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Investing in India - Honest Truth by Ajit Dayal
Taking a PSU to court A  A  A
PRINTER FRIENDLY | ARCHIVES
9 APRIL 2012

Coal India and the Government of India are being taken to court by The Children's' Investment Fund (TCIF) for, effectively, not maximising returns to shareholders and stakeholders in Coal India Limited, a public sector undertaking (PSU) that is listed in the stock exchanges.Interestingly, TCIF states that its claim will also benefit the majority shareholders, the "people of India".

The core of the issue is the allegation that the private sector power companies (who have a need for coal to run their power plants) have lobbied the government to ensure that Coal India will supply them with locally produced coal at prices which are 70% below the price of coal in the international markets. This, TCIF, says is against the interests of the "people of India" and other stakeholders.

TCIF has set up a web site www.Coal4India.com which acts as a platform for debate and discussion.The founder of TCIF, by the way, is also the biggest donor to a charity run by him and his wife to help children. News reports suggest that the founder of TCIF has given away over one billion dollars to the charity, representing a chunk of the profits and earnings he has made as a hedge fund manager. A very noble act.

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A typical PSU is built to be milked - and the cow is tethered.

On the other side of the ring is Coal India, 90% owned by the government of India - the "people" of India.The other 10% is owned by the "private" investors via an IPO. TCIF is the largest non-government shareholder and owns 63.6 million shares or 1.1% of Coal India.

The IPO was priced at Rs. 245in October, 2010. The shares were listed on November 4, 2010 and the closing price as of April 5, 2012 is Rs 341.60. This translates into a total return (including dividends) of 46.11% compared to the BSE-30 Index which had a loss of -13.55% and Oil and Natural Gas Corporation Ltd. (ONGC) which also saw a loss of -14.62% over the identical 17-month period. (source: Bloomberg)

There are 13 people on the Board of Coal India, of which 7 are Independent members (>50%), 5 Executive Directors (these individuals work for the company and are also on the board), and 2 government-appointed Nominee Directors. Note that one of the two government's Nominee Directors (Ms. Zohra Chatterji, Additional Secretary, Ministry of Coal), is also the Chairman-Cum-Managing Director and is classified as an Executive Director.

Coal India is, in many ways, a "typical PSU". It has this wonderful tag of "Maharatna" but that tag may be as useless as the tag of "Navratna".

Mahanagar Telephone Nigam Limited (MTNL) was (and maybe still is) a "Navratna". But what did the government do? Well, it could have empowered MTNL to go out and build a wireless network with the help of external capital (this has been done by state-owned companies in Europe) but, instead, the government chose to auction spectrum to new entrants. This, one could argue, has created wealth in "private industry" and destroyed the wealth of the "people of India" who are shareholders in MTNL.

Or by giving gas and oil fields to Cairn India, Essar Oil, Reliance Industries Limited (RIL), and Videocon, has the government destroyed public wealth that could remain in ONGC and enriched the private sector?

And by allowing private sector airlines did the government destroy Air India and Indian Airlines - companies owned by the citizens of India? Could Air India not have been made a better airline by restricting government ministers and ministries from using the airline? Instead we have private sector companies like Kingfisher Airlines and Jet who need the government-owned banks to bail them out PLUS the burden to bail out Air India still exists - all paid for by the "people of India".

By allowing private sector groups to come in to banking, did the government not destroy the value of State Bank of India? And add wealth to the shareholders of HDFC Bank, ICICI Bank, and Axis Bank? What innovations did the private sector banks introduce which were not cut-and-paste services offered by banks in the developed world?

Of course, one can rationalise any of the above by saying that most (if not all) of the PSUs mentioned above were badly managed and had government interference: valid arguments.

But would the national interest - as the "people of India" are the ultimate owners of these PSU shares - have been better served by forcing more efficiency and changes in the way PSU's are managed and run? A more difficult task for sure. The easy option was, probably, to allow private sector participation on one hand and list these PSUs on the other hand.

ONGC and SBI

But listing of the PSUs does not come with a guarantee that they will act in the interest of the minority shareholders. ONGC is selling oil to the refiners like Bharat Petroleum Corporation Ltd. (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) at USD 55 per barrel. It could ask for more. Like USD 100 per barrel. But, if it did, you would have to pay that higher petrol price. Or if you refused to pay the market price, the government would swallow it as a deficit and then it would show up in some tax hike or in higher inflation.

At USD 100 dollar a barrel of oil, ONGC would be very profitable and its share price would surge. The "people of India" would be rich, because they are shareholders of ONGC. On the other hand, the users of petrol, diesel, and kerosene would be hit since they now pay the higher price. Since millions use these oil products one could say that the people of India would be hit by paying more for these energy sources. Also, there are many within the "people of India" who cannot afford to pay anything. Therefore, the government subsidies would increase further. Therefore, wealth comes into one pocket, but money flows out from the other. The "people of India" may not gain.

But a select,private shareholder group in ONGC (including Quantum Long Term Equity Fund) would benefit from such a re-calibration of oil prices.

If the chances of a full market price are slim, why has Quantum Long Term Equity Fund bought ONGC? And what has Quantum AMC not gone to court against ONGC or the government? One of the first rules of investing is to know

what you are investing in. And we recognise that ONGC is a puppet of the government. A large puppet - but a puppet none the same. There is obvious intrinsic value in the company if, and it is a big if, ONGC were to ever charge global prices for its crude.

The fund managers at Quantum AMC know the potential but recognise this catalyst is far away. To compensate for this risk, they will be willing to buy or sell ONGC at different valuation criteria than they would for a private sector enterprise in the same business. And if there is no hope of change, the fund managers can sell and exit on the stock exchanges.

State Bank of India is another stock which the Quantum Long Term Equity Fund owns. Banks, as a gentleman from SBI reminded us a few years ago, do 3 things:

  1. The raise money as deposits at a certain rate of interest,

  2. The lend money at a certain rate of interest, and

  3. They need to decide who to lend to - and how much to lend.
The government is the largest shareholder, the State Bank Of India (SBI) employee said frankly, and they influence all the 3 things.

Yet, the fund managers at Quantum AMC have bought SBI. They know the risks of being investors in SBI and they pay less for the future earnings than they would for the similar earnings from an HDFC, for example. Because SBI is listed, the risks of government interference did not go away. It is still a PSU with social objectives.

Governance is lacking, but "people of India" is a complex issue.

This "people of India" flag raised by TCIF is a complex issue.

In the case of Coal India, let's assume that the government steps away and tells Coal India to decide the price of coal as they deem fit. Coal India then decides to raise the price of coal to the power companies by, say, 100%. There is no coal-cost and fuel pass-through under the tariff agreementsfor most of these new private sector power plants. This means that the private sector power companies would have to absorb the losses due to the higher input price of coal. This could result in Tata Power and the other private sector power companies throwing up their hands and declaring bankruptcy.

Typically, power plants are financed with about 3 times as much debt as equity. So, the 16,000 MW of private sector power plantswould cost approximately Rs 64,000 crore to set up. If they go bust the losses to the banking system are probably in the region of Rs 45,000 crore.

And that will require a bail-out from the Reserve Bank Of India (RBI) using money belonging to the "people of India".

And imagine what would happen to the entire stock market (and the value of PSU shares owned by the "people of India") if there was a banking crisis in India?

And imagine a country with a power shortage - what will happen to overall GDP growth and to economic activity? And share prices of all companies owned by the "people of India"?

So, the "people of India" will see two conflicting outcomes:
  1. They will have gained from the value of their shares surging in Coal India by "tens of billions" of dollars because coal is now being sold at a market price, and

  2. They will probably see some collapse in the value of their other PSU holdings also of the magnitude of the "tens of billions" - maybe more - due to a market meltdown.
As a custodian of the wealth of the "people of India", should the government hike the cost of the coal being given to the private sector companies? A majority shareholder does not have to surrender his rights and obligations to please a "minority". There is a national interest and a "minority" interest and a larger government, shareholder has a right to pursue that "national" interest.

As an aside, the private sector power companies have done to India what Goldman Sachs, Morgan Stanley, and RBS to name a few have done to their respective governments and countries. They have put us in a "heads I win" and "tail you lose" situation.

The private sector power companies know that India is short of power. They know the banks will be in trouble if they declare bankruptcy. As pampered industrialists seeking constant favours, they are running to the PMO to help with the coal price and the coal availability.

The issue, from the "public of India" perspective is not that Coal India will give away coal cheap. It is that after having been given coal cheap, the private sector power companies will get to keep 100% of their profits.

The big financial firms in the US, UK, and Europe put all the risk on the tax payers and got to keep the profits.

The private sector power companies bid for many of these power plants knowing that there was no pass through of fuel allowed. Now they want a favour of low coal - and they wish to keep the profits.The private sector power firms are in the same sweet spot as the financial geniuses.

Before investing in India, better to understand India

None of this is an excuse to justify that PSUs should always be managed badly or that Coal India is doing the right thing.

But TCIF is wrong to make a case that India will get a bad name in the investment world if Coal India is allowed to get away with their FSA contracts to Tata Power, Reliance, and other private sector companies.

What it will prove is that foreign investors have been too busy reading the fairy-tale news stories spreading across the world since 2005. The 8%, 9% and 10% rates of growth in GDP that India has achieved over the past few years are not as a result of some great policy planning. The high growth rate was a function of global flows and big-time favours being granted to the well-connected whether it is for coal, gas, iron ore, oil, real estate, or spectrum. An industrialist armed with a license for theft was happy to invest in extracting the assets - this led to higher capital expenditure which shows up in the higher GDP numbers.

The foreign investors ignored the fact that a society determines its politics and this influences economic policies - and every industry is a sub-set of these criteria.

Sometimes, the system gets a shock and the very assumptions on which societies are based are questioned.

Take the case of the US or UK. It was long assumed that when a company in these countries fail, they will die. However, the US and UK taxpayers have bailed out the bigger financial firms. The "capitalist" society of the US and UK worked well as long as the well-connected did not get hurt. And economic policies were designed around that assumption. But, once the well-connected were hit, the rules of the game were changed.

Or the assumption that, since Greece was part of the Euro, it would have the same low risk as Germany. This myth has also been shattered.

The listing of PSUs did not make them "capitalist" entities maximising profits. It made them companies with access to large pools of capital but the inherent conflict of the "national interest" and the "minority interest" remains. If there is a conflict, the government has resolved it and issued Coal India a presidential decree. Will all PSU shares now be shunned? I doubt it. They will - and should - trade at a discount to their private-sector peers as they deserve to. And IPO-punters will be more aware of the risks they face in subscribing to such issues. Not that Coal India has been a bad investment - it has done very well.

India remains, in our opinion, a great place to invest - if you know where to invest and what price to pay for the investments you make. One can make money by investing in India and controlling your risks - we have done so by being shareholders in PSUs and in private companies; and avoided many of the suspect managements along the way.

TCIF has a valid point to make and it wishes to maximise its returns. That is the fair objective of TCIF and the minority shareholders of Coal India. They are fighting for their interests - and there is nothing wrong with that.

But its claim that this will help the "people of India" is debatable. The majority have a right to protect their own interests - however wrong they may be in the eyes of the minority.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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10 Responses to "Taking a PSU to court"
Ragini Ghanekar
Apr 11, 2012
I understand logic behind all the discussion. But still I feel that gradually and not all of a sudden and to the full extent this subsidy thing should go. People have to face the fact that oil price is not going to come down drastically. And similar case for all other subsidies. Also all other aam aadmi yojanas. There will always be people who need help and hand outs. But everybody does not need it. The reality will have to be shown to the people but in a gradual manner. Different routes should be found out to help destitute not rojgar hami yojana with no accountability. It will be better to encourage private players to build roads which will last than government building them which wash out in next rainy season. Private players will also create employment at right price. similar argument can be forwarded for all other things. It is not appropriate not to raise railway fares by few paise and not to provide for improvements and safety requirements. Like 
Badri
Apr 11, 2012
What is the fuss all about? Please look at the Prospectus.... Risk factors, item No. 17. --

Begin Quote

We sell our coal at prices lower than the prices otherwise in the Indian and international coal
markets. xxvii
Although pricing of coal in India was completely deregulated with effect from January 1, 2000, since the price
of coal has significant ramifications on the Indian economy in general and the thermal power sector in
particular, we have followed a strategy of focusing on improving cost efficiencies to avoid price increases,
particularly for our lower grade coal, and generally consult with the GoI in determining the price of our coal. In
determining the price of our coal, we take into consideration general inflation levels, increase in production
costs that cannot be offset through efficiency improvements, the need for generating internal resources to ensure
viability of projects and, to a lesser extent, the landed cost of comparative imported coal. The price of raw coal
sold under our FSAs does not fully reflect market prices for coal in India or in international coal markets. In
addition, in the event that our production costs or other costs associated with the purchase of our coal that are
payable by our customers, such as transportation cost and statutory levies, were to increase, there can be no
assurances that we would be able to increase the price of coal to offset any such increases. For policy or other
reasons, we may not price our coal at levels that would adversely impact the power sector or the Indian
economy. For further information, see “Business – Pricing of Coal” beginning on page 63.

End Quote

this has been mentioned very clearly. This is again a very clear tactic of poor research and bad decisions, and now cribbing.. just because he is gora, doesn't mean he should get away with this.

If people bought into this, knowing the risk, they should not complain.

Like 
Prem Khamesra
Apr 10, 2012
Nothing meaningful can come out of a debate/ discussion that is centered around a company when the issues involved are far wider. What the Government is doing in Coal India is an interventionist action. Through this action the Government wants to interrupt the unchecked flow of free market forces. From a pure capitalist perspective this is not desirable. From a pure socialist angle, it is too little. Like 
Mukul
Apr 10, 2012
This should be viewed as the case of how minority shareholders are treated when majority shareholder (in this case Govt) do as it wishes. You yourself has raised such issues in some other posts (Ranbaxy etc). If you feel Govt has valid social responsibilities for giving things at low cost or for free, then they are free to do it by delisting the entity and buyback shares from minority shareholders. In this case they are causing loss to minority shareholders "the people of india" Like 
Sharat
Apr 9, 2012
Ajit,
I think it has been proven many many times that the govt does not act in anyone's interest but in the interest of trying to retain power. Its actions are totally irrational in most cases and do not make any sense in the most cases.

My questions to you:
(1)What is the difference in the way shareholder's money is handled by say a Reliance, which you have hinted many times has dubious balance sheets, and the GOI run PSUs? I think you would agree that these managements are "suspect management".
(2)Why should I, a share holder in QLTEF, invest in QLTEF if you are not investing it in right places and support such useless managements and have openly suggested that you would not doing so? Many of these PSU stocks have been proven total duds like the example you quoted of MTNL.

I would fully support what CIL does. It is a different matter that in the need we are all carnivals and the guy with biggest truck of weapons (money, bureaucrats etc) may run amuck.
Like 
P.Prasad
Apr 9, 2012
The loot of India by Indians is far more than all the hordes that passed through India. The tragedy is WE Indians have lost OUR own self respect. It's not minority or majority, it is just LOOT by all and sundry. Like 
Dr. Hitesh Wadhwani
Apr 9, 2012
You have pointed out all the conflicts in a very lucid way. I liked the observation that better to invest in a PSU than dubious private management, after taking into account that there shares will be always valued at a discount. After reading your article my perspective in value investing has widened. Like 
K.G. Rao
Apr 9, 2012
Mr. Dayal doesn't seem to have got it right. Firstly, are these FSAs only for the pvt power plants, or a mix of both pvt and public. I believe it is the latter. Not forcing an FSA on Coal India will result in higher fuel costs to the power plants, and ultimately higher cost of electricity to the consumer, i.e. people of India, but I fail to see how the possibility of bank collapse and economic chaos follows from this. And, whether Coal Indi runs losses or power plants run losses, does it really matter? At least the true cost basis scenario will emerge, and knowing the actual problem is the best way to devise means of fixing it. No, I do think Mr. Dayal has got it wrong, and the law suit is a very good idea. Would Mr. Dayal be able to respond? Like 
Ramanand
Apr 9, 2012
Sir,
I'm of the view that if Government continues to remain a majority shareholder (and a particularly influential shareholder at that...note that Govt no longer has much influence in Maruti Suzuki), such companies should not be listed in the capital market at all. Why subject a section of capital market investors to substantial hope/stress when the companies objectives are not aligned with shareholders interests? Such Public 'Service' Units should be re-nationalized and delisted. Then let government do as it wants with its babies.
While it may be true that India will not get a bad name in the investment world due to this Coal India presidential decree, I can assure you that the governments Disinvestment plans are sure to take a big hit. Especially if govt wants to exit via offloading shares to the public.
Like 
Anish Shah
Apr 9, 2012
A very realistic comment on how the markets move i.e. purely based on fund flows. Nice post indeed Ajit. Like 
  
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