A very slippery business

It’s like a two decade-long engagement that ends with the bride left standing at the altar. But this isn’t the plot of a Great Expectations-ish classic tearjerker novel. It’s more of a reality show, featuring the Ruias of Essar Oil in the starring role as they decide to break their courtship with minority shareholders after raising money from them 19 years ago. 

The story began in 1995 when the company issued an IPO to set up a refinery at Vadinar in Jamnagar district, Gujarat. At the time, the state government was offering companies a five-year sales tax break if they set up units there. Essar Oil claimed it would start the refinery by 1998, but a cyclone that year ravaged the coast of Gujarat, in turn delaying the project. In April 2002, the management informed the state government that considerable time was lost in reassessment; construction would begin in June 2002 and production by November 2004; and asked for an extension of the tax holiday. This time, environmental clearances caused a delay and the company could not start the refinery until 2006.

Meanwhile, in 2004, Essar Oil was referred to the corporate debt restructuring cell and it was only nine years later, in 2013, that it emerged stronger, thanks to the benevolence of its lenders. The management openly acknowledged that; in an earlier interaction with Outlook Business, Lalit Kumar Gupta, Essar Oil MD and CEO, said, “Had it not been for the collective wisdom of lenders, we wouldn’t have achieved what we have today.” 

The refinery, which finally commenced commercial production in May 2008, initially with a capacity of 10.5 million metric tonne per annum (mmtpa), was upgraded to 20 mmtpa with an increased complexity to process various grades of crude. In the same article, the company’s CFO, too, credited bankers for their foresight. “Refineries had to scale up their operations to meet the new environmental standards and just processing light crude wouldn’t have ensured long-term viability of a refinery. The lenders invested an additional ₹4,600 crore in tranches during the course of the restructuring and that ensured long-term viability of the project,” said Suresh Jain. 

Since FY08, Essar Oil’s net sales have climbed from ₹652 crore to ₹98,353 crore in FY14, and it swung back into the black with a net profit of ₹126 crore in FY14 from a loss of ₹42 crore in FY08. In other words, just when a spanking world-class refinery is getting into the groove and churning up profits, the promoters decide to do away with minority shareholders. Essar Oil’s promoter company, Essar Energy Holdings (EEHL), intends to buy back the 9.46% public shareholding at ₹108.15 per share, a marginal premium to the current market price of ₹106. Minority shareholders are, not surprisingly, upset and market observers are critical of the Ruias’ delisting a company just when it starts performing well. 

A tale of two delistings

The Mumbai-based Essar Oil is the Essar group’s flagship company, with interests in oil exploration and production and crude oil refining. Twelve years after it listed on the BSE, the Ruias first attempted to delist the company, at the same time as they delisted another group company, Essar Steel. The Essar Steel bid was successful, but the management scrapped its plan for Essar Oil. Instead, it chose to issue global depository shares (GDRs) to the promoters on a preferential basis, at an effective price of ₹200 per share. 

Interestingly, the Ruias created an indirect holding structure in Essar Oil. Currently, EEHL, which was listed on the London Stock Exchange in 2010, holds 90.54% stake in the company. EEHL, which has interests in Essar Oil and Essar Power, is, in turn, owned by Essar Global, which is owned by the Ruias. Pre IPO, EEHL had invested $293.3 million via GDRs in Essar Oil, which reduced the public free-float of Essar Oil to 10.6%. Post IPO, EEHL invested another $225 million via GDRs, which further reduced the public free-float of Essar Oil to 10.04%. In December 2013, EEHL converted the entire holding of FCCBs into equity, further reducing the public free-float of Essar Oil to 9.46%. The holding structure was, in fact, highlighted as one of the risks in EEHL’s IPO prospectus, which stated the group has “a complex structure and a lack of clarity on the flow of funds between the UK unit and its Indian subsidiaries”. 

Though the EEHL IPO raised nearly £1.3 billion at 420 pence a share, the buoyancy did not last for long as the share price fell to 55 pence by February 2014. If investors were still waiting for the good times to roll in, they were in for a shock. Earlier this year, Essar Global, EEHL’s parent company, chose to delist the company instead of complying with the FTSE-imposed rule that mandated a minimum 25% free float by March 2014: the move would have entailed a 3% reduction in stake for EEHL’s promoters. At 70 pence a share, the delisting offer did not go down well with minority shareholders. Though an independent committee led by non-executive director Philip Aiken argued that the £900-million bid “materially” undervalued the company, it could not do much since the Ruias had won acceptances from nearly two-fifths of the minority shareholders since launching the formal offer in March, enabling Essar Global to increase its stake in EEHL from 78% to 86%. Finally, in June this year, EEHL was delisted from the London Stock Exchange. 

Before all this, though, back home, the Ruias had been fighting court battles. In the case of Essar Oil, the Gujarat government turned down the sales tax rebate of ₹6,165 crore for the refinery since the company did not start operations within the stipulated period. Essar Oil moved the state high court, which ruled in its favour, but the state government contested the ruling in the Supreme Court and won a ruling in its favour in November 2013. Meanwhile, the Ruias got embroiled in the 2G spectrum scam case. The stock price came under pressure and fell to ₹46 by March 2013.

Towards the second half of FY14, Essar Oil seemed to be over the hump, as it recorded the highest gross refining margin of $9.33 per barrel in Q3FY14. It ended the year achieving its highest ever throughput of 20.23 mmt, and PAT of ₹124 crore against a loss of ₹1,180 crore the previous year. The Vadinar refinery operating above 100% capacity promises even stronger revenues in the coming years, believe analysts. Not surprisingly, then, they’ve been largely bullish on the Essar Oil stock. In May when the price was quoting at ₹77 levels, Macquaire gave a buy rating with a ₹115 target price; Edelweiss gave a target price of ₹93, while Deutsche Bank predicted a price of ₹97 for the stock. 

Rallying cry

Good results are only part of the story behind the rally in the Essar Oil stock. The market was buzzing with rumours of the stock delisting from Indian bourses for several months before the formal announcement in June. Fanning the flames was the Ruias’ decision to delist EEHL. Though the company initially denied to the exchanges any intimation from the promoters on delisting, the stock rose steadily, with the price hitting a high of ₹117 on June 11. Finally, on June 23, Essar Oil announced it was delisting from Indian bourses by buying out the residual stake. Since the announcement, the stock fell 9% from its June 11 high.

According to the management, the rationale behind the delisting was this: “[EEHL] believes [Essar Oil] requires sustained, substantial investment to develop and grow its businesses (especially the refining and marketing business). Full ownership of the company will provide [EEHL] increased operational/financial flexibility to support the company’s businesses and strategic needs.” The management’s standpoint was buttressed by Gupta’s comments in a recent media interaction. “Our rupee debt currently — if you include all sales tax etc. — is something about ₹21,000 crore. We have no major capex going forward, we have always said this and, therefore, going forward whatever generations are there, they will be mostly to liquidate the debt only...”

Market observers aren’t too happy with Essar’s aggressive approach to delisting — and make no bones about their displeasure. “Now, when the going is finally good and expected to get better, Essar Oil’s promoters are seeking to delist and throw out 350,000 shareholders,” fumes Gaurav Parikh, managing director, Jeena Scriptech Alpha Advisors. He points to the company’s CDR stint. “The expansion of the refinery happened only with the support of banks, lenders, debenture holders and shareholders. Essar is denying shareholders the ‘superior stakeholder value’ promised.”

Others echo Parikh’s views. Says JN Gupta, founder of Stakeholders Empowerment Services (SES) and a former director of Sebi, “Investors who stuck to the company with a long-term horizon will be disappointed if the exit offer is successful as they will be forced to exit just when the good times are rolling in.”

While the board of directors has given its consent to delisting, approval of shareholders is also required — and that may not be as easy to come by. According to a report by Institutional Investor Advisory Services (IIAS), “The revised Clause 49 of the Listing Agreement and, in some instances, the Companies Act, prohibits controlling shareholders from voting on related party transactions, while allowing public shareholders to vote.” That strengthens Essar’s minority shareholders, says IIAS COO Hetal Dalal. 

She explains that approval for delisting is far more stringent than for most other resolutions and promoters cannot vote in the resolutions. This multiplies the vote of minority shareholders. A resolution for delisting is passed only by a two-third majority. “In Essar Oil’s case, promoters (not including promoter-owned GDRs sans voting rights) own 72.5%. Thus, the remaining 27.5% public shareholders will decide, increasing their voting power by more than 3.6X over their shareholding. Assuming all public shareholders vote, institutional investors (which hold 8.8% of the total shares) along with retail shareholders holding 0.5% shares, can defeat the resolution.” 

Whether investors choose to exercise the option remains to be seen. But then, the group never ever kept its investors comfortable.

Governance grouses

In May 2014, SES accused the company of not complying with laws pertaining to corporate governance and transparency while acquiring Vadinar Power (VPCL) from Essar Power, another subsidiary of EEHL. “…by setting up a separate company not being a subsidiary of listed company, the promoters are able to keep all aspects of VPCL away from public shareholders scrutiny,” the SES report states. “Even at the time of consideration for acquiring the entire stake, financials of VPCL are not in public domain. This violates the rules of related party transactions under Section 188 of the Companies Act, 2013,” says Gupta. 

He points out that Essar Oil’s notice on acquiring VPCL states that the valuation report and fairness option document are available for inspection at the company’s registered office. “In this age of e-voting, such an archaic option is nothing but an attempt to comply with the law in letter, but not in spirit.”  

There’s another issue with the VPCL acquisition. Essar Power will use the money earned from selling VPCL to buy preferential shares in group company Essar House. Trouble is, Essar House is a debtor to Essar Oil, since it has to return some ₹1,900-odd crore of deferred tax money to the latter. “The company is bailing out Essar House from its default by converting its current debtors to long-term investment. In one stroke, the company will remove the default situation of its group company at the cost of Essar Oil shareholders,” says Gupta. 

SES also raises objections to related-party directors participating in board meetings. While Essar Oil insists that “None of the other directors or key managerial personnel of the company either directly or through their relatives are in any way concerned or interested whether financially or otherwise in this resolution”, Gupta disagrees. “Ravi Ruia is an interested party and the company has not disclosed his interest,” he points out.

This isn’t the first time the Ruias have come directly under the scanner for corporate governance issues. In 2012, London-based Pensions Investment Research Consultants (PIRC) warned investors that “Director independence and board attendance are issues at [EEHL]”. In its July-August 2012 Proxy Voting Review, PIRC criticised Ravi Ruia for holding the post of an independent director, despite having “an indirect interest in 76.72% of the company” and pointed out that he had not attended two of the five scheduled meetings in 2012. PIRC recommended that shareholders oppose the appointment of Deloitte as EEHL’s auditors. It stated that Deloitte’s non-audit fee of $2.4 million exceeded the audit fees for the year under review. PIRC’s study stated, “The level of non-audit fees tendered as a part of the Stanlow [refinery] acquisition creates a potential for conflict of interest on the part of the independent auditor.”

Back home, it didn’t help that Essar Oil initially deflected all queries regarding the delisting — indeed, on May 21, the company denied to the stock exchanges that it had received any notice of a bid from the promoters. Barely a month later, on June 22, the board of directors approved the delisting bid, in a meeting that was brought forward by a day — Essar cities “convenience of the directors” as the reason. Parikh expresses his scepticism at Essar’s claims, pointing to the rising share price. “Strong delisting moves have obviously been known to insiders from May 2014 and the [share] price has since moved past ₹100.”

If that’s not enough drama, there’s also the role Life Insurance Corporation of India (LIC) has played in the delisting process. LIC acquired a 1.83% stake in Essar Oil in January 2010, purchasing 22.1 million shares worth ₹309.4 crore through open market transactions at ₹140 per share. Interestingly, LIC is not mentioned as holding more than 1% of Essar Oil’s shares under the terms of the Listing Agreement to the bourses: market analysts believe that is perhaps because the investment has been spread over multiple portfolios.

LIC will incur a loss of ₹70.3 crore if the delisting goes ahead at the current market value. Had LIC invested the same amount in term deposits at 9% in 2010, it would have earned more than ₹150 crore as interest over a four-year period. What makes the situation even more incongruous is that LIC has a nominee on the board of governors, R Sudarshan. Why would he agree to a delisting price that harms the interests of the company he represents? Despite repeated e-mail requests and a pending RTI request on the issue, LIC declined to comment on its stake in Essar Oil, citing the need to maintain secrecy regarding individual firms for fear of affecting stock prices. On its part, EEHL, too, remained tight-lipped about naming directors who attended the meeting. An e-mail response merely stated that the board meeting “had the required quorum” and did not answer a question on what were Sudarshan’s views on the delisting proposal.

Despite all the speculation and controversy, EEHL has decided to go ahead with delisting Essar Oil. For its part, the Essar Oil management feels that the minority investors have not been short-changed and have more than got their dues. In the e-mail response, the company stated, “Essar Oil’s IPO came in the year 1995, when two types of shares were offered. The pure equity portion was offered at ₹45 per share. The second was optionally fully convertible debentures, which were converted at an average price of ₹47.5 per share over a period of time till 1997. Since the beginning of the fiscal year, the share price has more than doubled from ₹51.65 to ₹109 as on July 1st.” In other words, the writing on the wall is very clear for retail investors: heads I win, tails you lose.