Disinvestment Market Strategy 12 May 2009 1 RHH: Winner of LIPPER-STARMINE broker award for “Earnings Estimates in Midcap Research 2008” | “Honourable Mention” in Institutional I nvestor 2009 RHH Research is also available on Bloomberg FTIS <GO> and Thomson First CallAmitabh Chakraborty, CFA Vinod Nair Bandish Mehta (91-22) 6766 3404 (91-22) 6766 3443 (91-22) 6766 3454 [email protected][email protected][email protected]Market Strategy 12 May 2009 Draft prospectus filed with SEBI for public offering Company Expected amt to be raised (Rs bn) Rail India Technical & Economic Services (RITES) 3.5 National Hydro Power Corp 55.0 Bharat Oman Refineries 24.0 UTI Asset Management Co 23.0 Oil India 14.7 Total Potential 120.2 Strategic sale cases called off earlier Company Percentage of proposed strategic sale (%) Listed entities Balmer Lawrie and Company 61.8 Engineers India 61 Hindustan Petroleum Corporation 39.01 National Aluminium Company 61.15 National Fertilizers 53 Rashtriya Chemicals and Fertilizers 53 Shipping Corporation of India 54.12 State Trading Corporation of India 75 Unlisted entitiesEngineering Projects India 74 Hindustan Paper Corporation 74 Hindustan Petroleum Corporation 39.01 Manganese Ore India 51 National Building Construction Corporation 74 Sponge Iron India 100 Recommendation snapshot Sectors likely to gain from stake sale Logistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fertilizers Disinvestment A step towards improved fiscal fitness Populist fiscal sops announced with an eye to the elections coupled with fiscal stimulus injections have skewed the Indian government’s books of accounts. India’s fiscal deficit is now estimated at 6% of GDP for FY09 against the initially projected 2.5% (5.5% for FY10). In our view, the divestment ofgovernment holdings in public sector enterprises is the best option to increase public revenues without fanning debt. Ballooning fiscal deficit: Although the revised government estimates for FY09 revenue receipts show a growth of 3.7% over FY08, this is significantly lower than the 11.3% previously anticipated. What is more worrying is the increase in debt required to finance fiscal deficit, which has been revised upwards by 145% for FY09. The government, in its interim budget, drastically increased its fiscal deficit estimate, announcing that the central government deficit for FY09 would come in at 6% of GDP instead of the initially projected 2.5%. The government is more upbeat about its FY10 budget which estimates a growth of 8.4% in revenue receipts over FY09RE and a decline in fiscal deficit to 5.5% of GDP. However, the continuation of populist fiscal sops amidst the recessionary climate is likely to suppress contributions to the government kitty and could lead to a downward revision of revenue receipt estimates during the course of the year. The case for disinvestment: Disinvestment was successful under the NDA regime, mobilising Rs 337bn over 1998–2004, until Left party opposition derailed the process. During 1998–2004, the government realised an average ofRs 56bn per year. This helped pare the fiscal deficit from 6.5% of GDP in 1998–99 to 4.5% in 2003–04. Going by our back-of-the-envelope calculations, ifthe new government manages to mobilise ~Rs 100bn through lined up public offers and strategic sales in FY10, it can lower fiscal deficit by ~25bps. PSEs identified for disinvestment in the past, but where plans were later shelved, would likely be the first to go under the hammer. Who stands to gain: Our analysis shows that stocks belonging to sectors such as Logistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fe rtilizers would stand to gain if the process of disinvestment takes place for PSEs identified as stake-sale candidates in the past.
Populist fiscal sops announced with an eye to the elections coupled with fiscalstimulus injections have skewed the Indian government’s books of accounts.India’s fiscal deficit is now estimated at 6% of GDP for FY09 against theinitially projected 2.5% (5.5% for FY10). In our view, the divestment of government holdings in public sector enterprises is the best option to increasepublic revenues without fanning debt.
Ballooning fiscal deficit: Although the revised government estimates for FY09revenue receipts show a growth of 3.7% over FY08, this is significantly lowerthan the 11.3% previously anticipated. What is more worrying is the increase indebt required to finance fiscal deficit, which has been revised upwards by 145%for FY09. The government, in its interim budget, drastically increased its fiscaldeficit estimate, announcing that the central government deficit for FY09 wouldcome in at 6% of GDP instead of the initially projected 2.5%.
The government is more upbeat about its FY10 budget which estimates a growthof 8.4% in revenue receipts over FY09RE and a decline in fiscal deficit to 5.5%of GDP. However, the continuation of populist fiscal sops amidst therecessionary climate is likely to suppress contributions to the government kittyand could lead to a downward revision of revenue receipt estimates during thecourse of the year.
The case for disinvestment: Disinvestment was successful under the NDAregime, mobilising Rs 337bn over 1998–2004, until Left party opposition
derailed the process. During 1998–2004, the government realised an average of Rs 56bn per year. This helped pare the fiscal deficit from 6.5% of GDP in1998–99 to 4.5% in 2003–04. Going by our back-of-the-envelope calculations, if the new government manages to mobilise ~Rs 100bn through lined up publicoffers and strategic sales in FY10, it can lower fiscal deficit by ~25bps. PSEsidentified for disinvestment in the past, but where plans were later shelved,would likely be the first to go under the hammer.
Who stands to gain: Our analysis shows that stocks belonging to sectors such asLogistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fertilizerswould stand to gain if the process of disinvestment takes place for PSEs identifiedas stake-sale candidates in the past.
Fig 2 - Central government deficit as a percentage of GDP
5.76.2
5.9
4.54.0 4.1
3.43.0
6.05.5
2
3
4
5
6
7
2 0 0 0 -
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0 9 R E
2 0 0 9 -
1 0 E
(%)
Source: RBI, RHH
Disinvestment – an analysis
With tax revenues sapped by fiscal sops and subsidies, the best option for the newgovernment to improve it revenue inflow without raising debt would be to divest itsstakes in Public Sector Enterprises (PSE). Past experiments with PSE divestment haveproved successful. However, the process came to a virtual standstill during the last 3–4years due to the opposition of the Left parties, which were a key coalition partner for alarge portion of the UPA government’s rule.
Various modes of disinvestmentDisinvestment transactions in India can be classified into four main categories:
Transactions involving the sale of the government’s minority shareholding (eitherthrough an offer for sale to the public or an auction to selected investors), subject tothe residual equity of the government remaining at least 51%.
Sale of all or a part of the government’s residual shareholding in disinvestedPSEs/companies either through a public offering or private placement.
Sale of a large block of shares in a PSE (including subsidiary of a PSE) along withtransfer of management control to a strategic partner. This is termed as a strategicsale. After the strategic sale, the PSE ceases to be a government company.
Sale of a block of shares in one PSE to another PSE.
Successful past deals
The government successfully mobilised Rs 466bn through the disinvestment processfrom 1994–95 to 2007–08. During the NDA government’s rule from 1998–99 to 2003–04, the government raised Rs 337bn through the process of disinvestment with Rs 155bncoming in during 2003–04 alone.
Hindustan Zinc 18.92% Exercise of call option 3,240 Nov-03
ICI 9.20% See note* 771 Oct-03
IBP 26%Residual shares throughoffer for sale
3,507 Mar-04
Indian PetrochemicalsCorporation
28.95%Residual shares throughoffer for sale
12,029 Mar-04
Dredging Corporation of India
20% Offer for sale 2,212 Mar-04
GAIL 10% Offer for sale 16,274 Mar-04
ONGC 9.96% Offer for sale 105,340 Mar-04
Source: Department of Disinvestment * 9.2% of the equity (consisting of 3760783 shares of Rs 10 each) held by government in ICI sold by the Department of Fertilizers to Asian Paints (India) at the rate of Rs 205 per share.
Several potential targets for disinvestment…We believe there is a large window of opportunity for the next government to bolster itsfinances via the divestment process. With improving market conditions, the stakedisinvestment would attract a wider audience and higher valuations. There are aplethora of PSEs in which the government can sell off its stake:
Firstly, there are those PSEs which have filed for a public issue with SEBI, but areyet to see the light of day on the primary markets. These include Rites, NationalHydro Power Corp, Bharat Oman Refineries, UTI Asset Management Company
and Oil India. (Ref Fig 5)
Secondly, there are about 25 PSEs recommended by the Disinvestment Committeewhich can be potential targets of divestment.
Thirdly, there are those PSEs which were slotted for disinvestment but for which theprocess was later called off for various reasons.
Fig 5 - Draft prospectus filed with SEBI for public offering
Company Sales PATExpectedamt to be
raised
Stake to bedivested
(%)
Current holdingby govt or govt
led companyBrief description
FY08 (Rs bn) (Rs bn)
Rail India Technical &Economic Services(RITES)
6.6 1.0 3.5 28 100
Three distinct fields of business: (1) consultancy intransport infrastructure; (2) leasing, export,maintenance & rehabilitation of rolling stock, andexport & rehabilitation of railway equipment; and(3) running of railway systems under concessionagreements
National Hydor PowerCorp
36.8 12.3 55.0 15 100Planning, development and implementation of hydroelectric power stations
Bharat OmanRefineries*
- - 24.0 48 50Grassroots petroleum refinery in Bina, MadhyaPradesh
Past strategic sale candidates to be the first in line
In our opinion, if the next government takes the disinvestment route to improve itsfinances, the companies which were identified for strategic sale are likely to be the firstto go under the hammer (see fig 7). Based on our analysis, if the disinvestment in thosecompanies happens, stocks belonging to sectors such as Logistics, Shipping, Engineering
& Construction, Oil & Gas, Metals and Fertilizers stand to gain.
The following tables show the relative valuations of companies identified for strategicsale (highlighted), with their peers in the respective sector. We find that the strategic salecandidates are currently trading almost at par or at a discount to other peers within thesector. We believe that any stake divestment by the government in these PSEs woulddrive valuations of these companies and thereby push up the valuation of theirrespective sectors.
Fig 8 - Valuation (Logistics)
M Cap Valuation TTM (x)Company
(Rs bn) P/E Fwd P/E P/B P/S EV/EBITDA
Balmer Lawrie & Co Ltd 4.7 4.6 4.1 1.1 0.3 3.2
Container Corp Of India 104.7 14.3 12.2 3.3 3.1 10.3
Apart from the above options, we have analysed listed PSEs that offer scope fordisinvestment, such that the government’s stake remains at least 51% post-dilution.
Fig 14 - Listed government companies offering scope for disinvestment
Recommendation Expected absolute returns (%) over 12 months
Buy More than 15%
Hold Between 15% and –5%
Sell Less than –5%
Recommendation structure changed with effect from March 1, 2009
Expected absolute returns are based on share price at market close unless otherwise stated. Stock recommendations are based on absolute upside (downside) and have a12-month horizon. Our target price represents the fair value of the stock based upon the analyst’s discretion. We note that future price fluctuations could lead to a temporary
mismatch between upside/downside for a stock and our recommendation.
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