8/8/2019 Disinvestment of Public Sector Undertakings in India

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By

Pankaj Kumar

Enrolment No: 10810041

MBA Batch 2010 12

DoMS IIT Roorkee

Referenced from: Indian Journal of Finance, August, 2010

Authors: Dr. M.K. Ramakrishnan and Sandhya R.

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Disinvestment is a wider term extending from dilution of the stake of the

Government to a level where there is no change in control to dilution that

results in the transfer of management.

It involves the sale of equity and bond capital invested by the government in

PSUs.

It is the government and not the PSUs who receive money from disinvestment.

Disinvestment is generally expected to achieve a greater inflow of private

capital and the use of private management practices in PSUs, as well as enable

more effective monitoring of management discipline by the private

shareholders.

Such changes would lead to an increase in the operational efficiency and the

market value of the PSUs.

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y The announcement of industrial policy on July 24th 1991, in which thecentral government expressed its intention to bring the private sector

participation through a system of disinvestment of PSUs

y The new economy policy of liberalization, privatization and globalizationde-emphasized the role of the public sector in the nations economy.

y Two mode of disinvestment were adopted by the government.

1. Minority sale: Dilution of government stake withouttransfer of control.

2. Strategic sale: Transfer of control to privateentrepreneurs

y First 10 years, disinvestment was marked by minority sale only showsgovernment conservative approach towards implementation of disinvestment policy.

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Methodology and Data Used:

y This case study is based on the fundamental analysis of financialinformation for two modes of disinvestment.

Two company are considered for minority sale: 1. Dredgingcorporation of India limited (DCIL) and 2.Gas Authority of IndiaLimited (GAIL) and one company for strategic sale: Hindustan ZincLtd (HZL)

y Accounting ratios are extensively used to study the financialperformance of the target companies.

y Ratios measure three dimensions of financial performance:

Profitability, Liquidity and resource Utilization levels.

y Financial year 2003-04 is taken as the base year (pre disinvestmentperiod).

y

A period of 4 years that is 2004-05 to 2007-08 represents postdisinvestment period.

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Analysis f Pr fitability1. Net Profit Ratio: It establishes relationship between net

profit and sales. It indicates the efficiency of thecompany in manufacturing, administration, selling andother core business functions.

y

Net profit Ratio=Net Profit / salesy The study reveals that disinvestment has caused

improvement in profitability of enterprises.

The average profitability of disinvested companies hasgrown at compounded annual growth rate (CAGR) of

more than 10% in the post disinvestment period. Theimprovement is more significant in case of strategic sale.

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2. Return on capital employed (ROCE): It measures return in termsof profits before interests and taxes (PBIT) as a function of the

total capital employed.y ROCE=(Net profit before Interest and taxes/Capital employed)*100

y ROCE is a product of net margin and the efficiency in which theassets are managed. In the post disinvestment period, the combined

profitability of disinvestment entity has recorded a CAGR of 11.21percentage points.

3. Earnings per share (EPS): This shows the earning potential of thecompany from the point of view of equity shareholders. Thisestablishes the relationship between earnings as a function of the no.of equity share in the issue.

y EPS=(Net profit after Taxes and Dividend for preference shares/

Number of equity shares)

y Study shows that average CAGR on EPS has increased by 30% inpost disinvestment period. Further strategic sale is again moresignificant in term of mode of disinvestment.

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Analysis f Liqui ity1. Current ratio: It measures the relationship between two primaryelements of liquidity: current asset and current liability. It measures the

firms ability from short term liability to short term assets. Current assetsare all asset classes that are converted into cash within a period of oneyear and current liabilities are those liabilities that are repayable within ayear.

Current Ratio= current asset/ current liability

y The short term liquidity of company has increased substantially sincedisinvestment as indicated by average CAGR of 18% on current ratio.

2. Cash Flow From Operation to current liabilities: One of the objectiveof the financial management is to optimize cash flow from operations. In

the absence of adequate supply of cash flow from operation (CFFO), acompany will have to find non operating sources to maintain liquidity andlevel of operations.

CFFO To Current liability=CFFO/Current Liability

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y Disinvested has boosted the cash flow of generating capacity ofcompanies. In post disinvestment period, it has increased to 1.37registering a CAGR of 27%.

3. Debt equity ratio: It measures extent to which debt financing hasbeen used in the business. The ratio indicates the proportionalclaims of owners and outsiders against the firms asset. Debt ratio

measures financial leverage of a firm.

Debt Equity Ratio= Debt/Owners Equity

y

The lower debt equity ratio indicates the reduced financial riskexposure of these companies.

y Debt component of the disinvested companies has reduced in thepost disinvestment period as indicated by the negative CAGR of22%.

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Analysis fass t utilizati n1. Debtor turnover ratio: This indicates the velocity of debt collection of a firm, afactor contributing to the movements in operating cash flows. It measures collection

efficiency of the firm.

y Debtors turnover in Days = (Average Debtors/Total Credit sales)*100

y The collection period of disinvested entities on an average has increased in the postdisinvestment period from 44 days to 51 days. Thus, it is evident from case study

that disinvestment has caused decline in collection efficiency of firms.

2. Inventory Turnover Ratio: This measures the velocity of conversion of stock intosales. It indicates whether inventory has been efficiently used or not. It evaluates theefficiency with which a firm is able to manage its inventory.

y Inventory days = (Average Inventory/ Cost of goods sold) * 365

y It is evident from the case study that the inventory management efficiency hasimproved during the post disinvestment period as indicated by the decrease ininventory days from 69.5 to 54. Usually a low inventory period indicates theefficient management of inventory.

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3. Working Capital Turnover: This indicates the velocity of utilization of networking capital. This ratio indicates the number of times the working capitalis turned over in the course of a year. Higher the ratio, the better will be theutilization of working capital and the resulting operating cash flows.

y Working capital Turnover Ratio= Total Sales/ Net Working Capital

y The average working capital efficiency has declined marginally in the postdisinvestment period where as strategic sale helped to improve workingcapital efficiency.

4. Fixed Asset turnover ratio: This measure the efficiency in the utilization offunds tied up in this form of assets. It establishes the relationship betweennet fixed capital investment and the corresponding sales revenue.

y It is evident from the study that the companies have improved their fixedasset utilization levels after disinvestment by the CAGR of 3.98%.

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y Altman Z-score model: Altman developed a multivariate Z-score model to studythe financial distress of public companies whose shares are listed in the stockexchanges. This model shows the combined impact of all the aspects of financialperformance on the overall financial health of target companies.

The model is expressed as follows:

Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 1(X5)

Where:

X1: Working Capital / Total assets

X2: Retained earnings/ Total assets

X3: Earnings before interest and Taxes/ Total assets

X4: Market value of equity/ total liabilities

X5: Sales/ Total assets

A Z- score below 1.81 indicates high profitability for bankruptcy or financialdistress. A score above 2.99 indicates a low profitability for bankruptcy. A scorebetween 1.81 and 2.99 indicates grey areas where managerial actions needed to

improve the financial health of the firm.

y This model clearly supports the results of many of the foregoing analysis relating toliquidity, profitability and asset utilization aspects of target companies performancein the post disinvestment period.

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Conclusiony The study reveals that disinvested entities generally improved

their performance in all three aspect (liquidity, profitability andasset utilization) of financial performance in the postdisinvestment period.

y Disinvestment through Strategic sale has achieved remarkable

progress in all three aspect of financial performance than theircounterparts representing minority sale.

y The Z score analysis based on Altman model also supports thisfinding of the study.

y The strategic sale mode of disinvestment provides company morefreedom and opportunities to carry our structural changes forachieving rapid growth and to improve their competiveness.