The Modi government has electrified the stock market by its promise to “privatise all non-strategic public sector companies”. Even in strategic sectors, like atomic energy, space, power, defence, telecoms, transport, oil, insurance, banking, coal and minerals, it intends to own just 3 or 4 companies in each sector, getting rid of the rest.
In simple numbers, the government has promised to sell nearly 300 public sector companies! This could unlock up to half a trillion dollars (Rs 35-40 lakh crore) of investible resources for the state. No surprise, then, that the stock market jumped nearly 10 percent in less than a week, shocked and awed by this ambition.
Severe Pitfalls in Current Privatisation Model
But hold on. All of this is easier said than done. Remember, in seven years, the Modi regime has not managed to sell even one public sector company, simply because the whole process is fraught with severe pitfalls:
- Politically, it shall be accused of selling the family silver to big domestic cronies or ‘neo-colonialists’, aka giant western corporations that are modern clones of the East India Company
- Assets have to be fairly valued, which is a controversial, subjective process, easily challenged in courts and vulnerable to charges of corruption. Often, as with Air India, the overhang of debt makes the whole deal unviable unless the government bites the bullet and waives off thousands of crores. Or, as with BPCL, some of the strategic assets on the balance sheet need to be ripped out before the company can be sold. The net result, of course, is ‘no sale’ for years on end
- Workers hate privatisation, fearing layoffs and adverse working conditions. It’s critical to get their buy-in with incentives, generous stock options, or voluntary exit packages
- Bureaucrats simply do not have the skill sets or competence to pull off a quintessentially market-driven and complex merger or acquisition. As always, they are highly suspicious of professional talent
So, it’s a gigantic task to sell even five PSUs in one year. But even at this optimistically accelerated rate of sale, it would take the government sixty years to sell 300 companies! In other words, the promise of such a massive privatisation — nearly half a trillion dollars — is aborted at birth.
Kaput. Dead. Over. Out.
Or is there another model of privatisation that could avoid the deadly pitfalls? Can, for instance, public sector companies be privatised without selling a single government share?
Yes We Can.
Maruti Model: Govt Didn’t Sell, Just Transferred Control, and Created Massive Value
The clue to this seemingly impossible feat is embedded in the Maruti Model of Disinvestment, perhaps the most successful privatisation ever:
- It was a joint venture between the Government of India (GOI) and Suzuki Motor Corporation of Japan that began in the early 1980s. It was unlisted
- GOI was the majority shareholder, but Suzuki was allowed to exercise control over the company even though Suzuki owned only 26 percent
- In 1982 and 1992, Suzuki was allowed to increase its shareholding, first from 26 to 40 percent, and then to 50 percent
- But GOI, which had nearly equal ownership, ceded more control to Suzuki, winning several valuable concessions in exchange, including access to larger export markets and the manufacture of global models in the Indian plant. Consequently, the joint venture’s valuation increased exponentially
- This was followed by a master-stroke. The company did a hefty rights issue of Rs 400 crore. GOI renounced its shares in favour of Suzuki
- Bingo, the JV got a dollop of capital to multiply its ambitions, and Suzuki got a controlling stake. But wait
- GOI also got a massive Rs 1000 crore as ‘premium for shedding control’. And it got Suzuki to underwrite an offer of sale to the public at a price of Rs 2300 per share
- Eventually, Maruti got listed (and became India’s most precious auto company), and GOI made a terrific ROI — all because it kept the ownership, but gave up control, exiting in several small tranches, allowing its entrepreneurial partner to create a huge amount of value in the joint venture
So, How to ‘Do the Impossible’ and Privatise 300 Banks/Companies in Under a Decade?
Picking up from the Maruti Model, here’s a typical, illustrative case study that proves how we could ‘Do the Impossible’, that is, enable GOI to transfer control without selling any shares, eventually exiting the company in tranches as its value scales up over time:
- Assume that the State owns 60 percent of our illustrative PSU which is quoting at a distressed value of Rs 25,000 crore; now reclassify its capital structure such that the government’s equity shares are converted into 10-year Compulsorily Convertible Preference Shares (CCPS), which are separately listed; remember that CCPS are equal to ‘equity’ under Indian accounting standards, so the government’s economic ownership shall stay fully intact after such a conversion, but it will lose its voting rights, thereby allowing a new owner to take charge without the government crimping his management
- Transfer 9 percent of these CCPS into an employee stock pool, and liberally grant options to the workforce; the government will continue to own 51 percent of CCPS (that is, equity), but without any voting rights
- Either pedigreed corporations or a group of Indian professionals with stellar track records would be eligible to bid for a 30 percent ‘management stake’ in the asset; the professionals would be allowed to tie up with credible private equity investors to transparently fund their bids
- If we assume that the winning bid would be at twice the current/distressed value, then a 30 percent management stake would cost approximately Rs 6000 crore (at a total market capitalisation of Rs 50,000 crore, but since 60 percent of that would have been converted into CCPS, one would need only Rs 6000 crore to get a 30 percent voting stake), which is a reasonable sum of money that even individual professionals would be able to raise
There you go! The privatisation would have been successfully pulled off, without triggering any controversy:
- GOI would continue to be the majority owner, although control would have passed to a pedigreed corporation or group of professionals
- GOI would not be forced to sell its equity at today’s throwaway price; in fact, if the asset were to multiply 10 times in value over 10 years, the government’s 51 percent CCPS stake would be worth Rs 1.25 lakh crore (up from the Rs 15,000 crore of current/distressed valuation)
- ESOP holders, that is, the PSU’s employees, would see their 9 percent stake go up to Rs 25,000 crore in value
And everybody would live happily ever after!