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Column : Destroying shareholders’ wealth

Nov 27 2012, 01:17 IST
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SummarySelling Hindustan Copper shares at a 42% discount wasn’t a bargain as the share price was artificially high.

The recent sale of Hindustan Copper shares at a huge discount to the market price to LIC, public sector funds and banks raises a large number of questions that need to be analysed.

The current disinvestment policy of the government states that citizens have every right to own part of PSU shares; PSUs are the wealth of the nation and the wealth should be kept in the hands of the people, but the government has to retain majority shareholding, i.e. at least 51%, and management control. It further states that the government will divest 10% stake in unlisted profit-making PSUs in the market. The purpose is clear: the public should own at least 10% in all companies. This float also allows the company’s performance to be judged by millions of shareholders, through pricing of shares, rather than the performance being only judged by a few bureaucrats and technocrats in the government, and ministers, in an incestuous environment. The market scrutiny through a transparent market process keeps the public sector managers on their toes, unlike being judged only by a few in the governments, who can be influenced.

The auction of Hindustan Copper shares at 42% discount to market price gives the impression that the shares have been sold at unrealistically low prices and the existing shareholders have lost huge value due to the government action, else their value would have continued at the earlier high levels. But is that really the case?

The problem with Hindustan Copper Limited was that about 99% of its shares were owned by the government and a minuscule number of shares were traded by very few. This led to the possibility that the share prices could be manipulated by a very limited number of shareholders to very high levels by mutual sales, to enable these shareholders get a very high price at the time of open offer; of course, if the discovered price was a function of the market price. To stop this, it is always advised in contemporary literature that such companies should first be delisted, and then shares sold. Sale of shares at the time of disinvestment can then be based on intrinsic value of the company, which is based on performance, and discovered with the help of advisors and valuers. This was done in this case, but the high manipulated market prices before sale led to an impression that the government undersold the shares under fiscal pressure, not being aware that the high market price was a function of market manipulation of a few.

The optimum share price based on the inherent value of the company’s worth was R155/share. However, the company was traded at more than R300 before disinvestment and around R266 at the time of disinvestment. Such high market price gave an impression that the company was sold at a very low price. It has started falling very severely after the sale, and would go soon below the discounted purchase price. LIC and public sector banks would then incur losses, and the purpose behind transferring public sector risks to the market/people will also be destroyed, the price having not been discovered through a transparent process in the market, and the price discovery based on the bids from public sector institutions brings in unnecessary government intervention. The taxpayer would then pay again if the company’s performance does not improve.

In the current situation, it makes no difference whether the shares are owned by the government directly or by public sector institutions. The price of R155 also looks a very high price. As the following analysis would show—public sector institutions have been forced to quote a high price in their offering, close to the government price.

One of the ways to look at the efficiency of sale is to see its price-earnings ratio. If the market price was the correct index, this ratio would have been around 80. It has been sold now at a ratio of around 45, very high according to any standard, and if nothing miraculous happens in the company, the public sector financial institutions will incur a huge loss, contrary to the current public impression that the government has sold at very low prices due to fiscal distress. And the last word, it is a bad idea to transfer government risks to public sector financial institutions. It may be recalled that even blue chip companies of the government were sold in earlier disinvestments in the 1990s at ratios of 5 to 7.

However, it is welcome that the process has started, and the government has not succumbed to price manipulation in the market by cancelling the deal midway, and that the government has got a high price. Hopefully, now, in the interest of buyers, the government would exert pressure on the PSU to improve its performance in order to ensure that the public sector institutions that have bought shares do not suffer, and that the future share prices are high based on improved performance by the PSU.

The author is former disinvestment secretary, power, and chairman, Trai

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