The government’s financial managers have found a new way to meet the fiscal shortfall. The one on top of their mind is to tap the funds with public sector units (PSUs).
According to a Business Standard study, 15 listed PSUs that fit the cash surplus criteria given by the divestment ministry have total cash and bank balances of Rs 1.1 lakh-crore on their books.
It isn’t without reason that the government’s fiscal deficit has shot past the targeted levels. The administration’s failure to sell shares worth Rs 40,000 crore in PSUs has added half a percentage point to the deficit. Thanks to volatile markets, which have been trending down, the government has raised just Rs 1,145 crore so far this year from sale of PSU shares.
Reports indicate the government proposes to tap a part of the cash balance with PSUs through share buybacks and cross-holdings by cash-rich state-owned companies (one PSU buying shares of another PSU from the government). However, most market experts believe the move, if enforced on PSUs, will be harmful and only worsen investor sentiment. That is not only because it would take away the cash, and income earned thereon, from these companies. They could also end up with investments that do not add value to their companies and shareholders (in case they buy shares of other PSUs). Not surprising, heads of a few large PSUs have already said on record that they are not in favour of such moves.
An inter-ministerial note put up by the department of disinvestment last week sought a Cabinet approval to sell government shares to PSUs in the form of cross-holdings and buybacks. The department has proposed tapping only those companies that have high cash balance. Accordingly, in cases where the cash balance is more than the annual turnover, the buyback of shares will be up to 10 per cent. Others with a cash surplus of at least half the annual turnover can buy back five per cent of shares currently owned by the government. There is no word on a ceiling in the case of cross-holdings. This, however, is likely to be subject to Sebi’s takeover rules.
At least 15 public sector companies satisfy this criteria. These companies (only those engaged in manufacturing activities, excluding banks) have cash worth Rs 1.1 lakh crore on their books, almost 87 per cent of their combined sales turnover and considered fairly large surplus for existing operations.
Most of these companies use the surplus cash to generate significant interest income through treasury operations. Last year (2010-11), these companies generated other income of Rs 12,828 crore. Thus, the cash pile generated a significant return of 11.7 per cent.
If the buybacks go through, income from such sources will decline. There will, thus, be a huge impact on profits. In the companies analysed, income from other sources accounted for 40 per cent of net profits in the financial year 2011.
However, at the earnings per share level, this could be partly offset by the fall in number of shares outstanding. In a buyback, the company can extinguish the shares bought back, resulting in reduction in a number of shares or holding these in a trust. The former option will result in a reduction in equity capital and can partly offset the impact of lower income on earnings per share. However, in the cross-holding route, the impact could be larger, as the yield (income from dividend) on such shares is likely to be lower than the interest income the companies earn from such cash balance.
In addition to the earnings issue, the move could deprive these companies of any expansion, especially in the current environment, where it is very difficult to raise capital. Amit Tandon, former managing director of Fitch Ratings and co-founder of Institutional Investors Advisory Services, notes the move was not good for companies which have capital expenditure plans laid out. "For companies like SAIL and ONGC, which have laid out huge expansion plans and are in need of capital, diverting of resources to buy back own shares is debilitating. This certainly (government's plan) needs to be revisited," he told Business Standard recently.
Saurabh Mukherjea of Ambit Capital reflects a similar view. "This may not be a prudent move from the PSU's perspective, given that in the current environment it is difficult to raise the capital," he notes. "Companies — private or PSUs — that want to expand operations should keep enough cash on their balance sheets. It will give them an enormous competitive advantage as we move further into the downturn," adds Mukherjea, head of equities (institutional) of his firm.
| CASH COWS TURN SITTING DUCKS? | |||
| (Rs crore) Company | Cash and bank balance in FY11 | Cash & bank balance | |
| as % of sales | as % of M-cap | ||
| Coal India | 45,862 | 77 | 22 |
| NMDC | 17,228 | 152 | 23 |
| Oil India | 11,771 | 102 | 43 |
| Bharat Electron | 6,537 | 116 | 54 |
| Power Grid Corpn | 4,806 | 56 | 10 |
| Neyveli Lignite | 4,424 | 111 | 35 |
| NHPC Ltd | 4,265 | 83 | 15 |
| Natl. Aluminium | 3,795 | 64 | 28 |
| Container Corp | 2,296 | 59 | 19 |
| SCI | 2,157 | 61 | 76 |
| SJVN | 2,064 | 114 | 24 |
| MOIL | 1,880 | 165 | 48 |
| Engineers India | 1,798 | 63 | 25 |
| Orissa Minerals | 703 | 1,569 | 31 |
| Dredging Corp | 235 | 51 | 39 |
| Total | 109,822 | 87 | 24 |
| Note: Companies (except banking companies) that satisfy the buyback eligibility criteria. M-cap: Market capitalisation based on November 30 share prices. Source: Capitaline | |||
The good news is that firms like Coal India, in which the government holds 90 per cent stake and has been sitting on huge cash (Rs 45,862 crore in FY11), have taken the lead and objected to the government's plans.
Coal India needs cash to expand its production and acquire companies and mines in international markets. In the T&D space, Power Grid is sitting on cash but it needs to deploy this for expansion of infrastructure of transmission capacities, already facing delays and under-invested. In these cases, analysts believe there is not much clarity but it will also depend on the companies to say no to such buybacks.
Mukherjea is all praise for Coal India for having said it would not participate in the buyback. "But," he adds, "I doubt if all PSUs will have that courage, especially the smaller ones (to refuse the government)."
Analysts also believe this is not good news for companies with debt. Companies such as SCI (debt of Rs 4,715 crore), Neyveli Lignite (Rs 5,114 crore) and Power Grid (Rs 41,612 crore) have debt that is more than the cash in their books.
Though the buyback plan is a god-send for a cash-strapped government struggling to make ends meet, it may not go down well with market participants and investors.
Many experts believe the move will not only lead to erosion of wealth, but will raise concerns over corporate governance as well. "The government's move asking PSUs to buy back the shares will lead to total confusion and value destruction," says S P Tulsian of sptusian.com. "Why should the disinvestment ministry tell them to buy back shares? The board of directors of each company should take the decision talking into account relevant factors."
At the macro level, should another global crisis occur, such PSUs could end up in a tight spot if they don't have cash with them. In the 2008-09 crisis, stocks of PSUs had outperformed their private peers, thanks to strong balance sheets and businesses. More so, at a time when India Inc has been seen hoarding cash, asking PSUs to part with their cash may not be a good move.
In the most desperate situation, a dividend payout would be a more prudent move. That is because it will mean distribution of cash to all shareholders in the proportion of their stake. That is, provided it is only from the surplus cash (after taking care of business and growth needs of these companies). This will ensure that investors’ sentiment is impacted least.
