Condemn First, Rationalise Later

Back in 1981, I remember veteran politician HN Bahuguna distributing handouts giving his reaction to the budget immediately after the budget speech. To the naive, it looked an admirably fast reaction. But I realised that Bahuguna must have drafted his handout without even listening to the budget speech. That is how he managed to have it printed and ready for distribution as soon as the speech ended. He had cleverly condemned the budget in such rhetorical and non-specific terms (like calling it a petty accountant’s budget) that the criticism would look okay regardless of the actual content of the budget. His strategy was clear: Condemn first, rationalise later.

It seems to me that the same strategy is being followed by at least some MPs in opposing the privatisation of Bharat Aluminium Corporation (Balco). The world over, the most transparent way of selling assets is to invite global bids and choose the highest one. This is exactly what was does in the case of Balco. Yet Opposition parties paralysed the functioning of Parliament by declaring it a sell-out. Are politicians simply uninformed about valuation or are they cynics who will oppose anything on the principle of opportunism?

I do not know for certain. What I do know is that the only valuations worth taking seriously are those backed by actual cash. Valuations made by people who do not put their money where their mouths are, mean nothing. I can declare that shares of Infosys are valueless, you might declare they are worth Rs 10,000 each, but what matters is the fact that the shares actually change hands at Rs 5,800 on the markets. Property is worth what people are actually willing to pay for it.

Do some trade unions or politicians feel Balco is worth more? Please seek out venture capitalists to finance a higher bid. After all, VCs have been willing to pour billions into risky, unproven dotcom companies, and will surely be willing to back any bidder who can show them reasonable ground for thinking that other bids will be low. But if you cannot find any backer, please accept that your personal valuation has no commercial value.

Bids should be allowed from any party in the world, to maximise competition. This is exactly what was done in the case of Balco. The three bidders at the final stage were Sterlite, Hindalco and Alcoa. Sterlite bid Rs 551 crore for a 51 per cent stake in the company, double the second-highest bid of Rs 275 crore by Hindalco. In global bidding, the winning bid is typically just a bit more than the second-highest one. So in Balco’s case we should be very happy that such a high winning bid was received. Indeed, the stock market clearly thinks Sterlite bid too much: The company’s shares nosedived on hearing that Sterlite had bid twice as much as its rival.

Look at the accompanying chart. It shows that of the various aluminium producers in India, Balco was by far the least profitable. Yet Sterlite’s bid for Balco represented the highest multiple of price to earnings among all aluminium companies. The Birlas must be laughing silently that their competitor bid so much more than they did.

Balco’s margin of operating profit to sales for 1999-2000 was only 14 per cent against 20 per cent for Indal, 46 per cent for Hindalco and 49 per cent for Nalco. But the P/E ratio measuring current market value as a proportion of net profit in 1999-2000 was by far the highest for Balco at almost 20 times, against 9.6 times for Hindalco, 7.5 times for Indal and 7.7 times for Nalco. In other words, the worst performer got the highest relative valuation! There could hardly be a better deal for the seller.

What the chart also shows is that Nalco is intrinsically undervalued by markets today. If auctioned to private bidders, it will surely go for a much higher price. The inherent value in public sector shares can be unlocked by privatisation, which gives shareholders confidence that profits and management will improve. Otherwise they will fear a steady erosion of future profits as it happened in the case of Balco, which made Rs 163 crore in 1996, but will make only Rs 25 crore or so this year. Maruti is another case of a company going downhill. Some others have done better, but public confidence remains low in the future of public sector units if they are not privatised. The longer you delay privatisation, the less they are likely to fetch. The classic case here is VSNL, whose sale at almost $ 40 was stalled in Narasimha Rao’s time, and today trades at barely $ 14.

Some politicians claim that the assets of Balco are high–it has reserves of Rs 450 crore. Politicians need to understand that reserves do not mean liquid cash, they can also mean investment in dud machinery and buildings. Balco has liquid assets of Rs 310 crore and debts of Rs 255 crore, meaning net liquid assets of Rs 55 crore. That has been factored into Sterlite’s bid, which values the company at Rs 1,100 crore.

Disinvestment minister Arun Shourie has told Parliament that the winning bid was far higher than other forms of valuation like valuation of physical assets. I personally would not stress this argument, since the value of a company is determined by its future profitability, not its physical assets. Indian Iron has enormous physical assets in land and buildings, but is worthless from an investor’s viewpoint. By contrast, Wipro and Infosys are software companies with very modest assets (they have no factories), yet they have a market value of over $ 10 billion each since they are highly profitable companies which keep doubling their profits year after year. That is what counts in any commercial valuation.

Physical assets would have more value if companies were allowed to sack workers and dispose of the land and buildings. Arguably, many PSUs would be worth more if they could dispense with their workers and machinery and become a real estate business. They are sitting on prime urban land. But our laws and rules make it virtually impossible to sack workers or sell land, which is why so many mills sitting on what looks like very valuable property are bankrupt and closed.

A change in the rules on labour and land would greatly increase the future profitability and hence the value of public sector shares. But no Opposition politician (or Ruling politician for that matter) seems interested in such radical reforms. Those crying aloud that Balco is undervalued are the very ones who stall reforms which would increase Balco’s value.

What do you think?