Emasculating a giant

BS Compass

The Supreme Court's body blow to the government's plans to sell off HPCL and BPCL has resulted in IOC becoming the new sell-off candidate.

The move appears to be a knee-jerk reaction to the Court's decision, rather than a well thought out plan.

IOC is the only Indian Fortune 500 company that has built up its revenues over the years. Hence, selling it off piecemeal will only make sense if each individual part sold fetches a value more than the entire company as a whole.

For IOC, however, that is certainly not the case, since it is the retailing network that is its most precious asset.

In FY03, marketing of petroleum products contributed around 50 per cent to operating profits. Further, it will not be a simple stake sale by IOC.

Instead, the option being mooted is splitting up of IOC's business and then selling off around 50-60 per cent of the company's retail business.

Marketing margins, according to analysts, are currently around $5 a barrel on an average, considerably above refining margins (around $3-3.5 per barrel).

Nor has the government taken into consideration the practical considerations of divesting its stake in IOC.

Consider, for instance, the time taken to divest the government's stake in HPCL, and it's clear that the process for IOC will take even longer since IOC is bigger than HPCL and also more important.

IOC controls over half the industry's marketing units and accounts for 35 per cent of total refining capacity.

It also has the marketing units of IBP under its fold, which add to the attractiveness of the company since it gives the company a monopolistic position in the industry.

Selling off a part of its marketing network will therefore irreparably damage the company.

Thirdly, while the government may argue that it is only swapping the units being divested, but IOC has a definite strategic edge over either HPCL or BPCL since it supplies to the defence sector in the north, where neither of the other two companies have a refining presence.

Also, IOC is relatively insulated from price fluctuations since only around 30-35 per cent of its revenues accrue from the retail segment and the rest form institutional sales like the defence sector, public transport undertakings etc.

Fourthly, IOC's refineries in the north-east such as Bongaigaon are unattractive for buyers given the low economies. Hence, the sale of such refineries will lower the valuation of IOC.

In sum, the IOC selloff plan neither meets the criterion of enhancing the efficiency of the company, nor will it result in revenue maximisation for the government.

All that will happen is that after the sale of its marketing assets, the government will be left with a rump company with a much diminished valuation.

What could be the valuations that IOC commands? A broad parameter for valuing a refining company is Rs 1,000 crore per million tonne for a new company.

For a company like IOC, fair estimate by analysts points to around Rs 600-700 crore per million tonne. With 8,000 retail outlets that would result in an enterprise value of around Rs 35,000 crore. Adjusting for debt, the equity value of IOC would be around Rs 20,000 crore.

That results in a very low value for the company of around Rs 175 per share. But this does not include its pipelines and other infrastructure.

Some analysts however, estimate valuations at around 9-10 times its earnings as a benchmark, which results in an upper limit of Rs around Rs 520-550 per share.

And lastly, given the kind of premiums that have been paid for divested companies, the final valuation of IOC can be significantly different from any estimates.

In any case, it's not clear whether the IOC divestment too will not be challenged. Some constitutional experts have opined that if the government's intention is to set up an "instrument of service" that will require the approval of Parliament for a sell-off, even if the company is not explicitly created through an act of Parliament.

The markets are certainly not convinced that the government's IOC sell-off plan will be more than Arun Shourie's pipe dream. Despite all the negative publicity, IOC's stock price appreciated around 4.5 per cent yesterday.

With contributions by Sameer Ranade