How to privatise PSUs
T Thomas
The current setback to the government's privatisation programme has created an opportunity to reflect on the real purpose of divestments and to seek alternatives to achieve this goal.
Whilst realisation of the best possible value from public sector undertakings, or PSUs, has to be a key objective, the over-riding purpose of privatisation is to get the monkey of government off the back of the PSUs.
That is why even rich countries that do not need to supplement government finances through the sale of assets believe in privatisation.
In India the need to unshackle PSUs is greater than elsewhere because our politicians are more corrupt and less experienced in supervising commercial enterprises.
To achieve the twin objectives of freeing PSUs and of optimising the financial realisation from privatisation, the government has two options, viz. (a) sale through an initial public offering, or IPO, and (b) selling to a strategic partner. Both routes have advantages and disadvantages:
Sale to strategic partner
This option has the following advantages as compared to an IPO:
- Sale to a strategic buyer should normally bring with it the injection of competent management with knowledge of the industry and free the PSU from the shackles of government control.
- The strategic acquirer will be willing and able to pay a premium because of the synergy he perceives in combining the PSU business with his own existing business. Such a premium can be substantial and cannot be realised in a sale to the public.
- The strategic acquirer will be able to inject more capital and modernise/expand the business of the PSU, whereas an IPO will not necessarily result in fresh capital injection into the PSU.
- Loss-making PSUs will be unattractive to the public whereas a strategic acquirer can have the skills to turnaround the business even after paying a reasonable price. This was demonstrated in the case of Hindustan Lever acquiring the loss-making Modern Bakeries, which has been turned around in a short time.
But there are some disadvantages in selling a PSU wholly or partly to a strategic partner:
- The whole process of selecting a strategic partner and settling the terms of sale will involve the exercise of judgement by ministers and officials. Their ability to do so with honesty and shrewdness is highly doubtful as they are amateurs with selfish motives. The present government has been fortunate in having Arun Shourie as the minister for divestment. There are not many like him in any political party.
- Since the strategic partner is likely to restructure the PSU business to align it with his existing business, there will be uncertainty among the employees of the PSU and they will try to frustrate the deal.
- The acquisition of a PSU with significant market share by a partner in a similar business can lead to a monopolistic or oligopolistic situation, which is against the interests of consumers.
- Once even a small part of the equity is sold to a strategic partner, other potential bidders will be put off, thereby lowering the value of the rest of the PSU's shares. This is illustrated by the acquisition of a minority stake in Larsen & Toubro by Grasim, which has kept out other potential bidders for L&T's cement business.
Sales via an IPO
In selling through an IPO, the advantages are as follows:
- It can be a much more transparent and efficient process as the price is set by competent merchant bankers and validated in the market.
- It will provide continuity and security to existing employees of the PSU, and there will be less resistance. It can be further sweetened by offering shares to employees.
- IPO of a large PSU can provide the much needed boost to the Indian stock market, and serve to attract foreign investment.
- Even if the price realised is not the highest, the beneficiaries will be largely the Indian public as shareholders.
The disadvantages of the IPO route are as follows:
- The premium that a strategic investor may pay for perceived synergies will not be realised in an IPO.
- The government will have to sell at least 51 per cent in a single step in order to get the PSU out of government control.
- If such a sale of majority holding is not executed in a single step and the process is delayed due to political interference, the value of the enterprise will be diminished.
- The traditional PSU management may continue to be in charge and there will be very little change in the culture.
In order to realise the advantages of both routes and to minimise the pitfalls, the government could adopt the following method for privatisation of PSUs.
Recommended method:
- Appoint a proven and competent CEO (from within or from outside) and key managers of the target PSU for a fixed term of 3 years with a clear mandate to prepare the PSUs for privatisation.
- Get the PSU valued by two leading merchant bankers of international repute.
- Reserve 5 per cent of equity for the employees at a discount to the value set by the merchant bankers. This will overcome skepticism among employees.
- As part of the IPO (a) allocate 15 per cent of the PSU shares for mutual funds and financial institutions, (b) 20 per cent as ADRs on the New York Stock Exchange, (c) 25 per cent to the Indian public.
Thus 65 per cent of the government holding can be disposed of in one shot, thereby taking the PSU out of government control.
When the government wants to dispose the remaining 35 per cent, it can harvest the benefit of the improved performance of the company after the IPO.
Furthermore, regulatory authorities can exercise oversight on the transaction, to avoid oligopolies.
In the case of non-profitable companies, the government has to choose either (a) to shut it down through very generous VRS or (b) sale to a strategic buyer (a la Modern Bakeries) or (c)organise a management buyout with a strategic partner.
But implementation of any of the above methods will require intelligent and committed political leadership at the Centre. It cannot be steered by a committee of amateurs in the Cabinet.
The present government has already lost two of its limited number of able professionals as ministers, viz. (former Law Minister) Arun Jaitley and (former Power Minister) Suresh Prabhu.
It is probably running the danger of losing the only other one, Arun Shourie, who must feel totally let down by his leader. Perhaps he is waiting for the three-month moratorium on disposal of the petroleum public sector units.
The prime minister seems to have neither the will nor the strength to impose his own sound economic policies on his scheming colleagues.
The manoeuvre by Ram Naik and George Fernandes on privatisation of BPCL and HPCL is a repetition of what Sukh Ram did a few years ago with VSNL by pulling the plug at the last minute.
The government lost billions of the realisable value of VSNL at that time. It has obviously not learnt its lessons from that episode.
But more important than the monetary loss is the loss of credibility of the Indian government among investors, both at home and abroad.
India's credibility as a destination for investment can be restored at least to some extent only if the government implements some of the ideas set out above.
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