To Get Value From Oil PSUs, Government Should Untangle The Cross Holding Maze

A recent news item in The Economic Times on 4 February caught this author’s attention. The Government of India is pushing the large public sector oil and gas companies to give additional dividend before 31 March 2020 so that the government can show a lower deficit.

The oil companies are apparently reluctant to do this as they feel it would reduce the funds for capital expenditure.

The objections seem justified as capex is desperately needed for exploration as well as upgrading the refineries and investing in pipelines and distribution network.

Is there a way out that can address these contradictory requirements of dividend pay-out as demanded by the controlling shareholder (Government of India) and the need for capital expenditure without getting the oil companies to borrow more?

Surprisingly, there is a way out – at least for the oil PSUs. There is a maze of cross holdings of listed PSUs in the oil and gas sector.

Untangling these cross holdings will satisfy the needs of both government and the companies. It will also improve the stock performance by improving the return ratios in these companies thereby benefiting minority shareholders

Background of cross holdings in public sector Oil and Gas companies

In the late 1990s, the then NDA government faced a lot of opposition in divesting even a part of the government holdings in the oil sector PSUs.

Further, the stock markets were in a bearish phase and it was felt that government will not be able to realise value out of the disinvestment.

Then the government came up with the idea of selling some stakes of oil and gas PSUs to other oil and gas PSUs.

So, Oil and Natural Gas Corporation (ONGC) holds stake in Indian Oil (IOC) and Gas Authority of India Ltd (GAIL). Indian Oil in turn holds stakes in ONGC, GAIL and Oil India Ltd (OIL).

Similarly, GAIL holds a stake in ONGC and OIL holds a stake in IOC. All these companies are listed

Selling off cross holdings will fetch the government Rs 22,000 crores

Selling off Indian Oil’s stake in the other listed companies and paying a special dividend out of the proceeds will fetch approximately Rs 6,200 crores for the government.

Similarly, selling off the stakes held by ONGC in other companies will fetch Rs 10,700 crores to the government if all the proceeds are distributed as dividends.

Oil India Limited holds 485,590,496 shares in Indian Oil valued at Rs 5681 crores. The government, which holds 59.57 per cent in OIL will get Rs 3,385 crore if these shares are sold and proceeds distributed to shareholders

Similarly, GAIL, which holds 308,401,602 shares in ONGC, will be able to realise Rs 3,308 crores out of which the government will get Rs 1,725 crore based on its 52.19 per cent holding in GAIL.

In all, the government can expect to get Rs 22,000 crore when the exercise is concluded (assuming current stock price).

Untangling the cross holdings maze will benefit the government, oil companies and the minority shareholders.

The government benefits by the dividend receipts of Rs 22,000 crore mentioned above. If the step is announced and the transactions executed transparently, the markets could re-rate the stocks, driving up the realisation out of this activity itself.

The re-rating will be because the market is not valuing the cross holdings and the cross holdings are supressing the return ratios (Return on Net Worth and Return on Capital employed) of the oil and companies.

The companies will benefit by leaving them with cash/borrowing room to pursue their expansion plans. The improved return ratios will push up the stock price and the valuation.

The minority shareholders too will gain because of the onetime dividend and improved returns.

Lastly, this step is an important precursor if the government plans other restructurings/privatizations in the oil and gas sector. For example - GAIL is likely to be restructured by splitting its pipeline business from its gas marketing business.

It would be prudent to get rid of cross holdings before undertaking such a step.

(Note: This does not address the other shareholdings of some of these companies. For example, ONGC has controlling stake in Hindustan Petroleum and Mangalore Refineries. Oil India has a stake in Numaligarh Refinery. GAIL has a significant stake in Indraprastha Gas, Mahanagar Gas and Petronet LNG. These are of strategic nature – ONGC and OIL wanting to expand into refining and distribution and GAIL wanting a take in City Gas Distribution and sourcing of gas.)