PSU divestment sets sail

But government must try harder to sell to retail investors

A year and a half ago, in March, 2013, the government had to work hard to sell a five per cent stake in Steel Authority of India Ltd (SAIL). Minutes before the issue was scheduled to close, it had to be bailed out by Life Insurance Corporation (LIC). This time around, the market is bullish, and retail investors last Friday bid for more than twice the number of shares on offer; but, in spite of strong demand, LIC was the biggest participant once again, mopping up nearly 40 per cent of the shares on offer. Arguably, however, the issue's success itself reveals the level of optimism out there. The stock was picked up in spite of being valued at what some would say a hefty premium and a subdued outlook for the steel sector. At its current share price, SAIL is one of the most expensive steel stocks, trading at nearly twice the price-earnings multiple of its peers, such as Tata Steel and JSW; and metal producers face a demand slowdown in China and a global slump in prices.

Nevertheless, the SAIL share offer success will encourage the government to go ahead with its planned divestment in other such companies in the commodity sector, such as Oil and Natural Gas Corporation Ltd (ONGC), GAIL and Rashtriya Ispat Nigam Ltd. The separate retail quota in the SAIL issue worked well; it tapped the rising retail interest as suggested by net positive inflows in equity mutual funds and quarterly changes in the shareholding pattern of companies. In fact, the quota should be expanded - most retail investors will be interested in widely held public sector companies. Disinvestment will not provide any real benefits except to government finances unless the shares being sold are picked up by private-sector entities or retail investors. In the just-concluded SAIL issue, 55 per cent of the shares sold went to state-controlled entities.

However, from the limited point of view of government finances, this issue is good news: it seems there is now a real possibility of the government meeting its ambitious disinvestment target for 2014-15, given the continued bullish sentiment. In general, demand for PSU papers is likely to outstrip supply given the portfolio requirement of institutional investors. Large long-only investors, such as insurance companies, pension funds and sovereign wealth funds, find it tough to get hold of large blocks of shares in top companies at reasonable valuations in a bull market. That's because their orders in the shallow secondary market lead to a sudden spike in share prices, raising their acquisition cost and reducing their long-term returns. So if the pricing is right, large institutional investors will be more than happy to buy PSU shares.

The government, however, will have to do some more work if it is to ensure that the right buyers - global funds, for example, or long-term private finance entities in India - do the buying. In particular, divestment targets in companies, such as ONGC and GAIL, may require more homework and greater participation by domestic retail, as well as foreign institutional investors given the more than adequate free-float in these counters. At the end of September 2014, the government owned 69 per cent and 56 per cent of ONGC and GAIL respectively. The biggest challenge for the government will be to convince foreign investors to increase their exposure to these stocks in view of a bearish outlook on energy and commodity stocks globally. This will require a strong commitment to reforms in the energy and minerals sectors, and a willingness to give the top management of PSUs enough operational headroom. The next phase of growth cannot happen without these deep-pocketed PSUs leading the capital-expenditure charge. Large global investors will only be willing to participate in this growth story if the government plays its cards well.