DISINVESTMENT IN INDIAN ENERGY SECTOR

SUBMITTED BY: NIDHI GOLA

DATE: 14th Jan 2011

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CONTENTS:

Genesis of disinvestment

Definition of disinvestment

Types of disinvestment

Bodies governing the disinvestment process

Disinvestment Policy

Valuation of shares – The disinvestment process

National Investment Fund

Disinvestments till date

Disinvestment in Energy sector – An analysis

Benefits of disinvestments

Issues in disinvestment process

Forthcoming disinvestments

Politics of disinvestments

Conclusion

References

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GENESIS OF DISINVESTMENT

India, for almost four decades was pursuing a path of development in which public sector was

expected to be the engine of growth. But by mid-eighties their short comings and weaknesses

started manifesting in the form of low capacity utilization, low efficiency, lack of motivation,

over-manning, huge time and cost overrun, inability to innovate and take quick decision, large

scale political and bureaucratic interference in decision making etc. But instead of trying to

remove these defects and to increase the rate of growth of national economy, gradually the

concept of self-reliant growth was given a quiet burial. The Government started to deregulate the

imports by reducing or withdrawing import duty in phases. This resulted in dwindling of

precious foreign exchange reserve to abysmally low level.

This was mainly due to large imbalances in internal and external account, making economy

highly venerable. There was worsening of fiscal deficit from 1985-86 due to steady increase in

govt. expenditure, particularly non- plan expenditure. Fiscal deficit rose to 8.4 % of GDP in

1990-91 and the consequent rise of oil prices further worsened the situation. Erosion of

confidence of govt.‟s ability to manage, led to drying up of the market for external commercial

loans. The net outflow of NRI deposits also significantly added to balance of payment crisis.

The foreign debt repayment crisis compelled Government of India to raise loan from IMF against

physical deposit of RBI gold reserve, on conditions harmful to the interest of the country. Thus,

this resulted in genesis of the Industrial policy of 1991 which included the process of

delicensing. For except 18 industries, Industrial licensing was withdrawn. The market was

opened up to domestic private capital and foreign capital was provided free entry up to 51%

equity in high technology areas. The aim of economic liberalization was to enlarge competition

and allowing new firms to enter the market. Thus the emphasis shifted from PSEs to

liberalization of economy. Also, the gradual disinvestment of PSUs was offshoot of

unprecedented macro economic crisis during 1990 – 1991.

DEFINITION OF DISINVESTMENT

Disinvestment involves the sale of equity and bond capital invested by the government in PSUs.

It also implies the sale of government‟s loan capital in PSUs through securitization. However, it

is the government and not the PSUs who receive money from disinvestment. The process leads

only to dilution of ownership and not the transfer of ownership. Privatization refers to transfer of

ownership from govt. to private investors. Disinvestment is called „Partial Privatization‟.

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TYPES OF DISINVESTMENT

Strategic sale - This transaction has two elements:

o Transfer of a block of shares to a Strategic Partner and

o Transfer of management control to the Strategic Partner

Offer for sale of equity share to public at large at a pre-determined fixed price.

Example: BALCO, IPCL

Reduction in Equity

o Buy back of shares

o Conversion of equity into other instruments

Asset Sale and Winding up – This is done in the companies that are either sick or facing

closure. This is done by the process of auction or tender.

Management/ Employee Buyout

BODIES GOVERNING THE DISINVESTMENT PROCESS

Cabinet Committee on Disinvestment (CCD) – A separate “Ministry for

Disinvestment” has been set up by the central government. Also, CCD has been

appointed consisting of following members: Minister for Disinvestment, Minister for

Industries, and Finance Minister.

Disinvestment Commission – It was formed by an executive order in August 1996 as an

advisory body and not as a statutory commission. It is located in Ministry of Industry and

that has led to some difficulties in its smooth functioning. In this light, it was felt that

there is a need of a statutory commission. So, the Disinvestment Commission was

abolished in November 1999.

Department of Public Enterprise (DPE) – It was the nodal agency to steer the

disinvestment process. The department was responsible for preparing the bundles,

advertising the bids and selecting the bidders.

Department of Disinvestment – After the completion of the tenure of the Disinvestment

Commission in Nov. 1999, the govt. made a new Department of Disinvestment. This was

done to have a systematic approach to disinvestment and hence gave a fresh momentum

to the disinvestment program. Now, the main emphasis is on strategic sale of selected

PSUs.

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DISINVESTMENT POLICY

The salient features of the Policy are:

(i) Citizens have every right to own part of the shares of Public Sector Undertakings

(ii) Public Sector Undertakings are the wealth of the Nation and this wealth should rest in

the hands of the people

(iii) While pursuing disinvestment, Government has to retain majority shareholding, i.e. at

least 51% and management control of the Public Sector Undertakings

VALUATION OF SHARES – THE DISINVESTMENT PROCESS

The fixation of share/bond price is an important part of disinvestment. Several aspects of the

company‟s activities are examined while making a valuation. These could be the past

performance of the company, analysis of position of the company in that industry, analysis of

inherent strength and weaknesses of the business, forecasting the future performance, impact of

the current policy framework and so on. Disinvested shares are listed, quoted examine and traded

on the stock market. Indian and foreign financial institutions, banks, mutual funds, companies as

well as individuals can buy disinvested shares / bonds.

The various methods used for share price valuation are:

1. Discounted Cash Flow (DCF) Method – In this method, the all the future cash earnings

capacity of the business is projected and then it‟s present value is calculated by

discounting all the earnings by an appropriate discount factor.. This is done using the

concept that money has a time value

2. Balance sheet method or Net Asset Value (NAV) – This methodology values a

business on the basis of the value of its underlying assets. This is relevant where the

value of the business is fairly represented by its underlying assets. The NAV method is

normally used to determine the minimum price a seller would be willing to accept and,

thus serves to establish the floor for the value of the business. This method is pertinent

where:

a. The value of intangibles is not significant

b. The business has been recently set up

3. Transaction multiple method

4. Asset valuation method

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All the methods (except the Asset Valuation Method) are generally used for valuation of a going

concern, whereas the Asset Valuation Method is relevant only for valuation of assets in case of

liquidation of a company. In addition to that, in case of listed companies, the market value of

shares during the last six months is also used as an indicator. However, most PSU stocks suffer

from low liquidity and the price determination may not be always efficient. Moreover, there

could be increased trading activity after announcement of the disinvestment, which could be on

account of high market expectation of the bid price and even based on mala fide intent. This

could lead to the price being traded up to unsustainable levels, which is not desirable.

NATIONAL INVESTMENT FUND

On 27 January 2005, the Government had decided to constitute a 'National Investment Fund'

(NIF) into which the realization from sale of minority shareholding of the Government in

profitable CPSEs would be channelized. The Fund would be maintained outside the

Consolidated Fund of India. The income from the Fund would be used for the following broad

investment objectives:-

75% of the annual income of the Fund will be used to finance selected social sector

schemes like APDRP, Mahatma Gandhi National Rural Employment Guarantee Scheme

etc., which promote education, health and employment.

The residual 25% will be used to meet the capital investment requirements of profitable

and revivable CPSEs that yield adequate returns, in order to enlarge their capital base to

finance expansion/ diversification.

Fund Managers of NIF - UTI Asset Management Company Ltd., SBI Funds Management

Company (Pvt.) Ltd. and LIC Mutual Fund Asset Management Company Ltd. were appointed

initially as Fund Managers to manage the funds of NIF

DISINVESTMENTS TILL DATE

The disinvestment announcement was made on 4th

March, 1991 during the interim budget

session for 1991-92 under the Chandrashekhar govt. The policy has evolved over the years. This

period could be broadly into four phases:

1. First Phase (1991-92 to 1995-96): The disinvestment process started with sale of

minority shares in Dec 1991, Feb, 1992 by auction method in bundles of "very good",

"good" and "average" companies. In 1991-92, Government disinvested an average of

about 8% of the shareholding in 30 CPSEs and realized Rs.3037.74 crore over two

auctions.

2. Second Phase (1996-97 to 1997-98): An effort to institutionalize the disinvestment

process was undertaken on a firm footing by constituting the Disinvestment Commission.

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0.39 Crore shares of VSNL and 7 crore shares of MTNL were sold in GDR market

realizing a total amount of Rs. 910 crores.

3. Third Phase (1998-99 to 2007-08): Department of Disinvestment (now a ministry) and

National Investment Fund was formed. Government sold a small portion of its

shareholding in one Central Public Sector Enterprise (CPSE) to another CPSE. Example -

Through this mechanism, ONGC and IOC each purchased 4.85 per cent shares of GAIL‟s

equity shareholding.

4. Fourth Stage: The current phase where govt. is planning to sell its stake in IOCL, SAIL

and Hindustan Copper Ltd.

Findings from the analysis (using the graph below)

Till now only 8 times, the govt. is able to achieve the disinvestment targets.

In some of the years, govt. failed to achieve even 20% of the target set. Govt. has

measurably failed to attract various parties for buying the PSUs.

No funds received in 1993-94. Equity of 6 companies sold by auction method in1993-94

but proceeds received in 1994-95.

In 2003-04, govt. exceeded its set target of Rs.14, 500 Crores. 20% of govt.‟s

shareholding in DCIL was sold. A small portion of govt.‟s share in GAIL and ONGC

were also sold. These all resulted in bringing total receipts for 2003-04 to Rs. 15,547.41

crores.

No target was set for the years – 2005 to 2010.

Till date total Rs. 99,738.92 Crores have been received through disinvestment.

*Source:

divest.nic.in

0

5

10

15

20

25

30

35

40

45

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

19

96

-97

1997

-98

1998

-99

1999

-00

20

00

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

20

09

-10

2010

-11

Rs.

'000

Cro

res

Disinvestment Target Versus Actually Achieved

Target Set Actual Receipts

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GAIL IBP ONGC NTPC

Floor price per share/ Price Band (Rs.) 185 620 680-750 52-62

% of Government equity prior to the Offer 67.35 26 84.11 100

% of CPSE's equity offered for sale 10 26 10 5.25

Shares offered for sale (crore Nos) 8.457 0.576 14.26 43.2915

Final price per share (in Rs) 195 620 750 62

Total amount realised (Rs crore) 1627.36 350.66 10558.4 2684.07

Cumulative total (Rs crore)

Total amount realised in 2003 -05 from all

disinvestments (Rs crore)

REALIZATION FROM OFFER FOR SALE OF SHARES

IN CPSEs DURING 2003-05

15441.7 (84% of total disinvestments)

18,312.28

DISINVESTMENT IN ENERGY SECTOR – AN ANALYSIS

Disinvestment in energy sector started in 1998-99. Government sold a small portion of its

shareholding in one CPSE to another CPSE. Through this mechanism, ONGC and IOC

each purchased 4.85% shares of GAIL‟s equity shareholding. IOCL purchased 10% of

the shareholding of ONGC, whereas ONGC purchased 10% of equity shareholding of

IOCL. 3.06 Crore shares of GAIL were sold to institutional investors in the domestic

market.

During 1999-2000, 13.50 crore shares of GAIL were sold in the GDR market.

In Dec 2003, small portions of Government‟s stake in GAIL and ONGC were sold.

In 2004-05, 43.29 crore equity shares of Rs.10 each out of the Government‟s equity in

NTPC were sold for Rs.2684.07 crore, along with a fresh issue of equity of a similar

quantum by NTPC through an IPO in October, 2004.

Total receipts from energy sector disinvestments during 2003 – 05 were around Rs.

15,441.7 Crores.

It was around 84% of the total disinvestment receipts during 2003-05 came from

disinvestment in energy sector.

* Source: divest.nic.in

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Recent disinvestments in energy sector (from April 2009 onwards)

From April 2009 onwards, govt. has been focusing on disinvestment majorly in energy

sector.

Following companies from energy sector have been disinvested since April 2009

o NHPC (5% of govt.‟s equity disinvested)

o NTPC (5% of govt.‟s equity disinvested)

o REC (4.35 % of govt.‟s equity disinvested)

o SJVN Ltd. (10.03 % of govt.‟s equity disinvested)

o CIL (10% % of govt.‟s equity disinvested)

o PGCIL ( 9.09 % of govt.‟s equity disinvested)

Out of total disinvestment receipts of Rs. 23552.93 crores in 2009-10, funds totaling Rs.

20825.94 Crores came in from energy sector (REC, NTPC, OIL and NHPC) only. It was

around 88.4% of the total funds received in that year.

In 2010-11, till now Rs. 22762.96 crores have been collected through disinvestment and

out of which funds totaling Rs. 19983.35 crores came from disinvestment in energy

sector (PGCIL, CIL and SJVN Ltd.)

Recently in Nov 2010, govt. sold its 9.09% stakes in PGCIL for Rs. 3721.17 Crores. The

shares were sold at Rs 85 to Rs 90 during the FPO process. It was 14.79 times subscribed.

CIL IPO came up in Oct. 2010. Govt. disinvested its 10% shareholding in CIL for Rs.

15,199.44 Crores. The issue was 15.14 times subscribed.

* Source: divest.nic.in

PGCIL CIL SJVN Ltd. REC NTPC OIL NHPC

Opening Date 9/11/2010 18/10/2010 3/5/2010 19/02/2010 3/2/2010 7/9/2009 7/8/2009

Closing Date 12/11/2010 21/10/2010 20/05/2010 23/02/2010 5/2/2010 10/9/2009 12/8/2009

Instrument EQUITY EQUITY EQUITY EQUITY EQUITY EQUITY EQUITY

Issue Type FPO IPO IPO FPO FPO IPO IPO

Final Offer Price (Rs.) 85.5 to 90 232.75 to 245 24.7 to 26 193 to 206 201 to 202 1050 36

%age Govt. Equity

Divested 9.09 10 10.03 4.35 5 5

Issue Amount (Rs. crore) 3,721.17 15,199.44 1,062.74 3,530.04 8,480.10 2,777.25 6,038.55

Times Subscribed 14.79 15.14 6.24 3.47 1.22 30.64 23.53

ISSUE DETAILS

RECENT DISINVESTMENTS IN ENERGY SECTOR (Apr 2009 Onwards)

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BENEFITS OF DISINVESTMENT

Improves efficiency in PSUs through structural adjustments

Reduces or mitigate fiscal deficit

Introduces competition and market discipline – In present era of globalization,

disinvestment could provide stimulus to some robust PE‟s to grow and become truly

global corporations. Disinvested companies would be exposed to market discipline and

they would become more efficient and survive or will cease on their own

Brings about a measure of economic stabilization - New private investor will put in more

money in privatized PSEs and economic activity will increase

Depoliticizes essential services

Consumers will be benefited as they would have more choices and cheaper and better

quality products and services

Releases govt.‟s tangible and intangible, such as large manpower currently locked in

managing poor performing PSUs, and their time and energy, and deploys them in high

priority social activities

ISSUES IN DISINVETMENT PROCESS

Loss of public interests - PSUs are resources of the nation. They belong to the people.

By selling them to private companies, government is seriously affecting the people's

welfare.

Fear of foreign control - Selling equities to foreign companies result in serious

consequences shifting the nation's wealth, power and control to outsiders.

Issues with workers - The jobs of lakhs of workers in the PSUs will fall in danger by

privatization.

Less number of bidders - Even though government plans to disinvest, there are actually

less number of people willing to place their bids.

Apart from these, it is the government and not PSUs who receive funds from

disinvestment. This raises conflicts between the government and the employment

union of the PSU.

Impact on employees

o Significant increase in work load and stress

o Fear regarding job cuts

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FORTHCOMING DISINVESTMENTS

Oil and Natural Gas Corporation

Steel Authority of India

Hindustan Copper Ltd.

POLITICS OF DISINVESMENT

Disinvestment has always been a very politically sensitive issue, with different parties taking

different views in different positions. Strategy towards disinvestment has also been subject to

govt. and their allies. There has never been a clear stance on disinvestment by any govt. The

abolishment of the ministry of disinvestment in 2004, after the formation of Congress coalition

was mainly due to Left parties. Another example of this is the scrapping of recommendations of

the Rangarajan Committee and setting up of a new committee by the United Front Govt. when it

came to power.

CONCLUSION

From April 2009 onwards, govt. is focusing on disinvestment, especially in the energy sector. It

was around 88.4% of the total funds received in that year. Disinvestment in India was not an

attractive idea till 2009. This is simply because successive governments have treated

disinvestment merely as tool to raise resources rather than as one designed to restructure the

massive public sector. The arguments in favour of disinvestment, either in terms of resource

mobilization or in terms of “people-ownership”, are devoid of sound economic rationale. Rather,

the disinvestment agenda is driven by powerful interests; like the big players in the stock market

whose fortunes depend on “good news” and the private corporate sector, which wants to escape

the responsibility of paying taxes for financing the government‟s welfare programmes.

The fact that till now only 8 times out of 20 years budgetary targets were met show the

ineffective implementation of this process by the govt. Administrative loopholes have led to

many controversies regarding disinvestment leading to many legal hassles and creating a

negative image regarding disinvestment. There has never been clear direction on disinvestment

as it has been subjected to vagaries of politics of power.

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References:

Books

o Disinvestment in India – by Sudhir Nair

o Business Environment – by Sheikh Saleem

Newsletter of Industrial Research and Consultancy Centre (IRCC), IITB, on

“Disinvestment of India’s Public Sector Units”

http://www.myicwai.com/StudyMaterial/Fin/Chap-2/2-8.pdf

Article by V.Gangadhar and Dr. Yadagiri on “Disinvestment in Public Sector

Enterprises”

www.india.gov.in

http://www.divest.nic.in/Valuation_Methodology.asp