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Indian oil refinery: the government has found a new |
Dogged by political opposition, India’s government is going half-throttle on the privatization of two key petroleum refining and marketing companies. The sale of Hindustan Petroleum (HP) and Bharat Petroleum (BP), once owned by foreigners and nationalized in the 1970s, have faced several roadblocks over the past year, minister for petroleum Ram Naik being a staunch opponent.
The government cleverly worked out a compromise late in January that conceded little to its critics while removing an important obstacle to privatization, and paving the way for possibly India’s first billion-dollar privatization sale.
Soon after the attorney general ruled that the sale of HP and BP did not need parliamentary approval in January, the government announced that it would privatize just HP, and sell minority shares of BP to investors. The plan is for 34% of HP’s shares to be sold to a strategic investor around July this year (the government currently owns 51%), while around 35% of BP will be sold in the Indian and international capital markets in the third quarter. HP and BP, originally foreign-owned oil companies Standard Vacuum, Esso and Burmah Shell, were nationalized in the 1970s.
Incentive for foreigners
The government also ruled out bids by public-sector oil companies for HP. That should encourage foreign companies likely to bid. Royal Dutch/Shell and Kuwait Petroleum were among disappointed bidders last year when Indian Oil Corporation, a large government company, bought IBP, a smaller company, for what many believe was an exorbitant price. IOC paid three times the reserve price, and twice as much as Shell’s bid.
HP shares have run up to Rs322, from Rs167 a year back, and the company’s market capitalization was Rs109.5 billion ($2.3 billion) on February 21. The buyer will bid for 34% of its shares from the government, and is required under India’s takeover rules to make a tender offer to buy another 20% of its shares from minority investors. That should make the deal worth over $1 billion at current market prices, the highest ever for a privatization sale in India.
The competition between buyers in the final line-up for the company could drive up the control premium the buyer might be willing to pay. One leading US investment bank privately says the deal could hit $1.75 billion. Keeping BP out of bounds for now has possibly raised the entry stakes into India’s newly deregulated petroleum market.
“India has a highly consolidated fuel marketing sector – just three companies dominate the sector,” says Rajeev Gupta, head of investment banking at DSP Merrill Lynch. “The opportunity to buy a 25% market share in one of the world’s fastest-growing petroleum markets is what makes HP attractive.”
HP’s origins as a foreign company made it better managed than most other public sector companies, he adds. “Globally, margins in the petroleum chain are enhanced over time by retailing and marketing products and acquiring HP gives a substantial market share and a head start to any company that is seeking an entry into the Indian market,” says Ajay Sondhi, managing director of Kotak Mahindra Capital Company, a Goldman Sachs affiliate. Goldman is tipped to advise British Petroleum on the deal.
“There is little doubt about the quality of asset on offer. Buyers will weigh the time value of buying a distribution network rather than building one when they bid for HP,” says a US investment banker, which advised Shell in the IBP sale.
The size of the deal rules out contenders other than those with deep pockets that are keen on India. Shell and Reliance have said they are interested in acquiring HP. Shell has invested close to a billion dollars in India and owned BP before it was privatized. Shell India managing director Vikram Singh Mehta told CNBC on February 11 that he would be surprised if the company’s board decided not to bid for HP. Shell “was definitely interested in meeting the retail challenge” in marketing petroleum products, he added.
Reliance, which is India’s biggest oil and gas company, is the local contender, having already acquired Indian Petrochemical Company (IPCL) in a privatization sale last year. Other possible bidders are British Petroleum, Petronas and TotalfinaElf. Bankers reckon that oil majors Exxon Mobil and Chevron Texaco might be interested but are unlikely to bid. They expect that, as in the case of IBP last year, around eight to 10 companies will put in expressions of interest due by March 17. The competition will narrow down to about four or five after due diligence and negotiation over the shareholder’s agreement are completed.
The main risk is the political one of getting the HP deal through, particularly if it runs close to several local state elections at the end of the year and the general elections due next year. A long war in Iraq, or a continued rise in oil prices, could delay the process, says Mukul Nag of investment bank ICICI Securities.
Late in February, even as the government invited expressions of interest for HP and picked HSBC as its adviser for the sale, minister for disinvestment Arun Shourie faced parliamentarians from several political parties angered by the privatization of profit-making state companies. Many of the critics are members of parties in the fractious ruling coalition. Opposition from the Samata party has already stalled the privatization of aluminium company Nalco, after investors were blocked by angry workers from conducting due diligence last year on the company’s plant in the eastern state of Orissa.
Much will depend on how the government manages the process internally. Bankers see three points at which the process could get derailed. First, in case there is a fairly large number of potential bidders, a credible qualitative basis must be found to “get the fluff out” and prune them to around four or five.
Second, the unions must be managed so that the due diligence process is not disrupted (5% of HP’s shares have been set aside for employees) and finally, skilful negotiation around tricky clauses in the shareholder’s agreement, such as those protecting labour, will be needed to encourage foreign companies to bid.
In the past, foreign investors have been put off by the government’s penchant for throwing in restrictive clauses and the slowness of the political process. One banker points out that Dow dropped out of the race for IPCL after the deal was stalled for more than a year by a political lobby keen to keep Reliance out. “Foreign companies want a quick, clean process,” says the banker.
Let’s see what they get.
