PUBLIC INVESTMENT PRIVATE GAINS

After winning the recent general election with a thumping majority, the UPA (united progressive alliance) government has once again brought back the issue of disinvestment into limelight. A number of public sector undertakings (PSUs) are on the radar of government’s disinvestment plan- either complete disinvestment or offloading a minority stake.

The names of some companies where the govt plans to offload stake are BSNL (Bharat Sanchar Nigam), Coal India and Airport Authority of India among others. But does privatisation really change the fundamentals or the growth trajectory of a company? Past is the best indicator of the future. And hence it is best to carryout a reality check as to what happened to those PSUs that were divested during the NDA (national democratic alliance) regime.

Among those companies that were privatised during the NDA regime, prominent names are Hindustan Zinc (HZL), Bharat Aluminium (Balco), CMC, Videsh Sanchar Nigam (VSNL) and Indian Petrochemicals Corporation (IPCL). While Vedanta group-owned Sterlite Industries acquired HZL and Balco, Tata group-owned Tata Consultancy Services (TCS) took a controlling stake in CMC.

Another big name from the oil & gas sector-Reliance Industries (RIL) took management control of IPCL. A performance analysis, pre- and post-acquisition, of these target companies shows that the financial performance of the PSUs saw a turnaround after privatisation, the degree of improvement, though, varied. Since each of these PSUs came from different industries and faced different sets of challenges, their financial performance was adjudged within the context of external business environment.

HZL, the largest zinc producer in country, is one of the most successful turnaround stories after divestment. The company reported seven-fold rise in its revenue within five to six years after divestment. The acquirer’s ability to quickly ramp up the production volume played a major role in achieving this kind of milestone.

In the mean time, the company took several steps like backward integration to expand its operating margin. As a result bottom line grew at a faster pace than its topline. Its operating margin reached new high of 75% in financial year 2006-07. Since then the company has been putting constant efforts to bring down the cash cost of production. Its unit cost of production has come down steadily to below $700 in FY ’09 and is expected to come down further.

However, Vedanta group, constrained by external factors, was less successful in turning around Bharat Aluminium Company (Balco). For instance, Balco’s operating margin in financial year 2005-06 was around 25%, similar to what it was a decade back. Absence of captive mines for bauxite played a major role in keeping the operating margin at such a lower level. Recently, the company shut down one of its Balco plants due to a sharp fall in aluminium prices, high unit cost of production and resulting operating losses. The company is selling the surplus power from this plant.

All these factors indicate that for an acquisition to be successful, a major external factor like, allocation of mines, sometimes, plays a very important role. In businesses like metal production, some of the changes like acquiring mines are beyond the control of the parent company. For instance, if Balco had full backward raw material integration, the operating profit margin would have definitely improved. But the availability of raw material, in this case Bauxite, requires government approval and has to pass through several regulatory and environmental hurdles.

The acquisition of VSNL by Tata group in the beginning of this decade exemplifies the importance of external environment in an acquisition. Tata group’s failure to generate the estimated profits from VSNL acquisition shows how changes in regulation and industry structure may throw a spanner in the best of intentions.

Some of the reasons for this were change in government policy, increased competition and rapid structural changes in telecom industry. Also, in 2002, Indian international long distance telephony market was liberalised ahead of schedule and entry of private players was permitted. As a result the tariffs for transmitting ILD (international long distance) calls declined sharply between 2002 and 2006.

In spite of all these changes, it managed to maintain its earlier international traffic volume and the operating margin. The margin could have been squeezed further had there been no reduction in headcounts, thanks to voluntary retirement schemes (VRS) and natural attrition due to change in management control. The number of headcounts came down by more than one-third, within one year of acquisition, bringing the total employee strength down to 1,775 by mid 2003.

Another major focus area for cost cutting was bandwidth charges, which accounts for a sizeable share of VSNL’s operating expenses. It reduced costs by maximising bandwidth capacity utilisation through re-grooming cables, surrendering excess bandwidth and identifying lower-cost suppliers. As a result of all these, the operating margin, in the range of 25-30%, remained almost flat in spite of steep fall in sales realisation.

Though the acquisition has not rewarded much to the shareholders of the company, it fits well within the overall strategy of Tata group. The group has made significant investment in last few years to expand its footprint in global communication network market and to reach end-customers through its mobile telephony business. Hopefully, this end-to-end integration strategy would yield better results for the shareholders in the years to come.

Another big ticket acquisition made by Tata group was CMC, one of the biggest and oldest IT (information technology) solutions companies focussed on domestic market. The company continued to grow its revenue, thanks to its leadership position in domestic market, during initial years after the acquisition in 2002. However, this competitive advantage faded up with the entry of multinationals such as IBM and HP (Hewlett Packard) in the Indian market. These multinational IT companies have the capability to offer end-to-end solutions in system integration projects and have competitive advantages over CMC.

As a result, CMC has seen a declining trend in its topline in last two years. For instance, its revenue declined by around 10% in financial year 2008-09. With the recession in many developed countries and India’s emergence as a strong economy, many global IT players are eyeing to grab a portion of India’s domestic IT market. This would further put pressure on the growth of CMC. Though the company can’t control the external factors such as increased competition, it has certainly put sincere efforts to control the internal factors such as improvement in operating efficiencies. This is clearly visible from the 700 basis points improvement in operating margin in last three years, the time period when revenue actually declined. This probably would have been very difficult had CMC continued to be managed by the government.

Another PSU, IPCL (Indian Petrochemicals Corporation), was acquired by one of the well-known Indian business houses, Reliance Industries (RIL). Post acquisition, RIL increased its market share in downstream petrochemical products and IPCL, in turn, could get an assured supply of naphtha, a raw material, from RIL. The synergy from the integration is clearly visible from the improved financials of IPCL. The revenue of IPCL got more than doubled within four years after acquisition compared to only 56% growth seen during the same time period before acquisition. Even the return on capital employed (ROCE) increased from 11% in 2003 to 35% in 2006. IPCL was completely merged with RIL in 2007.

The last phase of divestment in India indicates that when a PSU is acquired by a large corporate house, it brings with it the internal operational practices that help the target company to improve its performance. If these target companies had not been divested, they might have faced severe challenges due to liberalisation policies of the government. Considering the past, it would be interesting to see how many of large private business houses are going to participate in the next phase of divestment.

 Source: www.economictimes.indiatimes.com

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