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Gail pricks the divestment bubble

It has been eight years since the government started the PSU divestment process. Once the political decision was made, the selloff ought to have been a simple matter. What you had was a bunch of single owner companies. All the owner had to do was choose issue managers, make a decision on how much equity to sell set a reasonable price and make the necessary disclosures.

The primary market would have done the rest as it has for hundreds of single-owner companies. If the owner was unsure about the best price, a more sophisticated process of book-building could have been set in motion. Normally this is done at the institutional level. But the recent success of the retail Hughes Software Issue and the earlier abortive attempt by Nirma suggests that it is entirely possible to employ this price discovery mechanism at the retail level also.

But as Winston Churchill once remarked, governments are often distinguished by a desire to scratch their elbows when they are afflicted by piles. The divestment process was originally kicked off with the insanely complicated first tranche. Baskets of good, bad and ugly shares were force-fed in a non-negotiable khichri of price and quantity. The first tranche contributed to the scam as brokers found convulated ways of making profits from helping FIs unload their scrips.

In 1993, the government actually accessed the market normally with the State Bank of India ('new') issue. It worked well. So did the BPCL and HPCL sell-offs, which followed the same pattern, a couple of years later. But the government decided this was much too easy. P Chidambaram then created the 'Navratna' concept but he had a run-in with the Divestment Commission. The Congress pulled the plug before the UF government could get the process back online.

The next so-called divestment was the cross-holding method Yashwant Sinha and Vijay Kelkar devised to balance the fiscal deficit. This was actually outright banditry with the government starring as raider of the reserves. At the end of it, the government's net holdings in the PSUs remained unaffected while PSU net-worth disappeared.

GAIL -- the Gas Authority of India Limited -- is the next episode in this shoddy serial. One negative investor perception about Gail is that the government still remains in complete control and may try some bright new idea like the cross-holdings scheme. Another negative aspect is lack of floating stock. Liquidity is abysmal and the prevailing prices are completely notional.

But the market conditions were certainly not inimical, given the sequence of new highs. The domestic price was Rs 79 and the government could certainly have got that with no trouble. The government could as well have gone to the Indian primary markets to sell a tiny Rs 1,200 crore (Rs 12 billion) chunk. On the basis of its own earlier valuations, the government could possibly have got Rs 150 a share, if it had sold a substantial chunk via book-building. If it had invited bids from strategic partners it may even have got Rs 180 to Rs 200 per share.

Instead it chose to sell six per cent to British Gas and Enron in the GDR market at an equivalent price of Rs 70 share through an extremely opaque process. Both these firms are competitors. Both could have been induced to pay a great deal more if they had been offered a strategic stake. If an element of competition had been induced, they and other investors would certainly have paid more.

Someone has obviously blundered. However, it's a case of Chidambaram calling the kettle black when he accuses the BJP government of under-selling. All through 1997, he failed to take a decision while the market price moved between Rs 110 and Rs 180. The Congress too hardly did better between 1991 to 1995. Government incomprehension of the market process appears to be institutionalised. The Divestment Commission did not work, nor has the Core Group. Let us see whether MTNL and VSNL are handled any better.

To come back to Gail, is it under-valued at the current price? Well possibly, but so are thousands of other listed companies. And many companies are also over-valued. I doubt that anyone trawling through the 2,000-odd actively traded companies will discover more than a dozen that are trading near their respective fair values.

Anyhow, value is a notional concept. How many years earnings is any given share worth? What sort of growth projections do you factor into any valuation model? How well will a company face potential competition? How cyclical is the business? Ask any ten analysts these questions about a given company and you will get thirty different answers. None of which will necessarily be close to its prevailing price!

For what it is worth, Gail does have a monopoly in its wholesale supply and transport of natural gas. Building pipelines is a high-entry barrier business, so even if there is competition, it will take a while to match the entrenched Gail with its ability to supply West and North India via the Hazira-Bijapur-Jagdishpur pipeline. It is also a major player in LNG intending to enhance capacity to 1 MTPA (2001). It intends to enhance its petrochemical capacity from 0.3 MTPA to 0.5 MTPA but this is still low volume.

Topline growth this half-year was 12 per cent with revenues (excluding other income) rising to Rs 3,722 crore (Rs 37 billion). Enhanced half-year net pprofits at plus 10 per cent in September 1999 could mean little, since Other Income rose by 210 per cent. Cash flows are better because of high depreciation (+36 per cent). Problems could, however, easily arise on the interest front where costs rose 78.5 per cent this half-year. This appears to be a direct consequence of the cross-holding scheme that bled reserves dry.

Another problem is under-performance by supplier ONGC, which could force Gail to look for new sources. It is also moving into petrochemicals with the commissioning of a new plant this May. The business is inherently cyclical and heavily dependent on international prices. A lot depends on the dismantling of the administered price mechanism in 2002. Right now the government sets transportation charges for LNG. Making stable long-term projections about cash flows is almost impossible in the light of all these factors.

But the fact still remains that the government made no apparent attempt to get the best price it could have for a Navratna. The tragedy is that a better price could have been obtained by simply using normal means to access the domestic market. Conspiracy theorists will no doubt see many dark designs. But it looks more like simple incompetence. Just another case of scratching elbows when the problem is piles.

Devangshu Datta

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