Market Sounding: How Appetite Is Tested Without Leaking

A market sounding is asking a small number of parties whether they would participate, before anything is public. A sounding is a trade: the transaction gains information about appetite and pays for it in people who now hold information they may not act on. Every party sounded is a decision, and the count is never a detail.

The awkwardness comes first. Everything else in a sounding follows from it. Asking somebody whether they would lend into a purchase that has not been announced makes the question itself carry the news. There is no phrasing that asks without telling. The moment the call ends, a person who did not know that something was being planned now knows, and no amount of care in the wording takes that back.

Take it out of the transaction and into a house. A household is planning to add a room and needs to borrow about Rs 8 lakh to do it. Before signing anything with the builder, somebody rings two relatives to ask, quietly, whether they could lend that much if it came to it. The call is sensible. The call is also irreversible. Both relatives now know the household is short of money and planning something it has not told anybody about, and they will know it whether the room is built or quietly dropped. The household bought a useful answer and paid for it in two people who now hold a private fact. Nothing dishonest happened. A price was simply paid, and it was paid in a currency that is not money.

A market soundingA small number of confidential approaches made before anything is public, to find out whether parties would take part in a transaction or in the money that funds it. is that call, made by a company, about a transaction, at a size where the answer matters. Harivansh Packaging Limited is buying Sundarban Polymers Private Limited, and needs to know whether the money to do it is actually available before it commits to doing it.

What is a market sounding, and why would anybody make the call?

A sounding is a controlled set of approaches, made before anything is public, to find out whether parties would take part. Take part in what depends on the transaction. On a share sale it is investors who might buy. On a purchase funded with debt, the case here, it is potential lenders who might put up the money. The word that matters in all of them is appetiteWhether a party would actually take part, at the size being asked for, and roughly on what terms. Appetite is an indication and nobody treats it as a promise., and the whole exercise exists because appetite cannot be looked up anywhere.

Ask why the call gets made at all. The alternative is not obviously worse. The alternative is to commit first and find out later: agree the purchase, sign the paperwork, then go to the market for the money and discover what the market thinks. Committing first also produces an answer. The answer arrives after the company is already committed, when the only remaining choices are to accept whatever terms are on offer or to fail publicly. A sounding buys the same answer earlier, and the entire value of it is the earliness.

So the case for a sounding is easy to state and easy to overstate. The case is easy to state because finding out late is expensive in a way that finding out early is not. The case is easy to overstate because the cost of finding out early is invisible on any statement anybody produces. Nothing is spent. No fee is paid. The cost is entirely in the fact that people know something they did not know before, and that cost has a habit of being treated as nothing because it never shows up as a number.

Information about appetite is bought with people who now hold information they may not act on, and there is no version of it that is free. That trade is the whole of the subject. Every rule that follows, about who gets called, what is said, what is withheld, what is written down and when the calls should not happen at all, is somebody trying to get more of the first half for less of the second.

Where does a sounding actually arise on this transaction?

On the money, not on the purchase. Harivansh Packaging Limited has agreed an enterprise value of Rs 1,320 crore for Sundarban Polymers Private Limited. Take off the target's own net debt of Rs 180 crore, taken on by the buyer rather than paid over, and the equity value handed to the sellers is Rs 1,140 crore. The Rs 1,140 crore is funded two ways: Rs 140 crore of the buyer's own cash, every rupee it holds, and Rs 1,000 crore of new borrowing at its own contracted 9.0 per cent.

Now look at the second of those against what the company had already borrowed. Opening borrowings were Rs 740 crore. The new borrowing is Rs 1,000 crore, so the money being raised for this one purchase is about 1.35 times everything the company had borrowed in its whole life to that point. Borrowings go to Rs 1,740 crore and cash goes to nil. On the buyer's own borrowings against its own earnings before interest, tax, depreciation and amortisation (EBITDA) of Rs 477 crore that is 3.65 times, against 1.26 times before. Naming that basis matters. The consolidated pairing of Rs 1,920 crore over combined EBITDA of Rs 609 crore is a different figure again at 3.15 times.

Rs 1,000 crore of new borrowing against opening borrowings of Rs 740 crore is not a routine drawdown, and a purchase that depends on money nobody has yet agreed to provide is a purchase with a hole in the middle of it. That is the whole case for making the calls. Devyani Kulkarni, the chief financial officer of Harivansh Packaging Limited, does not need to know the exact cost before agreeing the purchase. She needs to know whether Rs 1,000 crore of this shape is available at all, from somebody, at a cost the transaction can carry.

The rupee value of the answer is what justifies paying for it. At the contracted 9.0 per cent, Rs 1,000 crore costs Rs 90 crore a year before tax and Rs 67.5 crore after tax at the 25.0 per cent effective rate. Nobody knows what a sounded party will say until the call is made. The sensitivity is knowable, and the sensitivity is why the call is worth making. Half a percentage point on Rs 1,000 crore is Rs 5 crore a year before tax and Rs 3.75 crore after it. An answer that moves the assumption by half a point is worth several crore rupees a year, every year, and it arrives before anybody has signed anything.

Notice where in the sequence this sits. The milestones on this transaction run approach and confidentiality, indicative offer and term sheet, confirmatory diligence, documentation, signing, the conditions period, completion. A funding sounding belongs early in that list, around the indicative offer and term sheet. The whole purpose of the call is to inform a commitment that has not been made yet. A sounding run after signing is not a sounding. Calls made after signing are shopping, under pressure, with no way out.

Who gets sounded, and who decides the list?

Two questions, and the second is the one that gets skipped. The first has a short answer: parties that could actually take part at the size required. Not parties who would find it interesting. Not parties somebody knows well. Parties for whom Rs 1,000 crore of this shape is ordinary business. A party that could never do it cannot give a useful answer and will still hold the information afterwards. The cost of asking is identical whether the answer is worth anything or not, and the asymmetry should govern the whole list.

The second question is who decides. On a controlled process there is a named approverOne person who has to agree a list before any call is made, so that every name on it is a decision somebody took rather than something that drifted.. One person agrees the list before any call is made, and the same person has to agree any addition to it afterwards. Here that is Devyani Kulkarni, and Ashwin Rege, who leads the transaction team, makes the approaches against the list she approved. Splitting those two roles is the point. The person making the calls is the person most exposed to the pull of adding one more name. Each conversation naturally suggests the next one.

The list is decided before the first call. A list that grows during the process grows for one reason only, and the reason is that each call suggests another. An addition is not forbidden. An addition has to survive the same approval as the original names and the same test: what would this party's answer change? If nothing, the name comes off, however plausible it looked when it was mentioned.

What is said, and what is deliberately withheld?

Enough to get a usable answer and not one word more. Enough and no more is the whole design rule, and it produces a call much barer than people expect. The party hears the shape of what is being asked for, the size, the kind of business it relates to and the broad structure. The party does not hear the name of Sundarban Polymers Private Limited. A lender can say whether it would look at Rs 1,000 crore against a packaging business of a certain profile without ever knowing which packaging business. The name adds nothing to the answer and multiplies what a leak would be worth.

Holding that line is why a fixed scriptThe set form of words a caller uses, so that every party hears the same thing and nobody improvises past the agreed line. exists rather than a general briefing. Improvisation is not a character flaw, it is what conversation does. A party pushes back, asks a fair question, sounds sceptical, and the natural human response is to add a detail that makes the case better. The script exists so that the line where the call stops was decided in a room, calmly, before anybody was on the telephone being asked a reasonable question.

Then there is the part of the call that comes before any of it, and it is the step everything else rests on. The party is asked whether it is willing to receive information about an unannounced transaction, and it answers, and only then is anything said. In market language that step is a wall crossingThe moment a party moves from the ordinary side of a firm's information line to the side that holds unpublished information about a live transaction., and it exists because being told and agreeing to be told are completely different things.

Asking first turns being told into something the party accepted rather than something that happened to it. A party that says no has cost nobody anything. The party has not been told, it is not restricted, and it can carry on exactly as before. A party that says yes has weighed the restriction against its interest in the business and chosen. Take the question away and the choice disappears with it, and what is left is one company deciding, on its own, to limit what another may do.

What does a sounding cost, and who actually pays it?

The company pays first, and pays in leak riskThe chance that information about an unannounced transaction reaches somebody who was never meant to have it.. Every party approached is another place the information sits, another set of people inside that party who may end up knowing, and another chance that something travels. Leak risk is the cost everybody counts. Leak risk is the one that lands on the company making the calls.

Then there is the half that gets forgotten, and it is the reason this subject is worth treating on its own. The sounded party pays too. A party that has been told about an unannounced transaction becomes a restricted partyA party that has been told something unpublished and therefore may not act in the name it now knows about until it is released., and can no longer act in the name it now knows about. The party may hold that name already. The party may have been about to trade in it, or lend to it, or take a position for somebody else. None of that is now available to it, and none of it was its own transaction.

A party sounded without warning has had a restriction imposed on it that it never asked for. The question always comes before the information for precisely that reason. Read the two costs side by side and the asymmetry is uncomfortable. The company chose to make the call and gets the benefit of the answer. The party did not choose, gets no benefit at all, and carries a real constraint for as long as the constraint lasts.

The household version is exact, once the second relative is followed rather than the first. One of the two relatives asked about the Rs 8 lakh was themselves about to commit that money elsewhere, and now cannot. The relative may be asked for it any day and cannot say why the money is being held back. The relative gained nothing, and was not even told the room was definitely being built. The second relative is simply carrying somebody else's plan in their pocket, and the only person who can put it down for them is the person who put it there.

How does a sounded party get back to normal?

One question ought to be answered before the first call is made, and very often is not. A party has been told. The party is restricted. Ending the restriction takes a definite step. The step is called cleansingThe step that returns a told party to normal, either because the information became public, or because it went stale, or because the party was told the process has ended., and there are three routes to it and no fourth.

The first is that the information becomes public. The transaction is announced, everybody can read it, and what the party holds is no longer unpublished. The second is that the information goes stale. Time and events move far enough that what the party was told no longer describes anything live. The third is the one that costs nothing and gets skipped anyway: somebody rings the party back and tells it the process has ended. That is it. A transaction that has quietly gone away has not cleansed anybody. Nobody outside it knows it has gone away.

A sounding with no cleansing path leaves the party restricted with no end in sight, and that is the single most common complaint of the people who take these calls. The complaint is rarely about being asked. The complaint is about being told something, hearing nothing for months, and having no idea whether the transaction is live, dead or waiting.

Which route applies is decided before the calls, not after. If the plan is that everybody learns when the announcement comes, somebody has to accept that a transaction which never gets announced still needs a closing call to every party sounded. If the plan is staleness, somebody has to be able to say what makes it stale. The routes are cheap to plan and impossible to invent afterwards. By then the process is busy with other things and the sounded party has stopped being anybody's problem.

What gets written down, and why does that matter?

Six things, and none of them is optional if the exercise is to be a process rather than a habit. Who was approached. When. By whom. Which version of the script they heard. Whether they agreed to receive it before they were told. And when they were cleansed. The six together are a sounding recordThe written log of who was approached, when, by whom, what they were told, whether they accepted it and when they were released., and it is a short document that takes about as long to keep as it takes to describe.

The record is what makes a sounding a controlled process rather than a set of phone calls. Without it, nobody can say how many parties hold the information, which is the number that matters most if it ever travels. Nobody can show that the question came before the information, and that ordering is the safeguard the whole approach rests on. And nobody can cleanse anybody. Cleansing means going back to a list, and the list is the record.

Notice what it is not: a new burden invented for this exercise. A transaction is already keeping a list of the people who hold information about it, settled where the insider list is the subject. The sounding record is the same kind of thing, extended outside the company. Same columns, same purpose, one more set of names, and the fact that those names sit at other organisations is exactly why they are the ones most worth writing down.

When should a sounding not happen at all?

Two cases, and one of them is honest in a way the other is not. The first is easy to agree with and easy to apply: when the parties who could say anything useful are also the parties most likely to talk. If the only people who can answer the question are the people through whom information reliably travels, the trade is bad on its face, and the fact that the answer would be valuable does not make the price worth paying.

The second is the one almost nobody applies, and it is the test worth carrying away. The question is what the buyer would do if the answer came back positive, and then what it would do if the answer came back negative. If the two answers are the same, the calls should not be made. If the buyer would proceed either way, the sounding buys nothing and costs exactly what a useful one would have cost.

The reason it goes unapplied is not stupidity. The reason is that a sounding feels like diligence. A sounding looks careful. A sounding produces something to report and a sense that the ground has been tested, and none of that is worth anything if the plan was never going to move. A transaction team that has already secured its money and rings four parties anyway, to see what the market thinks, has spent the identical currency and bought a conversation.

How does a lender, an analyst or a household read this?

Three readers, three different first questions, and none of them is the question the company making the calls is asking. Start with the party being sounded, the reader this subject usually ignores. A lender taking the call is not deciding whether the transaction is attractive. The lender is deciding whether to accept a restriction, and the first thing it wants to know is how the restriction ends. A caller who can say what cleansing looks like gets a serious answer. A caller who cannot has asked the party to accept an open-ended limit, and a careful party declines before hearing anything. Declining is a perfectly good outcome for everybody.

An analyst reads it from the outside and never sees the sounding at all. An analyst sees, if anything, a name behaving oddly before an announcement, or a rumour arriving with more shape to it than rumours usually have. An analyst cannot tell a widened sounding from an ordinary leak, and neither can anybody else after the fact. The problem is exactly that. The process that widened its list will look like carelessness even when every single addition was individually defensible.

An investor already holding the shares reads it as a governance question rather than a transaction question. Not was this transaction wise, a question nobody can settle from outside, but does this company know how many parties hold its unpublished information and can it say when each of them was released. A company that can answer both is running a process. A company that cannot is running a series of conversations and hoping.

The household reading is the one to keep. Before a relative is asked for money that has not yet been decided on, two questions need answering: what will be done differently once the relative answers, and how the relative will be told it is over. If the first has no answer, the call should not be made. If the second has no answer, the call has not been planned, only the question has.