The story of Indian privatization had a rocky beginning. On May 3 1994, after enthusiastic roadshows selling shares in Indian telecoms company Videsh Sanchar Nigam (VSNL) were completed, investment bankers and company officials gathered in London to fill up their order books. “It was the most exciting story to come from India,” remembers an investment banker who was present. “A telecom company with a monopoly over international telephony till the year 2004 was a sure shot.” But, to his shock, the sale was abruptly withdrawn and the enthusiasm dissolved amid recriminations.
Global bookrunners Kleinwort Benson and Salomon Brothers had won a fiercely contested mandate to arrange the deal in January of that year. But by May market conditions had deteriorated and it became clear that the shares would only sell for Rs1,150, much lower than the price originally agreed. The then telecoms minister, Sukh Ram, was unwilling to agree the sale at this price and the deal was pulled. VSNL would have been India’s first state-owned company to float on the international capital markets.
For weeks afterwards allegations were flung at Kleinwort Benson and Salomon Brothers. Rivals accused them of having overbid for the mandate. “VSNL was an illiquid stock,” says one competitor. “And we had bid in a price range of around Rs1,400 to Rs1,600 in January based on an intrinsic valuation of the company. But ours was by no means the highest bid.” However, timing rather than undue optimism may have been the problem with the bid, he concedes. VSNL shares on the domestic bourses had fallen sharply by May as a result of heavy selling (allegedly orchestrated by rival banks) in the context of a bearish global market (after rises in US interest rates).
Small issues by two other state-owned companies, Indian Petrochemical Corporation and Steel Authority of India, which raised $85 million and $125 million in December 1994 and March 1996 respectively, failed to generate much enthusiasm. Then in March 1997, the new United Front-led coalition government decided to push the VSNL sale once again. Jardine Fleming was pulled in as a third lead manager and the company completed what was hailed as “a spectacular debut” by the local media.
The global depositary receipts were sold at $13.93 (then equivalent to Rs1,000) a share, at a premium of 1.5% to its domestic price. A deal that was promised at Rs1,400 then rejected at Rs1,150 was finally closed at Rs1,000. But there was hardly a political murmur even as the share price soared within hours of VSNL being listed in London. The relaxed response was an indication of how far attitudes towards the market had changed in India since the first attempted sale.
Flush with the success of the VSNL sale, the government pressed ahead with further privatizations. The gas-transmission monopoly, Gas Authority of India (GAIL), entered the market in early November – smack in the middle of the Asian stock-market collapse. After roadshows revealed the nervousness of investors, the issue was pulled by lead managers Morgan Stanley, Jardine Fleming and BZW. This clouded prospects for the sale of Mahanagar Telecom Nigam (MTNL), a fixed-line telephone operator, which was timed just weeks after the GAIL issue.
There were problems at home too. The United Front government was teetering on the brink of collapse. Says Uday Kotak, vice-chairman of Kotak Mahindra Capital, one of the lead managers to the MTNL issue: “We felt that we should go ahead with the issue and eventually this turned out to be a good decision.” The MTNL issue managed to mop up $418 million. MTNL was priced at a premium of 1.18% to its domestic price on a price-earnings multiple of 13.9 to its 1997 earnings.
MTNL – a heavily traded domestic stock well known to foreign investors – had clear advantages over GAIL. Investors considered GAIL’s offer price too aggressive: an illiquid stock with no reliable benchmark price, the stock trades in a range of Rs125 to Rs160. The $200 million sale of Container Corporation of India (Concor), slated for early February this year, was put off after surveys showed that the market was willing to pick up the stock only at a discount to its domestic price. The Concor and GAIL issues will now be pursued after a new government is in place in March.
A taste of blue chips
The success of the two Indian telecom issues last year is modest by international standards. Together the two issues raised just under $1 billion. Of this total, only $366 million will flow into the government’s coffers as the rest was raised from issuance of new equity. However, international investors who had lost money on shares issued by smaller private Indian companies got their first taste of blue-chip Indian stocks. Says Srinivasan Ramachandran, Kleinwort Benson’s country head: “Indiscriminate issuance by some companies in 1993 to 1994 when the international equity markets were first opened up to Indian companies had nearly killed the market for Indian paper.” According to the DSP Merrill Lynch GDR index, on February 10 this year, 48 of the 62 Indian companies listed on the London Stock Exchange were trading below their issue price.
In sharp contrast, investors see Indian public-sector enterprises as good companies with clean books. They are subject to annual audit by the comptroller and auditor general of India and their accounts are scrutinized by India’s parliament. “There is clearly no hanky-panky in their books,” says Kotak. Investors were also quick to see the huge opportunity the public sector offered.
The federal government owns 245 companies and calculates the historical value of its total investment in these businesses at Rs1,724 billion ($45 billion). Set up during the heyday of India’s planned command economy, these monoliths straddle 21 key sectors of the economy including power, steel, petroleum, minerals, heavy engineering, chemicals and pharmaceuticals, and transport. According to Kotak, India’s petroleum and oil companies in particular look hugely promising to foreign investors. In addition, the 25 state governments own hundreds of companies and a few, notably Gujarat and Orissa, have already taken steps to privatize them. The privatization of the state electricity boards, which generate, transmit and distribute power, is considered one of the most exciting prospects of Indian privatization.
“Disinvestment” not privatization
As part of India’s economic reforms, which began in 1991, the then Congress government under prime minister Narasimha Rao embarked on a programme to reform the public sector. In its new industrial policy of July 1991, the government outlined its strategy.
While large-scale privatization of the kind seen in eastern Europe was never on the cards, the Indian government made it clear that it wanted to divest part of its holdings. Several rounds of disinvestment – the word privatization is not politically acceptable – took place between 1992 and 1994 through a series of auctions. Shares in a clutch of companies were sold to some domestic financial institutions through an auction process and to employees through private offerings.
But plans for disinvestment involving both domestic and international investors only took off when the United Front government set up a five-member Disinvestment Commission in August 1996. This commission, headed by GV Ramakrishna, a bureaucrat and former chairman of the Securities Exchange Board of India, advises the government on the extent and mode of disinvestment.
The final decision on whether to privatize is taken by the government on the basis of the commission’s advice. So far, 50 companies have been referred to the commission and it has submitted its suggestions on the best way to proceed with 34 of them. Not all of these recommendations have been accepted in full, but the commission has given transparency and credibility to the process.
The commission is also helping to create what one banker calls a “philosophy of privatization” which takes into account strategies for enhancing the long-term value of the government’s assets and ways of sustaining investor appetite for new share offerings.
The commission has repeatedly urged the government to take policy decisions which will help it realize a better value on its shares. This has helped spur reform of state-owned companies. For example, the government accepted its suggestion that both GAIL and MTNL should be granted more management autonomy before their sale through GDRs.
The government also accepted a recommendation that GAIL should no longer be forced to subsidize customers in some parts of the country, addressing the politically charged question of pricing and subsidies. Late last year it also decided to phase out the administered price mechanism, a system of cross-subsidies between different sorts of fuel, and it took steps to help oil companies recover revenue lost by supplying fuel at below cost price. This is expected to enhance Indian Oil Corporation’s valuation when it comes to the market later this year.
In addition, the government has cleared the way for the strategic sale of five companies and seems willing to allow management control to be handed over to the private sector.
However, this month’s general election is creating uncertainty in the market. “Investors want to see the new government outline its economic policy,” says Hemendra Kothari, chairman of DSP Merrill Lynch. “They also want to see some signs of a reversal of the economic slowdown last year.” In its election manifesto the Bharatiya Janata Party, a Hindu nationalist party which some opinion polls indicate could lead the next government, talks of “disinvesting in non-strategic public-sector companies” and “pruning the public sector”. It will have to spell out these ideas more clearly if it comes to power.
Bankers point out that regardless of which parties form the next government, economic realities cannot be ignored and the government will have to raise resources to cover a deficit which is expected to rise to 5% of GDP this fiscal year. Nearly half of the state’s companies are loss-making, and the value of these losses has doubled over the past five years.
The new government will have to rethink its disinvestment strategies in the wake of the Asian crisis. India is talked of as something of a safe haven as it does not have the kind of banking, currency or stock-market problems that other Asian countries are experiencing. However, foreign portfolio investors, under pressure to cover losses in other markets and uncertain of the outcome of India’s election, have turned net sellers in the domestic market since November last year.
“The market is not ready for Asian equity yet,” says one analyst who believes the government should steer clear of the international markets for now. “Even as confidence is returning to the stock markets, fund managers are going to be looking for cheap Asian buys. This could depress valuations of even good Indian companies. This may be a good time to to look at domestic-market floats.”
Analysts who support this line argue that the government should sell its shares in the domestic market first to be able to realize a better price abroad later. They point out that India’s only Fortune 500 company, Indian Oil Corporation, which is to be floated later this year, will be valued as an IPO since it is a thinly traded stock. Only 1% of the corporation’s stock is publicly held. Conversely, companies like VSNL, which have been floated overseas, are finding it difficult to make a domestic equity issue at a comparable price. The company promised to offer 700,000 shares to domestic investors at a discount of around 10% to its GDR price in March last year.
Other analysts, including Shitin Desai, vice-president of DSP Merrill Lynch, say that while the principal mode of government disinvestment in the past has been through public issues, the focus is now likely to shift to strategic sales. Says Desai: “Even after the Asian crisis, direct foreign investment is flowing into India. Look at the number of foreign companies which are seeking to increase their stakes in Indian joint ventures. This proves that strategic investors are still bullish on India.”
Strategic openings
In January the government invited bids for global advisers on the sale to strategic investors of stakes in four companies: Kudremukh Iron Ore, Bharat Aluminium Company, Indian Tourism Development Corporation and Modern Food. Several global banks and consultancy firms have put in bids which will be evaluated after the new government is in place. “This is going to be a completely different ball game,” says one investment banker. “Strategic investors, unlike GDR investors who have no voting rights, are going to be looking at the prospects of running these companies.”
Whichever method of privatization takes precedence there will be work for investment banks. So which firms are in the running to win these mandates?
As in other parts of Asia, investment banks in India are consolidating. Peregrine, NatWest Markets, BZW (which won the GAIL mandate), Deutsche Morgan Grenfell and ING Barings have closed their Indian operations in recent months. Others are retrenching by reducing the size of their operations. The line-up now consists mainly of the large American firms: Merrill Lynch, Goldman Sachs, Salomon Brothers, Morgan Stanley and JP Morgan, and some European and Asian firms including Dresdner Kleinwort Benson, Jardine Fleming, SBC Warburg and HSBC.
The next couple of months may seem like a vacation for investment bankers in India. But with many more deals due in the second half of this year, they may not have long to rest.
