M & A CritiqueThe Central government has set a very ambitious disinvestment target for the current financial year. The Union Budget 2016 has set a target to raise Rs 56,500 crore through direct stake sales this fiscal — Rs 36,000 crore from sale of minority stakes in Public Sector Undertakings (PSUs) and Rs 20,500 crore from strategic disinvestment. The progress has been quite encouraging as the Modi government wants to make state-owned companies efficient and sell the loss-making ones.
In fact, the first six months of this fiscal (April to September FY17), the government has managed to raise Rs 21,000 crore by nudging five state-owned companies to go for share buyback and stake sales. Of these, Rs 16,500 crore came from buybacks in five state-owned companies. This achievement is highest ever half-yearly mop up by any government (previous high was Rs 13,000 crore FY 16) and the proceeds are already at 38% of the combined target and 58% of the minority stake sale and buyback target.
Share buyback: The preferred route
The tested option of buyback will be the white knight this year when it comes to disinvestment. The government is effectively tapping share buybacks by cash-rich PSUs for divestment if its stake. In other words, money will be transferred from the company to the promoter /r the government. Given the poor response to the government’s divestment issues in the past and maybe not right valuation, where state-owned Life Insurance Corporation of India had to bail the government out in most cases, it is relying more on buybacks this time.
The five state-owned companies, whose boards had approved the buybacks earlier and have successfully carried them are Coal India, NDMC, Nalco, Manganese Ore (India) and Bharat Electronics. The five-stake sales (offer for sale) which the government carried successfully to raise Rs 4,500 crore were NHPC, Hindustan Copper, NTPC, Indian Oil and Engineers India (the last three companies’ OFS were for employees).
One of the reasons for the stellar performance in disinvestment this year is because of the fact that the Department of Investment and Public Asset Management had come out with new guidelines in June on the capital restructuring of state-owned companies. The new guidelines underlined the fact that every central public sector enterprise with a net worth of at least Rs 2,000 crore, cash and bank balance of Rs 1,000 crore, will have to exercise the option of buyback of shares. As a result, more is expected to come from this route by the time the financial year ends. In fact, a total of 34 central PSUs hold about Rs 1.8 trillion in cash and equivalents – a cash pile that will be handy in case government wants more buybacks this fiscal. So, when the markets are volatile and there is a low appetite for government stocks, the government would look more into buybacks.
Why buybacks
The state-owned companies have been asked to buy back shares to the extent they can by the amount equivalent to 25% of the aggregate of their fully paid up share capital. Buybacks help improve financial parameters of the firms. This, in turn, improves investor’s interest in the firms, which enables companies to tap the equities market for funds when needed. Public sector companies look at buyback when share prices are low. Buyback reduces capital and improves earnings per share and even return on equity of the company.
The government prefers buyback because the transaction cost is low and can be done quickly. It is also suitable for those companies which are cash rich and have no capex plans. The downside with buyback is that it has a lock-in period as Securities and Exchange Board of India has made a regulation which does not allow the company to access capital for six months after a buyback is done.
Strategic sales
In order to cut back losses, the Cabinet Committee on Economic Affairs has given the approval to sell loss-making state-owned companies and subsidiaries to strategic buyers. This decision will roll the ball for privatization, which would help turnaround the loss-making companies and run efficiently. It will be strategic sales through a two-stage auction process, in which bidders will have to place technical and financial bids. Strategic sale refers to transfer of management control and ownership. Some of the companies approved for strategic sales include Scooters India, Pawan Hans, Bharat Pumps & Compressors, Central Electronics Ltd, Hindustan Newsprint and units of Cement Corporation of India.
In fact, Bharat Pumps is the first case of a strategic sale in 12 years as successive governments had put the process on the backburner due to the fear of triggering a controversy over valuations and backlash from trade unions and political parties. However, the Modi-government had unveiled the move to resume the strategic sale programme in last year’s budget. The government has identified the companies that are profitable and some that aren’t but have big asset bases. The key criterion is that none of them are engaged in areas that are strategically critical for India. In all the cases the valuation and the process will be sorted out by the core group of secretaries on disinvestment and the valuation will take into account immovable property and other assets. Valuations would typically take 2-3 months and various approvals have to be taken before some of the sick PSUs will be sold to buyers.
In the case of unlisted companies such as Certification Engineers International Ltd, which offers third-party consultancy, the government will exit completely, offering 100% equity. In the case of listed companies, the government will lower its holding to less than 49% to free them from state control. In fact, the government aims at delivering substantial progress by the end of this financial year. Selling off the three loss-making plants of Steel Authority of India will help improve the valuation of the profitable company. Similarly, Container Corporation is a zero-debt company worth over Rs 25,000 crore in market cap and is profit making. Also, companies like Air India will also be in the list of stake sale, but the government will wait for some time because it had announced a revival package and now wants to see its result.
The NDA government had in its previous term during the Prime Ministership of Atal Behari Vajpayee followed a privatisation strategy and sold off companies such as Maruti, VSNL, Balco and Hindustan Zinc. However, the Manmohan Singh government could not further privatise because of pressure from the Left parties. That the Narendra Modi government will follow the footsteps of the Atal Bihari Vajpayee government in embarking on the path of privatization was hardly surprising. Apart from looking at divestment, the government must chalk out a plan to improve the working of the country’s public companies and make them profitable.
