Tech Mahindra-Satyam: India’s first leveraged buyout?

At first, it might seem that Tech Mahindra’s plans did not work out, as its open offer failed, leaving it with a 43% stake instead of a 51%. This setback hardly matters, however, if the two companies merge. A merger could mean that the group could repay the entire debt taken for the acquisition, using Satyam’s shares held by Tech Mahindra, if it so wishes.

A failed open offer
Tech Mahindra has announced that its subsidiary Venturbay Consultants, the special purpose vehicle for the Satyam buyout, will increase its stake in Satyam through a preferential allotment. Earlier, the open offer to Satyam’s shareholders at Rs 58 got only 420,915 shares or 0.2% of the 19.9 crore shares that Tech Mahindra offered to buy. It got a poor response, since Satyam’s share price crossed Rs 70, as investors bought its shares especially enthused by its Q3 proforma numbers.

The bidding rules allowed the bidder to apply for a fresh preferential allotment, for the same number of shares as in the open offer. But an open offer is made to existing shareholders while a preferential offer is for new shares. That meant that Satyam’s equity capital increased after the preferential allotment from 97.7 crore shares to 117.6 crore shares. As a result, Tech Mahindra’s stake in the company came down to 42.7%.

A blessing in disguise; if they merge
But this may not be such a bad thing, as we will see now. It would seem that both Satyam and Tech Mahindra would eventually merge, with Satyam merging into Tech Mahindra. At present, only the company’s logo has changed to Mahindra Satyam. The share swap ratio could be determined on various parameters, of which the market price is a commonly used one.

If a merger were to happen today, 10 shares of Satyam which are trading at about Rs 70 each will yield one share of Tech Mahindra, which is trading at around Rs 700. After all the calculations, this is how it will appear: Tech Mahindra’s equity base will go up from 11.95 crore shares to 24.11 crore shares. The promoter group’s equity stake (M&M and British Telecom) in Tech Mahindra is 83.3% which will come down to 42% in the merged entity.

The treasury stock kicker
But Venturbay, which is a 100% subsidiary of Tech Mahindra, will also get 5 crore shares in the merged entity, because of its holding in Satyam. In theory, these shares can be extinguished, because they are its own shares. If it does that, the promoters’ equity holding in the merged entity will come down to about 54%, which is good enough to exercise control.

But in practice, many companies have opted to retain their own shares allotted in a merger (remember Reliance Industries) as treasury stock. This results in a couple of advantages. One, the promoters may be holding only a 43% stake in the merged entity, but along with the treasury stock held by Venturbay, the indirect holding goes up to 63%. Also, Venturbay can even sell some of this debt to raise money to repay the debt taken for the transaction. The 21.3% it will own in the merged entity will be worth Rs 3,500 crore, assuming today’s Tech Mahindra price as the base.

The amount spent by Tech Mahindra to acquire a 43% stake in Satyam, including the new preferential allotment, is only Rs 2,900 crore in comparison. In other words, Satyam’s shares itself can pay for the acquisition. The Rs 1,152 crore that it will pay to Satyam will also remain with the company, rather than being paid out to its shareholders in the open offer.

That’s as close as it gets to an American-style leveraged buyout. The only fly in the ointment is if the share prices diverge, more so if Tech Mahindra’s share price rises faster than Satyam’s share price.

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