Avoiding PSUs will help

It may not make you rich, but will insulate from decisions made to meet divestment targets

This week, columnists and commentators will be focussed on discussing likely returns in 2019. Rather than adding to the crowd, it makes sense to offer a piece of advice which is likely to save investors money, not just in 2019 but also in the longer run.

The advice is simple: Avoid exposure to public sector units (PSUs). The reason is equally simple: The promoter, meaning the government, treats minority shareholders with contempt and is less than interested in profitability. This has always been the case with PSUs, and has gotten worse in the past few years, when the slogan of “disinvestment” has turned into a parody of itself.

The HPCL-ONGC deal of 2017 and the PFC-REC deal of 2018 are the two clearest examples of the disregard of minority shareholders and a very twisted interpretation of disinvestment. Both deals followed the same pattern. One PSU “bought” another. In both deals, the net government stake effectively remained the same and full government control was retained. The money paid in the transaction was transferred from the reserves of the “buyer” into the government’s coffers. This was cash that should have been spent to grow the business, or handed back to shareholders, including minority shareholders.

In addition, the buyer company took out loans to clinch the deal. The borrowed money also went into the Government of India’s (GoI’s) coffers, while the borrower took the debt on its balance sheet. This meant that, instead of the GoI borrowing via Treasury Bills, PSUs took on loans at commercial rates and handed the cash over, with no need for repayment. Shareholders, including minority shareholders, were thus saddled with huge debts.

 

This is behaviour no private promoter could have gotten away with. Assume for example, that a private business group owned majority stakes in two listed companies, “A” and “B”.  It decided that the stake in B would be sold to A, by transferring cash from the reserves of A to the promoter’s private account. Minority shareholders and institutions would kick up a fuss, and rightly so.

In 2007, Ramalinga Raju proposed such a deal with computer major, Satyam taking over group company, Maytas. His idea was (the non-existent) reserves of Satyam would be “transferred” to the promoters – that is, Raju and his family. This would hide a big hole on the Satyam balance sheet, while Raju and family retained control of Satyam and Maytas. The stormy reception from institutional shareholders led to the withdrawal proposal and triggered the events that led to the scam being uncovered.

There are many other examples of poor governance involving PSUs. The entire bank crisis revolves around poor management of PSU banks. More than 90 per cent of non-performing assets are held by PSU banks, and outright scams like the Nirav Modi affair also involved PSU banks. That’s because PSU banks are not run on commercially sound lines with managements allowed to perform due diligence before sanctions. The politically influential and connected always get loans sanctioned, regardless of commercial soundness.

The government has also dilly-dallied at the task of bank recapitalisation. It refuses to allow the banks it owns to be run on commercially sound lines. Nor will it allow the RBI to punish erring managements. It has also forced bank mergers such as SBI taking over all the affiliates, and the ongoing Vijaya Bank, Bank of Baroda and Dena Bank merger. These aren’t necessarily commercially sound decisions.

The concept of creating cross-holdings, or sham takeovers such as ONGC-HPCL or PFC-REC are not new. Previous governments have used similar methods to milk PSUs; it’s just that these are larger, more blatant deals that involved taking on huge debts. The bank crisis has also developed over many years – the famous Raghuram Rajan list must have involved many loans sanctioned in earlier eras.

There were hopes that the Modi government would run PSUs on more commercially sound lines and genuinely disinvest.  Unfor­tu­nately, those hopes have been belied. Over the years, PSUs have consistently underperformed comparable private sector businesses. Look at Sail versus Tata Steel, or the erstwhile telecom monopolies, VSNL, BSNL and MTNL, versus the private telecom operators, or BPCL versus Reliance.

Avoiding PSUs will not make you rich. But it will prevent you getting badly hurt the next time there are “disinvestment” targets to be met.

Happy investing in 2019!