CHAPTER 1:

INTRODUCTION TO DISINVESTMENT

1.1 Definition
1.2 Disinvestment process
1.3 Methods adopted in India
1.4 Legal issues
1.5 Indian scenario
1.6 Advantage and Disadvantages

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1.1DEFINITION:

Disinvestment refers to the action of an organization or the government in selling or liquidating an

asset or subsidiary. In simple words, disinvestment is the withdrawal of capital from a country or
corporation. Some of the salient features of disinvestment are:

• Disinvestment involves sale of only part of equity holdings held by the government
to private investors.

• Disinvestment process leads only to dilution of ownership and not transfer of full
ownership. While, privatization refers to the transfer of ownership from government to
private investors.

Disinvestment is called as ‘Partial Privatization’

OBJECTIVES OF DISINVESTMENT:
Privatization intended to achieve the following:
• Releasing large amount of public resources
• Reducing the public debt
• Transfer of Commercial Risk
• Releasing other tangible and intangible resources
• Expose the privatised companies to market discipline
• Wider distribution of wealth
• Effect on the Capital Market
• Increase in Economic Activity

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1.2 DISINVESTMENT PROCESS:

Fig. 1 Disinvestment process

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PROCEDURE FOR DISINVESTMENT:
The procedure followed by Government of India for disinvestment seeks to Promote
administrative simplicity and speed of decision-making without compromising on transparency
and fair play. The process is as follows:

• Proposals for disinvestments in any PSU, based on the recommendations of the

Disinvestment Commission or in accordance with the declared Disinvestment Policy of the
Government, are placed for consideration of the Cabinet Committee on Disinvestment (CCD).
• After CCD clears the disinvestment proposal, selection of the Advisor is done through a
competitive bidding process.
• After receipt of the Expression of Interest (EOI), in pursuance of Advertisement in
newspapers / website, advisors are selected based on objective screening in the light of announced
criteria / requirements.
• Bidders are invited through advertisement in newspapers / website to submit their
Expression of Interest. On receiving EOI from bidders, the advisors, after due diligence of the
PSU, prepare the information memorandum in consultation with the concerned PSU.
• This is given to the short listed prospective bidders who have entered into a confidentiality
agreement. The list of bidders is prepared after scrutiny of EOIs and those are short listed, who
meet the prescribed qualification criteria.
• The draft share purchase agreement and the shareholder agreement are also prepared by the
Advisor with the help of the legal Advisors, and the final draft is prepared after detailed
consultation with the bidders, in consultation with the Inter-Ministerial Group (IMG)
• The prospective bidders undertake due diligence of the PSU and hold discussions with the
Advisor/ the Government/ the representatives of the PSU for any clarifications. Concurrently, the
task of valuation of the PSU is undertaken in accordance with the standard national and
international practices
• Based on the feedback received from the prospective bidders, the Share Purchase
Agreement (SPA) and Shareholders Agreement (SHA) are finalized by IMG. After getting them
vetted by the Ministry of Law, they are approved by the Government (CCD).

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• Thereafter, they are sent to the prospective bidders for inviting their final binding financial
bids. The material for finalizing upset price is taken from the advisors after receipt of financial
bids. The bids are not opened at this stage and are sealed after receipt, in presence of bidders.
‘Upset price’ determination exercise is thereafter completed by inter-ministerial
• ‘Evaluation Committee’ and the IMG. The sealed bids are then opened by IMG, in
presence of bidders and compared with ‘Upset Price.’
• After examination, analysis and evaluation, the recommendations of the Inter Ministerial
Group (IMG) are placed before the Core Group of Secretaries on Disinvestment(CGD), whose
recommendations are placed before the Cabinet Committee on Disinvestment(CCD) for a final
decision regarding selection of the strategic partner, signing of the Share Purchase Agreement and
Shareholders Agreement, and other related issues.
• In case the disinvested PSUs shares are listed on the Stock Exchange, an open offer would
be required to be made by the bidder before closing the transaction, as per SEBI guidelines:
Takeover Code.
• In the disinvestment process mentioned above, Ministry of Disinvestment is assisted a
teach stage by an IMG, headed by Secretary (Disinvestment) and comprising officers from the
Ministry of Finance, Department Of Public Enterprises, the Administrative Ministry /Department
controlling the PSU, Department of Company Affairs, Department of Legal Affairs, CMD /
Director (Finance) of the company being disinvested, and the Advisors and the Legal Advisors.
• After the transaction is completed, all papers and documents relating to it are turned over to
the CAG of India; the CAG prepares an evaluation for sending to Parliament and releasing to the
public.

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1.3 METHODS ADOPTED IN INDIA:

The following are the three methods adopted by the Government of India for disinvesting the
Public sector undertakings. There are three broad methods involved, which are used in valuation of
shares.

1. NET ASSET METHOD:

This will indicate the net assets of the enterprise as shown in the books of accounts. It shows
the historical value of the assets. It is the cost price less depreciation provided so far on assets.
It does not reflect the true position of profitability of the firm as it overlooks the value of
intangibles such as goodwill, brands, distribution network and customer relationships which
are important to determine the intrinsic value of the enterprise. This model is more suitable in
case of liquidation than in case of disinvestment.

2. PROFIT EARNING CAPACITY VALUE METHOD:

The profit earning capacity is generally based on the profits actually earned or anticipated. It
values a company on the basis of the underlying assets. This method does not consider or project
the future cash flow.

3. DISCOUNTED CASH FLOW METHOD:

In this method the future incremental cash flows are forecasted and discounted into present value
by applying cost of capital rate. The method indicates the intrinsic value of the firm and this
method is considered as superior than other methods as it projects future cash flows and the
earning potential of the firm, takes into account intangibles such as brand equity, marketing &
distribution network, the level of competition likely to be faced in future, risk factors to which
enterprises are exposed as well as value of its core assets. Out of these three methods the
discounted cash flow method is used widely though it is the most difficult

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TYPES OF DISINVESTMENT
There are various types of disinvestment. Some of them are as follows:

1. OFFER FOR SALE TO PUBLIC AT FIXED PRICE:

In this type of disinvestment, the government holds the sale of the equity shares to the
public at large at a pre determined price.

Examples:-MFIL, BALCO, CMC, HTL, IBP, HZL, PPL, and IPCL.

2. STRATEGIC SALE:
In this type, significant management rights are transferred to the investor i.e. majority of
equity holdings is divested. Examples: -Offer of 1 million shares of VSNL, listing of
ONGC IPO.

3. INTERNATIONAL OFFERING:
This is essentially targeted at the FII (foreign institutional investors). Ex:-GDR of VSNL,
MTNL etc.

4. ASSET SALE AND WINDING UP:

This is normally resorted to in companies that are either sick or facing closure. This is done
by the process of auction or tender. Ex:-Auction of sick PSU’s.

1.4 LEGAL ISSUES IN THE DISINVESTMENT PROCESS:

Legality of the disinvestment process has been challenged on a variety of grounds that slowed the
sale of public assets. However, there were two significant judicial rulings that broadly set the
boundaries of the D-P process. These are:

1. Privatisation is a policy decision, prerogative of the executive branch of the state; courts would
not interfere in it.

2. Privatisation of the PSE created by an act of parliament would have to get the parliamentary
approval.

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While the first ruling gave impetus for strategic sale of many enterprises like Hindustan Zinc,
Maruti, and VSNL etc. since 2000, the second ruling stalled the privatisation of the petroleum
companies, as government was unsure of getting the laws amended in the parliament

1.5 INDIAN SCENARIO:

A large number of PSUs were set up across sectors, which have played a significant role in terms
of job creation, social welfare, and overall economic growth of the nation; they rose to occupy
commanding heights in the economy. Over the years, however, many of the PSUs have failed to
sustain their growth amidst growing liberalization and globalization of the Indian economy. Loss
of monopoly and a protectionist regime, and rising competition from private sector competitors
have seen many of the government-owned enterprises lose their market share drastically. In many
instances, many of the PSUs have found themselves unable to match up to the technological
prowess and efficiency of private sector rivals, although many have blamed lack of autonomy and
government interventions for their plight.

Few factors that have prohibited Indian PSUs from performing upto the standards laid down for
them at their incorporation include among others:

• The first order issue is that of competition policy. When the government hinders
competition by blocking entry or FDI, this is deeply damaging. Once competitive
conditions are ensured, there are, indeed, benefits from shifting labour and capital to more
efficient hands through privatisation, but this is a second order issue.

• The difficulties of governments that run businesses are well-known. PSUs face little
"market discipline". There is neither a fear of bankruptcy, nor are there incentives for
efficiency and growth. The government is unable to obtain efficiency in utilising labour
and capital; hence the GDP of the country is lowered to the extent that PSUs control labour
and capital.

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 • When an industry has large PSUs, which are able to sell at low prices because
capital is free or because losses are reimbursed by periodic bailouts, investment in that
entire industry is contaminated. This was the experience of Japan, where the "zombie
firms" - loss-making firms that were artificially rescued by the government - contaminated
investment in their industries by charging low prices and forcing down the profit rate of the
entire industry.

• Further, in many areas, the government faces conflicts of interest between a

regulatory function and an ownership function. As an example, the Ministry of Petroleum
crafts policies which cater for the needs of government as owner, which often diverge from
what is best for India.

• There is a fundamental loss of credibility when a government regulator faces PSUs

in its sector: there is mistrust in the minds of private investors, who demand very high rates
of return on equity in return for bearing regulatory risk.

• Then the problem of corruption and misappropriations are all well known in India.
Thus, privatization was accepted in Indian context.

1.6 ADVANTAGES AND DISADVANTAGES OF DISINVESTMENT

Benefits of disinvestment

• Disinvestment would expose the privatized companies to market discipline, thereby

forcing them to become more efficient and survive or cease on their own financial and
economic strength. They would be able to respond to the market forces much faster and
cater to their business needs in a more professional manner. It would also facilitate in
freeing such companies from Government control and introduce corporate governance in
the privatized companies.

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 • Disinvestment should result in wider distribution of wealth through offering of
shares of privatized companies to small investors and employees.

• Disinvestment would have a beneficial effect on the capital market; the increase in
floating stock would give the market more depth and liquidity, give investors easier exit
options, help in establishing more accurate benchmarks for valuation and pricing, and
facilitate raising of funds by the privatized companies for their projects or expansion, in
future.

• Opening up the public sector to appropriate private investment would increase

economic activity and have an overall beneficial effect on the economy, employment and
tax revenues in the medium to long term.

• In many areas, e.g., the telecom and civil aviation sector, the end of public sector
monopoly and Privatization has brought to consumers greater satisfaction by way of more
choices, as well as cheaper and better quality of products and services.

• With the quantitative restrictions removed and tariff levels revised owing to
opening of world markets/WTO agreements, domestic industry has to compete with
cheaper imported goods. In the bargain, the common man now has access to a whole range
of cheap and quality goods. This would require Indian industries to become more
competitive and such restructuring would be easier in a privatized environment.

Arguments against Disinvestment:

• The amount raised through disinvestment till now is Rs.30,500 Cores. But the way
money realised by disinvestment is being used remains undisclosed.

• The loss of PSUs is rising from 9305 Cr. in 1998 to 10060 Cr. in 2000.

• Disinvestment of profit making PSUs will rob the govt. of good returns. Further, if
the department of disinvestment really wants to get away with commercial risk, why should
it retain equity in divested PSU’s? E g. BALCO (49%) and MODERN FOOD (26%).

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 • The point that huge manpower will be released after disinvestment of PSUs which
can be employed in social welfare is wrong as the growth in social sector is not in any way
hindered by non availability of manpower.

• The supporters of disinvestment have thought that taxpayers’ money would be

saved by private sector investment. Hindustan liver has categorically stated that it has no
plan for any capital infusion in Modern Food Industries acquired by it in January, 2000.

CHAPTER: 2
PUBLIC SECTOR IN INDIA

2.1 Evolution of Public Sector

2.2 Objective of Formation of PSU's
2.3 Problems of Public Sector Undertakings
2.4 List of companies disinvested

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2.1 EVOLUTION OF PUBLIC SECTOR:
Prior to Independence, there were few ‘Public Sector’ Enterprises in the country. These included
the Railways, the Posts and Telegraphs, the Port Trusts, the Ordinance Factories, All India Radio,
few enterprises like the Government Salt Factories, Quinine Factories, etc. which were
departmentally managed. India at that time was predominantly an agrarian economy with a weak
industrial base, low level of savings, inadequate investments and infrastructure facilities. In view
of this type of socio-economic set up, our visionary leaders drew up a roadmap for the
development of Public Sector as an instrument for self-reliant economic growth.

In early years of independence, capital was scarce and the base of entrepreneurship was also not
strong enough. Hence, the 1956 Industrial Policy Resolution gave primacy to the role of the State
which was directly responsible for industrial development. Consequently the planning process (5
year Plans) was initiated taking into account the needs of the country.

The new strategies for the public sector were later outlined in the policy statements in the years
1973, 1977, 1980 and 1991. The year 1991 can be termed as the watershed year, heralding
liberalization of the Indian economy.

The public sector provided the required thrust to the economy and developed and nurtured the
human resources, the vital ingredient for success of any enterprise; public or private.

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2.2 OBJECTIVES FOR THE FORMATION OF PSUS
The main objectives for setting up the Public Sector Enterprises as stated in the Industrial Policy
Resolution of 1956 were:

• To help in the rapid economic growth and industrialization of the country and create the
necessary infrastructure for economic development
• To earn return on investment and thus generate resources for development
• To promote redistribution of income and wealth
• To create employment opportunities;
• To promote balanced regional development
• To assist the development of small-scale and ancillary industries
• To promote import substitutions, save and earn foreign exchange for the economy.

2.3 PROBLEMS OF PUBLIC SECTOR UNDERTAKINGS

The most important criticism levied against public sector undertakings has been that in relation to
the capital employed, the level of profits has been too low. Even the government has criticised the
public sector undertakings on this count. Of the various factors responsible for low profits in the
public sector undertakings, the following are particularly important: -

1. Price policy of the Public Sector undertakings.

2. Underutilization of capacity.

3. Problem related to planning and construction of projects

4. Problems of labour, personnel and management

5. Lack of autonomy

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2.4 List of Companies Disinvested

No. Of
Shares(in % of
Name of the Enterprise crore) Disinvestment

Andrew Yule (AY) 0.1015 9.6

Bharat Earth Movers Ltd. (BEML) 0.6 20

Bharat Electronic Limited (BEL) 1.6 20

Bharat Heavy Electricals Limited (BHEL) 4.8952 20

Bharat Petroleum Corporation Limited (BPCL) 1 20

Bongaigaon Refinery and Petrochemicals Ltd. (BRPL) 3.9961 20

Cochin Refineries Ltd. (CRL) 0.4219 10.01

Computer Maintenance Corporation (CMC) 0.2528 16.69

Dredging Corporation of India Ltd. (DCI) 0.0402 1.44

Fertilizers and Chemicals Ltd. (FACT) 0.5232 1.54

Hindustan Machine Tools Ltd. (HMT) 0.4268 5.43

Hindustan Organic Chemicals Ltd. (HOCL) 0.987 20

Hindustan Petroleum Corp. Ltd. (HPCL) 1.2768 20

Hindustan Photo Films Mfg. Co. Ltd. (HPF) 1.919 16.05

Hindustan Zinc Ltd. (HZL) 8.0746 20

Hindustan Cables Ltd. (HCL) 0.1669 3.64

Indian Petrochemical Corp. Ltd. (IPCL) 3.72 20

Indian Railway Construction, Co. Ltd. (IRCON) 3.72 20

Indian Telephone Industries Ltd. (ITI) 0.0013 0.27

Madras Refineries Ltd. (MRL) 1.7538 20

Mahanagar Telephone Nigam Ltd. (MTNL) 1.9316 20

Minerals & Metals Trading Corp. (MMTC) 12 20

National Aluminium co. Ltd. (NALCO) 0.0334 0.67

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National Fertilizers Ltd. 3.51 2.72

Neyveli Lignite Corp. Ltd. (NLC) 1.1163 2.28

Rashtriya Chemicals and Fertilizers Ltd. (RCFL) 7.1791 5

Shipping Corp. Of India Ltd. (SCI) 3.1136 5.64

State Trading Corp. Of India Ltd. (STC) 5.2246 20

Steel Authority of India Ltd. (SAIL) 0.2393 7.98

Videsh Sanchar Nigam Ltd. (VSNL) 19.9075 5

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 CHAPTER 3

CASE STUDIES

3.1 BALCO

3.2 VSNL

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3.1 Bharat Aluminium Company Limited

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Company profile

Bharat Aluminium Company Limited, set up in 1965 at Korba in Madhya Pradesh to manufacture
aluminium rods and semi-fabricated products, is today the third largest player in the Indian
aluminium industry.

BALCO has its corporate office in New Delhi. Its main plant and facilities are situated in
Korba(Chhattisgarh), which includes bauxite mines, an alumina refinery, a smelter and a
fabrication

unit, besides a 270 MW power plant which meets a substantial part of the unit's power
requirements. It also has another fabrication unit in Bidhanbagh (West Bengal). The refining
capacity of BALCO is 2, 00,000 tonnes per year and its smelting capacity is 1, 00,000 tonnes per
year.

THE DISINVESTMENT DECISION

The Government of India had 100% stake in BALCO Prior to disinvestment. In 1997, the
Disinvestment Commission classified BALCO as non-core for the purpose of disinvestment and
recommended immediate divestment of 40% of the Government stake to a strategic partner,
and reduction of the Government stake to 26% within 2 years through a domestic public offering
It further recommended divestment of the entire remaining stake at an appropriate time
thereafter. The Cabinet accepted the recommendation of the Disinvestment Commission for
divestment of 40% stake through a strategic sale and further divestment through the capital market.

Later, in 1998 the Disinvestment Commission revised its recommendation and advised the
Government to consider 51% divestment in favour of a strategic buyer along with transfer of
Management, which was accepted by the Cabinet. The Government thereupon appointed M/s
Jardine Fleming as Advisor to assist in the sale of its 51% stake in BALCO to a strategic buyer.

This was followed by BALCO's equity being reduced by 50% thereby reducing the subscribed
share capital to Rs.244 crore from Rs.488 crore. As a result, the Government received Rs. 244
crore from the capital restructuring of BALCO and another Rs. 31 crore as tax on this amount, prior
to disinvestment. The strategic sale process for BALCO started in late 1997, after the first decision

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of the Government, and finally came to end in 2nd March 2001. The 51% stake was sold to Sterlite
Industries, the highest bidder, and fetched the Government Rs. 551.50 crore. The government thus
recovered Rs 827.50 crore from this privatization.

PRE DISINVESTMENT PERFORMENCE

DETAILS 1997-98 1998-99 1999-2000

Sales 848.51 870.90 896.64

Other income 48.10 68.84 70.08

Total income(1+2) 896.61 939.80 966.72

Total expenditure 714.08 758.24 806.28

PBDIT(profit before interest 182.53 181.56 160.44

depreciation and taxes)

PBIT(profit before interest and 141.53 140.64 122.01

tax)

PBT(profit before tax) 134.87 134.34 116.19

PAT(profit after tax) 79.84 76.32 55.89

Dividend 20.00 23.00 18.00

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VALUATION OF 51% STAKE:

There were three bidders viz the US-based Alcoa and Indian market leader Hindalco and Sterlite.
Sterlite’s financial bid was the highest among the bidders, according to an official release by the
government. The company was valued by three different methods:

Discounted cash flow

Comparative valuation

Balance sheet and asset valuation

VALUATION METHOD VALUE (IN RS. CR.)

DISCOUNTED CASH FLOW 651.2 TO 994.7

COMPARABLES 587.0 TO 909.0

BALANCE SHEET 597.0 TO 681.9

ASSET VALUATION 1054.9 TO 1072.2

The valuation was applied by the official valuer J P Morgan. The reserve price of Rs 514.40 crore
was reached by marking up the valuation, arrived at by using the discounted cash flow (DCF)
technique, by 25 per cent, used as the control premium.

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POST SALE SCENARIO

Post sale, a number of doubts have been raised by various quarters on the disinvestment of

BALCO, especially with regard to

Transparency

Valuation

Protection of employees’ interests

No sooner was the BALCO deal announced than it created a furor within and outside Parliament.
The opposition raised eyebrows. There was distrust from state government and the workers of
BALCO went on a 67 days strike. It seemed as if the Sterlite management had to sweat a lot before
it actually got the right over the catch it craved for. This finally came to an end when the new
management stroke a deal with the employees. Several new steps were Undertaken, some of which
are:

The new management had introduced VRS i.e. Voluntary Retirement Scheme from 31.07.01 to
16.08.01.

 981 applications (151 executives and 830 workers) were received. 694 old VRS
applications were pending. A total of 956 applications were accepted mostly where units were
lying closed.

 In spite of losses of Rs. 200 crore due to the strike, an exgratia payment of Rs. 5000
was made to all employees.

 Workmen get a guaranteed benefit @ 20% of basic pay.

 An Increase in allowances was also announced:

 Night shift allowance: Rs.10 to Rs.20 per shift.

 Canteen allowance: Rs.400 p.m. (instead of subsidised canteen facilities)

 Education allowance: Rs. 50 to Rs. 75 per month

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 Hostel allowance: Rs.150 to Rs.200 per month

 Scholarship amount to meritorious children doubled.

 Leave Travel Assistance of around Rs. 6000 as cash every year.

 Conveyance allowance: Scooter users Rs. 400 to Rs. 500 pm, Moped users Rs.240 to Rs.
350 pm

 Several new practices introduced. Few were:

 Job rotation

 Appraisal system

The new management is proposing an investment of Rs. 6000 crore which will increase production
4 times.

THE REAL PICTURE:

The disinvestment of 51% stake in BALCO by the government of India towards a strategic partner
was backed by two justifications:

· From a market share of around 17 per cent in 1995-96 in the primary aluminum Business,
BALCO’s share had dropped to 14 per cent in 1998-99. Several reasons were mentioned that were
responsible for hindering its growth. They were:

○ Lack of economies of scale

○ Old age technology

○ Overstaffing

○ Operational bottlenecks

○ Lack of managerial autonomy

Thus, a complete review and restructuring was urgent to enable the company to stand a better
chance to stake its claim in the globally competitive Indian aluminium Industry.
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· Although there were three bidders, Sterlite’s financial bid was the highest among the bidders,
according to an official release by the government. Intact, government claimed that it was getting a
price greater than expected.

However, there are certain facts from the other angle that demand attention. The following tries to
uncover some of them:

Government had no modernisation and expansion under consideration for the aluminium giant:

To quote the Disinvestment Commission: "BALCO as a PSU has suffered from procedural
bottlenecks and lack of managerial autonomy. The CRM project at Korba Has been cleared after
eight years with near-doubling of the capital outlay.

The company was not able to get clearance from the government for setting up 100% captive
power generation. As a result, the company had to depend on high cost power from the State
Electricity Board which resulted in avoidable cost increases. The delays and the lack of autonomy
have certainly affected its operating profits which would have been much higher had it been able
to implement these projects earlier."

Thus even the Disinvestment Commission's recommendation that the government should resort to
a strategic sale of 40 per cent of BALCO equity can be seen as misplaced.

What was required instead was a reorganisation aimed at allowing BALCO the freedom to use its
own capacity to mobilise resources to modernise, expand its captive power facility and raise its

profitability. In practice, as a prelude to the privatisation process, in March 2000 the subscribed
share capital of BALCO was brought down to Rs.244 crore from Rs.488 crore, by appropriating
part of the Rs.437 crores into the government's account. This was a clear indication that
modernisation and expansion was not even under consideration.

BALCO, a profit making PSU, was valued at what is considered a throwaway

price:

Cash flows determined by undermining profitability:

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This also implies that BALCO's profitability has been undermined by the government's own role in
stalling modernization and expansion at Korba. Hence, the then profit performance of the unit
cannot be the basis on which the future profile of profits could be estimated. However, the
tendency for Arun Shourie, the

Minister for Disinvestment, to emphasize repeatedly that profits earned by BALCO had fallen
from Rs.163 crore in 1996-97 to Rs.25 crore in 2000-01 suggests that this stream of profits has
entered into assessments of the future profile of profits that have been discounted to value the
worth of the company.

This amounts to squeezing the profits of a public sector unit and then using that to undervalue the
firm, consciously or otherwise.

○ BALCO’s assets were undervalued:

It is still being argued that a direct valuation of BALCO’s assets was worth around 10 times the
value paid by Sterlite. In fact, officials from the power sector have Argued that the captive power
plant alone would cost more than the sum being paid by Sterlite. According to reports, a senior
official held that if Sterlite were to

invest in a captive power plant of the kind owned by BALCO, it could cost Rs.1, 215 crore and
this figure matters, for the value of the plant at Korba (set up in 1988-89) is still substantial, since a
thermal power plant has a lifespan of around 35 years.

BALCO was self-sufficient to fund its projects:

Since BALCO was a profitable and cash-rich public sector corporation with an extremely low debt
to equity ratio, it would have been possible for it to finance its proposed modernisation plan
(estimated to cost Rs.1, 000 crore) without recourse to budgetary funds. The project was to include
the setting up of a cold rolling mill, the expansion of captive power generation and modernisation

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of existing facilities. This would have allowed the corporation to improve its profitability and
increase the dividend it pays to the exchequer.

No transparency in the deal:

The valuation procedure that yielded the undeclared reserve price below which the government
was not willing to sell has neither been transparent nor undertaken by qualified valuers capable of
valuing the plant and machinery of the company and the

bauxite mines that it has on lease. The whole procedure had been gone through in haste. Even
though the bids had been invited some time back, the valuation of the firm, the setting of the
reserve price and the acceptance of Sterlite's bid were all allegedly done within the span of a
month. Leaked evidence of undue haste has accumulated and this further puts a question mark over
the government's claims of transparency in the execution of the deal.

CONCLUSION:-

A combination of inappropriate procedure, undue haste and unwarranted secrecy had created a
veritable mess. This was followed by a roar and strike amongst the company workers.

There was an opposition from the state government to the extent of throwing an offer to buy the
Centre’s 51 % stake at Rs 5.52 bn. The claims on the lack of transparency are being continued till
date. As stated by The Times of India, December 28, 2009, in response to an RTI query filed by
advocate Arjun Harkauli, the Central Information Commission (CIC) observed that the tender
documents and minutes pertaining to the Rs 551.5-crore divestment of Bharat Aluminium
Company (BALCO) in Chhattisgarh’s Korba district eight years ago could not be traced by the
ministries concerned.

BALCO marks the first ever disinvestment deal in the history of India and is stained with several
question marks and pointing fingers. The deal certainly did not occur the way it was meant to, did
not bring the profits to the extent possible, nor was it intended towards any social cause.
Corruption and lack of accountability still remain the two worms eating away the Indian economy.

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3.2 VIDESH SANCHAR NIGAM LTD

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ABOUT VSNL
In 1947, the Overseas Communication Service (OCS) was established in the Department of
Telecommunications (DoT). Videsh Sanchar Nigam Ltd (VSNL) was created from the OCS as a
government owned corporate in 1986. The government felt that corporatization would enable it to
raise financial resources, an activity that would not have been possible under the government
framework. It was envisaged that this would also enable greater freedom to managers to plan,
operate, develop and accelerate the international telecommunication services.

In the initial years, VSNL offered voice telephone, telex, telegraph, television, bureau fax etc.
Efforts had started to increase India’s connectivity through investments in projects like submarine
cables. Compared with 2.69 billion telephone minutes in 2000-1, in 1986-1987 the figure was 0.13
billion minutes. Table 1 gives some comparative figures of VSNL’s performance over the years.

YEAR VSNL WORLD

1994 0.742 54.6

1995 0.972 61.6
1996 1.147 71.7
1997 1.384 82.5
1998 1.684 93
1999 1.935 108.9
2000 2.245 132.7

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The ratio of inbound to outbound calls had been 4:1 in 2001. One important reason for this is the
discriminatory pricing by VSNL. Another factor is that India is a much poorer than the typical
countries to which it connects (U.S., Europe and Gulf), so that inbound calls are bound to be more
than outbound calls.

For the year 2000-1, the total revenue for VSNL was Rs 6,430.7 crore.The profit after tax stood at
Rs 1,778.8 crore. This resulted in earnings per share of Rs 62.41 out of which Rs 50.00 was
declared as the dividend per share. VSNL had no debt. Its P/E ratio of each VSNL share was
4.68.It is seen that a large part of the costs is the network and transmission charge.

Much of this was charges paid out to the DOT as traffic costs. In this fixed revenue agreement,
VSNL paid Rs 2,734 crore to DOT and Rs 1,386 crore to foreign operators during 2000-1 [VSNL
Annual Report, 2000-2011

DISINVESTMENT IN VIDESH SANCHAR NIGAM LIMITED

1. Government had approved sale of 25% equity share holding out of a total government share
holding of 52.97% in Videsh Sanchar Nigam Limited (VSNL) on 5.02.2002. The total paid-up
capital of VSNL is Rs.285 crore, the Govt. holding being Rs.151crore. Rs.71.25crore of this equity
is being sold to M/s Panatone (Tata Group) at a price of Rs. 1439 crore.

2. Government had decided to disinvest in VSNL in January 2001 and the advertisement for
inviting Expression of Interest was issued in February 2001. Several interested parties had
submitted their Expression of Interest. After the process of due diligence was completed and the
transaction documents frozen, financial bids were invited from the bidders on 1.2.2002. Two bids
were received.

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3. SBI Capital Markets Ltd. and CSFB were appointed as the advisors at a fee of 0.19% of the
transaction value. M/s Crawford Bayley & Co. is the legal advisor and the asset valuer is Price
Waterhouse Coopers Ltd. After considering the Advisor's report, the Evaluation
Committee/IMG/CGD submitted their recommendations regarding acceptance of the higher bid to
the CCD.

4.The Government has in the process of disinvestment in VSNL received approximately Rs.3689
crore, Rs. 1439 crore as the bid price, Rs. 1887 crore as dividend and Rs. 363 crore as dividend tax
(table attached). Thus, the Government has sold its shares at a price of Rs. 202 per share, taken
additional amount as dividend, special dividend and dividend tax. Besides the Government has
also taken measures to take out surplus, yet very valuable land (value Rs.778 crore) from VSNL,
and also restrict use/sale of land through provisions in transaction documents.

5. The market price of VSNL shares as on 1.2.2002 was Rs.158/-. The Government had earned
Rs.10.4 crore per year on 25% of its equity in the last eight years. This year the Government has
earned Rs. 3689 crore from sale of VSNL and if this money is kept in thebank it would earn an
interest of 368.9 crore, i.e. the Government would gain more than Rs. 350 crore every year.

6. The strategic partner has been provided a call option for the 5th year subject to the condition that
the Government would be retaining at least one share and hence one vote position to enforce its
affirmative vote on assets. In addition, 1.97% share were given to employees, at confessional rates.

After partial disinvestments through sale of shares, Videsh Sanchar Nigam Limited (VSNL)
underwent a strategic sale to the Tata Group in April 2002. Subsequent to the sale, the government
holding became 26% and the Tata Group's 45%. The sale was followed by VSNL's decision (taken
by its new owners the Tata’s) to invest Rs 1,200 crore in Tata Teleservices Limited (TTL), a
wholly owned subsidiary of the Tata group. This led to concerns regarding the appropriateness of
the decision, since it involved a cash outflow of Rs 1200 crore to a fledging private company in the
telecom sector.

REASONS FOR DISINVESTMENT

The Ministry of Disinvestment cited the non availability of funds for critical areas like education,
health and social infrastructure because of fiscal burden in the flow of government funds into

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PSUs, as a strong argument for the disinvestment. There was also a need to stem further outflow of
resources into unviable, non-strategic PSUs. The divestment was also expected to reduce the
unmanageable public debt.

PRIOR TO DIVESTMENT:
When the privatization process of VSNL began in 1991-1992, there was no blueprint for the same.
In retrospect, there have been three phases.

The offloading of shares to domestic investors;

The offloading of shares in the international market;

Strategic sale.

In 1991-2, VSNL disinvested equity of the face value of Rs. 12 crore in favour of various financial
institutions, mutual funds and banks. As of March 1993, out of a paid up equity capital of Rs 80
crore, the Government of India (GoI) held 85% and financial institutions, banks and the public
held another 15%. The shares were listed in the stock exchanges of Mumbai, Kolkata, Delhi and
Chennai. As of 1995, the share of the GOI had come down to 82.02%. This accompanied the
transfer of shares from the GOI as a bonus offer. The Indian investor’s share holding remained
around 16.5% in 1999-0 which came down to 9.97% (including the 1.96% held by employees) as
on March 31, 2001.

GDR ISSUES
The Global Depository Receipt (GDR) issue for VSNL was the first of its kind by the GOI. It
helped VSNL to raise a substantial surplus that was earmarked for investments for its growth. The
first GDR issue (listed on the London Stock Exchange) was offered in 1996-97. It fetched US$
526.6 million in the market. At that time, it was the largest GDR issue from India. The offer was
oversubscribed, drawing 662 investors from 28 countries. The second GDR issue was completed in
February 1999. It involved a divestment of 10 million shares by the government of India to
international investors. Priced at US$ 9.25 it was at a 15% premium on the last closing domestic
price of Rs. 682 and a 10% discount to the ten-day average GDR price of US$ 10.275. The
government realized US$ 185 million from the sale of 20 million GDRs with each GDR being

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equivalent to half a share. The organizational problems in VSNL around the time of the second
GDR issue could have been one of the factors that led to lower valuations. During the process of
the second GDR issue, the VSNL staff had threatened a walkout owing to the pending issue of
allotting shares to employees. Due to delays in the government processes, VSNL did not have a
chief executive and many other crucial director level posts were vacant. The first GDR’s

Investment promises were not fulfilled and a promised domestic offering had not been made.

THE VALUATION
The government had fixed a reserve price of Rs 1,218.375 crore for its 25% stake in VSNL. In an
effort to bolster the VSNL valuation, the GOI intended to compensate the loss of monopoly
through special concessions. The government owned MTNL and BSNL would have to use VSNL
as their ILD carrier for two years on the condition that it would offer the most competitive terms in
the market. VSNL would also get a free license to provide NLD,

and a nationwide ISP license. In addition, VSNL possessed prime real estate in Mumbai and Delhi
and also cable capacities to facilitate international traffic. One of the major assets was the cash
stockpile of Rs 5,182 crore which was considerable even after disbursement of the special
dividends. Among the concerns were the loss of monopoly and the uncertainty of the loyalty of
BSNL and MTNL to continue to use VSNL for their international traffic, the dipping share prices
of VSNL and the falling accounting rates that could lead to lower revenues. One of the major
issues involved during the valuation process included the management of real estate owned by
VSNL. The disinvestment process stipulated that at least four VSNL surplus properties valued at
Rs 778 crore would not be available and were to be disassociated from VSNL after the
disinvestment. Even so, real estate value that would accompany VSNL was around Rs 1,200 crore

CONCLUSION:
The privatisation of VSNL is seen as leading to public expenditure accountability through a
realisation of higher return on the government’s asset formation. It also leads to an appreciation of
the remaining shares that are held by the government. To the citizen, the process is a step towards
the provision of better quality communication services at the most competitive prices. Public
flotation of stock might have led to better values for VSNL's stock, had the company been
correctly `prepared' for privatisation. Thus, disinvestment of VSNL was clouded with
controversies and speculations and this fact further indicates the failure of the disinvestment policy

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adopted in the case of VSNL, and also highlights the wrong reasons for which the disinvestment of
VSNL took place and its ultimate failure to match the required expectation of such a step. This
case on VSNL further corroborates to the fact, that the disinvestment policies adopted in India
have been a failure so far.

CHAPTER:4

CRITICAL ANALYSIS

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REVIEW OF DISINVESTMENT AND PRIVATIZATION
Disinvestment was initiated by selling undisclosed bundles of equity shares of selected central
PSEs to public investment institutions (like the UTI), which were free to dispose of these shares in
the booming secondary stock market. The process however came to an abrupt halt when the
market collapsed in the aftermath of Harshad Mehta led scam, as the asking prices plummeted
below the reserve prices. Since the stock market remained subdued for much of the 1990s, the
disinvestment targets remained largely unmet. The change of government at the Centre in 1996 led
to some rethinking about the policy, but not a reversal.

A Disinvestment Commission was constituted to advise the government on whether to disinvest in

a particular enterprise, its modalities and the utilization of the proceeds. The commission, among
other things, recommended (Disinvestment Commission, 1997):

• Restructuring and reorganization of PSEs before disinvestment,

• Strengthening of the well-functioning enterprises, and

• To utilize the disinvestment proceeds to create a fund for restructuring of PSEs.

The new government that came to power in 1998 preferred to sell large chunks of equity in
selected enterprises to “strategic” partners – a euphemism for transfer of managerial control to
private enterprises. A separate ministry was created to speed up the process, as it was widely
believed that the operating ministries are often reluctant to part with PSEs for disinvestments as it
means loss of power for the concerned ministers and civil servants.

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The sales were organized through auctions or by inviting bids, by passing the stock market (which
continued to be sluggish), justified on the grounds of better price realization. Not withstanding the
serious discussion on the utilization of disinvestment proceeds, they continued to be used only to
bridge the fiscal deficit. Strategic sale in many countries have been controversial as it is said to
give rise to a lot of corruption, discrediting the policy process. Aware of such pitfalls, efforts were
made to be transparent in all the stages of the process: selection of consultants to advice on the
sale, invitation of bids, opening of tenders and so on. Between 1999 and 2003, much greater
quantum of public assets were sold in this manner, compared to the earlier process, though the
realized amounts were consistently less than the targets – except in 2003.

There are series of allegations of corruption and malpractice in many of these deals that have been
widely discussed in the press and the parliament. Instances of under pricing of assets, favouring
preferred buyers, non-compliance of agreement with respect to Employment and retrenchment, and
many incomplete contracts with respect to sale of land, and assets have been widely reported.

N. R. Institute of Business Management Page 35

N. R. Institute of Business Management Page 36
 CHAPTER5:

CONCULSION

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 CONCULSION

DISINVESTMENT IS NOT A GREAT PIECE OF REFORM

Disinvestment is considered desirable for two sets of reasons. One has to do with the money that
flows into the government’s coffers as a result of the stake sale, augmenting the government’s non-
borrowed receipts and, thereby, reducing the fiscal deficit. The other set of arguments of
disinvestment has to do with efficiency.

Disinvestment would bring in shareholders who would, it is hoped, question arbitrary decisions by
the government that harm the finances of these public enterprises. Both benefits are exaggerated.
Look at the reduction in the government’s fiscal deficit brought about by disinvestment. The effect
of selling shares to the public is not materially different from the effect of selling government
bonds, as far as the quantity of the public’s savings mopped up by the government is concerned. In
the year in which the disinvestment takes place, the private sector would feel squeezed for funds
exactly as it would if the government were to raise the same amount by issuing bonds.

The public ends up holding shares, in one case, and bonds, in the other. In either case, the public’s
savings stand transferred to the government, rather than to the private sector looking for funds to
invest. That said, the future effect of selling shares would prove superior, from a budgetary point
of view, to the future effect of issuing bonds. By issuing bonds, the government takes on the
obligation to pay interest, year after year. By selling shares, the government forgoes dividend

receipts on the shares sold. Both widen the fiscal deficit in the subsequent years. However, the
interest payment obligation taken on to get one rupee from selling bonds would be significantly
higher than the dividend forgone per rupee received from selling shares in public enterprises. This
is because these shares would be valued significantly higher, in terms of asset price per rupee of
income accruing from that asset, than the bonds sold to fill theFiscal gap.

What about the efficiency gains at the enterprise level by inducting non-government shareholders
into the ownership structure, and possibly onto the board of directors? There is likely to be some
additional benefits, given the political culture that treats public enterprises as sources of revenue
for the minister (and officials) in charge of the controlling ministry. However, the overall reform
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project entails improving corporate governance across the board to a level where the running of
any company seeks to maximise the returns to shareholders regardless of who the shareholders are,
whether the state or private shareholders. If this goal is realised, efficiency arguments for
disinvestment would lose steam.

More germane is to what end the government keeps some enterprises under its ownership and
control. If it wants to own nuclear power companies because of the risks involved, or if it wants to
own the Food Corporation of India to ensure food security, the companies in question sub serve
public goals outside the calculus of commercial profit and loss. It does not make sense to privatize
such public enterprises. Many other public enterprises were set up at a time when the private sector
was too weak to create production capacity in areas considered vital for the economy’s long-term
dynamism. Steel, or machine tools, for example.

Now, every Punj, Mittal and Jindal makes steel, of the highest quality and lots of it. Is there any
strategic goal being served by retaining steel production in the public sector, anymore than is
served by keeping hotels and banquet halls in the public sector? Satellite, aero plane and rocket
manufacture, in contrast, are still beyond the Indian private sector’s capacity. It might arguably
make sense for the government to own enterprises in these sectors. What are strategic sectors
would change, with time. The government should ideally exit from areas that are no longer
strategic, and use the re-sources to build new strategic capability.

However, we don’t live in an ideal world. Even if the government continues to own some
companies in non-strategic sectors, but these companies are professionally run as commercial
enterprises, there would be little efficiency loss to the economy as a whole. Therefore,
disinvestment is not any key reform.

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