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Why selling 10% stake in Coal India at this point is not a good idea

It is neither good for the company nor country, and certainly not reformist, particularly given the market conditions and at a time when the company actually needs to invest in washeries.

The Narendra Modi government's stated intention to divest a 10% stake in Coal India Limited is aimed at establishing its reformist credentials after the humiliating defeat of the Bharatiya Janata Party in the Bihar assembly elections.

While the proceeds of the divestment will help contain the fiscal deficit, by moving money from one pocket of the government to another, the move will neither help the country nor the public sector company, which is the world's largest coal producing entity. Here's why.

Who gains?

The Union government currently owns a bit under 80% of Coal India. After the proposed third round of divestment of the company's shares over the last five years, the government's stake in the Kolkata-headquartered company will come down to 69.65%. The government hopes to earn more than US$ three billion or around Rs 21,000 crore from this round of sale of shares.

Will the sale be good for Coal India? Is the timing right? Is it good economics to persistently privatise or dilute government ownership of profit-making public sector companies to bridge the fiscal deficit?  The answer is a loud and clear "no" to all three questions. But the powers-that-be clearly think otherwise.

Besides the government, who gains? Merchant bankers and share brokers, of course. Finance Minister Arun Jaitley also hopes his image as an "economic reformer" will be enhanced. But will it?

Is this really divestment?

On 30 January, the country's biggest insurer, the Life Insurance Corporation picked up nearly half of the shares of Coal India on offer by investing roughly Rs 10,200 crore. In the process, LIC's holding in Coal India went up from 2.73% to 7.23%.

The pattern is predictable. In 2012, LIC bought 84% of the shares offered by the country's biggest producer of oil and gas, the Oil & Natural Gas Corporation. The following year, LIC purchased over 70% of the divested stake in the country's biggest steel maker, Steel Authority of India Limited.

Is this really divestment? Since LIC is government-owned like the other companies cited, what has been done so far is that money has been moved from one pocket of the government to another to dress up the books of account of the government of India. The world was then told how the deficit has been curtailed. Is this good for the economy? The jury is out on this one.

As of now, the government has raised Rs 12,600 crore through sale of stakes in four public sector undertakings against the budgetary target of Rs 69,500 crore (broken down into Rs 41,000 crore through sales of minority stakes in public sector undertakings and Rs 28,500 crore through "strategic" stake sales or outright privatisation). With the end of the financial year, March 31, not that far off,  Jaitley needs to garner more revenues to ensure that the arithmetic of his budget does not go awry. This much is clear.

Market size

Proponents of the kind of divestment the country has been following argue that capital markets get broadened, deepened and widened with new investors putting in their savings for productive purposes. True.

In 2010, when Coal India first offloaded its shares, the government raised around Rs 15,000 crore, roughly half of it in foreign currency. The second time round, earlier this year in January, the government earned more, Rs 22,558 crore, but as mentioned, largely thanks to the LIC. More resources could have been garnered if market conditions were favourable.

Coal India's current market capitalisation (that is, the market price of the share multiplied by the number of shares) is in excess of Rs 2,00,000 crore. Since the last divestment took place, the company's shares have shed around 6.5% of its value (which stood at around Rs 335 per share) implying that those who invested in January are net losers.

Bureaucrats handling divestment in the Ministry of Finance are optimistic that the time is right for the third round of sale of Coal India's shares. One official has been quoted as having said: "Our understanding is that the issue should do well and the markets have turned the corner ... we need to go ahead with the issue and actually come out with a sale by the beginning of the fourth quarter" (of the current financial year – in other words, January 2016).

Not all are equally sanguine. This is what Prithvi Haldea, founder and chairman of Prime Database, told the Indian Express:
"I am fundamentally against this method of sale. They can do a closed auction for interested institutional investors and sell the desired stake. When you opt for the OFS [offer for sale] route, your offer price is competing against your own market price and you are always hoping that the market remains strong so that the market price of the stock is trading above the offer price. If for some reason the market falls just ahead of the issue date then either you will have to call off the issue or it may not get subscribed and fail".

In other words, much depends on market conditions when the government decides to divest Coal India's shares, which could be anybody's guess. Una Galani, Reuters columnist, put it rather pithily when she quipped: "Coal India offers investors a cheap and dirty play on Indian reform".

No mean operation

India is, and is expected to remain, heavily dependent on the "black diamond" for the bulk of its energy requirements. Around 60% of the coal mined in India is used for the generation of electricity and this proportion is expected to remain more or less the same over the coming decade. Around 7% of the coal produced in the country is used for the manufacture of iron and steel and 4-5% in the cement industry.

Coal India is no mean operation by any stretch. It is not just the world’s largest coal producing company, it accounts for around 82% of India’s total coal output  – 494.24 million tonnes in 2014-15. Its gross revenues were Rs 95,435 crore last fiscal year and it employed over 333,000 people.

What is more, after years of incurring losses, Coal India and its eight subsidiaries are currently highly profitable at a time when most mining companies across the world, including coal companies, are deeply in the red on account of a sharp fall in commodity prices.

In 2014-15, Coal India's profit before tax stood at Rs 21,584 crore or more than a hefty 22% of gross sales. That year, the company paid Rs 9,572 crore as corporate tax and an additional Rs 21,482 crore as royalty, cess, sales tax and other levies.

The short point is that Coal India is correctly described as a "Maharatna" among public sector companies and is currently the country’s eighth most valuable company by market capitalisation. Should the government then be selling its shares − which is property that rightfully belongs to the people of India and not the government − in such a hurry without identifying value-enhancing initiatives

According to a former top official of Coal India, who spoke on condition of anonymity,  the runaway success of Coal India's initial public offering in 2010 was that it ended up receiving offers worth Rs 233,000 crore, implying an over-subscription of around 15 times the Rs 15,000 crore that it sought to raise. The official added that such confidence was generated by the company's commitment to setup at least 20 coal washeries to reduce the ash content of the coal it supplies.

Since the higher prices paid for imported coal are justified on the ground that the quality of Indian coal is poor because of high ash content, the setting up of washeries was widely perceived as a step in narrowing the quality gap and price differential between imported and domestic coal, the former official said.

Unanswered questions

Why would an ostensibly "reformist" government use half-truths and statistics to justify the sale of shares of a strategically significant company that has made good money and is still making money at a time when global commodity prices have fallen sharply? More importantly, what has really changed since October 2015, when the proposed third round of divestment of Coal India shares was deferred with global merchant bankers unsure about the coal company meeting its green commitments? 

Many concerns about investor appetite for energy stocks need to be taken on board. How would the disinvestment impact Coal India? The huge discount (50% or more) of its prices in comparison to import parity prices prevailing before the recent downturn enabled CIL to stay afloat, although the price discount has since shrunk substantially to near-zero levels.

The latest McKinsey insight into the mining industry (November 2015) talks of commodity prices remaining well below their 2011 peaks, with prices of metallurgical (or coking) coal (used for steel making) crashing by more than 70%.

Coal India has held its own, thanks to strong domestic demand that is expected to remain strong.  The company has publicly committed itself to doubling production over the next five years to a billion tonnes by 2020.

While inaugurating a new building housing the head office of Coal India near Kolkata in May, Union minister for coal and power, Piyush Goyal said: "One billion tonnes target would entail investment of anything between $20 (billion) to $25 billion. This would be invested over the next five years as we touch the production target. This would go in technologies, in equipment, in upgrading facilities and opening new mines"

This calls for investments that will surely not come from the proceeds of equity sales. It will have to be raised elsewhere. Divestment is likely to weaken Coal India's balance sheet, not strengthen it. It is common knowledge that repeated disinvestments do not allow stock prices to stabilise and realise their true market value. What is worrisome are discussions that discounts will be offered to retail investors on the offer price to prevent the kind of bailout by LIC that took place in January.

Time for investment

Coal India will have to undertake huge investments in washeries, because the Ministry of Environment, Forest and Climate Change, in its directive, will be restricting the transportation of coal with high ash content (above 34%) beyond 500 kilometres from next year onwards.

Investors, including foreign investors, would surely like to get hold of Coal India stock at cheap prices and these shares could yield handsome dividends in the long term. But this may not be in the best interests of the country.

Worse still, what will happen if the share offer does not get lapped up due to adverse market conditions? Will LIC bail Coal India out again? And will the government again claim the divestment was "successful"?

Coal India has fared remarkably well in financial terms in recent years, undoubtedly aided by a weak environment ministry that has been liberal with clearances for mining operations. Insiders claim the company has managed its relations with state governments and institutions such as the Indian Railways much better, more on account of personal rapport and closer coordination among top managers than institutionalised reforms.

Genuine reforms for Coal India would mean freeing its management from political and bureaucratic interference and granting it greater autonomy to improve the quality of coal, which would mean investment in washeries. The company also needs to do much more to invest in green initiatives on a massive scale as concerns on ecological sustainability and climate change become more important.That Coal India needs to become less corrupt and more efficient is a no-brainer. Indeed, in many coal-mining areas across the country where Coal India and its subsidiaries operate, mafia gangs call the shots with impunity. But is divestment the best way forward to improve the working of this company?

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