The Disinvestment Game – Issuer vs Subscriber

by Shyam Sekhar, Chennai.

Disinvestment has been  an obsession of the economic community even since we started liberalization. We somehow identify the extant of disinvestment as a measure of the serious intent of the Government to hasten the  liberalization process. At some level , the media even spins it around as if disinvestment is also an indicator of the will of the government to act decisively. In actuality , disinvestment is quite the opposite of what we think it is. The disinvestments made during the NDA regime were done at ridiculous valuations and if the Government had held onto its  assets , it would have made a pile by way of dividends. The government sacrificed annuity income for one time cash flows from poorly valued sale of companies . The proponents  favoring disinvestment somehow go silent when it comes to measuring the sensibility of selling a company cheap. This angle of selling cheap is a historic one and applies more to the disinvestment process under the NDA when it was run like a deep – discount sale.

The current sales under disinvestment  are actually at higher valuations and inflict  higher risk onto potential   subscribers.

It will be a close call for investors in the near term and government is risking its credibility by selling shares at high valuations. Then , why does the Government lean so much on the disinvestment process  ? The answer lies in the government’s never ending need for funds.The disinvestment process is actually  a compulsion delivered on the present regime because of the devastating fiscal consequences rendered by the stimulus program of 2008-2009.  The welfare side of the successive governments of the UPA leans heavily on the emotional leanings and pet projects of its leadership. The NREGA and the ridiculously leaky  kerosene subsidy are standing examples of half-thought strategies. But, that is the way we run our successive governments and the consequences are to be borne by our children. The widening gaps between revenue and expense are staring at us.

The financial profligacy of successive  governments have made them yearn to sell their holdings in public sector companies and somehow bridge the widening gaps. Disinvestment seems to be the must do thing to accomplish the impossible task of reducing deficits. Our  political leadership and economic community are always on the same page on that issue.

What i will be addressing in this write up is how we  handle the interests of the issuer and the subscriber when disinvestment takes place in PSU’s through issue of shares . Firstly,let us study  the timing of disinvestment issues . These issues are launched in bull markets or at least closer to peaking rallies . Valuations are inevitably stretched and the inevitable race among merchant banker to offer better deals to issuers plays out in full zeal. What happens is that the issues are mostly fully priced and`managed’ to get subscribed. The issuer take most of the upside leaving  very little on the table for the subscriber and inevitably the subscriber takes the full risk of the downside. From the subscribers viewpoint , this is not an intelligent thing for an investor to do. In the case of issues like NHPC, the issues were made at a reasonably high premium with an extended & long project gestation. That leaves investors with holdings bought at high valuations and no immediate earnings upside. The potential risk of losses is very high if the markets enter a bear phase in the interim period when earnings of NHPC will grow slowly.

NTPC is planning to disinvest in the next week. The valuations of NTPC are by no means cheap. Its trailing earnings trade at a Price earnings multiple of 20. But, the noise and hype surrounding disinvestment often drown the basic attractiveness of the valuation of the company. One understands that the government wants a higher price while the merchant bankers are pleading for a price closer to 200. While you read this the issue would have been settled and closed. Probably, it would have also got subscribed. But , the real issue would remain and haunt the subscribers to this issue for a long time to come.

What is in it for the subscriber to an issue at a trailing PE of 20 with a slow and stable earnings growth rate ? If market valuations and PE multiples fall to their long term mean , then how will the subscribers interest be protected ? In reality, investors who subscribe to FPO’s are taking bets where the odds are very much loaded against them.  The fact that the issuer of the shares in the Government of India does not materially alter the investment risk. Potential subscribers to the disinvestment must evolve a strategy to protect their interest as an investor. Here is how an investor can successfully play the IPO or FPO market.

First, the issue must be priced at a reasonable multiple . Second, the company’s  growth must deliver earnings  growth without time lag. Third , the earnings growth must be adequate to make the company look attractive to investors who buy in the secondary market. Lastly , the investor appetite for the issuing company must be assessed to see if follow on buying will happen subsequently.

Therefore , a subscriber must factor in the immediate growth potential of the company and the scope for sustained earnings growth. The PE multiples must also be closely scrutinized to evaluate if the earnings growth will be rapid enough to justify the high valuations adopted by the government in pricing the issue.

Market forces and global trends could however force the hand of the government to accept lower valuations for subsequent issues . Potential subscribers must keep a close watch of developments in the markets and cautiously select opportunities in the disinvestment program of the government.

Investors should  make an informed choice between playing safe now and being sorry later.

One thought on “The Disinvestment Game – Issuer vs Subscriber

  1. You make some good points. I guess it depends on your standpoint. – If only God would give me some clear sign! Like making a large deposit in my name in a Swiss bank. – Woody Allen Born 1935

    Like

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