“Protecting Those Who Invest in the Future of Brazil” 1
Download “Protecting Those Who Invest in the Future of Brazil” 1...
S erv i ço Pú b li c o Fed era l
“Protecting Those Who Invest in the Future of Brazil” 1
CURRENT ISSUES ON DELISTING REGULATION The
need to strengthen the delisting regulation was highlighted by the growing number of delistings that took place since the end of 1998.
process began with privatization and the general capital restructuring that started to take place in Brazil in the mid 90s.
low valuation of companies in Brazil created an opportunity for foreign controllers to buy back shares, thus delisting the Brazilian subsidiary, since they could raise capital at much better valuations in their country of origin. 2
NUMBER OF DELISTINGS
MAIN CONCERNS WITH THE DELISTING PROCESS Lack of liquidity and high concentration of volume traded in a few stocks. 1998
Market Capitalization (US$billion) (1)
Daily Volume–BOVESPA (US$million) (1)
Brazilian ADRs ( listed in NYSE)–Daily Volume (US$ million) (2) Market Capitalization/GDP(4)
Concentration (10 most negociated) (3)
(1)Bovespa; (2)Bovespa; (3) CNBV/Bovespa; (4)Bovespa
MAIN CONCERNS WITH THE DELISTING PROCESS
Low free-float Lack of equity culture. No retail market
Petrobras recent issue helped fuel Brazil`s equity Culture Internet trading Bovespa's Traded Volume in 2000 by Type of Investor Companies 4% Institutional Investors 17%
Other 1% Financial Institutions 37%
Individuals 19% Foreign Investors 22%
DISGUISED DELISTING #1 -BYPASSING INSTRUCTION 229 Controllers
were delisting companies in a disguised
way by circumventing CVM Instruction 229 of 1995, which regulated the delisting process. They
would simply acquire shares in the market until
no liquidity remained and them they would make a tender offer to buy the remaining shares.
DISGUISED DELISTING #2 -PROBLEMS WITH INSTRUCTION 299 CVM
puts out Instruction 299 in February 1999 to
regulate voluntary regular tender offers. According
to Instruction 299, if a controller wants to
buy more than 10% of the free-float, he has to make an offer to acquire all shares in the market. This
gave birth to another kind of disguised
delisting, which we will call disguised delisting #2. 7
DISGUISED DELISTING #2 -PROBLEMS WITH INSTRUCTION 299 In “disguised delisting #2”, controllers offer to acquire all free-float, but without intending to cancel the CVM registration, i.e., to officially “go private”. At this point it is important to mention that companies can buyback all shares and still be rated as a “public company”. Many companies go public in Brazil to issue debt instruments, but they do not list shares in the stock exchange. As we mentioned before, Instruction 229 regulates the process of going private (also known as delisting). 8
DISGUISED DELISTING #2 -PROBLEMS WITH INSTRUCTION 299 Controllers would file for Instruction 299 (voluntary tender offfer) and not for Instruction 229 (going private). The difference is that the former is much less protective than the latter.
According to Instruction 229, the delisting is only possible if 67% of free-float agrees to sell. In this case, a put option is offered to the shareholders remaining in a private company. Instruction 299 did not have such provisions. 9
DISGUISED DELISTING #2 -PROBLEMS WITH INSTRUCTION 299 Many companies were artificially delisted with this scheme and sometimes were left with less than 5% of free-float in the market.
% of ON freefloat acquired Coelba Cesp Paranapanema CPFL
% of ON shares left % of PN freeover as Freefloat acquired float
% of PN shares left over as Free-float
DISGUISED DELISTING #2 -PROBLEMS WITH INSTRUCTION 299 This new kind of artificial delisting created what we call “the liquidity dilemma”. In deciding whether or not to sell their shares in a tender offer, minority shareholders would no longer see the fairness of the price offered as the only variable to be taken into account. Minority shareholders would have to find out whether or not large shareholders will agree to sell. In case they do, the risk of remaining with an illiquid stock, drives minority shareholders’ decision to sell even if they think the price is unfair. 11
MORE PROBLEMS WITH “OLD” TENDER OFFER INSTRUCTIONS #229 AND #299 Liquidity issues also reduced the protection effect of Instruction 229 (delisting), because: If a group of shareholders was active enough to join some 35% of free-float against the delisting process and therefore no official delisting would occur, it may seem that this group was successful in their aim, but what did they really got out of it? The answer is: a huge problem, since 65% of the free-float would have been bought by the controller and the remaining 35% would not have the put option since the delisting did not occur. Thus, the 35% “successful” group was left with an illiquid stock. 12
FIRST STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 Instruction 345 of September 2000 rescued the spirit of the delisting and tender offer instructions through the reestablishment of an effective protection against the “liquidity dilemma”. Currently, over a period of 2 years, a controller unable to acquire 67% of the free-float, will not only lose the opportunity to delist the company, but he also will only be allowed to buy 1/3 of the free-float.
In this way, there is no buy-back between 33% and 67% of the free-float. 33% seems to be a reasonable figure to avoid liquidity shrinks and 67% seems to be a number high enough to legitimate the choice for delisting. 13
FIRST STAGE OF REFORM OF INSTRUCTIONS #229 AND #299
Furthermore, Instruction 345 has also eliminated “disguised delisting #2”.
It allows controllers to acquire all shares without officially delisting the company. They will file for instruction 299 with CVM. However, in order to acquire all shares, he will always also have to follow rules included in instructions 229 and 345, which are more strict and determine that there is no buying back between 33% and 67%. Some controllers might wish to acquire all shares without officially delisting the company in light of privatization rules forbidding delisting and/or wish to remain “public” to issue debt instruments. 14
FIRST STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 Another critical change introduced by instruction 345 was the granting of a put option to everyone remaining in the company after a 67% buyback -- even if the controller did not wish to officially delist the company. However, instruction 345 was issued in a hurry in order to immediately cease the “liquidity dilemma”. There are several other issues deserving significant changes in instructions 229 and 299.
A new and complete reform of all delisting instructions (229, 299 and 345) should be issued in April. The main changes compared to the present rules should be: 15
FIRST STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 n
Current In order to delist a company, more than 2/3 of minority shareholders stating their opinion about the delisting must agree with the proposal. Example: In a company with 100 shares, the controller has 51 shares. Out of the 49 shares composing the freefloat, only 21 shares replied to the proposal. Out of this 21, at least 14 shares have to agree with the delisting or the deal is canceled.
Future In order to delist a company, more than 2/3 of the entire freefloat have to be in favor of the delisting. Example: In a company with 100 shares, the controller has 51 shares. Out of the 49 shares composing the free-float, 2/3 or 33 shares must agree with the proposal. If only 21 shares show up to state its opinion, this will not be enough to reach the minimum quorum. The controller will have to look for the remaining 12 shares (33-21) and convince them to agree with the delisting. We believe this will significantly enhance the guaranty of a fair price. 16
SECOND STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 Current
The auction is set up with a given price which cannot be changed if the 2/3 quorum is not reached. Another proposal can only be made in 2 years time.
If, during the auction, the proposed price is only able to convince less than 67% of the free-float to sell their shares, the controller will have the option to offer a higher price right away and see if he can get 67% to agree. All this will occur during the auction. If the controller does not wish to raise his offer price to reach the 67% minimum quorum, then, another offer will only be possible in 2 years time.
SECOND STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 n
Current The broker dealer advising the controller has to declare if he has any mutual funds under his management possessing shares of the company to be delisted. If he has, this shareholder position has to be disclosed and the intention to accept the offer or not has also to be disclosed.
Future We are broadening the concept by including not only funds under the advisor management, but also groups linked to the advisor, such as insurance companies, asset managers and so on. But they will not have to disclose their intention as to wheter or not to accept the offer. 18
SECOND STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 n Current The controller chooses the offer price and provides CVM with a valuation report justifying the price. There is no explanation for the valuation criteria chosen, neither any information about what the price would be under other criteria.
Future The controller has to deliver a valuation report disclosing the price under 3 criteria: i) net worth; ii) average of stock price during the last 12 months; iii) economic value (discounted cash flow or multiples). Then, he has to justify why he chose any of these criteria. 19
SECOND STAGE OF REFORM OF INSTRUCTIONS #229 AND #299 n
Current The shareholders list is not included as a necessary document to be delivered to CVM in order to get our approval.
Future Shareholders list will be included as a necessary document to be delivered and it will be available for the public during the offer. This will facilitate a proxy fight.
CONCLUSIONS ABOUT DELISTING AND TENDER OFFFER PROCESSES A guiding principle for equitable treatment of shareholders in delisting or tender offer processes is to ensure that investors will be able to focus on the fairness of the price offered instead of having their decision influenced by other factors such as a “liquidity dilemma”. It is not the task of the regulator to avoid delistings and tender offers -- in fact, in our opinion, if a company does not have the proper culture to be a “public company”, then it should really file to go private or to acquire all its shares.
However, the regulator has to ensure that the rules of the process are fair and that the disclosure level is appropriate to feed investors with sufficient information to decide whether to sell or not. 21
CHANGES IN CAPITAL STRUCTURE
REGULATION ON STOCK ISSUANCE According to our Corporate Law, (Article 168) the Bylaws can rule about the authorization to increase capital. This authorization should specify: the limit of increase whether the GSM or the Board of Directors will be responsible for deciding about the issues
in which conditions shareholders will have preemptive rights or not (article 172).
Article 172 determines that the Bylaws can provide for a capital issuance with no preemptive rights if: the sale is made either on the stock exchange or through a public offering. 23
EXPERIENCE WITH RESPECT TO STOCK ISSUANCE The majority of companies choose to grant preemptive rights in capital issuance. In case of significant capital increases aiming to reach a large number of new investors, most companies grant 30 days to current shareholders to exercise their preemptive rights. However, there are cases of small capital increases or newly listed companies disclosing a need to raise capital constantly, in which preemptive rights of only 2 to 5 days are granted. 24
MAIN CONCERNS IN STOCK ISSUANCE The guiding principle for equal treatment in capital increases has been the fairness of the dilution resulting from the capital increase. The regulator has been focusing on ensuring the enforcement of article 170, which establishes that the issue price has to be determined by one of the following parameters: (1) market value; (2) book value; (3) profitability perspectives. The aim is to avoid an unjustifiable dilution of the stake of minority shareholders. 25
SHARE BUY-BACKS CVM Instruction 10 established that companies are allowed to buy back a maximum of 5% of outstanding shares. In 1997, CVM amended instruction 10 to allow a buy back of 10% of outstanding shares because the overall stock market was going through a low valuation period (Asian crisis). A return of the 5% limit is under study -- however, the 10% limit could be allowed in cases of a later cancel off of the shares acquired. 26