Takeovers have a significant economic role and M&A activity provides economic value to investors.

With the capital market in its present love affair with ICE (infotech, communications and entertainment) stocks, it is the right time for an acquirer to look at low-cost pickings in Old Economy companies. Vulnerable companies are those with low promoter holding, and market capitalisation lower than the equity investment for setting up similar projects.

Take a company with 30 per cent promoters' stake in an equity of Rs 30 crore whose shares are quoting at Rs 20. For a 51 per cent stake, the acquirer requires an investment of about Rs 38 crore, assuming he pays an average price of Rs 25. If such a greenfield project would cost Rs 150 crore to set up and assuming a debt-equity ratio of 2:1, a 51 per cent stake would cost Rs 51 crore. Here a takeover makes sense. Apart from the basic differential in fund outlay, there are other factors to consider like cost and time overrun, time and cost of setting up a distribution network, building brand, etc. On the flip side a hostile bidder has to consider other risks like litigation and an aggressive reaction from the target company.

The recent hostile bids for Bombay Dyeing and Gesco have raised significant questions. The most important is whether our companies are prepared to face a hostile bid. It appears that the promoters of many of our companies are not. The Bombay Dyeing management putting pressure on Sebi (Securities and Exchange Board of India) and unnecessary litigation speak volumes.The holding of many of our promoters is low - 25-40 per cent - with a large percentage held by financial institutions (FIs). There was a time when FIs could be relied upon to support the existing management. Today they themselves face competitive pressures and the need for enhancing their shareholder values and pressure on their bottom line will probably drive them to accept a good offer irrespective of who makes it. As for support from Sebi, it is best not to depend on it. The takeover code is drafted with hostile bids in mind. A hostile bidder strictly following procedure will not face opposition from Sebi.

What can a promoter in a vulnerable position do? By vulnerable position, I would think of a situation where the promoter holding is below 35 per cent.

If he waits for a bid to happen and then reacts, his options would be very limited. Most defence tactics that are common in the USA such as Poison Pill, Fat Man, Disposal of Crown Jewels, Golden Parachutes, etc, are not possible in the Indian legislative structure. The existing promoter can think of a counter offer. However, counter offers are expensive and need not be successful all the time. Moreover the hostile bidder can up the ante on a competitive offer.

The best defence mechanisms are preventive: enhancing shareholder value and market capitalisation. The higher the market capitalisation, the more unattractive the company becomes to the predator. For example, take Infosys where the promoter holding is not high and is dispersed. Can a predator launch a takeover bid? Unlikely, on account of the horrendously high market capitalisation and the positive perception of the existing management in the eyes of investors.

Enhancing shareholder value is a difficult thing to do but Indian Industry is on the learning curve. Professionalisation of management, corporate governance, transparency and communicating with shareholders are a few of the things which build investor confidence and enhance market capitalisation. Another way is available under the takeover code - the creeping acquisition limit of 5 per cent a year. A few companies have been using this mechanism to shore up their holding but their numbers are few. A few captains of industry feel this limit is low. I think it is adequate since this mechanism is available without an open offer. Thus promoters can enhance their holding without resorting to the expensive way of open offer.

If the limit is set too high and with the markets gyrating, promoters can buy under the creeping acquisition route at lows thus depriving investors of the benefits of an open offer. If a promoter wants to enhance his holding by a higher percentage, let him make an open offer.

The other way is the buyback route. Buyback can be used effectively when prices are low and can lead to effective utilisation of the surplus funds of the company. Buybacks also build up investor confidence and increase market capitalisation. Alternatively the preferential allotment route under Section 81(1)(a) of the Companies Act can be used. However this needs fund deployment by the promoters and Sebi pricing guidelines need to be followed.

Innovative structures like cross holding are another way to prevent hostile bids. For example, suppose A has a controlling interest of 30 per cent each in Company X and Company Y. If Y buys 21 per cent into X and vice versa, A would ultimately control 51 per cent of the equity in each company.

Given the low promoter holding in many a mid-cap as well as mid-large cap companies, there are plenty of opportunities for predators hunting for cheap bargains. The promoters of such companies need to wake up and look at ways to prevent this. Making emotional appeals when such a thing happens is not the way out. The way is to build up preventive defense mechanisms that make takeovers difficult or unattractive.

Sidharath Kapur is head of finance of Petronet India Ltd. These are his personal views