The news that the government is planning to pursue merger of various oil PSUs to boost the economy, comes as a surprise. How the merger of PSUs would push the economy is a question that does not have any easy and clear answer, probably not even with our policy makers. Nonetheless, the push for mergers bring two important issues related to oil companies. We believe that such integration is a step in the right direction. Besides savings of operational expenditure, the bigger reason is that large integrated oil companies will have a balance sheet, which will help it to expand in the global markets in meaningful ways and hence diversification of risks would be possible for oil companies.
Till now, the attempt by Indian oil exploration companies to expand in the global markets has not been successful, mainly because the size of balance is extremely small as compared to other large international oil companies. The oil business is highly risk-prone and deep pockets are essential for being successful in the long term because exploration assets by their very nature are tricky when it comes to giving returns. This is also because the oil price cycle can be very long — an asset can give sub-par returns for a decade and then suddenly deliver rewards, which can account for all the underperformance. But only when a company has deep pockets, can it survive that phase of low prices and also expand its asset base. So, both in term of timing and intentions, it is perfectly in sync.
The crucial question is what happens to the rights of small investors when these mergers are taking place? When a merger is taking place between two private companies, there are many laws and a regulator that ensures that rights of non-promoter shareholders, small or big, are protected. But when it comes to PSU mergers, it is the primary responsibility of the government, the major shareholder, to ensure that rights of retail shareholders are protected. In the last couple of days, news reports have speculated on the way these oil PSU mergers are going to take place, particularly whether it would trigger open offer made to non-promoter shareholders or not. There is also speculation that it could be straight treasury buy out of government stake over a period of time. The end result is that the stock price of both companies, the buyer and the bought, witnessed sharp volatility.
As a first step, the government should state openly what it plans to do and put all speculation to rest because this volatility not just leads to insider trading, but also erodes the confidence of long-term investors, both institutional and retail, in PSU companies as a whole. Being fair to all shareholders is not just a moral and legal obligation, but it also makes economic sense for the government to be fair.
A comparison between valuation of differentials between PSU and private companies would reveal that government-owned companies get far less multiples. Some of this difference is because of the inherent operational strength, which private companies have, but it is partly triggered because of the uncertainty about what the government would do when it when it comes to mergers or expansion plans. If the government is able to create confidence in the minds of investors about the protection of their rights, then the PSU stock would get higher multiples, which means that increased government wealth will help it in subsequent divestments.