Lessons from the Balco fiasco

The move to effect a 'strategic sale' of equity in the profitable and cash-rich public sector Bharat Aluminium Company Ltd. at a throwaway price is a questionable one for a host of reasons.

IN a desperate last-minute, pre-Budget manoeuvre, the Union government chose to announce on February 21 the 'strategic sale' of equity in Bharat Aluminium Company Ltd. (Balco). Set up in 1965 at Korba in Madhya Pradesh to manufacture aluminium rods and s emi-fabricated products and instructed in 1984 to take over a sick unit in Bidhanbag, West Bengal, with downstream facilities in sheets, foils and alloy rods, Balco is today the third largest player in India's aluminium industry. The Korba facility inclu des bauxite mines, an alumina refinery, a smelter and a fabrication unit, besides a 270 MW power plant, which meets a substantial part of the unit's power requirements, and a fully built-up township spread over 15,000 acres (about 6,000 hectares) in whic h over 4000 families live.

Sterlite Industries Ltd., which won the bid for Balco, would have to pay Rs.551.5 crores for a 51 per cent stake in the company that controls these assets. In the government's recently coined disinvestment terminology, a 'strategic sale' refers to one in which a minority shareholding of 26 per cent or more is divested to a single buyer who is handed over management of the company. The use of that term in the proposed sale of Balco makes little sense, since Sterlite with its majority equity holding would in any case be in a position to control totally the operations of the firm.

No sooner was the Balco deal announced than it created a furore within and outside Parliament. The opposition to the deal has been strong on many counts. First, since Balco is a profitable and cash-rich public sector corporation with an extremely low deb t to equity ratio, it would have been possible for it to finance its proposed modernisation plan (estimated to cost Rs.1,000 crores) without recourse to budgetary funds. The project was to include the setting up of a cold rolling mill and the expansion o f captive power generation and modernisation of existing facilities. This would have allowed the corporation to improve its profitability and increase the dividend it pays to the exchequer.

To quote the Disinvestment Commission: "Balco as a PSU has suffered from procedural bottlenecks and lack of managerial autonomy. The CRM project at Korba has been cleared after 8 years with near-doubling of the capital outlay. The company was not able to get clearance from the government for setting up 100% captive power generation. As a result, the company had to depend on high cost power from the State Electricity Board which resulted in avoidable cost increases. The delays and the lack of autonomy ha ve certainly affected its operating profits which would have been much higher had it been able to implement these projects earlier."

Thus even the Disinvestment Commission's recommendation that the government should resort to a strategic sale of 40 per cent of Balco equity can be seen as misplaced. What was required instead was a reorganisation aimed at allowing Balco the freedom to u se its own capacity to mobilise resources to modernise, expand its captive power facility and raise its profitability. In practice, as a prelude to the privatisation process, in March 2000 the subscribed share capital of Balco was brought down to Rs.244 crores from Rs.488 crores, by appropriating part of the Rs.437 crores into the government's account. This was a clear indication that modernisation and expansion was not even under consideration.

This implies that Balco's profitability has been undermined by the government's own role in stalling modernisation and expansion at Korba.

Hence, the current profit performance of the unit cannot be the basis on which the future profile of profits is estimated. However, the tendency for Arun Shourie, the Minister for Disinvestment, to emphasise repeatedly that profits earned by Balco had fa llen from Rs.163 crores in 1996-97 to Rs.25 crores in 2000-01 suggests that this stream of profits has entered into assessments of the future profile of profits that have been discounted to value the worth of the company. This amounts to squeezing the pr ofits of a public sector unit, and then using that to undervalue the firm - consciously or otherwise.

Secondly, it is being argued that a direct valuation of Balco's assets suggests that with an investment of just Rs.550 crores Sterlite is to get control over assets that according to some are worth around 10 times that value. In fact, officials from the power sector have argued that the captive power plant alone would cost more than the sum being paid by Sterlite. According to reports, a senior official has held that if Sterlite were to invest in a captive power plant of the kind owned by Balco, it coul d cost Rs.1,215 crores. And this figure matters, for the value of the plant at Korba (set up in 1988-89) is still substantial, since a thermal power plant has a lifespan of around 35 years. Further, the deal not only involves an immediate loss from the u ndervaluation of the controlling stake in the company and over its assets that is to be handed over to Sterlite. Once control rests with Sterlite, big buyers would be unwilling to purchase large chunks of the stock remaining with the government even at t he price being offered by Sterlite, since that would give them little say in the running of the company. A 51 per cent equity sale at an indefensible price also undermines the value of the remaining stock that would be held by the government.

Third, it is being alleged that the valuation procedure that yielded the undeclared reserve price below which the government was not willing to sell has neither been transparent nor undertaken by qualified valuers capable of valuing the plant and machine ry of the company and the bauxite mines that it has on lease. Keeping the reserve price a secret and declaring that the Sterlite bid was in keeping with the reserve price only fuels suspicion further. A more transparent procedure would have been to decla re what the minimum bid the government would consider is, based on its independently conducted valuation.

Fourth, the whole procedure has been gone through in haste. Even though the bids had been invited some time back, the valuation of the firm, the setting of the reserve price and the acceptance of Sterlite's bid were all allegedly done within the span of a month. Leaked evidence of undue haste has accumulated, and this puts a question mark over the government's claims of transparency in the execution of the deal.

Finally, the deal allegedly violates a Supreme Court order banning private sector units from running mines and industries in tribal population areas. In order to circumvent this obstacle, the government had ostensibly been contemplating a change in the l aw.

All of this has generated opposition to the deal to divest a controlling stake in a profit-making public sector unit at what is considered a throwaway price. At the time of writing it appears that the deal may not be finalised because of this opposition. Clearly, a combination of inappropriate procedure, undue haste and unwarranted secrecy have created a veritable mess. The question that remains is why the Bharatiya Janata Party was willing to go through with this procedure even at the expense of aliena ting some of its allies in the National Democratic Alliance.

THE announcement of the sale close to the end of fiscal 2000-01 and just before the release of the Economic Survey and the presentation of the Budget suggests that two different motives have guided the government's actions.

The first, of course, is the need to garner some resources through public sector equity sale, so that the "revenue" side of the Budget can be padded to some degree - even if not to tune of the Rs.10,000 crores projected to be yielded by means of privatis ation in Budget 2000-01. In fact, given the haste with which the Balco deal was finalised, it was likely that if the opposition to the deal was not as strong a couple of more deals among the many that are 'pending' may have been pushed through.

The second motive appears to be the need to establish that the government is serious about pushing ahead with "economic reforms" and implementing its intentions to privatise the public sector. Those intentions have not only been declared repeatedly by of ficial spokespersons, but have been made one of the principal steps forward on the economic policy front by the Economic Advisory Council to the Prime Minister and the authors of the Economic Survey for 2000-2001. If those declarations were to be taken seriously, a major thrust on the disinvestment front was called for. After all, the recommendations of the now-dissolved Disinvestment Commission have been circulating for a while, a whole Ministry has been created to deal with disinvestments and s uccessive budgets have set over-ambitious targets for resources to be garnered from privatisation.

Driven by these motives, the government has chosen to push through the deal on two grounds. To start with, it argues that the Sterlite offer exceeds that warranted by a reasonable projection of future revenues and indicates that the company is willing to pay a premium for the controlling stake it is being offered in a major player in the aluminium market. Further, much is being made of the fact that Sterlite's offer was more than double the competing bid from rival Hindalco. What is ignored by this reas oning is the fact that neither what the market is willing to offer nor the net worth computed on the basis of projections grounded on the current profits of public sector undertakings would constitute sums which make any privatisation exercise worthwhile . Private investors looking for bargains would use valuation procedures which would short-change the government. The fact that Hindalco was willing to offer only half of the amount of the undervalued Sterlite bid only goes to prove this point rather than establish the fairness of the Sterlite offer. This makes it difficult to justify economically all but the most unprofitable public sector units. But those are the very companies that no private sector buyer would even consider.

Given this, the government should give up its stubborn advocacy of privatisation on grounds that have not been supported by the experience in areas like the airline industry and cellular and basic telephony. Instead it should return to implementing plans to reorganise, modernise and expand profitable public sector undertakings, since the successful completion of that task would yield revenues that are many multiples of the interest revenue it can garner by investing the proceeds from privatisation or sa ve by using it to retire accumulated public debt.