Disinvestment

Market Strategy

12 May 2009

Market Strategy

12 May 2009

Disinvestment
A step towards improved fiscal fitness
Populist fiscal sops announced with an eye to the elections coupled with fiscal stimulus injections have skewed the Indian governments books of accounts. Indias fiscal deficit is now estimated at 6% of GDP for FY09 against the initially projected 2.5% (5.5% for FY10). In our view, the divestment of government holdings in public sector enterprises is the best option to increase public revenues without fanning debt. Ballooning fiscal deficit: Although the revised government estimates for FY09 revenue receipts show a growth of 3.7% over FY08, this is significantly lower than the 11.3% previously anticipated. What is more worrying is the increase in debt required to finance fiscal deficit, which has been revised upwards by 145% for FY09. The government, in its interim budget, drastically increased its fiscal deficit estimate, announcing that the central government deficit for FY09 would come in at 6% of GDP instead of the initially projected 2.5%. The government is more upbeat about its FY10 budget which estimates a growth of 8.4% in revenue receipts over FY09RE and a decline in fiscal deficit to 5.5% of GDP. However, the continuation of populist fiscal sops amidst the recessionary climate is likely to suppress contributions to the government kitty and could lead to a downward revision of revenue receipt estimates during the course of the year. The case for disinvestment: Disinvestment was successful under the NDA regime, mobilising Rs 337bn over 19982004, until Left party opposition derailed the process. During 19982004, the government realised an average of Rs 56bn per year. This helped pare the fiscal deficit from 6.5% of GDP in 199899 to 4.5% in 200304. Going by our back-of-the-envelope calculations, if the new government manages to mobilise ~Rs 100bn through lined up public offers and strategic sales in FY10, it can lower fiscal deficit by ~25bps. PSEs identified for disinvestment in the past, but where plans were later shelved, would likely be the first to go under the hammer. Who stands to gain: Our analysis shows that stocks belonging to sectors such as Logistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fertilizers would stand to gain if the process of disinvestment takes place for PSEs identified as stake-sale candidates in the past.

Draft prospectus filed with SEBI for public offering

Company Rail India Technical & Economic Services (RITES) National Hydro Power Corp Bharat Oman Refineries UTI Asset Management Co Oil India Total Potential Expected amt to be raised (Rs bn) 3.5 55.0 24.0 23.0 14.7 120.2

Strategic sale cases called off earlier

Company Listed entities Balmer Lawrie and Company Engineers India Hindustan Petroleum Corporation National Aluminium Company National Fertilizers Rashtriya Chemicals and Fertilizers Shipping Corporation of India State Trading Corporation of India Unlisted entities Engineering Projects India Hindustan Paper Corporation Hindustan Petroleum Corporation Manganese Ore India National Building Construction Corporation Sponge Iron India 74 74 39.01 51 74 100 61.8 61 39.01 61.15 53 53 54.12 75 Percentage of proposed strategic sale (%)

Recommendation snapshot
Sectors likely to gain from stake sale Logistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fertilizers

Amitabh Chakraborty, CFA

(91-22) 6766 3404

Vinod Nair
(91-22) 6766 3443

Bandish Mehta
(91-22) 6766 3454

RHH: Winner of LIPPER-STARMINE broker award for Earnings Estimates in Midcap Research 2008 | Honourable Mention in Institutional Investor 2009 1

amitabh.chakraborty@religare.in nair.vinod@religare.in bandish.mehta@religare.in RHH Research is also available on Bloomberg FTIS <GO> and Thomson First Call

Disinvestment

Market Strategy

12 May 2009

Fig 1 - Public sector (center + state) deficit

(%) 11.5 11.5 12 10.7 10.6 11 10 9 8 7 6 2006-07 2007-08 2009-10E 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2008-09RE
Too high for comfort

Fig 2 - Central government deficit as a percentage of GDP

(%) 7 6 5 7.3 4 3 2 2006-07 2007-08 2008-09RE 2009-10E 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 6.2 5.9 4.5 4.0 4.1 6.0
Too high for comfort

9.8

10.0 9.2 8.0 7.9

5.7

5.5

3.4

3.0

Source: RBI, RHH

Source: RBI, RHH

Disinvestment an analysis
Divestment of government stake in public sector enterprises the only way to help plug the fiscal gap

With tax revenues sapped by fiscal sops and subsidies, the best option for the new government to improve it revenue inflow without raising debt would be to divest its stakes in Public Sector Enterprises (PSE). Past experiments with PSE divestment have proved successful. However, the process came to a virtual standstill during the last 34 years due to the opposition of the Left parties, which were a key coalition partner for a large portion of the UPA governments rule. Various modes of disinvestment Disinvestment transactions in India can be classified into four main categories: Transactions involving the sale of the governments minority shareholding (either through an offer for sale to the public or an auction to selected investors), subject to the residual equity of the government remaining at least 51%. Sale of all or a part of the governments residual shareholding in disinvested PSEs/companies either through a public offering or private placement. Sale of a large block of shares in a PSE (including subsidiary of a PSE) along with transfer of management control to a strategic partner. This is termed as a strategic sale. After the strategic sale, the PSE ceases to be a government company. Sale of a block of shares in one PSE to another PSE. Successful past deals The government successfully mobilised Rs 466bn through the disinvestment process from 199495 to 200708. During the NDA governments rule from 199899 to 2003 04, the government raised Rs 337bn through the process of disinvestment with Rs 155bn coming in during 200304 alone. Fig 3 - Amount realized from disinvestment

Past experiments with divestment have proved successful

(Rs Bn) 160 140 120 100 80 60 48 40 20 0 1994-95

155

54 2 1995-96 4 1996-97 9 1997-98 1998-99 19 19 2000-01

57 33 28 16 2005-06 2006-07 24

2001-02

2002-03

2003-04

2004-05

Source: Department of Disinvestment

1999-00

2007-08

Disinvestment

Market Strategy

12 May 2009

Fig 4 - Key disinvestment deals

Company Maruti Udyog Jessop & Co Hindustan Zinc ICI IBP Indian Petrochemicals Corporation Dredging Corporation of India GAIL ONGC
Source: Department of Disinvestment

% of Govt. equity disinvested 27.5% 72% 18.92% 9.20% 26% 28.95% 20% 10% 9.96%

Mode IPO Strategic sale Exercise of call option See note* Residual shares through offer for sale Residual shares through offer for sale Offer for sale Offer for sale Offer for sale

Deal value (Rs mn) 9,930 182 3,240 771 3,507 12,029 2,212 16,274 105,340

Date of completion of transaction July-03 Aug-03 Nov-03 Oct-03 Mar-04 Mar-04 Mar-04 Mar-04 Mar-04

* 9.2% of the equity (consisting of 3760783 shares of Rs 10 each) held by government in ICI sold by the Department of Fertilizers to Asian Paints (India) at the rate of Rs 205 per share.

Several potential targets for disinvestment We believe there is a large window of opportunity for the next government to bolster its finances via the divestment process. With improving market conditions, the stake disinvestment would attract a wider audience and higher valuations. There are a plethora of PSEs in which the government can sell off its stake:
PSEs that have filed for a public issue with SEBI offer scope for a stake sale

Firstly, there are those PSEs which have filed for a public issue with SEBI, but are yet to see the light of day on the primary markets. These include Rites, National Hydro Power Corp, Bharat Oman Refineries, UTI Asset Management Company and Oil India. (Ref Fig 5) Secondly, there are about 25 PSEs recommended by the Disinvestment Committee which can be potential targets of divestment. Thirdly, there are those PSEs which were slotted for disinvestment but for which the process was later called off for various reasons.

Fig 5 - Draft prospectus filed with SEBI for public offering

Company Sales PAT Expected amt to be raised (Rs bn) Three distinct fields of business: (1) consultancy in transport infrastructure; (2) leasing, export, maintenance & rehabilitation of rolling stock, and export & rehabilitation of railway equipment; and (3) running of railway systems under concession agreements Planning, development and implementation of hydroelectric power stations Grassroots petroleum refinery in Bina, Madhya Pradesh Provides asset management services Primarily engaged in the exploration, development, production and transportation of crude oil and natural gas in India Stake to be divested (%) Current holding by govt or govt led company Brief description

FY08 (Rs bn)

Rail India Technical & Economic Services (RITES)

6.6

1.0

3.5

28

100

National Hydor Power Corp Bharat Oman Refineries* UTI Asset Management Company Oil India
Source: RHH

36.8 4.0 60.8

12.3 1.4 17.9

55.0 24.0 23.0 14.7

15 48 54.2 10

100 50 99.9 98.13

*Yet to commence operations

Disinvestment

Market Strategy

12 May 2009

Fig 6 - PSEs recommended by the Disinvestment Committee

Company Projects & Equipment Corp. Central Inland Water Transport Corp. Cochin Shipyard Hindustan Shipyard National Projects Construction Corp. Semiconductor Complex Telecommunications Consultants India Cotton Corp. of India Indian Medicines Pharmaceuticals Jute Corp. of India National Buildings Construction Corp. Hooghly Dock & Port Engineers Rajasthan Drugs & pharmaceuticals Karnataka Antibiotics & Pharmaceutics Brahmaputra Valley Fertilizers Corp. Hospital Services Consultancy Corp. National Seeds Corp. National Film Development Corp. North Eastern Electric Power Corp. Electronics Corp. of India Ennore Port Ltd North Eastern Handicrafts and Handlooms Development Corp. Central Warehousing Corp. Numaligarh Refinery
Source: Department of Disinvestment *FY 07 numbers

Sector Construction Shipping Shipping Shipping Construction Capital Goods Telecom Textiles Pharma Textiles Construction Shipping Pharma Pharma Fertilizers Healthcare Agri product Media Power Capital Goods Shipping Textiles Logistics Oil & Gas

FY08 Sales 57,263 NA 8,572 5,101 5,869 NA 8,465 16,386 NA NA 20,249 NA NA 1,880 NA NA NA NA NA 9,817 1,437 NA 7,762 71,765* PAT 414 NA 939 113 23 NA 1,001 214 NA NA 2,798 NA NA 52 NA NA NA NA NA 1,341 349 NA 1,369 5,688*

Fig 7 - Strategic sale cases called off

S. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 Name of the CPSU Balmer Lawrie and Company Engineering Projects India Engineers India Hindustan Paper Corporation Hindustan Petroleum Corporation Manganese Ore India National Aluminium Company National Building Construction Corporation National Fertilizers Rashtriya Chemicals and Fertilizers Shipping Corporation of India Sponge Iron India State Trading Corporation of India Percentage of proposed Strategic Sale 61.8% 74% 61% 74% 39.01% 51% 61.15% 74% 53% 53% 54.12% 100% 75% 65% through Strategic Sale and 10% to Employees 51% through Strategic Sale and 2% to Employees 51% through Strategic Sale and 2% to Employees 51% through Strategic Sale and 3.12% to Employees 10% Domestic Issue, 20% ADR Issue, 29.15% Strategic Sale, 2% to Employees 34.01% through Strategic Sale and 5% to Employees 51% through Strategic Sale and 10% to Employees Comment Current Govt (Centre + State) holding (%) 61.8* 100.0 90.4 100.0 51.1 100.0 87.2 100.0 97.6 92.5 80.1 100.0 91.0

Source: Department of Disinvestment

* Government holds 59.6% stake in Balmer Lawrie Investments, which in turn holds 61.8% in Balmer Lawrrie and Co.

Disinvestment

Market Strategy

12 May 2009

Divestment most likely in companies already considered for strategic sale

Past strategic sale candidates to be the first in line In our opinion, if the next government takes the disinvestment route to improve its finances, the companies which were identified for strategic sale are likely to be the first to go under the hammer (see fig 7). Based on our analysis, if the disinvestment in those companies happens, stocks belonging to sectors such as Logistics, Shipping, Engineering & Construction, Oil & Gas, Metals and Fertilizers stand to gain. The following tables show the relative valuations of companies identified for strategic sale (highlighted), with their peers in the respective sector. We find that the strategic sale candidates are currently trading almost at par or at a discount to other peers within the sector. We believe that any stake divestment by the government in these PSEs would drive valuations of these companies and thereby push up the valuation of their respective sectors.

Fig 8 - Valuation (Logistics)

Company Balmer Lawrie & Co Ltd Container Corp Of India Gateway Distriparks Ltd Average
Source: Bloomberg

M Cap (Rs bn) 4.7 104.7 7.5 P/E 4.6 14.3 11.1 10.0 Fwd P/E 4.1 12.2 8.5 8.3

Valuation TTM (x) P/B 1.1 3.3 1.3 1.9 P/S 0.3 3.1 3 2.1 EV/EBITDA 3.2 10.3 7.2 6.9

Fig 9 - Valuation (Engineering & Construction)

Company Engineers India Cummins India Punj Lloyd IRB Infrastructure Thermax Ltd IVRCL Infrastructure Average
Source: Bloomberg

M Cap (Rs bn) 33 44 38.4 34.1 29.4 22.9 P/E 17.2 13.2 9.9 24.8 9.7 8 13.8 Fwd P/E 12.1 13.5 9.4 8.9 10.3 9.6 10.7

Valuation TTM (x) P/B 2.9 3.5 1.4 2.1 3.7 0.9 2.4 P/S 4.5 1.6 0.5 3.9 0.8 0.6 2.0 EV/EBITDA 11.7 10.1 6.3 12.0 6.9 7.2 9.0

Fig 10 - Valuation (Oil & Gas)

Company HPCL BPCL Mangalore Refinery Petronet LNG Ltd Chennai Petroleum Reliance Industrial Infra Hindustan Oil Exploration Average
Source: Bloomberg

M Cap (Rs bn) 83.3 129.5 92.6 39.7 18.3 11.1 11.9 P/E 6.4 7.4 7.2 7.7 1.6 50.9 35.2 16.6 Fwd P/E 6.9 7.8 14.8 7.6 11.2 9.7

Valuation TTM (x) P/B 0.8 1 2.4 2.5 0.5 7.6 1.2 2.3 P/S 0.1 0.1 0.3 0.5 0.1 16.1 9.4 3.8 EV/EBITDA 7.7 5.1 5.0 6.2 2.0 18.6 7.4

Disinvestment

Market Strategy

12 May 2009

Fig 11 - Valuation (Metal & Mining)

Company National Aluminium Tata Steel Hindustan Copper Hindalco Inds JSW Steel Ltd Average
Source: Bloomberg

M Cap (Rs bn) 157.6 206.3 181.9 116.1 76.6 P/E 9.4 1.6 56.9 3.6 4.3 15.1 Fwd P/E 5.9 19 6.7 10.5

Valuation TTM (x) P/B 1.7 0.7 14.3 0.5 1 3.6 P/S 3.1 0.1 8.8 0.1 0.6 2.5 EV/EBITDA 3.0 38.2 5.1 6.1 13.1

Fig 12 - Valuation (Fertilizers)

Company National Fertilizers RCF Chambal Fertilizers Coromandel Fertilizers Khaitan Chemicals & Fertilizers Mangalore Chemicals & Fertilizers Nagarjuna Fertilizers & Chemicals Shiva Fertilizers Deepak Fertilizers & Petrochem Corp Average
Source: Bloomberg

M Cap (Rs bn) 21 26 20 19.4 0.3 1.9 10.7 0.2 6.4 P/E 19.6 16.5 8.5 3.4 3 5.4 33.1 20.8 4.1 12.7 Fwd P/E 20.7 8.1 5.2 23.4 4.7 12.4

Valuation TTM (x) P/B 1.5 1.7 1.7 2.4 0.4 0.5 0.7 0.8 0.9 1.2 P/S 1.3 1 0.6 0.2 0.1 0.1 0.5 0.2 0.6 0.5 EV/EBITDA 9.2 12 7.2 4.3 4.1 6.3 10 4 7.1

Fig 13 - Valuation (Shipping)

Company Shipping Corp Essar Shipping Ports & Logistics Great Eastern Shipping Company Shreyas Shipping & Logistics Varun Shipping Company Aban Offshore Garware Offshore Services Great Offshore Average
Source: Bloomberg

M Cap (Rs bn) 40 31.3 36.3 0.6 7.6 17.2 2.5 10.6 P/E 4.8 6.9 2.5 9.8 3.2 2.9 6.0 5.9 5.3 Fwd P/E 3.8 6.7 1.7 3.2 4.6 4.0

Valuation TTM (x) P/B 0.7 0.6 0.9 0.4 0.8 3.2 1.1 1.6 1.1 P/S 1.1 1 1.1 0.2 0.8 0.5 1.4 1.6 1.0 EV/EBITDA 15.2 2.9 9.4 5.8 11.2 2.6 6.4 7.6

Disinvestment

Market Strategy

12 May 2009

Apart from the above options, we have analysed listed PSEs that offer scope for disinvestment, such that the governments stake remains at least 51% post-dilution. Fig 14 - Listed government companies offering scope for disinvestment
Company HMT Scooters India Allahabad Bank Bank of India Bank of Maha Canara Bank Central Bank Corporation Bank Indian Bank Indian Overseas Punjab Natl Bank St Bk of India Syndicate Bank UCO Bank Union Bank (I) BHEL Engineers India Hind.Organ.Chem. Bharat Electron ONGC Andrew Yule & Co FACT Madras Fert. Natl. Fertilizer RCF Balmer Law. Inv. Guj. State Fin. Haryana Fin. Co. Power Fin Corpn Rural Elec Corpn GAIL (India) ITDC Container Corpn GMDC NMDC Ltd Dredging Corpn Hind Photo Films Hind Copper Natl Aluminium Mysore Paper Bharat Immunolog Neyveli Lignite NTPC Power Grid Corpn Ircon Intl. IOCL SCI SAIL MTN L ITI Punjab Commun. MMTC
Source: RHH, Capitaline

Sector Automobile Automobile Banks Banks Banks Banks Banks Banks Banks Banks Banks Banks Banks Banks Banks Capital Goods Capital Goods Chemicals Consumer Durables Oil & Gas Diversified Fertilizers Fertilizers Fertilizers Fertilizers Finance Finance Finance Finance Finance Gas Distribution Hotels & Restaurants Logistics Metals & Mining Metals & Mining Miscellaneous Miscellaneous Metals & Mining Metals & Mining Paper Pharmaceuticals Power Power Power Realty Refineries Shipping Steel Telecomm Telecomm Telecomm Trading

Govt. (Central / State) holding (%) 98.9 95.4 55.2 64.5 76.8 73.2 80.2 57.2 80.0 61.2 57.8 59.4 66.5 63.6 55.4 67.7 90.4 58.6 75.9 74.1 94.4 98.1 59.5 97.6 92.5 59.7 55.1 97.0 89.8 81.8 57.3 90.0 63.1 74.0 98.4 78.6 90.6 99.6 87.2 64.7 59.3 93.6 89.5 86.4 99.7 80.4 80.1 85.8 56.3 93.0 71.2 99.3

Disinvestment possible (%) 47.9 44.4 4.2 13.5 25.8 22.2 29.2 6.2 29.0 10.2 6.8 8.4 15.5 12.6 4.4 16.7 39.4 7.6 24.9 23.1 43.4 47.1 8.5 46.6 41.5 8.7 4.1 46.0 38.8 30.8 6.3 39.0 12.1 23.0 47.4 27.6 39.6 48.6 36.2 13.7 8.3 42.6 38.5 35.4 48.7 29.4 29.1 34.8 5.3 42.0 20.2 48.3

Valuation TTM (x) P/E 3.6 6.7 6.9 6.1 7.7 5.7 7.5 6.3 8.1 15.4 4.8 7.4 5.3 36.8 20.3 19.0 10.6 13.5 156.1 89.4 19.0 19.3 14.6 16.4 11.2 14.6 15.5 18.0 43.5 12.3 73.5 18.6 17.2 19.3 23.5 30.2 7.7 7.2 10.5 11.2 0.0 565.1 P/B 14.2 6.9 0.8 1.5 1.2 1.1 1.1 1.0 1.5 1.6 1.5 2.1 1.0 1.2 1.3 9.3 3.3 2.6 3.0 1.4 1.9 4.6 1.8 1.7 2.8 3.5 4.4 16.5 1.5 20.2 3.3 1.2 3.5 2.2 3.0 3.0 1.3 1.0 3.3 0.5 0.4 105.8 P/CEPS 3.4 6.5 5.6 5.5 6.7 5.3 6.7 5.9 7.4 13.9 4.2 6.3 4.9 33.2 19.2 6.5 9.5 12.4 94.3 17.9 10.2 12.4 14.6 (0.6) 16.3 11.1 11.9 13.5 13.1 42.7 9.6 69.1 15.8 5.9 13.4 17.9 17.7 5.5 5.2 9.0 4.9 530.3 EV/EBITDA 256.6 12.3 14.0 13.8 11.6 15.1 12.6 13.9 12.5 13.9 14.5 12.9 14.0 12.7 19.4 8.1 6.4 4.7 7.5 31.7 10.9 8.7 10.4 12.3 187.0 11.8 12.5 7.3 9.2 9.0 25.9 8.0 103.5 9.1 7.8 9.6 12.2 15.3 6.1 3.9 5.1 1.8 224.4

Disinvestment

Market Strategy

12 May 2009

Coverage Profile By recommendation

(%) 50 40 30 20 1 0 0 Buy Hold Sell 35
(%) 50 40

By market cap

41 24

42 36 22

30 20 1 0 0 > $1 bn $200mn - $1 bn

< $200mn

Recommendation interpretation Recommendation Buy Hold Sell Expected absolute returns (%) over 12 months More than 15% Between 15% and 5% Less than 5%
Recommendation structure changed with effect from March 1, 2009

Expected absolute returns are based on share price at market close unless otherwise stated. Stock recommendations are based on absolute upside (downside) and have a 12-month horizon. Our target price represents the fair value of the stock based upon the analysts discretion. We note that future price fluctuations could lead to a temporary mismatch between upside/downside for a stock and our recommendation.

Religare Capital Markets Ltd 4 Floor, GYS Infinity, Paranjpe B Scheme, Subhash Road, Vile Parle (E), Mumbai 400 057.
th

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