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Privatization—the 3P challenges

We find the Street’s hopes about privatization of PSUs quite misplaced given the issues of (1) policy, (2) practice and (3) price. (1) The government’s stated policy on privatization of PSUs, (2) practical issues seen in previous attempts to privatize PSUs and (3) high prices of PSUs should provide plentiful caution against making privatization as an investment thesis for PSUs.

Sharp run-up in PSU stock prices; don’t bank on privatization

We are not sure if the privatization thesis for PSUs is an ex ante reason for or a post facto justification for the sharp run-up in stock prices of PSUs in the past few months (see Exhibit 1). We are surprised by the privatization argument for PSUs in light of (1) stated policy of the government for PSUs, (2) practical challenges seen in the attempts to privatize BPCL, CCRI and (3) high prices (inflated valuations) of the PSUs with many PSUs trading at a large premium to their private sector counterparts, presumably the bidders for the PSUs.

Policy—one or more PSUs in four broad strategic sectors

We rule out privatization of most of the larger PSUs (see Exhibit 2 for a list of PSUs and their respective sectors) given the stated policy of the government to retain control over one or more PSUs in a strategic sector. Under its New Public Sector Enterprise Policy of February 2021, the government has classified certain sectors as strategic for national security, energy security, critical infrastructure, etc. reasons. These four broad sectors include (1) atomic energy, space and defense, (2) banking, insurance and financial services, (3) power, petroleum, coal and other minerals and (4) transport and communication.

Practice—not easy

We note severe practical challenges that have stymied and may stymie the government’s privatization efforts. The case of CCRI is noteworthy, as the government had to rework several agreements between CCRI and Indian Railways (see Exhibit 3 for details) to enable the privatization of CCRI, which is yet to take place despite being cleared for privatization in November 2019. BPCL did not see much interest among potential bidders given the sunset nature of the oil refining and marketing sector. BPCL is a good example of the difference in approach to investment and ownership between strategic (long-term view of sector) and financial (relatively short-term view) investors.  

Price—PSUs are trading at a premium to their private sector peers

We note that valuations of most PSUs have expanded sharply over the past few months (see Exhibit 4, which compares current, six-month ago and 12-month ago 1-year forward P/E or P/B of select PSUs). The high valuations of the PSUs may reduce the interest of potential bidders even assuming that the government was keen to privatize some of the PSUs. In fact, some of the possible candidates for privatization in the non-strategic sectors (metals, transportation) now trade at a large premium to their private sector peers (see Exhibit 5).