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Corporate Apr 9, 2012

PSUs are not for shareholders, so why invest in them?

By Arjun Parthasarathy

Investors in government-owned companies are the most optimistic of all investors.

The reasons for the optimism stems from a) markets doing well and taking up share prices of PSUs in the process and b) government will deliver shareholder value for its own benefit.

The government has the capability of suppressing its own companies from growing and helping private sector competitors in the process. Reuters

Unfortunately the optimism is misplaced on both the counts. This is because the owner, which is the government of India, is inherently socialistic and uses all its assets to fulfill its so-called social responsibilities. Shareholder interests are secondary and hence government-owned companies will always come out second to better-managed counterparts in the private sector in terms of creating shareholder wealth.

The BSE PSU index, which is an index of listed companies that have the government as the majority shareholder, has underperformed the BSE Sensex in the ten-year period from 2002 to 2012. The PSU index returned 342 percent in the 2002-2012 period while the BSE Sensex gained 417 percent in the same period. (Table 1.) In one sense investor optimism on the market taking up PSU stocks is right but the fact is that investors could have gained more by just investing in the BSE Sensex, which is more diversified than the PSU index.

On the other hand in weak market conditions the PSU index underperforms the broad market in negative terms. The PSU index has lost 29 percent in the 2007-2012 period while the Sensex has lost 14 percent in the same period. (Table 1.). PSU stocks are not defensive in nature and fall more than the broad index when markets are weak.

Source:BSE

The government is the biggest beneficiary if its companies work towards creating shareholder wealth as the value of its investment goes up, enabling it to encash the value when it requires money to fund its fiscal gap. But it doesn't see it that way. It believes its companies are required to fulfill social responsibilities and also help the government in times of need. Minority shareholders do not figure in the government's scheme of things except to buy out a part of its ownership when the government disinvests a small stake.

Cash- rich ONGC is used for fuel subsidy while Coal India is used for power subsidy. The fact that these companies are a monopoly and will continue to make oversized profits will not help shareholders, as the government will make them distribute the profits for social benefits rather than shareholder benefits.

The government has the capability of suppressing its own companies from growing and helping private sector competitors in the process. The state of oil marketing companies such as IOC, BPCL and HPCL is a case in point where these companies have been on the back foot for over eight years as the government has consistently been lagging in subsidy payments. The result is that these perennially cash-starved companies have been forced to abandon capital expansion plans. The result: Reliance and Essar Oil have gained market share instead.

The lack of focus on shareholders wealth is telling on companies where private sector participation has growth. The performance of companies like MTNL against its private sector counterparts shows the lack of competitive capabilities in these once large monopolies. Bharti Airtel has gained 2800 percent while MTNL has lost 67 percent in the 2002-2012 period. The stark difference in performance shows the complete indifference on the government's part to its shareholders.

So why would you want to own PSU shares?

The recent activism by the UK-based Children's Investment Fund (TCI) against Coal India is more laughable than anything else. The government owns 90 percent of Coal India. However, the monopoly status is the only thing going for the company. Coal India signifies the socialist nature of the government, where coal prices are not passed on to end users and the government is forcing the company into supplying fuel at disadvantageous prices to power producers. The government believes that cheaper coal costs will help power companies produce power at cheaper prices and pass this on to consumers. The fact that power companies will use the cheap coal to increase margins does not figure in the government's plan but that is a separate analysis altogether. TCI is the last thing on the government's mind when it dictates the affairs of Coal India.

TCI must have a very solid reason to stay invested in Coal India. Similarly other investors must also have a solid reason to stay invested in PSU shares and the reason cannot be the ones stated at the beginning of this analysis. Investors should truly believe that PSU stocks will outperform the broad market and its private sector counterparts to stay invested. The past performance does not suggest good gains and the current government's stance on PSU companies do not instill confidence. If there is some other good reason to stay invested in PSU stocks we all would like to know.

by Arjun Parthasarathy

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