Economize, Privatize, and Prosper

Danish Faruqui & Raghav Sud

Introduction

India has seen a movement towards the privatization of state owned enterprises in recent years. The process although in it’s embryonic stages, has already generated a great deal of controversy. The major part of political opposition has risen with regard to the way in which the enterprises have been sold. At the time that this study was being done the methodologies of the sales of BALCO (Bharat Aluminium Corporation) and Modern Foods India Limited was being hotly debated. The aim of this project was therefore to explore what exactly are the available options in terms of the ways in which Public Sector Enterprises (PSEs) could be hived off. The project was accordingly divided into three parts:

The first part involved studying "the methods of valuation and sale of PSEs" in theory. Next, the intention was to evaluate these methods on in certain select criteria. Here, one realized that one was really not equipped with the financial expertise to delve deeper into whether one method of valuation of PSEs was better than another. The "Methods of Sale" though presented a perfect subject for a critical study, which is presented here.

After this, we picked six public companies up for sale and perused the Disinvestment Commission’s recommendations with regard to them. The companies that we picked (as the reader will see) were such that they make you wonder why they were set up under the government’s aegis in the first place. Nonetheless the objective of this last section of the project was to see if the recommendations made were foolproof and (in the light of my new found knowledge?) we found them logically inconsistent on many counts.

This project was completed during the summer of 2001 as part of a Research Internship Program with the Center for Civil Society (CCS), New Delhi. We would like to take this opportunity to thank Dr. Parth J Shah, President, CCS for his considerable support and even more considerable advice.

Methods of valuation of public sector enterprises

While valuing a public sector enterprise, one needs to be very careful so as to not overvalue or undervalue it. According to Chief T O Fatokun, a fellow of the Nigerian institute of surveyors and valuers, underpricing would be tantamount to deliberate plundering of the national wealth and it would erode all public confidence in the administration. Overpricing would not only bring about mis-allocation of scarce resources, it would also worsen the gulf between the rich and the poor since only the rich will be able to buy the overpriced enterprises. The objects of privatization are usually valued by applying any one or a combination of the following methods:

1. Comparable value/ analogous selling price/ earnings multiple

The market value is determined by comparing real transaction prices of analogous goods, taking into account the difference between the object valued and an analogous object. In other words multiples for which similar firms are currently selling is being determined. If the unit is part of an industry in which there are freestanding public companies, it is likely that one or more have been sold recently enough that the multiple of sale is relevant. When we say that the ‘differences’ have to be taken into account, we are saying that the earnings of the unit to be divested and the firm chosen for comparison have to be comparable. For e.g., if the unit divested is heavily supported by debt obtained at nominal rates from the parent corporation, the earnings of the unit should be adjusted to reflect a market rate for the debt.

2. Replacement value/ cost

Here we are calculating the price at which goods can be replaced, broadly in their existing state according to the technologies and prices at the time of evaluation.

3. Price-earnings based value/ income capitalization/ discount cash flow/ net present value/ Going concern value

Here the asset is valued as a profit yielding business rather than the total of separate assets. The forecasting of future cash flows and their present value constitutes the basis for this method. Normally when we speak of net present value, we refer to the present value of future cash flows plus the terminal value.

It is interesting to note that according to Arun Shourie (minister of disinvestment), BALCO was valued by three methods before disinvestments- the above discount cash flow method, comparable valuation and the balance sheet method. The first gave the highest value and was eventually taken as the sale price- between Rs. 332 to Rs. 507 crore. In his inaugural address at the Conference on Disinvestment in 1997, C Rangarajan, former governor of the Reserve Bank said the discounted cash flow method is the most comprehensive and holds the greatest relevance.

4. Book value

This is often the lowest price that the firm will consider. Anything below this amount would be recorded as a loss. Book value to the selling firm is the total value of the assets less the total liabilities owed to anyone but the parent firm. It may contain both equity and long term debt.

5. Market value/ liquidation value

This value presupposes that the firm will not continue as a Going concern. In some cases it could be substantially more than the book value. The plant or enterprise may be worth more dead than alive. The value of the alternative purposes to which the firm may be put may be considerably more than the value of operating the firm. This situation may occur if the unit assets have appreciated in value. Property values especially need to be checked, as do buildings. In some cases, the value of the intangible assets may be considerably more than appears on the balance sheet. For e.g., the value of patents associated with products.

6. Special value method

This is applied for the valuation of unique objects of art and history, jewellery, and antiques, etc.

7. Investment value

This refers to the investment required for entry into a similar business.

Valuation from the buyer’s point of view

Before entering into negotiations, the seller should consider the potential value of the firm from the buyer’s point of view.

• The value of the unit may be different for different buyers, for e.g., the buying firms may reduce overhead by not taking the senior management with the division.
• Conditions regarding employment and its terms (stipulations as to the continuation of present manpower, their terms of service and benefit levels).
• Similarly restrictions on the shifting of location of a business could constrain the growth potential of a business, raise its endogenous cost and increase the exogenous costs of relocation.
• The composition and character of impending liabilities (massive resource requirement for meeting debt).
• The choices provided to the investor in terms of deferred payment could increase the value.
• Restrictions on the transfer of shares, foreign investment, conditions for enlisting domestic investment could also reduce the attractiveness of investment in the public enterprise.

Problems with the valuation process:

• In case capital markets do not exist, the value of the enterprises and hence the price of their shares would not be known.
• The sale of enterprises would thus have to wait for liberalization.
• There is a perception that the population does not have enough purchasing power to buy the enterprises.

Chief T O Fatokun speaking on Nigeria says that the since the capital market is made up of the primary and secondary sub-markets, the new public issues being offered to Nigerians would constitute the primary sub-market. Then there is a problem in using the secondary market prices to determine the value of primary market offers (especially in case there is not much faith in the quoted prices on the stock exchange).

In India the one case in point is that of GAIL (Gas Authority of India Limited). The government sold 18% of its equity in GAIL at Rs. 70 per share through the issue of 22.5 million GDR’s (Global Depository Receipts)--each GDR entitling investors to six shares. The pricing of the sale at Rs. 70 meant a discount of about Rs. 11 per share on the prevailing market price and a total loss of about Rs. 140 crore. Enron and British Gas picked up 5% and 13% stakes in the company respectively. The issue followed a book building process where investors were allowed to bid within a price band—a process that is used to deter speculative investors and one that is essential when it is difficult to determine the intrinsic worth of the company. The problem arose when it was revealed that the United Front Government had rejected a price of Rs. 115 per share in 1997. Also it was the first time that corporate entities had picked up a stake in a public sector company. It was also revealed that FII’s had driven down the price of the shares. But the underlying facts also reveal that of the 17% of the equity outside the hands of the government before the GDR issue, 10% was with the IOC and ONGC. Only 7% was being traded in the stock markets. Thus getting the price right was difficult.

Take the example of Russia, when the privatization program began in 1991, the valuation of enterprises came out to be pretty low as a result of the primitive state of the Russian capital market, modest demand of the population and widespread corruption. Another problem faced was that one could find almost anything on the balance sheet of the Russian enterprises (housing, kindergartens, municipal services, etc).

Considering the amount of heat the BALCO disinvestments generated it may be fitting to conclude with the thoughts of a Mr. B Paul in Business Standard. "Their (Ajit Jogi and his government’s) contention is that the government used four methods of valuation. In the fixed assets valuation, BALCO’s worth came to more than the Rs 550 crore odd Sterlite is paying for it. The conclusion: Sterlite should pay more. But that is ridiculous. Take an example. Assume that the fixed assets of the Chhatisgarh government is Rs. 10,000 crore. But anyone buying the government has also to absorb Jogi and the entire government staff. They can’t be sacked. Their collective liability is much more than the Rs. 10,000 crore the state government is worth. Obviously, such a calculation cannot be used for the sale of the Chhatisgarh government as a Going concern. The buyer should be given money to accept Chhatisgarh."

Methods of Sale Of Public Sector Enterprises

1. Public Subscription for Shares/ Public Offering of Shares

   Public subscription for shares is a method of selling of shares where the shares are sold in an open manner, i.e. neither the number of purchasers nor the number of shares subscribed by them is limited and the selling price of the shares is determined according to the supply and demand ratio. The Public Sector company is assumed to be a Going concern set up as a public limited liability company. Overall, this amounts to a secondary distribution of shares (as only existing shares are sold), as opposed to more traditional capital raising exercises involving an issue of new shares for public subscription.

   While technically the public offering is a secondary distribution of existing Government held shares, it is generally handled as if it were a primary issue. A prospectus is usually prepared for offering. It has to be determined whether the offer would be underwritten, how the shares would be priced (whether fixed price, tender, open price offer), who the shares would be marketed to (retail sector, domestic/ international institutions), the type of marketing campaign, what advisers would be appointed, and whether the shares would be listed overseas. The offering would involve, apart from sales to the general public, incentives for employee participation. There also could be restrictions on the size of individual shareholdings.

   Sometimes if the PSE is not a strongly performing public limited liability company, a public offering is useful only to extent that primary restructuring and a turn- around in operations are a realistic option. If the objective is to achieve widespread share ownership or to target certain segments of the investing public, specific mechanisms (incentives, restrictions, etc) need to be introduced to ensure those objectives are obtained and maintained.

   This is the most common process in OECD countries and also meets the political objective of raising the number of shareholders in the economy. The size of some large utilities would means they would be sold in stages. It is difficult to set the price for these types of share offers, as there is usually--almost by definition--no comparable company listed on the market. This gradual sell off means that the market would determine the "right" price for the shares and the government could then maximise its revenues when it sells subsequent stages. The first stage frequently generates a quick profit for private investors, at the expense of the public exchequer, but this is seen as a small price to pay for the gains of establishing where the market price lies, as well as convincing small shareholders of the merits of privatization--thereby further ensuring their political loyalty.

   Some economists however contend that public offerings are a relatively expensive way of disposing nationalized industries. Apart from the tendency to under-price there are also large costs involved in advertising to inform and persuade private investors, the fees charged by financial advisers and the administrative costs of handling large numbers of applications. For this reason, other means of securing the transfer to the private sector are also used. The lack of developed capital markets means this method has not been favoured in Eastern Europe. According to C Rangarajan, "In the case of those PSEs for which the first sale of equity is yet to be made, or those where the track record of trading in shares is yet to be established, the tender system would be advantageous."

2. Public auction

It is the method of selling of the privatisation object, when the number of privatisation subjects participating in the auction is unlimited and the purchaser would be that bidder who offers the highest price. The administrative costs of such a process are lower and a market price can be obtained for the sale if there are several competing bids.

3. Open tenders

Open tender is the transfer of one or more privatisation objects to the tenderer who is recognised winner in accordance with the procedure established and has offered the highest price, having taken into account his written proposals as to further operation of the enterprise and which meet the requirements of the tenders, announced in advance. Usually the obligations of the winner of the tender process are announced beforehand and conditions are laid down. This type of bidding is usually used in case the value of the shares sold is greater than a certain amount and also when the shares of several enterprises are being sold together.

4. Sale by direct negotiations

The selling of privatisation object through direct negotiations is such a method of privatisation when privatisation transaction is concluded with one purchaser in the event of only one purchaser taking part in a public auction or open tender. Direct negotiations may also be applied when the offers of other purchasers do not meet the privatisation conditions announced in advance.

(Methods 2, 3, 4 outlined above are also called trade sales. The principal advantage of a trade sale is that prospective owners are known in advance and can be evaluated. They may be selected based on their ability to bring to the PSE benefits such as management, technology and market access. In many instances, the future success of the PSE may be as important to the Government as the proceeds from the sale. In some cases, a partial private sale may be a necessary first step to full privatisation, because it would brings in a leveraged party who would be able to turn the company around so that it becomes attractive to investors.)

5. Fragmentation

This method of sale permits piecemeal privatisation, in particular the privatisation of component parts where there is no potential buyer for the whole company. For example, in seeking to privatise a company, it is not unusual to find that some activities are more attractive to buyers than others.

There are several possible ways to proceed depending on the legal structure of the enterprise. The options include: breaking up the PSE into several legal entities; transforming the PSE into a holding company that would acquire the shares of the subsidiary companies which would have taken over the assets and liabilities of the original PSE; hiving off of some activities, with the Government retaining others.

6. Lease with the option to purchase

Privatization object can be sold by this method by announcing open tender for the lease of this object. The buyer usually acquires the right of ownership to the privatisation object only after he pays for this object the full price and fulfils the conditions of acquisition of this object, set forth in the privatisation transaction.

Under Lithuanian law the unpaid balance of the value of the privatisation object each year can be adjusted according to the annual market price index. When the payment for the privatisation object is made in other currency this amount can be adjusted according to the market price index of the country the national currency of which is used for the payment. The payment for the privatisation object shall be made by "paying the rent and upon the expiration of the lease, by purchasing out the privatisation object."

7. New private investment in PSE

A government may wish to add more capital to a PSE and achieve this by a capital increase opening up equity ownership to the private sector. The main characteristic of such a privatisation method is that the government is not disposing of any of its existing equity in the PSE. Rather, it would increase the overall equity of the GBE and cause the dilution of the government's equity position. The resulting situation would be joint private/government ownership of the enterprise.

Normally a new equity raising does not result in sales proceeds for the government. Rather the capital is returned to the company through recapitalisation. This directly addresses the funding problems of an undercapitalised PSE or permits rehabilitation or an expansion of the capacity of a PSE.

8. Management/ employee buy out

The term management/employee buy out refers generally to a transaction where employees, or management and employees, acquire a controlling interest in the PSE for which they work. The leveraged management/ employee buy out involves the use of credit to finance the acquisition. The assets of the acquired company are generally used as security.

A management/ employee buy out is a relevant means of transferring ownership to management and employees with little wealth or knowledge of share ownership. It may be a solution for PSEs not otherwise saleable. It also may constitute a substantial incentive to productivity.

The case of mass privatisation

Czechoslovakia created a new method of privatisation called mass privatisation. Emphasis was placed on speed and equity. 98% of all property was in state hands and less than 1% of net material product was generated by the non-agricultural private sector as late as 1989. Almost by necessity the government adopted a multi track approach that relied on a variety of privatisation methods including:

1. Transfer of state property to municipalities
2. Restitution to original owners
3. Transformation of cooperatives
4. Small scale privatisation through public auctions
5. Privatisation of medium and large scale enterprises through direct sales, joint ventures and the coupon scheme

The government used conventional methods of privatisation where these methods would result in a rapid transfer of ownership, but they opted for a mass privatisation program for almost 3/4^th of medium and large scale enterprises undergoing privatisation at the start of the reform program.

The coupon scheme

The Centre for Coupon Privatisation published a list of 1491 companies with a book value of Kcs 300 billion (about $10.6 billion) on may 13 1992 which would be included in the coupon scheme (out of a total of 2744 enterprises slotted for privatisation in the first wave). The publication included the following details for each enterprise: name, address, business activity, id no., shares offered, book value, value of other enterprise assets, debts, output and profit, no of employees, etc.

All Czechoslovak citizens 18 years or older were eligible to participate in the coupon scheme through purchase and registration of a coupon book at one of the 648 registration centres around the country by the end of February 1992. Coupon books were sold for a nominal fee of Kcs 1000 which along with the registration fee amounted to about $35 or one week of the average wage.

The coupons were not tradable in the primary market in which they the initial distribution of shares would occur. Since there were political motives for having wide spread share ownership, the tradability of vouchers was postponed till the secondary market.

The initial response to the coupon scheme was fairly limited with only 2 million coupon booklets being sold until January 10, 1992. The most important factor in increasing public interest in the scheme was the advertisement of the Investment Privatisation Fund (IPF) which was similar to mutual funds some of which promised returns of tenfold or more on coupon books if citizens allowed the to manage their shares. The promises were quite realistic considering the fact that the average book value on offer was equivalent to about Kcs 150000 for each of the 2 million owners of voucher booklets. Participation increased rapidly and ultimately an estimated 8.5 million registered out of an estimated 10.5 million. In case of mass privatisation, even the pricing policies were designed so as to clear the market for shares as soon as possible. The following were the guidelines:

1. Perfect equilibrium: in the hypothetical case where demand by citizens was exactly equal to supply, all enterprise shares would be sold in that round.
2. Under subscription: where a firms shares were under subscribed, those that bid receive shares at that price and remaining shares are offered in the next bidding round at a lower price. This enables the state to capture the consumer surplus associated with some bidders valuing shares in a particular enterprise more than the eventual market clearing price.
3. Over subscription by less than 25%: where there is excess demand for shares that is less than 25% of the shares on offer, individual citizens were given priority. The demand of the investment funds is reduced however much is necessary to clear the market at that price. Over subscription by more than 25%: when the excess demand is large, all shares are offered again in the next bidding round at a higher price. The magnitude of the price adjustment is a function of relative demand.

Kimio Uno in a book entitled What is to be done? Proposals for Soviet Transition to the Market gives arguments for and against the free distribution of shares. According to him, Poland, the Czech Republic and Slovak Federal Republic & Bulgaria are moving towards the free distribution of shares to the general public.

1. The objective is not only to privatise, but also to build popular allegiance for reform measures. The sale of stocks would only make a small portion of the population shareholders.
2. Sale of stock could lead to highly unequal distribution of wealth.
3. A free distribution scheme would sidestep the need for asset valuation (a task that as mentioned before is doubly difficult in Russia)

Kimino Uno proposes that privatisation via distribution should then involve equity intermediaries who would then be given shares in public enterprises and their shares would be distributed to the public. The investment funds would derive their income from the dividend on enterprise shares they own and they would use such income to pay dividends to the public.

He also then goes on to list the reasons why this kind of a system is still considered dubious:

1. Many people who are unfamiliar with such investment instruments and nervous about the business climate would sell their shares in the investment funds quickly. Hence the stage where everybody is a shareholder would be a transitory one and the stock would end up in the hands of the richest anyway.
2. The sheer logistics of disseminating information and distributing shares in a large country are overwhelming.
3. Giving stock away would create future political problems for policymakers. It would be much more difficult to break up monopolies because private shareholders are likely to fight the breakup in the political arena. For similar reasons, foreign trade liberalization would be easier to achieve. Finally, any desired environmental legislation would be more difficult to introduce.

Methods of sale of public sector enterprises: a critique

Privatization is a complicated issue. Different countries use different methods of privatization depending on the conditions prevailing there. This paper aims at evaluating the various methods of sale of PSEs according to certain desirable criteria. Various criteria we have selected are:

1. Rate of divestiture: Here we refer to the pace at which the privatization takes place. Different methods ensure varying speeds of privatization. Public distribution of shares (selling equity in market), takes upto 3-4 months (according to the disinvestment commission report) given the fact that preparing a prospectus, underwriting, marketing, pricing of shares, listing of shares, all have to be taken care of. This is not only time consuming but also an expensive exercise. According to the disinvestment commission report, the costs are upto 4-5% depending on issue size. In case, the government was to use secondary market operations (only possible in case companies have sizable floating stock), the process would be quicker and entail lesser costs. But the problem with this method lies in the fact that the pricing remains uncertain and is susceptible to day-to-day changes and price rigging.

On the other hand the voucher system, where a person could obtain a certain number of investment points in return for a token fee and use these to purchase stocks directly or through investment funds; is relatively quick. It took a total of 15 months to bid for 1500 enterprises in the Czech Republic.

The administrative cost of the auction/open tender process is lower than a public distribution of shares and a market price can be obtained for the sale if there are several competing bids. For small and medium firms, direct sales are simpler and less costly than a public offering. That is one reason why developing countries have reserved public listing for their larger privatizations. Direct sales accounted for the vast majority of privatizations (80%) that occurred from 1988 to 1993. In case we go in for mass private placement of equity or for an auction, it would be less time consuming since there are fewer regulatory compliance requirements (1-2 months by DoD report). In case of strategic sales, as a result of all the regulations and because of issues relating to labor, management, etc, it may take a longer time- 6-10 months (DoD rep).

2. Productivity & profit: One of the aims of privatization is to increase productivity, which is low as a result of under-utilization of resources. Though management/employee buy-outs normally results in limited restructuring, but empirical evidence shows that it can have positive impact on efficiency. Econometric research on firms in OECD countries has demonstrated that a firm’s performance can be improved by employees participating in the firms profit results, it's stock ownership and decision making. Direct employee ownership of significant amounts of stocks has also shown to have boost productivity and sales growth, though the impact would decreases if the stock ownership were held in a collective ESOP trust. For employee ownership to have a strong impact this should be accompanied with provision of worker participation in decision making. Employee participation in Germany, for example had a positive effect when combined with employee participation in decision making, otherwise it was negative. Care has to taken that there are policies that force necessary structural changes, otherwise the efficiency will drop drastically.

Strategic sales/auctions on the other hand would leave greater scope for restructuring as they will be able to bring to the PSE benefits such as management, technology and market access. In fact direct sale may be most appropriate for troubled large firms that could benefit from a strong owner and would be an inappropriate risk to offer on a fledgling stock market. Sometimes when immediate privatization is not possible, management contracts (leases) are a good option. They have by evidence improved productivity. Sri Lanka for example used such contracts for 22 rubber and tea plantations in 1992. 18 of them improved their financial performance by 1995 (inspite of government mandated wage increases). This could be attributed to competition (competitive bidding for the contracts, no one bidder entitled to more than one contract); rewards and penalties (success fee as opposed to a fixed fee, a chance to extend contracts if the profits exceeded a certain level); etc. Voucher sales in the Czech case, eventually resulted in about a vast number of the firms (where the state didn’t retain control) having control by the 2 biggest investment funds. This arose because a majority of individuals participated in the process so as to take advantage of the transfer element which they then converted into a cash transfer as soon as possible. Thus the voucher method as such did not thwart effective governance although a restriction on the IPFs ownership (20%) may have restricted important restructuring decisions which would require an absolute majority.

3. Transparency: The privatization program should be transparent so that there is minimum scope for malpractice. Public distribution of shares is most transparent. This would involve a preparation of a prospectus, valuation of the company, issue of shares in compliance with the stock market norms and regulations, etc. Additionally, the company then becomes directly responsible to the general public. The Voucher System in Russia on the other hand, did not emphasize minimum shareholder information, protection system and enforceable contracts. So it became a transfer of productive resources from the state to the influential few. They stripped the assets from the firms and did not restore growth or create jobs. The transparency of such a mass privatization process was essential for ensuring broad-based public support which was the aim of using this kind of process in the first place. Even in the private sale of shares (trade sale), some kind of competitive bidding will always more transparent than a negotiated sale. This is because competing investors will insist on clear rules. Although direct sales have been amongst the most popular methods of privatization all over the world, there have always been allegations of corruption (Read BALCO). For ex, in Russia Menatep Bank acquired a 78% stake in the Yukos Oil Company after it had organized the sale. One distinction may be made. For smaller firms, open auctions such as those held in transition economies (Czech, Estonia) are a simple and transparent method. For medium and large firms, the investors would have to invest time and resources to determine the firm’s value. Therefore, sealed competitive bids, later made public may be more appropriate (provided fairness can be ensured).

4. Competition: For privatization to give maximum profits and information, the bidding procedure should be competitive. Competition increases the availability of information about current performance of the enterprise, the fair sale value, the labor redundancy (part of the tenders submitted), future prospects, etc. which contributes to the likelihood of success. In addition, the government—if it has decided against hastily disposing off its companies—might as well try and get the best possible price for them. An analysis of privatization of 346 state owned enterprises in Mexico found that the government had gained more when the bidding was more competitive (foreign investors for ex. were not excluded). As mentioned before in the Sri Lankan experience, even with regard to contracts, it is advisable to have a bidding process and get the best deal. This again makes for the case for any kind of competitive bidding as opposed to the negotiated sale. The voucher system and management/employee takeovers preclude any kind of competition in the privatization procedure in any case. This did lead to problems in the case of the Czech Republic where enterprises were required to proceed with privatization inspite of declared insolvency. The consequence was that some individuals and IPFs (Investment Privatization Funds) came to hold worthless shares. This was particularly the case where some banks with bad loan portfolios were privatized—the largest IPFs were owned by banks. What the government could have done was to reorganize these firms, privatize the viable parts, and liquidate the remaining assets. This is where the importance of information, which stems from competition, comes in.

1. Political feasibilit: Privatization is political at all stages, and at the earlier stage, most political of all, in the sense that non-economic concerns are uppermost in the minds of the people. The objective is not only to start the whole process but also to build a strong commitment towards it. Privatization is a long-term project. Moreover it marks a move away from the existing economic system. This results in conflicts of interest and as a result there may be opposition to privatization. Such opposition delays the process. Hence while choosing the method we must consider its acceptability by the general public (which includes the politicians and the labor force). The World Bank report on privatization very clearly says the main reason that privatization in India has not been able to be carried out for so many years is because it has not been politically desirable and feasible. It further uses a study to show that slowest SOE reformers (Egypt, India, Turkey) have all been those where there was a high level of over-staffing. The extent of overstaffing of course tells you what number of SOE employees would lose their jobs as a result of reform. Management buy-outs are, therefore politically more desirable. It is probably due to this reason that most countries have laws where laborers are given special privileges during privatization. The employee ownership provisions range from 10-15%upto as high as 100%. Most of the legislation is not only recent but also is not region specific. The form of employee ownership can defer from direct shareholding to holding of shares through ESOP, with the latter being more popular.

It was the political consideration of equity that forced the Czech authorities create dual markets for privatization. One was a true market where demand was based on purchasing power. The other was a market where participation was restricted to citizens who were given purchasing power by the state in the form of coupons. In case, only citizens were allowed to bid cash, the method would favor the wealthy and those with access to foreign capital. If foreign capital was to be kept out, the enterprises could have gone underpriced. Additionally, the coupons could be used to give greater claims on shares to the poor, the elderly, to workers or other groups. The selling of the enterprise to one private buyer will always result in the maximum threats of restructuring and hence maximum opposition.

Ideally, the government's aim should be to not only give away ownership of loss making enterprises, but also reform them so that trimming of excessive workforce is essential. Otherwise, political considerations are eventually going to lead to re-infusion of capital into enterprises (if they fail after privatization) which is nothing but recapitalization and hence renationalization (next). There needs to be a political consensus on privatization because the only way to offset resistance is through a combination of compensation and compulsion—offering fired workers severance packages and by banning strikes or reducing labor union power. Even with VRS packages the government could try and offer the "reservation price" (which could differ from worker to worker). For this purpose, hiring an independent evaluator might help.

6. No scope for re-nationalization: There are chances that even after privatization is complete, subsequent governments may decide, for whatever reason to reverse the process. One way to prevent this happening is to have as wide disbursement of shares as possible. In this case the public distribution of shares is helpful and so is the voucher system. The problem however lies as mentioned above if the privatized company goes into huge losses and the government then has to reinvest in it. Thus it would be prudent at the time of privatization to see how much restructuring and improvement in productivity and prices can be expected. In case we have heavily indebted enterprises, it may be better to break them up and sell the components separately.

KEY

Positive 3

Mixed 2

Negative 1

Precedents

Chile: From 1988-1999, among the complete sales, 4 were direct (single buyer) and one with 97% bid and 3% employee buyout. There were 4 trade sales, all between 40 and 90% of the company and all between 1998 and 1999. The others were mostly direct sales between 40 and 90% and there was one case of an NYSE issue.

Malaysia: Between 1991 and 1999, among the complete sales, there were three sales to management, 4 direct sales to local investors and one more sold partly to one local investor and partly to a foreign investor. The others were sales of smaller stakes to local investors, foreign investors and through public issue.

Mozambique: One of the more successful privatization stories in Africa, between 1994 and 1999 it had 21 cases of tender and restricted tender and one case of direct negotiation.

United Kingdom: Public floatation on stock exchange, either by a fixed price offer, a tender offer with a minimum bid or a combination of both was used for 40% of the privatization. This method was used for larger companies where the demand for their share was expected to be high. To encourage small investors the government frequently sold some shares to them at a fixed price whereas the larger investors were asked to submit tenders. Management/Employee buy-out was used 23% of the time.

In some cases though the government’s role as a producer decreased its role as a regulator increased (for e.g. electricity sector).

Use of different methods worldwide (in %)

Direct sale: 57.74

Management/Employee buy-outs: 0.21

Public offers: 38.49

Lease/Concessions: 21.85

When Goliaths Fall…

The basis for the entire process of disinvestment in India is the Disinvestment Commission Reports, which are then followed up on by a special Cabinet Committee. Here we have tried to pick up at random a few PSUs, look at the recommendations of the commission and analyze them. These PSUs include consultancy companies, a vegetable oil company and a condom manufacturing enterprise.

It started essentially with a view to gain self-sufficiency in the steel consultancy business in 1959 when the first three 'Integrated Steel Plants' of SAIL were being set up. In the beginning the work was centered on design, detailed engineering and project management work for the steel sector. It then diversified into procurement and construction work for the same. It is now into non-ferrous metals, mining, power plants, chemicals, etc. Most of this stems from the expertise it has gained by work in the steel sector especially in coke ovens, blast furnace equipment, rolling mills, etc (as a result of the captive business of government owned power plants, roads, coal handling plants of the ISPs).

Going by the Disinvestment Commission Report, the company got 53% of its income in 97-98 out of consultancy and the remaining out of equipment procurement. Within that, the steel sector accounted for 60% of the company's consultancy business. MECON usually gets orders of smaller sizes from other sectors. This can be attributed to the fact that although there is only one other competitor in the steel sector, M N Dastur and co.; the other sectors have a lot of other players both in the public and private sector (e.g. for power there are Development Consultants, TCS, Desein; for petrochemicals there are EIL and Humphery Galss). Within the steel consultancy sector, MECON is strongly positioned with the ISPs at Durgapur, Bokaro and Bhilai. In the private sector, the penetration of Dastur and co. is much greater. MECON has tie-ups with a lot of foreign companies for the requisite technical knowhow. In 1997 MECON commissioned the MTBE cracker unit of Lubrizol India, Mumbai (production of isobutene). MECON provided EPC (engineering, procurement, construction) work based on the knowhow of Sanprogetti, Italy. Similarly, it has a tie-up with Demag of Germany for blast furnace technology. Currently, there is an extended slump in MECON’s business in the steel sector with a fall in demand for steel (especially from the SAIL plants).

In the supply business MECON has been taking up LSTK (lump sum turn key business). This involves arranging for equipment by contracting the same to sub-contractors for which the company receives advance from the client for sourcing the equipment. MECON takes responsibility for commissioning the project as per schedule and agreed parameters. Here too, MECON basically has the advantage with the three ISPs mentioned before. In 1997-98, MECON had the major part of its orders in the non-steel sector; the reason behind this could be attributed to one large LSTK project with the Tamil Nadu Electricity Board (Rs. 241 crore). The supply business has extreme variability in earnings because gross margins vary from job to job.

In addition these projects typically involve payment of liquidated damages for deviation from project parameters and schedules. Moreover, LSTK projects are awarded on the basis of competitive bidding, which requires strong tie-ups. There are often negative cash-flows as a result of the fact that the payments from the client are made only once certain parts of the project are completed and further more the payments are often delayed. In addition there is tremendous competition for MECON in all parts of the supply business including steel with the entry of MNCs (Hitachi, Kawasaki, Nippon, Bechtel, ABB, Siemens). Further, the company does not have adequate capital to finance a part of the equity in the LSTK projects as is the current practice.

If one was to look at the financial performance of MECON (as in the CAG reports 2000-2001); it has been running losses for the past 2 fiscals. The net worth has been eroded by 1/3rd. This is inspite of the fact that the net sales have improved. The dividend paid to the government as the sole shareholder declined from 40% in 1996 to 0% for 98-99 and 99-00. The exports of the company have also been 0 for the fiscals 98-99 and 99-00. The company employed 3092 employees as of March 2000. One of the findings of the disinvestments commission is that the company has large employee expenses. They actually increased from 34.6% of the operating income in 96-97 to 43.6% in 97-98.

The commission has recommended that there be a sale of a minimum of 51% stake on the basis of global competitive bids from a set of prequalified bidders along with an appropriate role in management. According to them, this strategic partner would be able to add to MECON’s strengths in terms of "technical consultancy and project management, particularly LSTK capabilities, access to international funds". They have also recommend a suitable VRS scheme. Strangely, however, they say that in the event of an inadequate interest in the equity stake in MECON, the government will have no option but to shut down the company.

First, lets take a look at this business of selling a majority stake. The commission talks of a ‘sale of minimum of 51% stake’. This easily got interpreted into a recommendation for sale of 51% only and last one heard the CCD was meeting to consider this. New capital needs to be infused into MECON so that it can take on more LSTK projects especially in the non-steel sector. It also need better technology for the consultancy business. The company needs to compete with foreign as well as Indian private sector companies in the sector while currently its only regular clients are three ISPs of SAIL which themselves are facing a high degree of losses and privatization in the near future. In this light, how does the commission expect to get a buyer to take only a 51% stake in the company? In fact the one stop recommendation of the commission for most companies seems to be the sale of majority stake and management and then waiting for a turnaround for the company after which the remaining part can be sold for a profit.

As for shutting down the company in case a buyer is not found. It seems strange because as the commission itself notes, the company has over 3000 employees. The costs of the severance packages to all of them after a shut down would be huge. If one visits the website of the company, one also learns that it has 32 offices all over the country. In these circumstances, does it not make more sense (in case a single buyer is not found) to break up the company and sell it in parts and even consider some sort of employee buyout? A complete shut down with over 3000 heads on the block doesn’t seem politically feasible in any case.

Hindustan Vegetable Oil Corporation

It was formed in 1984 when the government took over 2 private sick enterprises with a view to revive them. The revival however much there was, did not last very long. It has three basic businesses- production of Vanaspati Oil, refining and packaging of Palmolein oil for the PDS (public distribution system) and production of breakfast foods (cornflakes and oats) under the brand name ‘Champion’. Vanaspati contributed to more than 50% of the turnover at the start of the 90’s. Since then, the Vanaspati units have all been shut down due to a Supreme Court Order (in Delhi) and as a result of technological obsolescence (Amritsar, Kanpur). The PDS packaging system has the inherent flaw that it is directly dependent on the government for all its business. The allocation of oil for PDS packing depends on the demand for oil in different states and the amount of funds allocated for oil imports. Further the government has decided to decrease in a large way its oil imports and shifted the import itself to OGL (open general license--essentially a term for commodities relatively freer to import). Moreover import duty has been reduced to 15% from 25% from October 1998.

As far as the breakfast foods are concerned in the Commission’s words "HVOCL has made no investment in developing its brand or strengthening its network". It relies on Mysore Sales International Limited--a Karnataka government agency for nation wide distribution. The company is falling behind Kellogs and Mohan Meakins in the cornflake segment. It has already shut down its wheat flake business. It had a near monopoly in the oats segment, but now MNCs such as Quaker Oats and the Con-Agra-ITC-Agrotech combine have entered here too.

The employee structure of the company was one that needed immediate attention with a VRS package (offered in February this year). As of March 2000, the number of employees in the non-operational plants of the company were 1225 while the others were less than 300.

The company has made continuous losses for the past 9 years. Its net worth was Rs. 50.22 crores in 1991 and by 1999-2000 was down to Rs.–14.78 crores. It had taken an unsecured loan of 3.5 crore from the government on which interest has been due for the past 9 years.

The Disinvestment Commission found the revival of the Vanaspati plants unlikely and decided that it was most prudent to shut them down along with adequate compensation to employees. It also recommended the shutting of the PDS packing facility.

We completely support this recommendation. The government has no business running a vegetable oil plant and considering the state of the machines, the revival of these in even the private sector is likely. This was borne out by the highly successful VRS scheme in the company in February last year, when all but a dozen employees availed of the package, despite the fact that their wages had last been revised in 1992.

On the other hand we don’t quite agree with the recommendations for the breakfast foods division. According to the commission, this business has been running with a well established brand name especially in the oatmeal segment- ‘Champion’. However in light of the considerable competition that is prevailing and is likely to come in, significant funds as well as managerial inputs are required which are currently lacking. Thus it recommends hiving off the company and subsequent sale of 100% through a competitive bidding process.

The commission itself points out that there is no proper marketing or distribution system. One is therefore skeptical of the value of this enterprise to any buyer when there are already large multinationals competing in the same segment. Since the only strength that the division seems to hold is the brand name champion, it makes more sense to just sell off the right to the name by a process of competitive bidding, strip the assets and pay off the workers. The speed of divestiture would also be sped up. This is doubly important because the value of the company is declining everyday. The division is much smaller than the oil division and given the response to the VRS in the latter, the same here should not constitute a problem.

It was incorporated in 1974 primarily with the objective of providing consultancy services in all facets of rail technology and management both in India and abroad. The company has executed projects in developing countries around the world--some with the funding of development financial institutions such as the ADB and the WB.

The company has followed a policy of diversification to consultancy to the entire transport sector- highways, ports, harbors, inland water transport, airports, etc. The major customers in India are essentially the central and state governments and their organizations like the PSUs and the SEBs.

65% of RITES’s turnover in 1996 came from railway related business. Here it began with rendering integrated design services, institutional management and technical support for new railway projects and rehabilitation and modernization of existing railway systems. Currently, the other part of the railway business that yields steady income is that of "third party inspection services". The company has received ISO 9000 certification for its inspection services and provides consultancy to other clients to enable them to obtain these certifications. Other than these it is also in a few other businesses, which are still growing. It has specialized expertise in "quality assurance services" in power, coal and oil sectors. RITES has been permitted to export rolling stock (locomotives, passenger cars) on behalf of the Indian railways. It is able to supply an integrated package consisting of hardware, after sales service, spares, training and even operations and maintenance.

In recent times, RITES has bagged a lot of business in overseas areas. It has secured contracts to supply diesel locomotives to Bangladesh and Sri Lanka and passenger cars to Vietnam. RITES has recently made a foray into Latin American markets where it is set to bag a Rs 1.5 crore order to study the operation and maintenance aspects of the Jamaican railways. Chile and Peru are two other new markets in Latin America where RITES has made a beginning by supplying spare parts.

As a result of its monopoly in the domestic sector, RITES can only continue to make profits. As far as the infrastructural business (besides railways) is concerned, they are all areas with high growth potential. With the privatization of the highway sector kicking off, RITES is in talks with the National Highway Authority of India (NHAI) the government agency overseeing the development of national highways to take on consultancy work relating to the preparation of model documents for big build, operate and transfer (BOT)-based national highway projects. RITES is involved in major port projects like Ennore and Kandla. When the Andhra government decided to privatise the Krishnapatnam port, RITES was signed on to prepare the model. RITES is handling the Delhi "mass rapid transportation system project." It has been asked to prepare the detailed project reports for two railway bridges, one on the river Ganga at Patna and another on the Bramhaputra at Bogibil. BPL Telecom and Rites, a public sector company under the ministry of railways, have signed a memorandum of understanding (MoU) to form a joint venture company to build a 2000-km broadband telecom network along the railway tracks. RITES has been engaged by a British consortium to provide offshore design support services for modifications required in the overhead electric traction lines. The Maharastra Industrial Development Corporation (MIDC) has signed an agreement with RITES for 10 mini airport projects in Maharashtra.

All this is reflected in the financial performance of the company. It saw its profits zoom 73 per cent to Rs 23.6 crore on a turnover of Rs 172 crore. The company declared a dividend of 160 per cent for 1999-2000. It bagged new contracts worth Rs 210 crore in 1998-99, a 79% increase over contracts secured in the previous year. It posted a turnover of Rs 142 crore in 1998-99, against the previous year's Rs 133 crore. It declared a dividend of 100%.

However, the proposal to disinvest RITES was shelved by the Disinvestment commission. This is because of a contract with the Iraq Railways in 1989 which was never completed. RITES borrowed large sums of money to execute the contract on a deferred payment basis. However due to the UN sanctions, the five year contract was foreclosed. RITES has receivables from Iraq in the form of deferred payments along with the applicable interest. Similarly, the company has outstanding payments on the loans it had taken. As of the end of 1996, the assets representing the above transactions in the books of RITES stood at 101.2 crore and liabilities at 114.7 crore. The commission says that the whole liability could even wipe out the entire net worth of the company.

The Disinvestment Commission has chosen not to privatise RITES. It says that in light of the uncertainty surrounding the Iraqi dues, there is not likely to be a favourable response from small investors or institutions to an offer of shares from the company. It was even pleaded that the government release the payment in the form of bonds payable over a period, just as it had done in some other similar cases, but it was not granted.

This is absurd. The Indian government has had a long history of keeping sick enterprises running, granting bad loans, and running down the assets of development financial institutions. Here it is refusing to bail out a profit making body whose entire liability problem arises more out of a diplomatic stalemate than an internal crisis. But lets say for the sake of argument that the government has decided as a matter of policy not to bail out companies any more. Even then it is incorrect to jump to the conclusion that the Iraq receivable implies that the company's value (in the eyes of a buyer) would be 0. If (and only if) the company has a positive cashflow, a private buyer would attach a value to it. Suppose (say) this value is Rs. 10 crore. A private buyer would be happy to bid Rs. 9.99 crore for the company. If the Iraq money comes through, it's a windfall of Rs.101 crore for the buyer sometime in the future. If the Iraq money doesn't come through, he loses nothing.

Engineers India Limited

EIL was established in 1965 in collaboration with M/S Bechtel Corporation USA. Its main objective was to establish a consultancy service in the field of petroleum projects. Over the years it has diversified into other areas such as offshore explorations structures, oil production systems and fertilizers. It also has its own R&D where it provides specialized skills in the areas of project engineering design, tendering and procurement. Its services range from pre-feasibility to commissioning support for various projects. The company has high quality standards and as a result it has acquired the ISO 9002 certification. Currently it has a capital of Rs. 18 crore, 94%of which is held by GOI and the had been sold in the favour of financial institution, mutual funds and private parties at an average price of Rs. 585 per share.

There is no doubt that over the last decade EIL’s financial position has improved steadily. Its profits after tax went up from Rs. 26 crore in 1992 to Rs. 68 crore in 1996. Its gross margins are above 30% and the net margins at an equally impressive 25%. Its dividends also increased from 25% in 1996 to 35%in 1999. Moreover, due to the good quality of its service and its highly skilled staff it has enjoyed a very good reputation in the industry.

Analyzing EIL’s turnover of the past three years we see that 70%of its business comes from refineries, petrochemicals and allied activities, which are currently government controlled and are forced to go to EIL. When these companies are privatised, as they should be sooner rather than later, then most of its client base would disappear. With the entry of foreign firms like Kvaerner, Powergas, Chemtex, Betchel, Flour Daniel etc EIL would stop getting the preferential treatment it gets now. Infact the government is already considering giving the "navratnas" (the nine jewels of Indian PSU family) considerable autonomy in choosing the consultancy firm of their liking. Moreover there is a fear that once the big foreign companies are allowed to enter they would lure EIL’s employees away by offering them higher wages. This would drastically reduce EIL’s efficiency and hence its profits. Latest trends of the industry show that there has been a shift from cost plus and lump sum fee projects to Lump sum turnkey projects. As a result consultancies are now required to conceptualise, monitor and implement these projects. All this would require not only a huge amount of capital but also access to latest technologies. In the past EIL has been working with most of the major technology suppliers in the world and recommending their technologies to its clients. But another new trend has been emerging where major engineering consultancies have started acquiring specific technologies in order to create entry barriers. Keeping this in view EIL has already entered into a few strategic alliances with specific suppliers of specific technologies. This would enable it to get temporary access to technologies but in the long run it would need to acquire the technologies itself. In short EIL would now require a lot of resources and immediate access to latest technologies to be able to stand the competition and the changing face of the industry.

The Disinvestment Commission feels and rightly so that EIL has the potential of becoming a global consultancy firm if it can overcome the hurdles it faces. For this it suggests a mix of disinvestments modalities. It suggests that 30% of its shares should be sold to a strategic partner who would provide EIL with the resources and necessary technologies. An ESOP should be established and 10% equity should be set aside for this purpose. 10% equity should be offered to public sector oil companies and SAIL, GAIL, NTPC etc in view of EIL providing services to these companies. The holding of its equity with the public should be increased to 24% through an offer to domestic investors at an appropriate time, after the strategic partner has been inducted. Through this process the share of GOI would come down to 26%, which the DC feels that GOI can sell at a higher price when EIL starts making more profits.

We agree whole-heartedly with the Disinvestment Commission that EIL should be privatized, but it is the extent and the manner which we don’t agree with. Though setting aside 10% equity for ESOPS is a good idea, as it will improve efficiency, make it more difficult for foreign firms to lure EIL’s employees and make the process politically more viable, selling 10% to public sector oil producing companies and other PSUs is absurd. Not only is this exercise unnecessary and would create hurdles in complete privatization but it would also harm these other PSUs, as they would remain EIL’s captive market. Also if the Disinvestment Commission feels that government ownership is slowing the development of EIL, then it is absurd that it should suggest that the government should keep on holding 26% equity in EIL. It would make far more sense if 100% equity is sold. As far as the method is concerned, after setting aside 10% for ESOP the government could either go for public offer of shares or look for a strategic partner, whichever is quicker. Right now the company is making profits and finding a good buyer would not be a problem. Since the company is not overstaffed, retrenchment is unlikely, therefore opposition from workers would not be there. EIL should be privatized as quickly as possible because such favourable conditions may not exist for very long.

Hindustan Teleprinters Limited (HTL)

HTL was incorporated in 1960 for manufacturing electromagnetic teleprinters for the P&T department. As the market for these products dwindled due to advancements in technology, HTL diversified and started producing electric typewriters and electronic typewriters. Later it also started producing MDF, switches for telephone exchanges, transmission access and communication data. Currently most of its revenue comes from these products. The income from teleprinters and typewriters went from 77% in 1992 to 0% in 1996. In comparison, the income from switches for large exchanges increased from 0% in 1994 to 61% in 1996. HTL has made a complete transition from a manufacturer of teleprinters to a manufacturer of switching exchanges and transmission products. Currently the company has a paid up capital of Rs. 15 crore which is wholly held by the GOI.

HTL’S labour force has strong electromechanical skills but now a days digital technology is being used. As a result most of labour force is surplus and inefficient. It does not have enough resources to expand and it depends on other companies for acquiring technologies as its own R&D is non existent. Moreover in India there are a number of manufactures of telecom equipment. The competition is so severe that a lot of multinational firms are under-quoting their prices to penetrate the market. This has led to the reduction in the prices from Rs. 7000/- to Rs. 4300/- per line. As a result most Indian companies including HTL are finding it difficult to compete on there own. To overcome this most Indian companies have formed strategic alliances with foreign companies. For example BK Modi Group is in alliance with Alcatel, Tata Group with AT&T, and SR Jiwarajika with Ericssion. Even HTL has a renewable commercial agreement with Siemens but only for the technology used for producing large switches.

As a result of all these factors HTL’s financial position has become very weak over the last decade. Its profits came down from Rs. 6.5 crore in 1992 to Rs. 0.5 crore in 1996. Its sales for the same period increased from Rs. 67 crore to Rs. 141 crore, but this was mainly due the fact that DoT guarantee HTL a 15% quota of all its purchases. There is always a fear of withdrawal of this quota especially with the privatization of the telecom sector. Its liquidity position has also worsened over the last decade. It has not even been able to pay interest on the loans which it had taken from UTI & GOI.

There is no doubt that the future of HTL is bleak and the government is unable to run it. According to Disinvestments Commission report the Net Worth of the company is likely to erode further in the next couple of years, so much so that it would probably come under the purview of BIFR. On the other hand it has land in prime locations in Chennai. Though the profits of the company have increased in recent years this can be attributed to the growth in the industry as such and the continuation of the 15% quota that it enjoys.

In its earlier report the DC had suggested to first offer a VRS to the surplus workers and then sell the company. It suggested that either the 100% share could be sold or only 50% through global competitive bidding. Though this is an acceptable suggestion (with the exception of selling only 50%), we feel that given the current level of competition in the industry, the outdated machinery of HTL and its unskilled staff, it is highly unlikely that there would be many bidders for the company. Therefore we suggest that a better Idea would be to break-up the company and sell it in parts. Given the fact that it holds prime locations in Delhi and Chennai, selling the company in parts would be much more profitable. As far as the workers are concerned, they could be given a part of the proceeds.

Hindustan Latex Limited was incorporated in 1966 with the main objective of producing male contraceptives. This was done to help the government in its efforts towards population control. Then in the 90’s it diversified and started producing female contraceptives like oral contraceptive pills and Intra-Uterine device (IUD) and other health care products. These included "blood bags" which are now being increasingly used instead of glass bottles, "hydrocephalus shunts" which are now being used to remove excess fluid in the cranium and "latex gloves". It was awarded the ISO 9002 certification, AFNOR registration of France and US-510 K certification for the good quality of its products.

The government is the major buyer of all HLL products. HLL has a capacity of producing 600 mppa (the market in India is for 2000 mppa). The government accounts for 80% of its sales of male contraceptives, for all its other products the government is the sole buyer. Going by the Disinvestment Commission report 77.7% of all its profits comes from the sale of male contraceptives alone. As for the other products the latex gloves contribute 0.2%, H-shunts 0.1% and latex gloves contribute -5.4% to the profits. Other companies in the same field are making huge profits and are growing at a fast pace given the ever-increasing popularity of contraceptives. On the other hand, HLL’s profit has always been unimpressive and irregular. Whatever profits it makes can be attributed to the fact that the GOI gives it a purchase preference over other companies. The explanations for such a poor performance are neither hard to find nor any different from the problems which plague other government run businesses.

HLL has been in business now for over three decades and due to sloppy marketing and poor quality of its products its customer base is still very small. A point in case is the fact that the Confederation of Human Rights Organisations (Kerala) had petitioned the National Human Rights Commission against the ``unethical, dangerous and corrupt marketing practices" of HLL as it sold 9 lakh expired condoms. In another incident it was booked for violation of drugs licensing guidelines, and illegal blood bags worth Rs. 80,000 were seized from its premises at Guindy. About 618 blood bags were stored without any drugs license to do so. These bags were labeled as samples but they were meant for distribution among unlicensed blood banks. Its exports as a percentage of sales declined from 10.98% in 1997-98 to 4.42% in 1999-2000. The wage cost as a percentage of total cost is 32%, which is totally unacceptable, but not surprising given the fact that 38% of its labor is surplus. According to the Disinvest Commission report the quality of HLL’S products is of international standard, but recently even the government run "Department of Health and Medical Services" rejected HLL’s tender for supplying blood bags even though it was offered at a lower price. The reason given by the department was poor quality of HLL’s blood bags.

As on March 31, 2001, the company had an equity capital of Rs. 15.4 crore and the GOI held 100% equity. Our recommendation is clear and simple: sell the company and sell it fast. Since the technology for this industry is easily available and not a lot of capital is required there is no need to invite a "Strategic Partner". The GOI could either go for "Open Auctions" or it could set a minimum floor price for the company and give special preference to employees.

The only reason given for not selling the company is the role it plays in the population control program of the GOI. Keeping the success of the program aside, the logic behind the reasoning is absurd too. If the GOI were to privatize HLL then it would no more be forced to buy contraceptives from HLL. It could instead invite open tenders from all manufacturers. This will not only ensure cheaper products for the government but also better quality products for the masses. Even now Disinvest Commission has suggested the sale of only a 51% stake in the company. We feel that political pressures rather than economic rationality back this suggestion.

Finishing Comments

In India the government has its hands in every conceivable business. From making vegetable oils to condoms, from railway consultancies to running hotels, you name it and you will find the government in it. Most of these PSU’s have been loss making and those making profits are either monopolies or enjoy some sort of a preference from the government. This will change with the opening up of the economy and there will be more loss making PSUs in the country. Therefore the writing is clearly on the wall--sell off.

The process of privatization in India has been painfully slow and has taken place only in starts and stops. The problem essentially has been the failure of any government to come out with a clear policy decision on privatization. Any country, which has been able to privatize successfully, has either had a written law on how to privatize (e.g. "Law on Privatization of State Owned and Municipal Property", Republic of Lithuania) or a clear understanding across political parties on the subject, India unfortunately has neither. Take the case of valuation of PSUs, which becomes the bone of contention between the opposition and the government every time a company is put up for sale. According to most experts the Discount Cash Flow method is the best as long as the company is being sold as a Going concern. Yet the opposition talks of various assets of a company, which haven’t been valued by this method. What we need is a clear policy on how we are Going to value he company based on its status (Going concern, imminent dissolution, etc). For example the Discount cash flow method would be appropriate given a bottom ceiling of the book value.

The other hurdle has been the opposition from the labour unions that are strong politically and therefore no government is ready to take them head on. Moreover most Indian PSUs suffer from excess labour. We suggest that after offering innovative VRS a certain percentage of equity should be set-aside for ESOPS. This would reduce the opposition to a large extent.

The best way of selling the remaining equity is through public offer of shares. This would not only be transparent but would also help to further develop the Capital market in India. The International Federation of Stock Exchanges has said that the market capitalization of the Indian stock exchange can increase by more than 50% after the full disinvestment process. We feel that this would also bridge the gap between "savings and investments in productive assets" in India as people would start investing more in the Capital Market rather than in non productive assets like say gold.

In special cases where it is strongly felt that strategic partner is needed the government should invite competitive tenders and keep them as open as possible. However we feel that even in these cases a public offer will result in the strategic partner ultimately buying the share from the market. Also the move to limit foreign direct investment is absurd as it not only creates unnecessary delays in privatization but also hinders the most efficient utilization of resources. A case in point being the whole disinvestment saga of the two national carriers—Indian Airlines and Air India, where it will be better to allow foreign investor as they will not only provide better service but also spurt the growth of the sector.

Then there is the question of whether to sell a company as a Going concern or to break it up first and then sell it. To this there is no clear-cut solution and a case-by-case approach needs to be adopted. In some cases there would be enough buyers and hence there would be no problem in selling them as a Going concern. But in some cases there would be either no buyers or the value at which the company could be sold as a Going concern would be far less than the value of its assets taken individually (having considered the cost of employee lay-offs). Given the redundancy in operation of several PSUs the government should not shy of breaking up these corporations (for e.g. HVOCL)

As far the Disinvestment Commission recommendations are concerned, as we have demonstrated earlier, they are not logically flawless either. The commission usually makes a one stop recommendation of the sale of majority stake in a PSU, saying that once the private buyer turns the company around the stake can be sold at a higher price. Given the sorry state of the finances of these PSUs, a private buyer would be apprehensive about picking up a less than 100% stake in the company. We feel that political pressures rather than economic logic backs these recommendations.

Finally, the time to privatize is running out and the more we delay the process the more we cheat the common man, as the value of his companies runs down. This is due to a combination of factors such as technological obsolence and lack of capital. For example when VSNL was originally to sell its’ stake to private investors in 1994 an IPO was to begin in Europe. But the then minister cancelled the public issue at the last moment. Since then there has been a major decline in the dollar value of VSNL due to more attractive telecom investment opportunities around the world. As a result today it would fetch us 25% of what it would have then.

References

1. Boycko, Maxim; Andrei Shleifer; Robert W Vishny, "A Theory of Privatization" The Economic Journal, March 1996
2. Dowberger Simon, John Pigott, "Privatization Policies and Public enterprise: A Survey"
3. "Law on Privatization of State Owned and Municipal Property", Republic of Lithuania
4. Chief T O Fatokun, "How to Evaluate Assets for Privatisation" Speech at the Nigerian Institute of Estate Surveyors and Valuators, Abuja
5. Rangarajan, C, Inaugural Address at the "Conference on Disinvestment Strategies and Issues" Delhi, February 5, 1997
6. Taylor Marilyn L "Divesting Business Units"
7. Schmalensee Richard, "What Have We Learned about Privatization and Regulatory Reform?" Revista De Economico, 10(2)
8. Frydman Roman, Katrharina Apistor, Andrej Rapacyznski, "Exit and Voice After Mass Privatization: The Case of Russia." European Economic Review, 1996
9. Peck Merton J, Thomas Richardson What is to be done? Proposals for the Soviet Transition to the Market
10. Frydman Roman, Andrej Rapacyznski, John S Earle, "The Privatisation Process in Central Europe"
11. Frydman Roman, Andrej Rapacyznski, John S Earle, "The Privatisation Process in Russia, Ukraine, and the Baltic States"
12. Baijal Pradip, "The Italian Puzzle: From Nationalization to Privatization", EPW, November 25, 2000
13. Miller Alan N, "British Privatisation: Evaluating the Results"
14. "Bureaucrats in Business", World Bank publication
15. Blanchar O, P Aghon, "On Insider Privatization", European Economic Review, 1996.
16. Shafik Nemak, "Making Markets: Mass Privatization in the Czech and Slovak Republics", World Development, 23(7)
17. Multilateral Investment Guarantee Agency" The World Bank group for statistics for privatizations in Malaysia, Chile, Mozambique, Tunisia, Brazil, Argentina, Philippines from www.privatizationlink.com
18. Report On HLL selling expired condoms http://www.indian- express.com/ie/daily/19981207/34150414.html November 16, 2001
19. Latest Accounts of PSUs in India

http://www.cagindia.org/reports/2001.htm November 16, 2001

20. Recommendations of the Disinvest Commission