Should you play the disinvestment theme? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should you play the disinvestment theme? 

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In this issue:
» Govt fast tracks SAIL disinvestment. More to come?
» Should large PSUs be privatized?
» Can the OFS route help retail investors?
» Challenges that China faces with its PSUs
» ...and more!

00:00  Chart of the day
The Indian equity markets have enjoyed a dream run for the last few months on the back of the change in government. However, the last few weeks have seen some caution returning to the markets. While the initial euphoria may have died down, market participants already have begun to look forward for fresh triggers. It is quite natural that we will hear about many 'themes' in the middle of all this pre-budget speculation. The latest one doing the rounds is the 'disinvestment theme'. The question is should investors fall prey to it?

Disinvestment as a theme certainly has its appeal. It is no secret that the government's finances are in shambles. The ballooning fiscal deficit threatens to derail the nascent economic recovery. One of the quickest ways to reduce the deficit is by shoring up funds via stake sales in PSUs. The SEBI directive requiring a minimum of 25% public shareholding will also push the government in this direction. This could translate into about Rs 600 bn in stake sales in the next two-three years. Thus we can expect several public issues to hit the markets in the coming months. However, out of these issues the top 5 PSUs will account for about 80% of the total stake sale. The big 5 are Coal India, NMDC, SAIL, NHPC and Neyveli Lignite. While Coal India is by far the biggest of the lot, with a stake sale value of Rs 357.6 bn, the sizes of the other four are also not far behind. There will be a lot of hype around these big issues when they hit the markets. Your broker will almost certainly sing praises about these companies and ask you to invest in them. Should you oblige?

A detailed look at these companies will make it clear that the government will face problems trying to convince the street to swallow up the issues. Barring a few exceptions, all PSUs face headwinds that are company specific. For example Coal India, has recently faced serious pressure with regards to volume growth. This was the main reason for the fall in the stock last year. The company also has to deal with problems related to its labour force. SAIL too is struggling to deliver growth and improve internal efficiencies. Divesting a big stake of 15% in Neyveli Lignite would be a herculean task for the government considering the poor liquidity in the counter.

Despite these company specific problems, it must be kept in mind that India's PSUs can deliver a good performance in the long term if they are freed from government interference. Many of them are sitting on big cash reserves and do not have a debt overhang. However, this does not mean that one should blindly jump on to the disinvestment bandwagon. As and when these and other PSU issues come to the market, they should be assessed individually and not as one common theme. The long term fundamentals of these firms notwithstanding, the gains that can be made from the stocks will always depend on the price you pay while investing in them. Public issues tend to be overpriced as the promoters (in this case the government) try to squeeze out the maximum that they can get out of them.

Retail investors will do well to shut out the noise surrounding the disinvestment program. They should invest in these PSUs only after studying the fundamentals and considering their own risk appetites. As they are government owned, the interest of minority shareholders may not always be in sync with the intentions of the government. Investors must give due importance to this aspect while investing their hard earned money in PSU share sales. Finally, the price should be attractive. If the issue is overpriced, it would be best if investors avoid it altogether. When it comes to PSUs it is better to be safe rather than sorry. In the immortal words of Warren Buffett; rule number one is 'don't lose money' and rule number two is 'don't forget rule number one'.

Do you think that investing in PSU issues make sense? Let us know in the Equitymaster Club or share your comments below.

Will these mega issues succeed?

Just a few days back we wrote how the government took steps to kick start the capex cycle by clearing projects worth Rs 210 in a jiffy. Seems the government has also pressed the button when it comes to kick starting the disinvestment drive. And the first PSU in the divestment list appears to be SAIL. The government plans to divest 5% in SAIL which is expected to fetch Rs 20 bn at the current prices. Actually the UPA government laid down an original target to divest 11%. However, it was successful in off loading only 6% odd due to poor market conditions. Thus the balance 5% is likely to be sold off now.

Besides, the government has also started process to divest stakes in other PSUs. Divestment obviously makes government cash rich and helps it plug the fiscal gap when income from traditional sources like taxes is drying due to slowing economy. However, what is more interesting is to see whether the government will eventually go for full privatization or retain controlling stakes in these PSUs.

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While we are on the topic of PSUs, there's no escaping the old debate that comes up for discussion every now and then. Is the Government better off privatizing public sector behemoths that are virtual monopolies? An article in Livemint gives the example of three such firms, Indian Railways, Coal India and the Food Corporation of India (FCI). The assets that these companies lord over are nothing short of breath taking. And there's hardly any firm, public or private, that come anywhere close to the market shares that these entities enjoy. However, just as solid their pedigree is, the problems confronting them are perhaps even more daunting. None more serious than the fact that none of these companies are run as successfully as their sizes would justify. As a matter of fact, a couple of them are even finding it difficult to keep their heads above water. And thus have to rely greatly on Government hand outs.

Therefore questions are consistently raised on whether breaking these companies into smaller entities would make more sense. Better still, how about privatizing them? Well, we are all for privatization as it will unleash tremendous productivity and lead to gains for all the stakeholders involved. The move can also backfire though. And can lead to these companies fully exploiting their monopolistic status. However, we believe that the Government has enough checks and balances to ensure that its social objectives are also met through these companies.

SEBI's measures to make the IPO market retail investor friendly have already taken off well. The retail portions of recently concluded IPOs were oversubscribed several times thanks to the 'safety net' provision. It now seems that the secondary market too is set to fetch a lot more liquidity thanks to offer for sale (OFS) norms. The OFS route was so far taken by promoters wanting to dilute their stake in listed entities. However, going forward, even non-promoters having more than 10% holding in the company will be eligible to do so. Besides bringing in additional liquidity for minority shareholders, a minimum 10% of the OFS will be reserved for retail investors. Now, like the 'safety net' norm for IPOs, the norm for OFS is also in good intent. However, that does not allow investors to get complacent on due diligence. Just like the safety net should not be the reason to apply to any and every IPO, every company offering shares through OFS route may not be worth investing in.

Indian public sector companies are generally known to be quite inefficient and bureaucratic compared to their private sector counterparts. Government agenda often bears over the long term interest and profitability of these companies. But we would be wrong if we thought that Indian PSUs were the only ones that had trouble. Take our neighboring country China, where state-owned enterprises (SOE) play a very major role in the overall economy. Let us share some statistics we came across in The Diplomat.

At the end of 2011, there were 144,700 SOEs in China. These SOEs together controlled total assets worth 85.4 trillion Yuan, accounted for revenues of 39.25 trillion Yuan and profits of 2.6 trillion Yuan. It's worth noting that these SOEs account for 43% of China's total industrial and business profit. Many of these SOEs enjoy benefits in the form of easy and cheap credit, monopoly positions and government subsidies. Nonetheless, these SOEs suffer from many structural and organizational issues that pose a big challenge for the Chinese economy. Some problems include inaccurate accounting, illegal practices, and poor investment decisions and so on. In fact, SOEs have been the biggest contributors of non-performing loans in previous crises. So like India , China's public sector enterprises too need an overhaul. And this cannot be achieved without some bold economic reforms.

In the meanwhile; the Indian stock markets after opening in the green, closed in the negative territory. BSE-Sensex closed lower by 74 points (down 0.6%). Sectoral indices traded mixed with FMCG and IT stocks being the biggest losers, while metal and auto stocks led the gainers. Most of the Asian stock markets were trading weak with Hong Kong and Taiwan being the major losers whereas Japan was trading up marginally. Even the European markets opened the day on a negative note.

04:55  Today's investing mantra
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