To be sure, Reliance Retail is not the first unlisted company in the country to opt for such a buyback. Unlisted shares became mainstream during the covid pandemic, as pre-IPO shares, employee stock options (ESOPs), and restricted stock units (RSUs) found their way into the hands of eager retail investors. But, as history goes, there have been multiple cases where investors in unlisted stocks have been left high and dry.
Mint explores real-world examples, both triumphs and pitfalls, that shed light on the challenges faced by retail investors.
Reliance not at fault
What unfolded at Reliance Retail is not sudden. The first signs of this saga emerged in 2019 when RIL introduced a compulsory share swap deal for Reliance Retail. In a share swap, shares are exchanged between the parent company and its wholly-owned subsidiary, typically for the purpose of consolidating ownership or simplifying corporate structure.
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The swap ratio of 4:1 in the case of RIL and Reliance Retail resulted in a significant decline in the latter’s unlisted share price dropping from ₹950 to ₹475. However, with RIL’s stock price valuing Reliance Retail at a mere ₹385 per share, the offer faced opposition and was subsequently challenged at the National Company Law Tribunal (NCLT). This forced RIL to roll back the swap deal.
In 2020, SilverLake’s entry into Reliance Retail Ventures Ltd (RRVL) injected new life into the company. With a substantial investment of ₹9,375 crore, RRVL was valued at an impressive ₹4.28 trillion, giving it ownership of 99.91% of Reliance Retail. As Reliance Retail’s share prices surged to ₹4,000, its valuation surpassed that of its parent company, exposing the disconnect between valuations and price discovery in unlisted markets. Despite Reliance Retail contributing only 30% of its parent’s revenues, it was valued higher than RIL itself.
Early this month, RIL executed a minority squeeze-out, offering ₹1,362 per share for Reliance Retail. Independent experts had assessed a valuation range of ₹850-900 per share. However, RIL still offered a 50% premium to the shareholders. Retail shareholders who had purchased Reliance Retail at inflated prices over the past three years are distressed, as they face a substantial loss of 60-70% of their capital.
The targeted capital reduction and its impact on non-promoter shareholders raise concerns about the treatment of minority stakeholders. From a legal standpoint, NCLT primarily ensures compliance with legal regulations during the capital reduction process, while leaving valuation scrutiny to the expertise of professionals. Previous court cases have established that decisions regarding capital reduction primarily rest with majority shareholders, with judicial intervention limited to cases of apparent misconduct.
Ricoh and Jhunjhunwalas
In 2016, Ricoh India was embroiled in a ₹1,100 crore accounting fraud scandal. Consequently, its shares plummeted from ₹1,000 to ₹200. To mitigate the crisis, the Japanese parent company agreed to infuse capital into Ricoh India.
However, two years later, the parent company abruptly severed all financial support and filed for bankruptcy. This left Ricoh India in a vulnerable position. In 2019, a consortium led by Kalpraj Dharamshi and Rekha Jhunjhunwala submitted a successful bid for Ricoh India at the National Company Law Tribunal (NCLT). Nonetheless, their bid faced challenges twice—first at the NCLAT and then the Supreme Court.
Ultimately, the Jhunjhunwala-led consortium succeeded in acquiring Ricoh India. As part of the acquisition, the company underwent a substantial capital reduction of 60%, resulting in a ratio of 40 shares for every 100. This manoeuvre squeezed out the minority shareholders. Ricoh India rebranded itself as Minosha and obtained a pan- India license from its parent company.
Last month, investors who were pushed out of Ricoh India received payments deemed as dividends as per Section 2(22)e of Companies Act based on the balance sheet value of 2022. To illustrate this, if an investor held ₹100 worth of Ricoh India shares, they were left with shares valued at ₹40 after the capital reduction. Since these investors would typically be in the highest tax slab of 30%, after deducting tax of ₹15.6 on deemed dividends, the investor received a net payment of only ₹24.4.
Dhoni and CSK’s share price
The impending retirement of cricket legend Mahendra Singh Dhoni has had a notable impact on the unlisted share prices of the Chennai Super Kings (CSK) team. From 2019 to 2022, the share prices experienced fluctuations based on the team’s performance in each season, rising from just about ₹40 to over ₹200 per share. However, in June 2022, CSK finished 9th in the points tally at the Indian Premier League (IPL), resulting in a drastic crash of 30-35% in the stock value. Despite CSK’s triumph in May, the stock failed to respond positively. Dhoni’s retirement holds significant implications for the valuation of CSK, contributing to the uncertainty surrounding the team’s unlisted share prices.
The PharmEasy story
In 2021, the company’s shares reached a high of ₹140 per share in the unlisted market, coinciding with its acquisition of Thyrocare for a substantial amount of ₹4546 crore. At that time, PharmEasy’s parent company was valued at $4 billion. However, by June this year, the company’s B2C business suffered losses, prompting a shift towards the B2B sector. Consequently, share prices declined significantly, reaching a mere ₹19 per share.
In July, PharmEasy faced another setback as it took a substantial 90% cut in valuation to service a loan. Its new valuation stood at around $500-600 million, resulting in shares being exchanged at a modest price of ₹12-16. These events demonstrate the challenging and volatile nature of holding minority shares in Pre-IPO Startups or startups in general, with fluctuating valuations and a sharp decline in share prices over time.
“Though pre-IPO investment has merit, it should always be part of the satellite portion of a portfolio. The allocation should be within the risk framework of an individual investor who can hold these investments for an undefined long period without seeking interim liquidity. Pre-IPO investments should be ideally in themes or sectors which can’t be accessed through public markets. Blindly following footsteps of PE/ VC players is not advisable as they have a different time horizon and risk appetite; they follow ‘Power Law’ more diligently by spreading their bets. The contours of deals by VC funds are almost always in their favour. Liquidation preference and anti-dilution rights are also widely used by VCs,” said Arihant Bardia, CIO and founder, Valtrust.
Risks galore
One significant risk for minority shareholders is the possibility of capital reduction and squeeze-out by majority shareholders. This is often carried out using Section 235 of Companies Act, wherein if promoters hold more than 90% of the shares, they can squeeze out minority shareholders.
Also, when a company that was once listed and subsequently effects a squeeze-out post delisting, the remaining shareholders may have a greater power to protest as they initially entered the company through the market when it was listed. In an unlisted company like Reliance Retail, the dissenting minority cannot claim this.
Investors should also consider taxation risk. When a capital reduction occurs through a squeeze-out, the proceeds paid to minority shareholders are treated as deemed dividends, which are taxed at slab rates and could hurt those in the highest tax bracket the most after adding cess and surcharge (about 39%). There is also a lack of clarity regarding the treatment of capital loss in tax filings.
Further, minority shareholders face the risk of being excluded from future growth opportunities. If a company squeezes out minority shareholders at balance sheet value and subsequently unlocks value and conducts an initial public offering (IPO) in the future, the squeezed-out shareholders are deliberately denied the gains they could have potentially made from participating in the company’s growth.
Lastly, there are idiosyncratic risks involved, as seen in the case of CSK. The value of the team is significantly influenced by public sentiment surrounding the retirement of prominent player Mahendra Singh Dhoni. Such sentiment-driven factors can introduce volatility and unpredictability to the value of unlisted shares.