ONGC-HPCL deal: A marriage of convenience
The government is moving ahead with its proposal to create an integrated public sector ‘oil major’ but in the process, is also filling its own coffers. It is, however, denying minority shareholders that opportunity.
A merger of Hindustan Petroleum Corp. Ltd (HPCL) with Oil and Natural Gas Corp. Ltd (ONGC) would have been a neat structure, combining both businesses with the full benefits of integration available to claim. There would be no cash to be paid or debt to be raised. Instead, ONGC plans to acquire the government’s 51% stake in HPCL.
Whether this will be followed by a merger is not known, but is not on the cards yet.
The Street is rather unimpressed, with HPCL’s shares falling by 4.3% while ONGC’s share rose by 1.8% on Thursday. ONGC’s shareholders would have preferred a merger.
HPCL’s shareholders would be disappointed that the acquisition is unlikely to be accompanied by an open offer. That would be unfair as they too should get a chance to exit at the same price as the government.
A BloombergQuint article dated 20 July cites a precedent of Indian Oil Corp. Ltd (IOC) acquiring public sector IBP Co. Ltd, and then making an open offer. There have been instances where promoters have made an inter-se transfer and also sought exemption from making an open offer.
The government may have had a stronger case for an exemption, for instance, if it had created a holding company for all PSUs, and transferred its stake in HPCL to that entity. In this case, the market regulator will be making a special exemption. ONGC is acquiring the government’s stake by paying cash. It’s not the same thing as the stake moving within the government from one arm to another.
The government wears many conflicting hats, in this case of an owner, policy-maker and a law-maker. But it should set the right precedent for private sector promoters by tipping its hat to good corporate governance.
The gains in ONGC’s shares can be partly attributed to not having to spend cash for an open offer. Since 31 January, when the government first proposed consolidation of its oil assets till 19 June, ONGC’s shares have fallen by about 20% while that of HPCL have gained by 10%. ONGC’s fall was made worse by crude oil prices not having strengthened as much as expected.
The consideration has not been disclosed but, at current prices, a 51% stake in HPCL will cost ONGC Rs 29,000 crore. ONGC’s debt to equity ratio is a mere 0.25 times as of 31 March and even if it funds the entire purchase through debt, this ratio will increase to only 0.4 times.
Its cash and equivalents stood at Rs 16,648 crore. HPCL’s debt-equity, on the other hand, is relatively higher at about 1 times with cash and equivalents of Rs5,245 crore.
Analysts do not believe ONGC gains much since the transaction is being structured as an acquisition. A merger could have been used to extract improvements in profitability from cost savings and better operational efficiency.
For integrated oil companies, a lot depends on oil price levels and how best companies are able to hedge against price movements.
For instance, even as crude oil prices dropped in recent years weighing on earnings of oil producers, refining companies have been able to perform relatively better as refining margins have been more resilient.
That’s the benefit ONGC can hope to attain after acquiring a majority stake in HPCL. In FY17, for instance, HPCL’s standalone profit increased by two-thirds over a year ago. Some of that was due to inventory gains which may not accrue this year. That and competition from private companies are a threat to HPCL’s performance in FY18.
What can the impact on valuations be? Global integrated oil companies do not necessarily fetch better valuations than global pure-play refiners, according to Bloomberg data. But the structure of this transaction leaves ONGC looking more like a holding company rather than a fully integrated oil and gas major. While HPCL’s financials will be consolidated with ONGC, it may suffer a holding company discount.
For now, the government is the main beneficiary in this transaction, which helps it meet its divestment target to that extent. Investors will keep a close watch on whether an open offer is indeed not on, and then in the longer run, what plan does ONGC have—merger or not—to make the HPCL acquisition a worthwhile one.