Currently, the government’s policy on PSU follow-on public offers, divestments via ETF, subsidy burden sharing and inter-company stake sale makes investors view the whole sector suspiciously. Energy and Financial PSUs have larger policy implications on society as a whole and therefore some degree of operational restriction or oversight is understandable. But there are other PSUs, which can be allowed to function freely. The spillover from the ‘distorted PSUs’ to the clean ones is avoidably suppressing value creation. And if the air is cleared on such issues, significant value can be unlocked to the advantage of the government. What follows is a to-do list:
Start at the top
The government’s policy gets seemingly haphazard given its need to balance the Budget on a cash basis every year. I think this itself needs to be challenged and reset. The IFRS accounting standards for companies globally now give increasing credence to the concept of Marked-to-Market (MTM) with respect to financial assets. If government ownership in all the companies can be treated as financial assets on its own balance sheet, then the Budget can be balanced by simply MTM and thereby eliminating the need to sell via ETF or so on. We can also have a policy that looks at Budgets over a three-year period instead of annually. It will do away with the need to force something like ONGC buying HPCL.
Minimize collateral damage
Ad-hoc policies spill over from one company to the whole sector and then it leads to tarring all PSUs with the same brush. Ideally, no sector should have a non-market driven policy. If the Budget is balanced on basis of MTM, the need to be haphazard reduces. If sometimes, the government needs to absorb crude price volatility or some other subsidies, it can take the same on its own balance sheet than via the listed companies balance sheets.
As mentioned earlier, the policy uncertainty in such sectors and the standby remedy should be stated upfront. For the rest of the sectors, the policy with respect to operations, capital allocation and Offer For Sale (OFS) should be clearly stated and adhered to.
Specifically, the problem with OFS is that if the market knows there is a large seller lurking every year, then the share price takes a beating. As the government is time-bound to sell shares to balance the Budget, it sells at any price. That is like shooting oneself in the foot.
The effect of absorbing any subsidies in the listed companies’ balance sheets is that the value of the government’s holding in these entities goes down. This further accentuates the need to sell more stake at lower price, which is a vicious downward spiral. Instead, if no subsidy is routed via listed companies, the value of the government’s stake in them will go up, i.e. the government will have a MTM gain on its holding of PSU companies, and they can use this MTM gain to plug any Budget deficits.
In some years, when this may not be sufficient to bridge the gap, the government can do deficit funding just like most other governments. The downside here is the rating agencies downgrade. But with $15 trillion of negative yielding debt globally, there will be enough buyers for Indian paper ($20-30 billion), regardless of the ratings. Reserves of over $400 billion is an added comfort, especially with the low crude price. Paying a little higher interest due to a lower rating, which is compensated by the overall fall in interest rates is something we can happily live with. In fact, we are importing inflation via a weaker rupee, but that is a matter for the RBI to think about.
Define the strategy
Any promoter selling in the market must be strategic and palatable to the minority investors. It cannot be on the basis of arbitrary timeline, and regardless of price. So, the best way to do it is by enhancing the value of the asset by various confidence building measures. This includes coming up with a stated policy for each sector, and then demonstrating that the government is committed rather than adopt ad-hoc measures frequently. And once investors sense this and rerate the stock price, then government selling can be easily absorbed.
Along with the selling, the communication also needs to be calibrated. More so, to clear misperception, which are created on basis of presumptions. Currently, in the absence of any stated policy of the government for any sector or specific to a company, investors are voting with their feet. The market value of a company is determined by the earnings and the P/E ratio. The latter is a matter of perception, and that has clearly diminished over the years despite earnings remaining strong.
The combination of seemingly inconsistent policies and inadequate communication has led to monopolies like Coal India and GAIL to quote at P/E of 5x. Companies like EIL and MOIL have net cash more than 50% of their market capitalization. There are a dozen companies, which have a dividend yield of 6% (and even up to 10%) when FD rate is less than 4%. The government itself would be borrowing at these rates in the current environment.
Most of these businesses are hard to replicate. Even though they will not grow very fast and some may be cyclical, they are very stable. Their fair value is anywhere between 2-3x the current price. At the current depressed price, the government should be buying back the stock rather than doing OFS. That is the value unlocking potential that exists, of which the government will be the biggest beneficiary. The superior market value enjoyed by companies such as Petronet LNG, Midhani and IGL only demonstrates that possibility.