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ESOPs now offer bargaining power to employees in M&As
May, 07th 2008

In India, when takeovers happen, the promoters walk away with the lions share of the spoils. Minority shareholders benefit too, though not always.

But employees usually are left facing uncertainty. The growing trend of issuing employee stock options (ESOPs) may give them a new-found importance in M&A situations. This is seen in the case of Dabur Pharmaceuticals (Dabur), which is to be acquired by Fresenius Kabi, an international pharmaceutical firm.

Fresenius has acquired the promoter shareholding in Dabur at Rs 76.50 a share for Rs 782.6 crore. It is also making a 20% open offer as per Sebi norms at the same price.

The share purchase agreement between Fresenius and the Dabur promoters is contingent on certain events. Ajay Vij, CEO, will get Rs 2.7 crore as payment from Dabur as per his employment agreement due to the sale. Moreover, Fresenius will also acquire shares held by Ajay Vij and four other named employees, for Rs 1.77 crore and Rs 93.3 lakh, respectively. But this is not all. These employees have to surrender their ESOPs, too.

Fresenius aims to acquire a 75.7% stake in Daburs Rs 15.7 crore equity capital, a level which gives absolute control. But if one adds the ESOPs in circulation, then Daburs equity capital increases to about Rs 15.9 crore. Then, the new owners stake will fall below 75%.

Thus, one of the conditions of the acquisition is that Ajay Vij and four employees will surrender their ESOPs, getting about Rs 14-15 crore in cash in return. Other employees of Dabur Pharma, too, have an option to surrender their ESOPs and can get a consideration of about Rs 8-9 crore, depending on acceptance levels.

The price at which the ESOP holders are being compensated is Rs 94.81 or Rs 101.31, depending on the prevailing short-term capital gains tax (to be known once the Finance Bill is passed). This, at first, seems unfair because shareholders are being offered a lesser amount of Rs 76.50. Note that this money is being paid by Dabur and not the acquirer, yet that is no reason to affect share valuations.

The difference, according to a company official, is apparently due to the money being charged as income in the hands of the employees. At the highest tax slab, it will be taxed at 30% plus surcharge and education cess as applicable.

Instead of the ESOPs vesting over a period of time and then exercised later, we are giving an option to employees to surrender their ESOPs. They are being given a higher price to compensate for the 33% tax that will be applicable on this income, said Nikhil Kulshreshtha, company secretary and head-legal, Dabur.

The higher amount is also to compensate for the fact that these shares would have normally accrued over a period of time. He also stresses that this is just an option given to these employees. While that may be the case, the CEO and key employees had to surrender ESOPs as part of the acquisition agreement.

Minority shareholders may not take kindly to this view, as they pay tax too. But the company says that long-term shareholders will pay negligible tax on the profits earned from selling shares in the open offer. That may be true, though how many will sell at this offer price remains to be seen (just before the acquisition announcement, the market price was Rs 69).

This case is perhaps one of the few where employees have made a windfall from the sale of their company. Whether there is a need for some clarity on the pricing of surrendered ESOPs in such cases is, perhaps, a matter for Sebi to examine.

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