Desperate sale

A substantial disservice may have been done to the national interest by establishing a sub-optimal benchmark for the ONGC share, if the government intends to push ahead with the privatisation of the huge company.

THOSE who sell their family silver usually do not proclaim it triumphantly in public as the government has done in the aftermath of the recent "successful" sale of its stake in six public sector companies. Having mopped up Rs.15,400 crores - Rs.900 crores more than the disinvestment target for the current year - the government turned euphoric. Even before the completion of the 10 per cent divestment in the Oil and Natural Gas Corporation (ONGC), Arun Shourie, Union Minister for Disinvestment, remarked that the success of the issue showed that the world had reposed confidence in India. Even as the stock market nosedived soon after the disinvestment, the government hinted that such issues, amounting to Rs. 1,50,000 crores every year, could be made over the next five years.

On the block in this round of disinvestment was the government's residual stake in Indian Petrochemicals Corporation Ltd. (IPCL), which had been sold to Reliance Industries earlier; Computer Maintenance Corporation (CMC), in which management control had been ceded to the Tatas earlier; Indo-Burma Petroleum (IBP), which had been taken over by the state-owned Indian Oil Corporation (IOC); Dredging Corporation of India (DCI), in which 20 per cent was being sold through the issue; Gas Authority of India Ltd (GAIL); and ONGC. The biggest issue was obviously the one relating to the government's divestment of 10 per cent of its stake in ONGC. The size and scale of the company's operations meant that the issue would provide an overwhelming portion of the revenues that the government hoped to mobilise through the public issues.

Earlier rounds of disinvestment, made through the "strategic sale" of the government's equity to private interests, had raised a feverish controversy. These were mainly centred around the perception that the commanding heights of the government's involvement in key areas of industrial activity were being vacated in favour of private monopolies. In short, it was alleged that these companies were handed over to private interests at heavily discounted prices. To counter this criticism, and particularly because elections were around the corner, the government decided that in this round of disinvestment it would adopt the book-building route. Investors, it announced, would place bids for shares after the government announced a floor price for the shares of the six companies to be offloaded. It was argued that once a floor price was set, the market would evaluate the worth of the shares to be sold, resulting in the best possible realisation for the government.

The seemingly impeccable logic of the book-building route suffered a severe jolt when it became evident that powerful manipulators in the market, particularly the Foreign Institutional Investors (FII), hammered the prices of the shares. They had an incentive to do this because it was obvious that the floor price of the shares to be issued would bear some relation to the prevailing market price for these shares. Market analysts pointed out that investors would prefer to beat down the share price by selling their holdings in these companies, thus driving down the prices and then picking up the shares of the very same companies when the government made its offer for shares at lower prices. Indeed, this happened in almost all the six cases. The ONGC share, for instance, was trading at Rs.995 in January; the government sold its shares at Rs.750 apiece in March. In mid-February, the GAIL share was trading for about Rs.225. It was hammered down to Rs.196 and the issue was priced at Rs.185. The shares of CMC were hammered down from Rs.570 to Rs.540 apiece and the floor price was set at Rs.475.

The notion that the book-building route is technically a better way to realise prices has attracted criticism from analysts too. They say that there is tremendous scope for abuse of the system. In fact, they point to the fact that the lead managers of the issue, who may be more interested in marketing their own success, tend to make use of the loopholes in the system to create hype around the issue. This hype is particularly built around the extent of over-subscription to the issue. In fact, a Securities and Exchange Board of India (SEBI)-appointed committee had pointed out earlier that Qualified Institutional Bidders (QIB) often made multiple bids without having to submit margin money upfront. And, since the floor price is generally specified in terms of a price band, institutional investors tend to make multiple bids for varying lots at different prices. Artificial bidding of this kind, when investors are not serious about actually taking part in the bidding process, allows the lead manager to hype the issue as a success so that retail investors are drawn to the issue. To make matters worse, the faulty nature of the Bombay Stock Exchange's software resulted in over-counting the extent of oversubscription in all the six issues because it could not factor the multiple bids that investors were making. There was also a sharp fluctuation in the size of bids made by the QIBs for the ONGC share, implying that they withdrew their bids after making them earlier. On March 5, the first day of the Rs.10,000-crore ONGC issue, the bids were valued at about Rs.27,000 crores. There was speculation that the prominent investor Warren Buffet, Chief Executive Officer (CEO) of Berkshire Hathaway Inc., had bid for more than $1 billion worth of ONGC shares on the very first day.

In fact, the Congress(I) alleged that the government's claims of oversubscription were not only dubious but also injurious to small and retail investors. It accused the government of "actively misleading investors". It said that the hype caused by the resort to unfair means had resulted in small investors being misled about the extent of oversubscription. The party argued that investors would have believed that they stood a smaller chance of getting an allotment of shares and would therefore have placed bids for more shares, believing that the shares were in great demand in the market. Moreover, the exaggerated extent of oversubscription would have lured smaller investors to bid at higher prices.

From the start it was clear that the government was betting desperately on the success of the series of issues it had planned. And to achieve this "success" it pulled all strings at its command. Shourie cried himself hoarse about the manipulators in the market and claimed that his tough talk had saved the day. Significantly, when Shourie was asked why he could not take action against the manipulators in the market, he said that such action would cause a collapse in the market. It used state-led institutions, particularly the Unit Trust of India, the Life Insurance Corporation and the General Insurance Corporation to bid for these shares on offer. The autonomy of the SEBI was seriously jeopardised when it ruled that overseas investors bidding for ONGC shares could use the pernicious device of Participatory Notes (PN). The SEBI had banned the use of PNs in early 2004 because they are generally meant to obscure the identity of overseas and non-resident Indian (NRI) investors. The pressure tactics of the government paid off eventually, at least as far as mobilising revenues is concerned. The DCI issue was oversubscribed 12 times, IPCL 3.16 times, CMC 11.3 times, IBP almost three times, GAIL more than four times, and the ONGC about six times.

IN the euphoria over the successful marketing of the issues, the scale, significance and relevance of the companies to the national economy have been pushed to the background. In effect, by making the market's perception and evaluation of these companies' worth at the centre of media and public attention, the emotive issue of the government's sale of national property to private interests has been relegated to the background. This is particularly crucial in the case of ONGC, which is the largest Indian company, whether privately or publicly owned.

It is important to recognise that prior to the recent 10 per cent issue, only 3.88 per cent of the ONGC stock was in the market. The government held 84.11 per cent, Indian Oil Corporation 9.61 per cent and GAIL 2.4 per cent. In such a situation, economists would say that the "price formation" of the share, that is, the valuation of the company's intrinsic worth, is likely to be extremely hazardous because of the lack of depth in the market. The government has claimed that the bidding by investors through the book-building route has enabled it to "discover" the price of the ONGC share. This is clearly open to question given the specific facts relating to the performance of the company.

ONGC is a clear market leader in its field. During 2002-03 the company made a net profit of Rs.10,529.3 crores on net sales aggregating Rs.34,738.5 crores. Its reserves at the end of fiscal 2003 amounted to Rs.33,932.2 crores. The basis for these figures, which would dwarf most other companies' size or performance, rests on the nature of its operations. The integrated oil and gas company is the primary supplier of crude oil in India commanding a market share of almost 85 per cent. In recent times it has through its subsidiary also acquired oilfields in Sudan and is developing others overseas. Although the supply of crude has been its mainstay, it has, through its acquisition of Mangalore Refineries and Petroleum Ltd (some would say the latter was forced on it) established a retail presence too. ONGC has also bagged half the exploration licences that have been issued by the government. Given ONGC's monopoly status in a strategic sector, its operating margin, or its profitability, is extremely high even by industry standards. For instance, in the first nine months of the fiscal year 2003-04, its operating margin was 53 per cent, compared to 9.4 per cent in the case of IOC and 5.5-5.9 per cent in the case of two other state-owned oil majors, Hindustan Petroleum Corporation and Bharat Petroleum Corporation.

At the current market price the ONGC share has a price-earnings ratio of close to 10 per cent. Earnings per share of the ONGC stock at the end of the last fiscal stood at about Rs.74. This implies that each share with a face value of Rs.10 was earning the government a return of Rs.74. Significantly, the returns to the government if it had continued to hold the 14.26 crore shares that it disinvested would have amounted to about Rs.10,700 crores. Although these estimates have to be treated with a touch of caution because they can be significantly influenced by the vagaries of the stock markets, they nevertheless provide a ballpark figure to find out what the government would have gained if it did not make the issue at all. The economist in Shourie understood the magnitude of the ONGC disinvestment. After the closure of the issue he gleefully pointed out that ONGC's market capitalisation is about one and a half times Pakistan's national income.

It can be argued that the 10 per cent sale is only a sale of minority stake, which will not lead to its outright privatisation. This may be true, but it has to be seen in the context of what Union Minister for Petroleum Ram Naik promised several months ago. On August 11, speaking aboard Sagar Samrat, the country's first jack-up rig, he said that since ONGC was strategically important, its disinvestment could not be allowed. "I believe that privatisation of strategic organisations such as the Railways and ONGC must not be allowed," he said, while denying media reports of proposed disinvestment of oil companies.

So, what is the value of the ONGC share? It is like asking what is the rental value of the Rashtrapati Bhavan. It is evident that it is virtually impossible for the market to evaluate a company of this size and scale. More importantly, substantial disservice may have already been done to national strategic interest by setting a benchmark for the ONGC share for later use if and when the government pushes ahead with the outright privatisation of ONGC.