Why SEBI was right in rejecting the L&T buyback bid
In a surprising move last week, SEBI rejected L&T’s proposed buyback of shares. L&T had decided to reward its shareholders and had opted for buyback for the first time in its entire history. The total size of the buyback was Rs.9000 crore and entailed buying back 6.1 crore shares of the company at Rs.1,475 per share. This would roughly represent 18.72% of the net worth of the company. So, why was it rejected?
SEBI rejects the buyback
SEBI had a very technical reason for the rejection. As per the buyback rules, the debt equity ratio of the company should not exceed 2 after the completion of the buyback. On a consolidated basis, the debt/equity ratio of L&T stood at 1.77 prior to the buyback. Post the buyback, after extinguishing 18.72% of its equity, the debt equity ratio would cross 2. The logic that if the debt/equity is more than 2 then the primary focus should be on repaying the outside creditors and improving its financial solvency rather than rewarding shareholders with buy backs. But did the massive legal and secretarial team of L&T not know about that? The confusion arises in the definition of debt. The SEBI rules on buybacks are silent on whether the debt considered should be stand alone debt or consolidated debt. L&T had planned the buyback based on standalone debt while SEBI preferred consolidated debt as per its own internal policies. That is what the debate is all about.
Why L&T is wrong here
L&T has contended that since the SEBI rules were silent on the definition of debt, the company had considered standalone debt rather than the overall consolidated debt. If you think about it L&T has made the basic error of form versus substance. The finance teams of L&T had taken a form approach instead of taking a substance approach. A substance approach would clearly point out that if only the stand alone figures are considered then it would be very easy for any large company to shift its loans to the books of subsidiaries and reward its shareholders with regular buyback of shares. In case of L&T, most of the debt is in the books of L&T Finance, which is the NBFC subsidiary of the group. It is surprising that the L&T finance team would have interpreted the rule book so naively.
There is the IL&FS impact
After the IL&FS default, the government has become extra careful on this parent subsidiary demarcation. The whole problem with IL&FS was the convoluted web of group companies that made it difficult to get the real picture. So L&T can keep adding debt in the books of the finance subsidiary and keep doing buybacks at a premium in the parent company. Obviously, that would not be in the interests of the shareholders. It is surprising that the L&T finance team did not think about this!
