Distress disinvestment

Print edition : November 27, 1999

The manner in which the Government of India has disinvested 18 per cent of its stake in Gas Authority of India Ltd has raised questions about the integrity of the disinvestment mechanism.

SELLING the family silver is always an emotive affair. It can turn controversial if family members who have a claim to the legacy suspect distress sale. Even those who believe that disinvestment of government stake in profitable and cash-rich public sect or companies is a right step have faulted the Government for the manner in which disinvestment was done in the case of Gas Authority of India Ltd(GAIL). They have alleged that the Government, in a desperate move to bridge the fiscal deficit, sold 18 per cent of its equity in GAIL at a throwaway price of Rs.70 per share. But there is a more serious allegation, that GAIL's potential competitors - Enron Corporation, whose Indian operations have been dogged by controversy since the mid-1990s, and British Ga s - have bought their way into the company "for a song". While Enron has acquired 5 per cent of the company, British Gas has acquired a stake of 1.3 per cent.

On November 4, the Government issued 22.5 million global depository receipts (GDRs) of GAIL to foreign investors at a price of $9.67 (Rs.420) each. Each GDR entitled investors to six GAIL shares. This resulted in the disinvestment of 135 million shares. The Government also retained GDR subscriptions for 20 million shares. The 155 million shares disinvested by the Government constitute 18 per cent of its stake in GAIL. The pricing of the GDR at Rs.70 per share meant a discount of about 11 per cent on the closing price of the GAIL share in the Bombay Stock Exchange (BSE) on the day of issue. The Government raised Rs.1,085 crores through the disinvestment and the discount implied a loss of about Rs.140 crores. The disinvestment, coordinated by Morgan Stan ley and Jardine Fleming, resulted in the Government holding in GAIL declining from about 83 per cent to about 65 per cent. The issue followed the book-building process, a method by which investors are allowed to bid within a price band. Market sources ex plain that this process is used mainly to deter speculative investors and that it is adopted in issue-pricing when it is difficult to determine the intrinsic worth of the shares being offloaded.

Former Finance Minister P. Chidambaram fired the first salvo on November 8 when he drew attention to the fact that the United Front Government had rejected a price of Rs.115 per share in mid-1997. He said the Government had been advised to expect a price in the region of Rs.150-170 per share. The pricing of the share at Rs.70 was "scandalous", he said and pointed out that apart from Enron and British Gas, foreign institutional investors (FII) had picked up "significant quantities of the offer". He said the Government's handling of the GAIL issue made the entire disinvestment process "open to ridicule". "Doubts will be raised about the integrity of the disinvestment mechanism," he said.

The criticism grew stronger when, a couple of days later, Mahanagar Telephone Nigam Ltd. (MTNL) abandoned its GDR issue, citing the low price of acceptance in the international market (see separate story). There were questions as to why the Government co uld not have rejected the low offer for the GAIL share. The Polit Bureau of the Communist Party of India (Marxist) called for a "high-level probe into the scam" and asked the Government "to stop dismantling the valuable public sector assets in such a sur reptitious manner for private gains." S. Dev Roye, secretary, Centre of Indian Trade Unions (CITU), told Frontline that the Government's action in the GAIL affair was "unpardonable".

The All India Congress(I) Committee's (AICC) economic affairs secretary, Jairam Ramesh, who was connected with the decision-making process during Chidambaram's tenure as Finance Minister, alleged that multinational companies had made a back-door entry in to the Navaratna company which enjoyed a market share of 95 per cent in the natural gas business in India. He told Frontline that a "strategic sale to Enron would have got the Government at least three times more." He also pointed out that it was the first time corporate entities had picked up a stake in a public sector company. He observed that during the disinvestment in the Container Corporation of India (CONCOR), corporates had been kept out as a matter of principle.

Jairam Ramesh said that British Gas acquired a stake in Gujarat Gas in 1997 from the Mafatlal group at a price of Rs.270 per share. He reasoned that if the shares of Gujarat Gas, a much smaller private sector undertaking in terms of its capacity, could g et this price, the GAIL shares deserved much more. Jairam Ramesh and several other people have also pointed out that a "negotiated price", a strategic sale in other words, to those who had an interest in acquiring a stake as a long-term investment in GAI L, would have been a better option.

There are allegations that the Government has allowed Enron and British Gas, which acted as casual investors, to acquire a strategic stake in a company operating in their line of business. Both Enron and British Gas have ambitious plans for the Indian ma rket. There are fears that their entry into GAIL will enable them to leverage their way into its projects, reducing the scope for competition. Seen from this perspective, their acquisition of a stake in GAIL makes sound business sense.

In defence of its action, the Government said that there was nothing in the guidelines that prevented corporates from acquiring a stake in public sector companies. Although Finance Ministry sources said that the top management of GAIL had approved the en try of entities such as Enron and British Gas into the company, a senior GAIL official told Frontline that the company was not involved in the decision-making process. Officially, the company has maintained that the Government as the owner of the company has the final say in matters relating to ownership.

Sources in the market say that the Government had tied its own hands by signalling to the market that it was desperate to raise revenues from the sale of its equity in public sector companies in order to reduce the fiscal deficit. The time-frame for this was also limited because the Government had a target of raising Rs.10,000 crores before the end of the financial year in March 2000. In fact, in his first major interview after assuming office following the recent elections, Finance Minister Yashwant Si nha said that he planned "unconventional and innovative approaches" to achieve this. He also said that "a couple of big ticket items" were being considered.

Getting the price right is always difficult. This is particularly so if the market is imperfect or if it lacks depth. These conditions enable the players to manipulate markets. Some facts about the shareholding pattern in GAIL need reiteration here. Of t he 17 per cent of the equity that was outside the hands of the Government before the GDR issue, about 10 per cent was with Indian Oil Corporation and the Oil and Natural Gas Corporation. These shares, recently divested by the Government through a swap, w ere presumably a strategic investment, not meant for trading in the stock markets. Apart from this, the Government diluted its stake in three phases - totalling a little less than 7 per cent.

The first divestment, of 3.37 per cent of the government stake, was made in 1995. In 1997 the Government issued a small number of shares to GAIL employees. Later, in early 1999, the Government released 3.62 per cent of its stake in the company. Thus, onl y a small proportion of the 7 per cent of GAIL's shares were in active circulation in the Indian bourses. More importantly, this low volume of floating stock in the market determined the price of the November 4 issue amounting to 18 per cent of the equit y of the company. In other words, in market parlance, there was little room for a sound price formation for the share in the market.

At a GAIL facility.-V.V. KRISHNAN

It is common knowledge in the bourses that FIIs have a motive in driving down the domestic price of a share on the eve of a GDR issue. A Mumbai-based merchant banker told Frontline that FIIs sold in the domestic market, retaining their option to b uy in the overseas market because they knew that the price of the GDR issue was related to the price in the domestic market. In fact, soon after the first trends in the election results came in on October 7, the volume of trading in GAIL shares in the BS E increased sharply. Between October 7 and November 3, on an average 50,000 shares were traded each day. After the GDR issue -- up to November 18 - the average daily volume of trading fell to one-fourth this level. During the phase of intense trading in the GAIL scrip, the price reached as high as Rs. 98 per share, on October 20. That the price was hammered down before the GDR issue is thus a strong possibility. If an investor sold 100 shares on October 20 at Rs.98 per share and subsequently bought the same number of shares via the GDR issue at Rs.70 per share, he would have made a net profit of Rs.2,800 out of the transactions.

Although Chidambaram and others have suggested that domestic investors deserved a chance to acquire the GAIL shares at a cheaper rate, there are others who see little merit in this argument. Selling government equity at a cheap price is indefensible unde r any condition, even if the buyers are Indian entities. In fact, merchant banking sources said that the Government's decision to disinvest 3.62 per cent of its stake in early 1999 was just as bad as its recent GDR issue.

In early June 1997, the GAIL scrip was quoted at Rs.183 but a year later, in June 1998, it dropped below Rs.100. The price dropped below Rs.60 around the time the Government decided to make a domestic offer, in February 1999. It is significant that Finan ce Ministry sources have now justified the recent GDR issue by pointing out that this has been at a higher price than the sale in February 1999. Two things are missed in this explanation. First, the fact that the market, when it has tasted blood at a low er price, is likely to hammer the price again to a level close to that. Second, and more important, this is especially so if the market knows that the Government is desperate to push ahead with the issue regardless of the price.

An analyst in a reputed consultancy told Frontline that based on key parameters such as the book value of the GAIL share, the cash flow position of the company and the price-earnings ratio, which were important factors in the valuation of a compan y's worth, the GAIL share should have been sold for "several times" the Rs.70 that the Government earned per share. A merchant banker told Frontline that the recent issue price was likely to provide a benchmark for subsequent divestments in the co mpany. He said that Enron was likely to play the "waiting game because it knows that one day or the other, there will be further divestment". In fact, Enron, by virtue of its 5 per cent stake in the company, is among the biggest non-Government shareholde rs in the company. Informed sources say that it can have a "nuisance value" in the company if and when it manages to get a nominee on the board because of its new-found status in the company. However, Yashwant Sinha has clarified that Enron will not be a llowed to be on the board.

Although the option of a strategic sale has been recommended by some critics of the GAIL disinvestment, sources in the market say that this method of disinvestment can pose other problems. In a strategic sale the Government has the option of offering a s take to companies which may wish to take a controlling stake in the company. But the range of choices may be narrow in that case. Moreover, the bidders may form cartels to gain entry into the company at a low cost. While it may be true that in an underde veloped market a strategic sale may be a better option in terms of price realisation, other adverse effects such as the formation of private monopolies may follow.

Behind the growing interest

FORMED in 1984, Gas Authority of India Ltd. (GAIL) is a young company, and its assets are new. Its 4,300-kilometre-long cross-country pipeline network includes the 2,300-km-long Hazira-Bijaipur-Jagdishpur (HBJ) pipeline, which has recently been upgraded at a cost of Rs.2,000 crores.

Although the pipelines have been the primary assets of the company, GAIL has developed other linkages also in the last few years. One of the biggest producers of liquefied petroleum gas (LPG), the company owns five LPG processing plants with a total annu al capacity of 750,000 tonnes. Two more LPG and propane plants, which will almost double the total capacity, are being established. GAIL is also constructing a 1,264-km-long LPG pipeline from Jamnagar in western India to Delhi to distribute LPG to compan ies that market it.

In March 1999, GAIL commissioned its first petrochemical plant in Uttar Pradesh. Built at a cost of Rs.2,500 crores, the plant is the first petrochemical complex outside western India. GAIL has also bid for a power project near Delhi in association with BSES, the private power utility. It plans to bid independently for medium and large gas-based power projects in the future.

The demand for natural gas is projected to increase sharply in the next decade. According to a British Gas projection, the demand in India will increase from 65 million metric standard cubic metres per day (mmscmd) to 300 mmscmd in the next 10 years. A l arge part of this is likely to be imported. In order to take advantage of this situation, GAIL has joined as a partner in Petronet LNG, which will establish liquefied natural gas (LNG) terminals for the import of gas. The Indian oil majors also have a st ake in the joint venture.

With these arrangements in place, GAIL has a strong capability to expand as a major player in the gas retailing business. It has bid for gas fields so that it can extend its reach and ensure its own sources of supply. GAIL's earnings were nearly Rs.7,000 crores in 1998-99, and it made a net profit of Rs.1,060 crores.

Since the liberalisation process started in 1991, Enron and British Gas have been active in the Indian market. The two companies' operations in India are part of a process of consolidation by which the global energy conglomerates are vertically integrati ng their operations.

Although Enron in India is better known for its 2,450 mega watt power project at Dabhol, it is also active in the oil and gas sectors. It has 20-year contracts with two West Asian oil companies for the supply of 2.1 million tonnes of LNG, and the supplie s will start by the end of 2001. Enron's LNG terminal at Dabhol is an important part of its Indian operations in the import and supply of gas to industrial and commercial users. The downward linkages for these plans are being provided by the oil and gas fields in the Mukta-Panna and Tapti oilfields, which are owned by the wholly owned exploration and production company, Enron Oil and Gas (EOG). The reserves from these fields are estimated to be over one trillion cubic feet of oil equivalent.

British Gas has a controlling stake in Gujarat Gas Company, the biggest private gas distribution company in India. It has a joint venture with GAIL, Mahanagar Gas Ltd., which is constructing a gas distribution system in Mumbai for commercial, industrial and domestic users. It is also developing a project for the import and regasification of LNG at Pipavav in Gujarat. It is also likely to supply gas to the power projects of the National Thermal Power Corporation (NTPC) at Kawas and Gandhar.

Both British Gas and Enron have extensive plans for gas exploration, imports and processing in India. However, they do not have a distribution network. A pipeline network, like the one that GAIL has, would be difficult and expensive to replicate. Extensi on of these pipelines to meet additional demand would be a low-cost affair for GAIL; in comparison, fresh investments by new players would be an expensive proposition.

Moreover, with its assets being new, GAIL offers tremendous advantages because maintenance costs are low. Being a new company the technology used by GAIL is also of recent vintage; for instance, its IT strengths are reputed to be of a very high quality. Moreover, its manpower productivity is also reckoned to be very good; GAIL's rapid expansion, for instance, has endowed it with quality project management capabilities in-house. The recent acquisition of interests in GAIL by British Gas and Enron thus ma kes very good business sense. That the price was low was an additional bonus for the two energy giants.