Disinvestment: Government Weighs Its Options

The Finance Ministry has ambitious plans of mopping up huge funds through disinvestments and is considering a number of alternatives for doing so. While Amit Bhanot provides an analysis of the various routes the government can take to achieve its target and discusses their pros and cons, the OFS route seems like the most practical one.

The government is quite ardent on achieving its disinvestment target and has chalked out some plans to do so. Its successful disinvestment spree that enabled it to gross an all-time high of Rs 23920 crore in FY13, has instilled a sense of confidence to raise another Rs 40000 crore this year through a series of issues. 

As the Finance Minister is taking all possible steps to woo foreign investors for bridging India’s ever-increasing CAD, his ministry’s officials too are taking all possible efforts in this direction. The Department of Disinvestment (DOD), a key department under the Ministry of Finance, is working hard to ensure that the disinvestment target of Rs 40000 crore set for FY14 is met. Along with the usual Offer for Sale (OFS) method, the DOD is considering an array of different strategies to collect crucial funds including a buyback, Initial Public Offerings (IPOs) and Follow on Public Offers (FPOs). 

But the way the government has undertaken disinvestment in the last two years raises some key questions about the sanctity of the ways adopted for stake sales, particularly of blue chip PSUs. In fact, a parliamentary standing committee on finance under the chairmanship of Yahwant Sinha not only termed the government’s disinvestment policy as ‘selling family's silver to pay grocery bills’, but also called for a greater market penetration and encouragement to retail investors’ participation. 

The government certainly needs to resort to ways that attract more retail participation and this can be achieved efficiently via the OFS route, but that requires the government to generate awareness among retail investors regarding an OFS. Until now, retail participation in OFSs was very low owing to the confusion regarding their prices. “If we go by the benefits of OFS over other methods like FPOs, buybacks or even French Auctions, OFS certainly seems to be a better option. It saves on time and energy and the entire process can be carried out in a single day. Here, an investor can trade his scrip the next day, while it will take around eight to ten days in an FPO,” said Jagannadham Thunuguntla, Head of Research, SMC Global Securities.[PAGE BREAK]

For instance, look at the OFS of ONGC which came up last year. Although the stock price had taken a beating during the OFS period to reach a low of Rs 280 in March 2012, it gained almost 26 per cent to touch its 52-week high at Rs 354 on January 18, 2013. Now, in such a situation, institutions like LIC gained (as it had invested around Rs 12000 crore - may be as a bail out), retail investors faced losses. LIC, a few days ago, sold some shares worth Rs 8800 crore including those of ONGC bought at that time, thereby gaining heavily. Investors should thus go by the valuation of a company and participate in the OFS issues of good companies as they are likely to provide handsome returns. One can simply ask his/her broker to bid in an OFS which operates on a simple demand and supply mechanism for price fixation. 

The only disadvantage of an OFS is that it works on the principle of demand and supply which can sometimes lead to wide fluctuations in the share prices during and soon after the issue. “Investors need to understand that it is a temporary phenomenon and if the company’s valuation is good, it will certainly bounce back,” said Jagannadham. To keep this price volatility under check, the government is working on establishing a PSU Exchange Traded Fund (ETF), which will materialise in the next two to three months. 

According to the SEBI rules, only the top 100 companies with the highest market capitalisation in any of the last four quarters or companies which satisfy the minimum public shareholding norm (90 per cent of government holding in case of PSU companies) can come up with an OFS. Companies that do not satisfy these norms will have to opt for the lengthy and cumbersome FPO process.

PSU Exchange Traded Funds (ETFs): A Facilitator To Disinvestment

Stung by the sharp volatility in the share prices of PSU stocks soon after the disinvestment process, the government is all set to resort to a new mechanism. “While the Finance Ministry is in the process of planning for PSU ETFs since quite a few months now, the CCEA will soon take a decision on it. The ETFs will hit the markets in another two to three months as we are finalising the Asset Management Company (AMC) for it,” informed the DOD official.[PAGE BREAK]

Although the Kelkar committee had recommended the creation of a PSU ETF to satisfy the minimum public shareholding norms in PSUs, Haleem Khan, former secretary, disinvestment, suggested implementing another effective method to curb volatility. According to the proposal, a PSU ETF would have two to three per cent of the shares of listed PSUs and a diversified portfolio of shares (with companies from different sectors), each having a designated weightage. “We are deliberating on a few suggestions, one of which proposes an ETF with units of four to five big companies along with others that will be traded as a bunch. The final structure and modus operandi will ultimately be decided by the Empowered Group of Ministers (EGoM),” the DOD official said. Nevertheless, Goldman Sachs Asset Management and UTI Mutual Funds have been shortlisted to act as AMCs to the ETFs. 

A PSU ETF can definitely act as a facilitator to the disinvestment process. Currently, whenever the government plans to come out with a FPO or OFS of any PSU, the stock price goes haywire owing to the volatility and uncertainty surrounding the offer price. With the PSU ETF, the units of companies going for disinvestment can be freely traded throughout the year at exchanges with a proper weightage, which will help in minimising the price volatility. It will also aid the government in taking a professional view while deciding the price of an issue and the discounts offered to investors.

Buyback: A Tool To Scare Companies

Around a year ago, the government had allowed PSUs to buy back their own equities from the surplus funds available. Despite receiving an approval, this route hasn’t been availed to raise funds as an alternative to disinvestment. Under this option, PSUs which are rich in cash and cash equivalents can buy back their own shares at a much higher cost as compared to their market price. With the government holding a majority stake in PSUs, it would be benefitted with the sale of its stake back to the company. Experts feel that this will strengthen the market price of the stocks as the free float of stocks will come down and investors’ confidence in PSUs will be restored. On the contrary, it will pull funds from the PSUs’ coffers, thus disrupting their expansion plans. Thus various ministries and PSUs are dead against this route.

In fact, if you go by the cash reserves available with these companies, more than Rs 161000 crore (refer table) was available with around 28 PSUs till the year ending March 31, 2012. Of this, Coal India, ONGC, NTPC and Oil India have reserves of Rs 58202 crore, Rs 27871 crore, Rs 18091 crore and Rs 10936 crore respectively. The Finance Ministry is eyeing these funds to achieve its disinvestment target. But it does have an idea of the kind of resentment it is likely to face to execute this plan. “The ministry knows the pros and cons of the buyback route but to achieve the disinvestment target, it is using this measure as an effective tool to scare PSUs and other ministries to spurt up the disinvestment process,” said a DOD official on condition of anonymity. “So the choice is simple, tap the markets or leave the reserves,” he added.[PAGE BREAK]

Remember the SAIL OFS? It was successfully executed in March 2013 (after being deferred a couple of times earlier), soon after the company had been directed deliberation on the buyback option as an alternative. In this fiscal too, the government may use the same tactic, while the buyback of shares can also take place in some cases like Coal India. However, the OFS and FPO routes will be primarily used. “Another benefit of opting for buyback is that it usually doesn’t hurt the secondary market price of the company, which can tap the markets with an FPO whenever its valuation is good,” the DOD official commented.

The OFS route thus looks like the most prudent route for the government to meet its disinvestment target while ensuring inclusive participation at all levels. We leave you with a good initiative that the government is about to launch to safeguard investors from stock price volatility in PSU stocks once they enter the markets with an OFS.