Reliance Retail in the unlisted market is believed to have fallen from Rs 950 apiece to hit a low of Rs 475. 

How Do These Prices Go Up and Down?

The unlisted market is an Over-the-Counter(OTC) platform where brokers trade shares based on demand and supply. In India, numerous brokers deal in unlisted securities, enabling direct share transfers between depositories. Unlike listed markets, prices here fluctuate with rumors, news, and demand. While it offers fundraising opportunities for early-stage companies, its unregulated nature poses risks for investors. As this market evolves, stakeholders must stay informed and vigilant amidst the dynamic and uncertain financial landscape.

As news of the share capital reduction and the proposed share swap spread, shareholders voiced concerns over the relative valuation assigned to Reliance Retail. Many argued that the valuation offered by the company was significantly lower than expected, casting doubt on the fairness of the terms. In response, some shareholders even challenged the share swap ratio at the National Company Law Tribunal (NCLT), seeking a fairer deal for their investments.

In an extraordinary general meeting held on January 23, 2020, RRL addressed the growing discontent among shareholders by rolling back the initial mandatory share swap proposal. Instead, the company made the share swap optional, granting shareholders the choice to participate voluntarily. However, those who opt for the share swap are required to surrender their entire holdings.

Post that Reliance took back the scheme. 

The Fund Raise in Reliance Retail And Future Retail

During Covid-19, the holding company of RRL i.e. Reliance Retail Ventures Limited (RRVL) had raised funds of  Rs 47,265 crore from global private equity funds for a 10.09% stake, valuing the company at more than Rs 4.2 lakh crore. The list of marquee investors included the likes of Silver Lake, KKR, Mubadala, Abu Dhabi Investment Authority, GIC, TPG, General Atlantic and Saudi Arabia’s Public Investment Fund. 

With fundraising in the holding company RRVL , Reliance made it clear that value-unlocking opportunities will be available with RRVL  and not RRL.

Along with this, the whole Future Retail saga was also going on. Even Reliance took no steps to further buy back these shares until July 7, 2023, when it came up with a public notice on the same.

The Delayed Disclosure

In India, there is no law related to disclosing any event happening in unlisted material subsidiaries. 

But what will happen if it is done by India’s biggest company?

The interesting thing to note in the disclosure mentioned below is that the meeting was held on July 4, 2023 and approved on the same day, but the disclosure was issued on July 7, 2023 which is two  days after the board meeting of Reliance Retail Limited.

This is unusual. 

Even the trading in the unlisted market increased to 2,45,229 equity shares in June 2023 as compared to 43,740 shares in January 2023.

The 50% Discount

RRL approved the reduction of the share capital of share capital held other than its Promoter and holding company in RRL.

The hue and cry started in the unlisted market when the Consideration decided on the reduction of share capital is Rs 1,362 per share, whereas the share is trading at rs  2700-3000 per share in the unlisted market, which is more than two times of the consideration Reliance is ready to pay for the same.

The Legal Labyrinth

Navigating the legal intricacies of the share capital reduction process adds another layer of complexity. The proposal to reduce share capital requires the approval of the company's members through a special resolution. Additionally, it must secure the sanction and confirmation of the National Company Law Tribunal (NCLT). As the wheels of the legal machinery turn, shareholders anxiously await the outcome, acutely aware that their financial interests hang in the balance.

The Legality, Valuation & Process

As we delve deeper into the intricate web surrounding Reliance Retail's equity share capital reduction, the question that arises is whether Reliance has the legal authority to carry out such a move. Since RRL is an unlisted public company, it is bound by the provisions of the Companies Act 2013, rather than the regulations set by the Securities and Exchange Board of India (SEBI). In this regard, Reliance has invoked Section 66 of the Companies Act, 2013, specifically "Reduction of Share Capital," which necessitates a special resolution, with 75% of members in agreement, along with the approval of the NCLT.

Furthermore, an essential aspect of this analysis revolves around the valuation of RRL at Rs 1,362 per share. To determine this value, Reliance sought the expertise of two reputed independent registered valuers, Ernst & Young Merchant Banking Services LLP and BDO Valuation Advisory LLP.

The valuations provided by these entities were Rs884.03 and Rs 849.08 per share, respectively. These valuations resulted in the overall valuation of RRL amounting to Rs 7.63 lakh crores ($92.3 billion) and Rs 7.95 lakh crores ($96.2 billion), respectively. Notably, these valuations represent a premium of more than 250% compared to the previous valuation conducted in 2019, where one share of RIL was allotted for every four shares held in RRL.

Reliance is ready to pay the premium of 55-60% more than the value assigned by the independent valuers, valuing RRL at Rs 12.25 lakh crore ( $148 Bn), which lead to a premium more than 400% of the earlier valuation of RRL and ~65% of the whole Reliance Industries Limited Market Cap. The consideration decided by Reliance values the RRL more than FMCG Giants like ITC, HUL. The reason behind this premium is the tax liability on the shareholder. 

Since this capital reduction is taxable as dividend in the hands of shareholder as dividend under section 2(22)(d) of the Income-tax Act and dividend is taxable at slab rate of individual.

Let's take an example. If someone receives consideration decided by E&Y as 884 rs per share then if the individual is taxed at assuming 35%, then shareholders effectively receive only 575.25 per share.

Now to compensate the tax liability to the shareholders, reliance decided to take the higher of the fair value determined by the independent valuer and maximum income tax liability in hands of identified shareholder (which will be arrived at by grossing up the Rs. 885 at the maximum marginal rate).

In simple terms, if you deduct 35% from 1362, it comes to 885 which is the fair valuation decided by E&Y.

Current Structure

 

The unlisted market found itself in a state of panic as the stark disparity between the trading price of RRL shares and the valuation offered to shareholders became apparent. With shares trading at a mere fraction of the proposed valuation, investors were left questioning the fairness and rationale behind the share cancellation process. 

Adding to the unease was the fact that Section 66 of the Companies Act, 2013, which governs the reduction of share capital, necessitated a special resolution approved by 75% of members. However, with RRVL already holding over 99% of the shares, the influence of minority shareholders on the outcome was limited, further exacerbating concerns.

To comprehend the intricacies of the share cancellation process, it is crucial to understand the steps involved. Firstly, a board resolution is required to convene a general meeting, wherein the reduction of share capital is discussed. Subsequently, an application is submitted to the NCLT . The NCLT is obligated to provide notice to the Central Government, Registrar, SEBI (in the case of a listed company), and the creditors of the company. During this period, any representations made by the aforementioned entities within three months from the receipt of notice are taken into consideration by the NCLT.

Upon satisfaction of the necessary requirements, the NCLT grants approval for the share cancellation. Following this approval, Reliance Retail Limited proceed to distribute consideration, with the amount being transferred to the bank account linked to the shareholder's Demat account.

For minority shareholders of Reliance Retail, the options available are limited. After the special resolution and NCLT approval, the only choice left for the minority shareholders is to receive Rs 1,362 per share. However, there is a potential avenue based on the case law of Reckitt Benckiser Ltd. In this case, the Delhi High Court ruled that the reduction of share capital should be considered an internal matter of the company. As a result, the objecting shareholders were allowed to remain as shareholders, leading to the approval of the capital reduction. This precedent may offer some hope to minority shareholders seeking to challenge the share cancellation.

It is important to note that SEBI laws do not apply to Reliance Retail Limited, as it is an unlisted company. Instead, regulations related to the Companies Act, 2013, govern the proceedings. The valuation determined by registered valuers, such as E&Y and BDO Valuation Advisory, carries significant weight in this process. Reliance Retail Limited has opted to pay a premium of Rs 477.97 and Rs 512.92 to the valuations provided by these firms, indicating that any potential adjustment to the valuation by Reliance or the NCLT is unlikely. Moreover, the valuation already exceeds the minimum requirement set by law.

Stopping the reduction of share capital requires the involvement of creditors. According to Section 66, the NCLT must provide notice to every creditor of the company. If the creditor can establish that their debt or claim has not been discharged, determined, or secured, or if their consent has not been obtained, the NCLT can halt the process.

In terms of general legal practice, Section 66 of the Companies Act, 2013, offers wide-ranging provisions, with the two clauses in Section 66(b) serving as illustrative rather than exhaustive guidelines. Typically, in capital reduction applications, once approved by the NCLT, the reduction is binding on shareholders, irrespective of their objections.

Another provision relevant to this scenario is Section 230 of the Companies Act, which addresses compromises or arrangements with creditors and members. Section 230(11) specifically pertains to takeovers, allowing a member holding 75% of shares to file an application with the NCLT to acquire the remaining shares held by minority shareholders. In response, Section 230(12) grants the aggrieved party the opportunity to file an application opposing the takeover. If the NCLT approves the application under Section 230(11), minority shareholders' shares will be transferred to the majority, as directed by the NCLT. This provision has been utilized in the past by companies like Cadbury India Limited, Phillips India Limited, UTV Software, and Atlas Capco to facilitate the exit of dissenting minority shareholders after delisting.

For minority shareholders seeking recourse, appealing to the NCLT for valuation is a potential last resort. The NCLT has the authority to appoint another valuer or make the process optional for shareholders, allowing them to decide whether they wish to participate in the share cancellation.

Regarding taxation, the proceeds from the capital reduction would be deemed as dividends under Section 2(22)(d) of the Income Tax Act, 1961. If the amount of capital reduction exceeds the accumulated profits,whether capitalised or not, it would be taxable as dividend upto the accumulated profits of the company, post that considered as capital gain. As the transaction involving Reliance Retail Limited includes an amount approximately five times the profit made by the company in FY22, the deemed dividend would be taxed according to the applicable slab rates. Shareholders receiving dividends exceeding Rs 5,000 in a financial year would be subject to Tax Deducted at Source (TDS) deductions.

Means if someone is under Maximum 35% tax bracket, he will have 885 only post tax i.e. the fair value decided by E&Y.

Investing In 'Unlisted Market’ Is Dangerous

With fundraising from Private Equity players in RRVL, Reliance made it quite clear that Reliance Retail Limited is not going to be listed. Since the unlisted market is an OTC market, Lack of information and non-transparent discovery of price leads the share price to trade at more than 2x of its fair price. 

Now the question comes whether it is the fault of the unlisted market.

Generally, while investing in an unlisted public company or any private company one should always be careful and make informed decisions with available information. In unlisted securities only the Companies Act,2013 is applicable and no SEBI regulation is applicable. SEBI also has no right to preview in the matter of unlisted securities.

With such an astronomical valuation of Reliance Retail Limited (Rs 27 Lakh Crores), where they are valuing the company more than its listed arm Reliance Industries Limited (Rs 18 Lakh Crores) which holds it.

Some of the leading unlisted brokers are also misleading retailers by giving misleading information on their website as you can clearly see the screenshot of one such website where broker is claiming that Reliance Retail Limited will be listed on stock exchange.

One need to always caution as well as keep valuations and checks while investing in unlisted securities.

Lesson for Unlisted Market Investors

1. Know what you are buying, there may be a case that the entity you are buying may not get listed (as happened in the case of Reliance)
2. The price you are paying - sometimes it happens the price you are paying to buy an unlisted market is higher than its fair value or its IPO Price (happened in the case of Paytm, Policybazaar, and Nazara Tech)
3. Be informed - it's important that you get regular updates about the investee company’s important updates and events
4. Evaluate investment opportunity with based on facts rather than narratives
5. Be prepared to patiently hold the unlisted stock as IPO may not come soon
6. Be prepared for illiquidity - you may not be able to sell your stocks as soon as you do in the listed market.