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This article is more than 2 month old.

BOTTOMLINE: Public Sector and the risk of governance

Mini

The IRCTC action and retraction is an instance of disconnect between public governance and corporate governance

BOTTOMLINE: Public Sector and the risk of governance
Public interest and shareholder interest have different sets of considerations and the objectives and outcomes will also, hence, be conflicted. While one can only guess what the considerations might be for the government to have proposed appropriating half of IRCTC's convenience fee income (an accrual of Rs 300-400 crore at best), one suspects the Railways may have sought its pound of flesh for facilitating the convenience at its end. And while from a business-to-business standpoint that might have been a fair negotiation, from the perspective of public shareholders who have been investing in the company assuming 100 percent share of the fee, it seemed nothing less than a betrayal by the State.
And this triggered immense volatility in the stock, which is also an important development that can't be ignored.
The convenient sideshow
What stinks about the whole IRCTC escapade is the way the stock moved and burned the wealth of many innocent retail investors. The stock that hit a high of Rs 983 on October 28, plunged to a low of Rs 639.45 on October 29 after the receipt of the government order on fee sharing. It recovered to Rs 845.70 at the close. That's a 35 percent drop in value from the high to the low and a 32 percent recovery from there. That isn't normal volatility. Also, that's with over Rs 12,000 crore of turnover in the two sessions.
In any such sharp move, there will always be some who gained and some who lost. What gained from this is the big question. And that is a matter the market regulator, SEBI, must investigate, and not a matter to be brushed under the carpet. If there is even a hint of inside information, it needs to be severely dealt with.
The risk of public good
India has seen several sectors being opened up to private competition and public sector monopolies have suffered whenever this has happened. Doordarshan, BSNL and MTNL are prime examples of public enterprises that suffered the brunt of the private onslaught.
This also raises the question of why train bookings should remain the exclusive domain of a public enterprise. If you can book an Air India flight ticket on a MakeMyTrip, EaseMyTrip or ClearTrip, why not a train ticket? Any business model that is based on an exclusive right, vulnerable to be recalled, is hence flawed. Remember, MTNL used to find a place in many portfolios. Not today.
Public policies and the profit motives are likely to have divergent approaches, and hence the government's stated objective of not wanting to be in the business of running businesses is appropriate. As the conflict between public good and shareholder rewards often leads to value destruction, not creation.
A look at the numbers of 43 listed non-financial public sector enterprises reveals some interesting facts.
Public wealth erosion
The debt of the 43 public sector enterprises has grown at a compounded rate of 9.7 percent since the end of fiscal 2013, after which the present government took over, while their net worth has grown at a slower 5.8 percent. The Cash & Bank balances of these entities have also declined at a compounded 5.7 percent even as dividend payouts have ranged around 100 percent and gross block (fixed assets) have continued to grow at about 7 percent. All this even as sales have only inched up at a compounded 1.6 percent, though operating profits have grown at 5.8 percent. The net result: the combined market capitalization of these companies has compounded at just 0.02 percent, as on March 31, 2021. That's not something to boast about when talking about shareholder returns. In fact, if you adjust for inflation, the returns are deeply negative.
UNHEALTHY TREND
Key Financials8yr CAGR (till FY21)7yr CAGR (till FY20)
Gross Sales1.64%2.67%
PBIDT5.57%3.68%
Networth5.77%4.50%
Total Debt9.69%9.60%
Gross Block6.96%5.86%
Cash & Bank-5.66%-8.60%
Total Assets6.49%5.67%
Operating Cash Flow13.17%5.75%
Market Cap0.02%-3.82%
 
The government's policy of getting public sector enterprises to disgorge "surplus" cash via dividends and buybacks is likely to have kept the growth in net worth in check and depleted cash balances while pushing them to raise more debt to meet capex requirements.
The free cash flows have also been on a downward spiral, for the most part, barring a sharp FY21 recovery powered by the strong profitability of the oil marketing companies. And given the uninspiring sales trajectory, the market hasn't been kind to investors despite healthy dividends — directed more at adding to the exchequer.
What's also telling is the steady deterioration in the returns on capital employed and networth of these companies collectively. What used to be a healthy number, is now at risk of sliding below profitable levels.
RETURN ON CAPITAL SLIPS
Key RatiosFY21FY20FY13
ROCE (%)13.71520.3
RONW (%)12.710.715.5
 
Motives drive profits
At the heart of government decisions are several considerations other than profits. So, the public good may likely, more often than not, override the need to earn profits. There is thus a conflict between public governance and corporate governance. And what works for society may not always be the best thing for shareholders.
In this context, while the sale of "non-core" assets by public sector enterprises and the extraction of this value to fund social sector schemes would seem like a noble idea. Not always may this monetisation of "hidden" reserves of public sector enterprises be in the best interests of long-term shareholders looking to stay invested beyond the dividend largesse.
In light of this, the government's move to undertake strategic divestments is a good one, as it will allow the private sector with a clear business motive to run the enterprises keeping only commercial considerations in mind. And while there may be opportunities for gains from value creation in such strategic divestment entities, as a general principle, I’m more comfortable seeking to profit from gains in the shares of private companies that are only committed to growing the wealth of shareholders.
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