Disinvestment Dilemma

IMG_9229SWhen I recently read the OM issued by the DIPAM (that is Department of Investment & Public Asset Management) regarding Capital Restructuring of CPSEs, it brought back some very old faint memories of a lecture in Strategic Finance, on a rainy day, when the raindrops competed with the professor for my attention.

However the Professor was too good and held court very effectively with his knowledge and humour. He took us through a few case studies on the various ways shareholder returns can be maximized in a tax efficient manner. The rains, although very beautiful and melodious had lost out, but only for an hour. For the post class the analysis session was done in the open café enjoying the hot snacks to the tunes of the raindrops.

Firstly when we talk about shareholder wealth maximization through strategic capital restructuring, at the base we are talking of profit making companies with a positive networth to which every year some more digits are added. As a rule, we are not talking about making more profits, but making the most of the profits which have been made in the most recent year and making the most of the profits earned in the past, which currently sit cozily in the balance sheet.

How does it work in the context of the Central Public Sector Enterprises? No not at the level of the corporate, for at that level, the principles of corporate restructuring through buy back are the same. Things change in the broader context. These are CPSEs.

There are fifty profit making CPSEs listed on the stock exchange. Calling them behemoths would be an understatement, for together these fifty account for almost 12-15% of the NSE market cap. They operate in various industries and are broadly at the core of our economy. If any of these sneeze, the economy can catch severe cold.

The Government had got into business intentionally as part of our Planned Economy venture. However, somewhere during the late 90s the Government partially realized that it should not be in the business of mining coal, or gas or making power etc…Of course this realization was prompted by huge fiscal deficits and which was to be bridged by selling the “family silver”. So since then infrequent disinvestment rounds has fetched Rs 1.54 trillion INR. Some innovative steps like an ETF of CPSE stocks was also tried.

However in recent times the Government has been falling short on collecting money from the capital markets by hawking its family silver.

Year Target (Rs cr) Actual ( cr)
2009-10 No target 23,553
2010-11 40,000 22,144
2011-12 40,000 13,894
2012-13 30,000 23,956
2013-14 30,000 (excl sale of residual Govt stake) 15,819
2014-15 36,925 (excl sale of residual Govt stake) 1,771


Now these 50 CPSEs with their overwhelming dominance of the market cap, touching 15%, can

easily swing the market earnings multiples and other parameters that analysts use to guage the quantitative and qualitative state of the capital markets. These CPSEs have a large influence on the overall health of the stock market, which thereby necessitates a better financial performance from the management of these CPSEs.

Government of India has a responsibility for the overall economic prosperity and thereby for the overall health of the stock market which acts as a barometer for the broader economy. Towards this responsibility, since it has management control of the CPSEs, it is imperative for the Government to ensure that the CPSEs work to deliver superior financial performance and maximize shareholder returns.

And then at the next level, as majority shareholder, it needs to influence the management to deliver maximum returns, in the form of cash, directly in the hands of the shareholders.

So the latest Memo from the DIPAM, intends to achieve the same through capital restructuring and mandates the following:

  1. Every CPSE would pay a min annual dividend of 30% of PAT or 5% of networth whichever is higher;
  2. Every CPSE having a networth of atleast Rs 2,000 cr and Cash (bank balance) of over 1,000 cr  shall exercise the option to buy back their shares;
  3. Every CPSE shall issue bonus shares if their defined R&S is equal to or more than 10 times of its paid up equity capital;
  4. Every CPSE, where market price or book value of its share exceeds 50 times the FV will under take stock split.

More or less all these guidelines work under the assumption that not just these companies are very profitable, there is good cash flow, and there are inadequate expansion opportunities available.

Now may be some of these guidelines may not necessarily be independent of each other. Like between bonus and stock split essentially ends up achieving the same thing, i.e. bring the stock price down to a popular tradable level.

IMG_1601.JPGBut on the whole it is good to see the majority shareholder cracking its whip on the management, to maximize returns for the shareholders. Considering that retail investors own on average 5% in these CPSEs, it is good for the small shareholders also.

There are many scenarios in which a company may consider using these Capital Restructuring strategies like buying back, but there is only one reason why it should be done, i.e. to benefit the shareholder. From the company perspective, these restructuring tools like stock split it is but a (in real terms it is much more than) a simple book entry on the liability side by which the composition of the Paid Up Capital changes. Or in the case of a Buyback, instead of giving cash dividend to shareholders the company gives cash for shares, but in the process reworks its capital structure, by effectively reducing the balance sheet size.

There are a couple of more things that the DIPAM could have done, which would have led to improve the operating and financial performance of the companies without getting into micro management. Probably appoint a consultant who can study the operations and make suggestions which the management should be duty bound to implement to improve operational performance so that the operating cash flow improves. The DIPAM might as well give operational targets on various parameters to the management with the usual carrot & stick that is commonly practiced in the private sector.

Secondly, while it is within the government’s right to get as much as cash (in the form of dividend or buyback) from the CPSEs, we are missing out woods.

Instead of focusing on maximizing returns on its holdings in these CPSEs, we need to ask does the Government need to have these holdings. Not just in these 50 CPSEs, but also in the other hundreds of PSUs. The disinvestment program needs to be restarted and taken to its logical conclusion.

The white elephant called Air India is the best example of how not to manage CPSE. It is debt ridden.

It makes operational losses. Sometimes it flies, and whenever it does so, it tells the world, very proudly, that the Government of India is in the airline business. It is a dilemma.

And the concerned hon minister claims that no one would be interested in buying the airline. If that is really true, this may sound naive, then why the airline still not closed down?


by sanjayshankar

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