13 April 2012

ONGC ~ a comedy of errors

I have a piece in the current issue of Outlook Business on the ONGC share auction titled ONGC – a tragedy of errors  Here is the full piece:

Oil and Natural Gas Corporation’s (ONGC) auction of 5% shares a few days back through a special stock exchange based auction mechanism was doomed to fail. ONGC is public sector giant and the government which owns some 74% odd shares sought to sell 5% shares in the already listed company through a special auction window created by SEBI on the exchanges. The market price of the share over the past before the auction hovered around the 280 rupee mark. The government in its infinite wisdom decided to price it not at or below market rate but at a floor price or reserve price of Rs. 290, in other words above its market price over the past several weeks. This was inviting trouble.

Few would buy a packet of biscuit marked with a price of Rs. 10 at Rs. 10.25. Why then would someone pay more than the available market price for shares. This is especially so since the same product is available in the secondary market at a lower price at the very same time through the same exchange terminal. Imagine going to a super-store and seeing two adjoining shelves of Parle G biscuits with identical packets, one being sold for Rs. 10 and  another for Rs. 10.25. Now imagine how many packets of the higher priced biscuits you would have sold by the end of the day. The answer should be zero. But if you were to sell shares of ONGC shares on adjoining shelves, the answer would be that the biscuits would be  sold out. Not just that,  the store which was to close at 8 pm  would be kept open till 9 pm and the store owner would himself buy the biscuits. Now imagine, not just that the store owner bought the biscuits, but that he did not use his own money but used money of some random people (some of whom could be widows and orphans) to make these purchases.

That is pretty much what happened in the ONGC auction. Not only did the government sell shares in the name  of divestment at an above market rate, but they also caused some institutions controlled by them (we don’t know who all were the buyers except LIC) who had money belonging to innocent investors to purchase these obviously overpriced assets in the name of long term value. It is also reported that one of the investors bought the shares at an astounding Rs. 303, when the same investor could buy the same shares at the same time on the same exchange at an over 10% discount. So much for ‘long term value’. In addition, as SEBI had required a 100% upfront margin, the sudden last minute attempts to cause buyers to appear out of thin air meant that the bid could not be completed smoothly by the end of the auction and the auction market had to be kept open beyond the prescribed time. Of course, some argued that since this was the first auction of its kind the exchange auction system didn’t cope with the large order towards the end. This has been rebutted by both exchanges who hosted the auction by stating clearly that there was nothing wrong with the system and it worked perfectly. The joint statement of both exchanges said “The exchange systems operated normally and smoothly and there were no glitches.”

Besides being a bit dim to buy the same product at a higher price, as an institution you would also be in severe breach of fiduciary duty to your investors or principals. Every institution is obligated to buy products at the best possible price for its constituents. Paying more than market price for shares or a building would be a severe breach of this duty. So as a insurance company, mutual fund, bank or another public institution investing other people's money you could actually be sued for wasting the money of depositors, unit holders or policy holders. The individuals who invested at above market price could personally be held liable for such an obvious breach of duty.

I think the government had two issues at the back of their head when they chose a higher price, apparently shooting down the voice of bankers who had warned them of this near certain outcome. First, they expected the sale to have a control premium attached to the current market price. Second,  they did not want to be embroiled in another public allegation of selling the family silver at a discounted price what with so many other scandals coming to light. In fact since the auction we have already come across the Coalgate fiasco – a case of selling coal too cheap. They were in addition probably goaded by some self interested intermediaries involved in the process who told them that the shares could attract a premium. On the whole I am unable to find any third reason which could have caused the government to adopt this well meaning but illogical move.

Control premiums or a price above the market price is common when large chunks of shares are sold because they represent a premium of being able to control a company. Given that the government chose to auction only 5% of the equity capital, there clearly could not be a control premium attached. In any case, the government can never get a control premium at or above the 50% shareholding level as control cannot pass below that number almost by definition. Often it cannot pass even at 30% levels. Even if the number of shares sold was much higher, there would be little possibility of a control premium as no one entity could buy over a fourth of shares on offer (as per the regulations of SEBI only mutual funds and insurance companies, who never buy for control, can buy over a fourth of shares on offer - others are capped at 25% level). In this case, if the government really expected a control premium at 1.25% share capital levels, it needs to re-examine its understanding of business.

At the end of the day, the entire episode became a tragedy of errors - and all the errors were a by-product of the high price offered. Since the price wasn't attractive, the government made the right calls and made other public sector bodies to subscribe to shares in a last minute bid - which in the rush to punch in, was not entered properly, forcing the exchange to keep the auction window open beyond the 330 pm deadline to validate the erroneous trades. Even after several days the whole process is shrouded in secrecy and no one appears to know what happened - and we still don't know who subscribed to how many shares finally. There are reports however, that an unnamed entity, presumably of public sector blood rumoured to be SBI, had bid at over Rs. 330 for many of the shares. However, we do know that the average price was over Rs. 303 per share. The magician instead of taking out a rabbit from his hat took  out an elephant.

My own collation of stories from different papers shows three different events. All three cannot be correct. Though we might condone the problems in the auction if done in good faith - at the least the government should disclose what happened and who bought how many shares at what price. In the event, they used money of policy holders or mutual fund investors or banks depositors of public sector stalk, any overpayment could result in civil action against such an entity by its policy holders or unit holders or by the central bank. Even if they don’t sue, this is morally and legally not justifiable.

Postnote: On the date of writing this column, you can buy ONGC Ltd. from the market at Rs. 267.

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