Disinvestment of Public sector

Undertakings In India- An Impact

study
By
Pankaj Kumar
Enrolment No: 10810041
MBA Batch 2010 – 12
DoMS IIT Roorkee
 
 
Referenced from: Indian Journal of Finance, August, 2010
Authors: Dr. M.K. Ramakrishnan and Sandhya R.

 
 Introduction
Disinvestment is a wider term extending from dilution of the stake of
the Government to a level where there is no change in control to dilution
that results in the transfer of management.
It involves the sale of equity and bond capital invested by the
government in PSUs.

It is the government and not the PSUs who receive money from
disinvestment.

Disinvestment is generally expected to achieve a greater inflow of

private capital and the use of private management practices in PSUs, as
well as enable more effective monitoring of management discipline by
the private shareholders.

Such changes would lead to an increase in the operational efficiency and

the market value of the PSUs.
The announcement of industrial policy on July 24th 1991, in which
the central government expressed its intention to bring the private
sector participation through a system of disinvestment of PSU’s

The new economy policy of liberalization, privatization and

globalization de-emphasized the role of the public sector in the
nation’s economy.

Two mode of disinvestment were adopted by the government.

1. Minority sale: Dilution of government stake without transfer of
control.
2. Strategic sale: Transfer of control to private entrepreneurs

First 10 years, disinvestment was marked by minority sale only

shows government conservative approach towards
implementation of disinvestment policy.
Methodology and Data Used:
This case study is based on the fundamental analysis of financial
information for two modes of disinvestment.
Two company are considered for minority sale: 1. Dredging corporation of
India limited (DCIL) and 2.Gas Authority of India Limited (GAIL) and
one company for strategic sale: Hindustan Zinc Ltd (HZL)

Accounting ratios are extensively used to study the financial performance

of the target companies.
Ratios measure three dimensions of financial performance: Profitability,
Liquidity and resource Utilization levels.

Financial year 2003-04 is taken as the base year (pre disinvestment

period).

A period of 4 years that is 2004-05 to 2007-08 represents post

disinvestment period.
Analysis of Profitability
1. Net Profit Ratio: It establishes relationship between
net profit and sales. It indicates the efficiency of the
company in manufacturing, administration, selling
and other core business functions.
Net profit Ratio=Net Profit / sales
The study reveals that disinvestment has caused
improvement in profitability of enterprises.
The average profitability of disinvested companies
has grown at compounded annual growth rate
(CAGR) of more than 10% in the post disinvestment
period. The improvement is more significant in case
of strategic sale.
2. Return on capital employed (ROCE): It measures return in terms of
profits before interests and taxes (PBIT) as a function of the total capital
employed.
ROCE=(Net profit before Interest and taxes/Capital employed)*100
ROCE is a product of net margin and the efficiency in which the assets
are managed. In the post disinvestment period, the combined
profitability of disinvestment entity has recorded a CAGR of 11.21
percentage points.

3. Earnings per share (EPS): This shows the earning potential of the
company from the point of view of equity shareholders. This establishes
the relationship between earnings as a function of the no. of equity share
in the issue.
EPS=(Net profit after Taxes and Dividend for preference shares/ Number
of equity shares)

Study shows that average CAGR on EPS has increased by 30% in post
disinvestment period. Further strategic sale is again more significant in
term of mode of disinvestment.
Analysis of Liquidity
1. Current ratio: It measures the relationship between two primary elements
of liquidity: current asset and current liability. It measures the firms’
ability from short term liability to short term assets. Current assets are all
asset classes that are converted into cash within a period of one year and
current liabilities are those liabilities that are repayable within a year.

Current Ratio= current asset/ current liability

The short term liquidity of company has increased substantially since

disinvestment as indicated by average CAGR of 18% on current ratio.

2. Cash Flow From Operation to current liabilities: One of the objective of

the financial management is to optimize cash flow from operations. In the
absence of adequate supply of cash flow from operation (CFFO), a
company will have to find non operating sources to maintain liquidity and
level of operations.

CFFO To Current liability=CFFO/Current Liability

 Disinvested has boosted the cash flow of generating capacity of
companies. In post disinvestment period, it has increased to 1.37
registering a CAGR of 27%.

3. Debt equity ratio: It measures extent to which debt financing has

been used in the business. The ratio indicates the proportional
claims of owners and outsiders against the firms’ asset. Debt ratio
measures financial leverage of a firm.

Debt Equity Ratio= Debt/Owners’ Equity

 The lower debt equity ratio indicates the reduced financial risk
exposure of these companies.

 Debt component of the disinvested companies has reduced in the

post disinvestment period as indicated by the negative CAGR of
22%.
Analysis of asset utilization
1. Debtor turnover ratio: This indicates the velocity of debt collection of a firm, a
factor contributing to the movements in operating cash flows. It measures
collection efficiency of the firm.
Debtors turnover in Days = (Average Debtors/Total Credit sales)*100

The collection period of disinvested entities on an average has increased in the

post disinvestment period from 44 days to 51 days. Thus, it is evident from case
study that disinvestment has caused decline in collection efficiency of firms.

2. Inventory Turnover Ratio: This measures the velocity of conversion of stock

into sales. It indicates whether inventory has been efficiently used or not. It
evaluates the efficiency with which a firm is able to manage its inventory.
Inventory days = (Average Inventory/ Cost of goods sold) * 365

It is evident from the case study that the inventory management efficiency has
improved during the post disinvestment period as indicated by the decrease in
inventory days from 69.5 to 54. Usually a low inventory period indicates the
efficient management of inventory.
3. Working Capital Turnover: This indicates the velocity of utilization of net
working capital. This ratio indicates the number of times the working
capital is turned over in the course of a year. Higher the ratio, the better
will be the utilization of working capital and the resulting operating cash
flows.

Working capital Turnover Ratio= Total Sales/ Net Working Capital

The average working capital efficiency has declined marginally in the post
disinvestment period where as strategic sale helped to improve working
capital efficiency.

4. Fixed Asset turnover ratio: This measure the efficiency in the utilization of
funds tied up in this form of assets. It establishes the relationship between
net fixed capital investment and the corresponding sales revenue.

It is evident from the study that the companies have improved their fixed
asset utilization levels after disinvestment by the CAGR of 3.98%.
Altman Z-score model: Altman developed a multivariate Z-score model to study
the financial distress of public companies whose shares are listed in the stock
exchanges. This model shows the combined impact of all the aspects of financial
performance on the overall financial health of target companies.

The model is expressed as follows:

Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 1(X5)
Where:
X1: Working Capital / Total assets
X2: Retained earnings/ Total assets
X3: Earnings before interest and Taxes/ Total assets
X4: Market value of equity/ total liabilities
X5: Sales/ Total assets

A Z- score below 1.81 indicates high profitability for bankruptcy or financial

distress. A score above 2.99 indicates a low profitability for bankruptcy. A score
between 1.81 and 2.99 indicates grey areas where managerial actions needed to
improve the financial health of the firm.

This model clearly supports the results of many of the foregoing analysis relating
to liquidity, profitability and asset utilization aspects of target companies
performance in the post disinvestment period.
 Conclusion
The study reveals that disinvested entities generally improved
their performance in all three aspect (liquidity, profitability and
asset utilization) of financial performance in the post
disinvestment period.

Disinvestment through Strategic sale has achieved remarkable

progress in all three aspect of financial performance than their
counterparts representing minority sale.

The Z score analysis based on Altman model also supports this

finding of the study.

The strategic sale mode of disinvestment provides company

more freedom and opportunities to carry our structural changes
for achieving rapid growth and to improve their competiveness.