Populism the catch for minority investors

Public sector firms, typically large monopolies in their sectors with healthy balance sheets, are managed as big profit-making businesses with a capable senior management at the helm.

While investors look at these strengths when investing in state-owned companies, they often feel cheated when the largest shareholder—the government—uses the companies’ wealth to fund populist policy initiatives and to subsidize prices, hurting the interest of public shareholders.

“The idea of government being the policymaker, owner and manager is clearly not working," says Arun Jethmalani, managing director ofValueNotes Database Pvt. Ltd, a Pune-based research firm.

“Investor protection is poor. If there is a need for funds in the budget to run hundreds of schemes, they do not think twice. Concern for shareholders is the least on their priority list," Jethmalani says.

Even Coal India, which is hitting the market with a record $3.4 billion (Rs14,970.20 crore) IPO, sells coal at a price that’s lower than global prices because it’s considered to be a fuel used by the masses, he says. “I would like to share the profits when the coal prices globally are ruling high," says Jethmalani.

Prakash Shah, secretary of the Investors Education and Welfare Association, says there is a “100% need" for improvement of corporate?governance?standards and protection of minority investors. “Investors need to be properly informed. But the issue is too big to be adequately covered by one newspaper article," he said.

Disinvestment secretary Sumit Bose chose to sidestep the issue at the launch of the Coal India IPO last week when asked whether government apathy towards minority investors’ rights should be discounted as a “key risk".

He instead cited a study in the Journal of Finance, a monthly publication, which said the annual sales and profits went up significantly in firms where the government?had diluted its stake.

But some investors question what is the use of such profits if they are used to fund government policy initiatives or to subsidize products.

Jethmalani points to publicly traded oil explorers.

“Between 2002 and 2007, when oil prices went from $20 to $150, globally oil companies made huge profits. Look at the balance sheet of companies like Shell, you will find the amount of reserves they have built. But look what happened to our oil companies. The companies themselves have not seen the money; it has gone to the government."

According to a recent Right To Information (RTI) reply reported in the DNA newspaper, the ministry of petroleum and natural gas said that between 2004-05 and 2009-10, the three most profitable government firms, explorer ONGC Ltd, monopoly gas distributor GAIL (India) Ltd and explorer Oil India Ltd, had transferred Rs1.12 trillion to three loss-making oil marketing companies to subsidize fuel prices.

The three were forced to give subsidies in the form of discounts to refiners that sell fuels below cost. All three are listed firms.

In March 2009, US investment bank Goldman Sachs said it had “serious" concerns about ONGC’s corporate governance standards after cash withdrawals spurred repeated objections from investors and independent directors.

The government had taken cash from the energy explorer for six years to cushion losses at state-run refiners, it said. The report had put the cumulative impact of the subsidy burden on the explorer’s profit after tax in the six years to March 2009 at $12 billion.

“Issues with corporate governance at ONGC are among the more serious for companies in our coverage universe," Goldman Sachs analysts Nilesh Banerjee, Karthik Bhat and Durga Dath wrote in the 5 March, 2009 report. “We believe minority shareholders are likely to suffer in a situation where their interests are poorly protected."

The minority investor issue is not limited to the oil sector. Even highly regulated banks have been at the receiving end. In February 2008, then finance minister P. Chidambaram announced a Rs60,000 crore loan waiver, forcing investors in many listed public sector banks to run for cover.

Low public shareholding in many public sector units (PSUs) doesn’t help the cause of minority shareholders.

The “relatively small floats of listed PSUs and of Indian companies planning IPOs is of significant concern," says Seth R. Freeman, chief executive officer and chief investment officer at EM Capital Management Llc, a San Francisco-based foreign institutional investor.

“In existing listed companies, the low floats certainly impair shareholder rights..," he said by email.

Jethmalani adds: “In many companies, minority shareholders have 10%. What can you do with 10%?. You need at least 26% to make some noise."

The government recently said there should at least 25% public shareholding in companies. It later said public sector enterprises are exempted from complying with this rule.

Concerns over minority investor protection and corporate governance have historically led to PSUs quoting at a discount to their private sector peers.

“There has been a ‘PSU discount’ compared with the financial metrics of non-PSU competitors. I think this is a natural situation given the potential sovereign risks of investing in government-controlled companies anywhere," Freeman said.

But such concerns are unlikely to affect the prospects of the Coal India offer or the government disinvestment programme. In fact, some say that the divestment programme itself will act as a check against anti-minority shareholder policies being pursued by the government.

“With the large divestment programme, it is unlikely that the government would take policy decisions that would have an impact on minority shareholders in our view," said a recent report on PSUs by Centrum Broking Pvt. Ltd. “A more benign and pro-business policy regime would help minority shareholders and narrow the valuation discount of PSUs vs private peers."

Investors should be encouraged to invest in the Coal India IPO, says A.K. Narayan, president of the Tamil Nadu Investors’ Association. “In times of problem, every government in every country across the world has taken such (populist) steps. Government has done what was required keeping in mind the larger good," he says. “We should not focus too much on the negatives."

Freeman also says that Indian companies “compare quite favourably?to the way many emerging markets public companies are exploited by the regime in power and used as piggy banks by the leaders in power."

He feels that investors will overlook the issue of minority investor rights because the Coal India offer is “valuable".

“In the case of Coal India where the company is so large and valuable, the small equitization represents a large sum of capital in Indian terms and clearly foreign investors are willing to overlook being minority shareholders in order to get a piece of such a strategic business," he says.