To accept or not to accept an offer…

What is an open offer?

Let us first understand what an open offer is. Let us assume that there is a corporation that wishes to buy more than 15 per cent of the shares of a particular company. In the interest of small shareholders,the Securities and Exchange Board of India (Sebi) has passed a regulation regarding this matter. The regulation states that such a large buyer must offer all the shareholders a chance to sell their shares to him. This offer,which is made by a large buyer to all the shareholders,is termed as an open offer. Open offers typically arise when there is a change in a companys promoters or in case existing promoters wish to increase their share holding in the company. Sebi guidelines stipulate that the minimum price a buyer must offer to take the shares from the existing shareholders. However,depending on the situation the price offered can be higher or lower than the prevailing market price, I said

Would the decision to tender the shares in the open offer or sell them in the market be based on the difference between the two prices? Shahid asked as we walked along.

Yes,it would. Let us consider one case at a time. But please remember we are discussing only long-term investors like you who have held the stock for at least 12 months, I said. Shahid nodded.

Market price higher than open offer

In the first case,let us assume that the market price is higher than the open offer. In such a situation,it is best to sell the shares in the stock market. The advantage of a stock market sale is that it is exempt from capital gains tax. This is not the case if the shares are tendered in the open offer. In an open offer,the profit made on sale of shares is liable to long-term capital gains tax at the rate of 10 per cent.

Oh,so its tax free if sold on the stock exchange and taxable if tendered under the open offer, Shahid said.

Yes,that is correct for any stock held for over 12 months, I replied.

So why should one ever consider tendering shares in an open offer?, Shahid queried.

Offer price higher than market price

If the open offer price is much greater that the market price,then one may consider the open offer. The decision on whether to opt for the open offer is simple mathematics. First,find the difference between the open offer price and your purchase price. This is essentially the profit that you would make. Since your income is already above the taxable limit,you will be liable to tax at 10 per cent on this amount. Therefore,the post-tax profit would be 90 percent of your profit calculated above. Now calculate the profit that you would make if you sold it on the stock market. If the former is higher,then the open offer is better.

Simply put,one can avail of the open offer if the following holds true:

(Open offer price – Purchase price) x 90 % > Stock market price-Purchase price

Thats simple enough. Is there any thing else that should be taken into account before opting for an open offer? Shahid asked.

Yes,usually the open offer does not buy all the shares that you own but only a part of them. The minimum open offer is for 20 per cent of the shares. This means that if you own 100 shares of the company the maximum that the company will buy from you is 20 shares. The remaining 80 will be returned to you. So,if you wish to continue to hold the stock for the long term,you could go in for the open offer and re-buy the same number of shares from the market at a lower price, I said

Thats wonderful. So I continue to have the same number of shares and have received some extra money from the open offer, Shahid said.

Conclusion

That is correct. So in conclusion,if the market price is higher than the open offer and you wish to dispose of your shares use the stock market. If you wish to hold them since you believe that it is a good stock,do nothing.

On the other hand,if the open offer price is higher and the formula states that you should tender the shares,then go ahead and do so. Thereafter,if you do not want to hold the remaining shares you will have to sell them in the stock market. However,if you would like to continue to hold the stock for the long term,then tender the shares in the open offer and buy the same quantity back at a lower price from the stock market.

Shahid laughed. You really make it sound simple. I no longer need to keep asking various people what I should do in case of an open offer. I just need to follow the above steps, he said.

The remainder of our group had marched on far ahead of us. Lets catch up with them, I suggested. We hastened our pace.

The author,a certified financial planner,is the chief executive of Sardesai Finance. ceosardesai.com