Bailing out the govt

ONGC-HPCL deal has logic, but it can’t address fiscal woes

State-controlled oil exploration giant, Oil and Natural Gas Corporation (ONGC), has entered into a share-purchase agreement with the President of India for acquiring 51.11 per cent equity in another state-controlled oil refining and marketing company, Hindustan Petroleum Corporation Limited (HPCL). The transaction will be completed by the end of the month, converting HPCL into a wholly-owned subsidiary of ONGC. This deal is different from ONGC acquiring an 80 per cent stake in one of the gas blocks of the Gujarat government-controlled GSPC in the Krishna-Godavari basin in December 2016. That deal was widely seen as a bailout for the debt-laden GSPC at a cost of about ~80 billion, which ONGC had to incur.

There is no such bailout in the ONGC-HPCL deal. Established names in the mergers and acquisition space were involved as transaction and legal advisors to the deal and the price of about ~474 a share of HPCL reflected a 14 per cent premium to the stock’s last traded price (or 10 per cent of the stock’s 60-day weighted average price). Moreover, in this case, at least there is some merit because there are obvious benefits of synergy when a downstream refining and marketing company like HPCL is brought under the fold of an upstream oil explorer and producer like ONGC. As an integrated oil conglomerate, ONGC should be able to absorb the volatility of crude oil prices and gain from the diversification of its cash flows to midstream and downstream sectors.

Yet, questions are likely to be raised on two counts. The exemption granted to this deal from the open offer requirement will deny the non-promoter and retail investors an option to exercise their choice: Would they like to stay invested in HPCL or exit at the same price at which the sale of the 51.11 per cent equity took place? There will also be questions on whether the cultural synergies between the two companies were kept in mind before a final decision was taken. ONGC and HPCL are two companies that are run on vastly different management styles and the latter coming under the former will not be painless, particularly for the employees concerned.

An even bigger worry pertains to the credibility of the government’s fiscal consolidation exercise. The deal has provided a boost to the government’s disinvestment proceeds by over ~369 billion, helping the government exceed, for the first time in recent years, its total disinvestment receipts target of ~725 billion by a healthy margin. This, in turn, will help the government meet its fiscal deficit numbers. A shortfall in non-tax revenues and indirect tax receipts has raised concerns over the government’s ability to meet its fiscal deficit target of 3.2 per cent of the gross domestic product in the current year. The ONGC-HPCL deal could thus bail the government out from a difficult fiscal situation. While the transaction in itself has many benefits for the two companies and the oil sector, the government will do well to recognise that using such proceeds cannot be a sustainable strategy for staying on the path of fiscal consolidation.