Saturday, July 08, 2006

The Case of Neyveli Lignite

The following is the account of a fictional meeting which took place between Dr. Manmohan Singh, India’s Prime Minister (PM) and M. Karunanidhi, Tamil Nadu’s Chief Minister (CM). Tamil Nadu is a state governed by DMK, a political party with socialist leanings and a partner in the coalition of parties supporting the central government led by the PM.

The meeting’s agenda was to discuss the central government’s plans to sell 10% of the shares of Neyveli Lignite, India’s largest lignite-based power generation company based in Tamil Nadu. The government owns 93.56% of the shares of Neyveli and the balance shares are actively traded in India’s stock markets.

The Prime Minister had invited the CM to consult him on various issues related to the plan. A consultation paper had been forwarded to the CM prior to the meeting. The CM was totally opposed to the idea of selling shares in Neyveli. He became very upset after reading the consultation paper and was intending to deliver a “take it or leave it” threat to the PM in the meeting. The PM, a wise man, was quite aware of the hostile reaction he was likely to receive from the CM.

The PM was prepared…

Venue: Prime Minister’s Office

Date: 7 July 2006

PM (standing up and welcoming the CM into his room and pointing him to a sofa): Ah, welcome sir, please be seated here. I will be with you in just a moment.

PM then calls his secretary and informs him not to allow any calls in his room during this meeting. Then he goes around his table and takes a seat right next to the sofa at which the CM is seated.

PM: Thank you sir for taking the time to come to my office for this meeting.

CM (angry and tense): I have read your consultation document and as you may be aware, I and my party are totally opposed to your plan to sell shares in Neyveli. If you persist in going ahead with your plan, then my party will withdraw support from your government. Also, we have full plans to involve all the other left-wing parties supporting your government to join with us. Without our combined support, you government will fall. Please announce cancellation of your plan to sell the shares in Neyveli immediately.

PM (takes a deep breath): Sir, you are right.

CM (totally surprised): Huh? What do you mean? You mean you will not sell the shares? You don’t want to argue with me on this subject? You know, you are not supposed to do this. You are the one of the architects of India’s reforms who believes in privatization and flexible labor markets. Are you sure you are feeling ok?

PM (smiling): I am just fine sir. I just wanted to take your advice on this matter, that’s all. While I don’t have plans to sell shares in Neyveli, I do have some other thoughts on this matter which I will discuss later. But before that, may I ask you for the reasons for your opposition to the sale?

CM: Well, you know the party from which I come. You know my constituents. You know my background. All my life I have been a socialist. I simply cannot agree to your proposal of selling government's shares in profitable companies like Neyveli. And even more important, I cannot be seen to be agreeing with you on this either. I know you are a good man. But in this matter, my hands are tied.

PM: Sir, why don’t we look at the problem in a different light? Instead of getting caught in a face to face confrontation, why don’t we do side-by-side problem solving as collaborators? After all you have tremendous experience in negotiations. I just want to consult you. What are your chief interests in this matter?

CM: Well, I have already told you. My chief interest is to not allow this proposed sale. You simply cannot be allowed to jeopardize the employment prospects of my state's workers by selling shares in Neyveli.

PM: Sir, I have already agreed with you on this. I have done some thinking. I need your support. I am not asking you to support a sale. I have a much better plan.

CM (now a bit more relaxed): Well then, in that case let’s hear about your interests and your plan.

PM (smiling): Sir, my chief interest is not to sell shares of Neyveli, but to reduce the budget deficit for which I need your help and support. You see this is not a zero-sum game. We should look for ways to expand the pie. We don’t want your constituents or the nation to think I will sell the cream of India’s public sector for a song. We should try to make this a win-win deal for all of us – for you and your party, for Neyveli’s employees, and for its shareholders including my government. In fact, we want this to be a vote-winning proposition for you because it involves a substantial payment to all the workers at Neyveli with no risk of any job losses.

CM: Well I appreciate your concern for my interests. But where in the world will the money to pay the workers come from?

PM: From Neyveli itself.

CM: Huh? I told you that you cannot sell your shares in the company. And don't try to bribe my workers!

PM: Sir, I am not offering to bribe your workers and I am not proposing to sell the company’s shares either. Sale of Neyveli’s shares is not the only way to raise funds for reducing the budget deficit. We should try to be a bit more creative, isn’t it?

CM: Huh? Look you are confusing me here. I am an old man. Don’t do this to me. Please explain to me how your plan works. Where will the money for workers come from? How will it win votes for me so that I remain CM as long as I live?

PM: Sir, allow me to explain the concept of a leveraged recapitalization.

CM: Huh? Leveraged what? What are you talking about?

PM: I will try to make it as simple as possible. Neyveli is a very strong company, thanks mostly to the tireless efforts of the workers of Tamil Nadu. It’s highly profitable and is also debt free. Indeed it has in its possession substantial cash. I am told that currently it should have about Rs 40 billion in cash, net of all debt. If I were to sell 10% of the company’s shares at say Rs 70 per share, I would raise about Rs 12 billion which is a lot of money. However I can do even better- not just for me but for everyone. By making Neyveli undertake a leveraged recapitalization transaction, I can end up with lots more money to reduce my government's budget deficit, with money left over for distribution to the workers of Neyveli, without any need for me to sell any shares.

Most importantly, post leveraged recapitalization, Neyveli will remain a very strong company in which the government will continue to hold 93.56% stake. And its other shareholders will benefit too by receiving a substantial amount of cash and a fairer market price for their shares in the stock market.

CM: Tell me more…

PM: Sir, although I have no personal interest in the stock market, I am told by my financial advisors that Neyveli’s stock is selling in the stock market at a very low price.

CM: What do I care about its value in the stock market? We socialists have nothing to do with the stock market.

PM: Sir, market value matters. Why should I sell Neyveli’s shares in the market if they are quoting at an unduly low price? Why should I sell the family silver for a song? I won’t. Not when I have a much better plan.

CM: Ok. So market value is important. Tell me how your plan will work.

PM: Sir, the total market capitalization of Neyveli is presently about Rs 100 billion. It’s a debt free company already in possession of Rs 40 billion in cash. It can easily borrow Rs 30 billion. Let's see how.

At current interest rates of about 10% p.a., the annual cost of debt will come to Rs 3 billion. And during the last five years, the company has generated cash of more than Rs 15 billion per annum. Putting a debt of Rs 30 billion on the balance sheet of Neyveli will not jeopardize the company’s solvency or its future growth plans because of its ability to generate cash of about 5 times its annual interest requirements. Indeed, I am told, that should Neyveli raise this debt, it will enjoy a very high credit rating.

Now let’s see we already have Rs 40 billion in net cash. The company borrowes an additional Rs 30 billion by selling 10% bonds. That makes it Rs 70 billion of cash. Of this, I propose to distribute Rs 5 billion to the workers of the Neyveli in appreciation of their contribution to the company. Neyveli has 19,000 workers. Each of them will receive for his/her valuable contribution, one years’ salary as bonus out of the money raised by the company.

I propose to distribute the rest of the Rs 65 billion to its shareholders as a special dividend. The company has 1.67 billion shares outstanding so the dividend per share will come to about Rs 39 per share. Of the Rs 65 billion dividend distribution, the government will receive 93.56%, or Rs 60 billion. Without selling a single share, this is five times the Rs 12 billion I would have realized by selling 10% of the company’s shares!

The leveraged recap will go a long way to generate much needed cash for the development of the infrastructure of the country. It will also satisfy the interest of all stakeholders. It’s a win-win deal for everyone.

CM: But how can this be? It’s too good to be true is it not? How can I enrich my workers without taking money from the owners?

PM (smiling): Sir, trust me on this. I am an economist trained to understand the concepts of valuation and its distribution amongst stakeholders, zero-sum games, and pie expansion. This proposal, if blessed by you, will become the role model for providing the much-needed funds for the growth of India. The best thing about this plan- the Karunanidhi Plan – is that it does not require the government to sell shares in well-capitalized, profitable, public-sector companies.

CM (smiling): You are indeed a wise man, Manmohan. No wonder you are the PM! You have found a way to have your cake and eat it too! You are getting five times more money through your leveraged recap than through the sale which I would have opposed tooth and nail. I would have said no to the sale but I am happy to say that we agree to my plan. Because this new plan of ours does not require any sale but only a leveraged recap, I will be able to sell it to my constituents.

PM: Sale or Leveraged recap? What’s in a name? That which we call a rose by any other word would smell as sweet!

Thank you sir! I have taken the liberty to draw up the draft press release of the “Karunanidhi Plan”. Let’s sit here and read it together and see if we need to make any changes.

CM: Yes, let’s do this now. I want to announce it to the media myself.

Draft Press Release

Jointly issued by the office of the Chief Minister of Tamil Nadu and the office of the Prime Minister of India

Date: 7 July 2006

The Chief Minister of Tamil Nadu is pleased to announce the salient features of the “Karunanidhi Plan on Neyveli Lignite” prepared by him in consultation with India’s Prime Minister, Dr. Manmohan Singh.

  1. There shall be no sale of the company’s shares by the central government.
  2. The company shall, against the security of its assets and cash flow, borrow Rs 30 billion.
  3. After the completion of the borrowing, the company shall distribute a sum of Rs 5 billion to all the 19,000 workers in proportion of their existing wages, as special bonus for their valuable services to the company and the nation.
  4. After the payment of the special bonus, the company shall pay its stockholders, a special dividend of Rs 65 billion. Since the government of India owns 93.56% of the company’s shares, it will receive Rs 60 billion as dividends plus dividend tax. The existing cash resources with the company in addition to the recently borrowed funds, shall be sufficient to fund this large, dividend payout.
  5. The central government has undertaken that out of Rs 60 billion it expects to receive as dividend, it will spend at least Rs 20 billion towards the development of infrastructure of Tamil Nadu.

The Prime Minister welcomed the “Karunanidhi Plan on Neyveli Lignite” with the following words: “I congratulate Mr. Karunanidhi for showing the nation a path to achieve significant growth by raising resources from the markets, without having the need to sell government’s shares in profitable, public sector companies at unduly low prices. This model is likely to be adopted by the government in cases other than Neyveli Lignite.”

The Chief Minister commented: “I am grateful to the Prime Minister to endorse my plan for the transformation of financing the government’s deficits. My plan fully ensures that the ownership pattern of profitable, public sector companies does not change, that the employment at such companies remains unchanged, that workers are rewarded suitably for their valuable contribution to their company, and the central government can raise substantial resources, a significant part of which shall be allocated to the development of this state.”