Valuation of Shares - New Pricing Guidelines

In order to make the pricing methodologies more compatible with the current valuation practice, the Reserve Bank of India has issued the Notification Number FEMA 205/2010 (the New Notification) on April 5, 2010 which shall come into force with effect from April 21, 2010. The New Notification aims at providing more clarity on the pricing of shares issued by an Indian company to Non Residents and also brings with it an array of questions which would need clarification to make the guidelines fully effective. The salient features of the New Notification are enumerated below. I have tried to capture the difference between the regulations as they exist now vis--vis after the issue of the New Notification.

I.

PRICING GUIDELINES AS APPLICABLE TO ISSUE OF SHARES TO NON RESIDENTS

Current position The current provisions state that an Indian company must issue shares to non resident investors at a minimum price which should not be lower than: Valuation Criteria For Companies whose shares are listed on a recognized stock exchange Valuation Method Price worked out in accordance with the applicable Securities and Exchange Board of India (SEBI) guidelines For Companies whose shares are not Fair valuation of shares, which is required to be undertaken to by a Chartered price in Accountant determine the

listed on a recognized stock exchange

accordance with the erstwhile Controller of Capital Issues (CCI) Guidelines Provisions specified under the New Notification The New Notification now mandates that the price on issue of shares by an Indian company to a non resident should not be lower than:

Valuation Criteria

Valuation Method

Change from existing provisions

For

Companies listed

whose on a stock

Price worked out in accordance with the applicable Securities and Exchange Board of India (SEBI) guidelines

No Change

shares exchange For

recognized

Companies

whose stock

Fair SEBI

valuation registered

of

shares

SEBI category merchant bankers can also carry out the valuation in addition to Chartered Accountants DFCF method of valuation replaces the CCI guidelines

shares not listed on a recognized exchange

required to be undertaken by a CategoryI or a in Merchant Chartered accordance Free method Cash as Banker with Flow computed

Accountant,

Discounted (DFCF) under

Preferential Allotments

Price to

RBI has not prescribed any new guidelines in this relation. As per the current regulatory framework, the CCI guidelines are to be from applied for transfer of shares of Indian unlisted companies Indian residents to non residents.

transfer of shares from resident non resident in accordance with the RBI guidelines issued from time to time.

Authors Insights The CCI guidelines for the valuation of shares of unlisted companies use conservative method of valuation by considering an average of the Net Asset Value (NAV) of the company and the companys Profit Earning Capacity Value (PECV), which was arrived at based on its past financial performance. Whereas the notification instead specifies DFCF method which is based on future free cash flows. Since the valuation of shares is a future oriented practice, DFCF method is more appropriate as compared to CCI Guidelines. Also price to be computed using the DFCF method would normally be higher than that computed under the erstwhile CCI guidelines.

II.

PRICING GUIDELINES APPLICABLE TO RIGHTS ISSUE

Current Position The FEMA regulations required that if an Indian company issues shares by way of right issue to a non resident then the price of such shares should not be less than the price at which such offer of right issue is made to an Indian resident investor.

Provisions specified under the New Notification The New Notification now mandates that in case of right issue of shares by an Indian company to a non resident the price should not be lower than: Valuation Criteria For Companies whose shares listed on a recognized stock exchange For Companies whose shares not listed on a recognized stock exchange Authors Insights The New Notification gives more realistic approach to the pricing of right issue. Now the price of the right issue of listed shares would be determined on the basis of prices of such shares at the time of issue, which gives more appropriate basis of pricing. Grey Areas Some areas have been left untouched by the New Notification and require greater clarity from the government: In relation to pricing of shares, the New Notification defines three methodologies; it is unclear whether these methodologies are to be read independently or cumulatively. The meaning and scope of a preferential allotment, particularly in the case of a private limited company is not spelt out and consequently the treatment of cases that would not qualify as a preferential allotment is also unclear. The status of the applicability of pricing guidelines on share application money received but pending allotment on the effective date of notification is not clear. Price at which such offer of right issue is made to Indian resident investors Valuation Method Price as determined by the company