What is Disinvestment? [/b]
[/b]
In business, disinvestment means to sell off certain assets such as a manufacturing plant, a division or subsidiary, or product line. Some people use the term divestiture, or to divest when discussing disinvestment.
For example, an electric generator manufacturer might sell off its consumer generator product lines and manufacturing facilities in order to raise money that can be used to expand its industrial generator product line.
Another example is a consumer products company selling off a profitable division that no longer meets its long range goals. The proceeds from this disinvestment are then used to improve the company’s financial position by reducing its debt.
Investment refers to conversion of money or cash into securities, debentures, bonds or any other claims on money. At the same time, disinvestment involves the conversion of money claims or securities into money or cash.
Disinvestments, also known as divestments, are processes utilized by companies when there is a need or desire to initiate a reduction in capital investment. Essentially functioning as the polar opposite of an investment, the process of divestment involves selling off current investments in order to generate assets that can be used to better advantage in some other manner. Businesses sometimes use disinvestment as a means of changing the direction of the company in order to meet changing consumer needs and remain competitive.
One of the easiest ways to understand divestment is to think in terms of a company that has successfully produced a product for many years. However, changing technology is shrinking the demand for the company’s product. A new product is developed that is anticipated to recapture the interest of consumers. However, this will leave the company with several physical facilities and a great deal of equipment that is not required for the production of the new product.
In order to generate revenue that will aid in the manufacturing of the new product, the company will undergo a period of disinvestment. The plants and other facilities that are no longer required for production are sold off, along with the now obsolete equipment. By generating income from the sale of these divested holdings, the company creates resources that constitute a capital investment in the new product.
At times, a company may choose to sell off a subsidiary or business unit as part of a disinvestment strategy. Doing so allows the company to begin the migration from focusing on one market sector to a different sector that holds more promise. In some cases, disinvestment involves selling the business unit to another company. At other times, the business unit is spun off into a separate company altogether.
Disinvestment can also occur when there is a decision to make changes in the regulation of an industry. Perhaps the most well known example of this type of disinvestment application would be the deregulation of the communications industry in the United States during the 1980’s. As part of the process, the Bell System was completely divested and emerged as eight different entities: the new AT&T, and seven regional Bell companies that were known collectively as the Baby Bells.
Because disinvestment does involve the sale of resources, companies often look very closely at the process before actually implementing any type of divestiture action. It is important to make sure that the investments that are released are not likely to be required in the future, and that the revenue generated from the sale of the investments is highly likely to result in increased profitability for the company in the long run.
Objectives of Disinvestment[/b]
The following are the main objectives of disinvestment policy of the government.
Reasons for disinvestment
[/b]
The public sector in India at present is at cross roads. The new economic policy initiated in July – 1991, clearly indicated that the public sector undertakings have shown a very negative rate of return on capital employed. On account of this phenomenon many public sector undertakings have become burden to the government. They are in fact turning out to be liabilities to the government rather than being assets.
This is a sector which the government clearly wants to get rid off. In this direction the government has adopted a new approach to reform and improve the public sector undertakings performance i.e. 'Disinvestment policy'. This has gained lot of importance especially in latter part of 90s. At present the government seriously perceives the disinvestment policy as an active tool to reduce the burden to financing the public sector undertakings.
Disinvestment of Public sector undertakings
[/b]
Disinvestment is a wider term extending from dilution of the stake of the government to a level where there is no change in the control to dilution that results in the transfer of management. The transfer of ownership may occur when in an enterprise the dilution of government ownership is beyond 51 percent. The disinvestment implies that the government will sell to public or private enterprises / public institutes part of its holding in public sector enterprises.
The functioning of many public sector units (PSUs) has been characterized by low productivity, unsatisfactory quality of goods, excessive manpower utilization, inadequate human resource development and low rate of return on capital. For instance, between 1980 and 2002, the average rate of return on capital employed by PSUs was about 3.4% as against the average cost of borrowing, which was 8.66%. Disinvestment (or divestment) of the PSUs has therefore been offered as one of the solutions in this context.
Disinvestment involves the sale of equity and bond capital invested by the government in PSUs. It also implies the sale of government’s loan capital in PSUs through securitization. However, it is the government and not the PSUs who receive money from disinvestment.
The fixation of share/bond price is an important aspect of disinvestment. Now, the Disinvestment Commission determines the share/bond price. Disinvested shares are listed, quoted and traded on the stock market. Indian and foreign financial institutions, banks, mutual funds, companies as well as individuals can buy disinvested shares / bonds.
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. This in turn would enable the much needed revenue generation by the government and help reduce deficit financing.
However, to date the market experience has been otherwise. The large national budgetary deficit on revenue account has been increasing. The government has not used the disinvestment proceeds to finance expenditure on capital account; i.e. the disinvestment policy has resulted in capital consumption rather than generation. Administrative costs of the disinvestment process have also been unduly high.
The actual receipts through disinvestment have often fallen far short of their target .During the period 1991-92 to 2002-2003, the government had targeted the mobilization of about Rs. 78,300 crores through disinvestment, but it could actually mobilize only Rs. 30,917 crores.
Problems of Public sector undertakings[/b]
The most important criticism levied against public sector undertakings has been that in relation to the capital employed, the level of profits has been too low. Even the government has criticised the public sector undertakings on this count. Of the various factors responsible for low profits in the public sector undertakings, the following are particularly important :-
i. Price policy of public sector undertakings
ii. Under – utilization of capacity
iii. Problem related to planning and construction of projects
iv. Problems of labour, personnel and management
v. Lack of autonomy
The government in order to put an end to these problems, decided to disinvest its stake in the PSUs. The companies traditionally established as pillars of growth have now become a burden on the economy. Except few mighty oil and petroleum companies, almost all other PSUs are incurring losses. The national gross domestic product and gross national savings are also adversely effected by low returns from PSUs. About 10 to 15 % of the total gross domestic savings are reduced on account of low savings from PSUs.
A number of problems and issues have bedevilled the disinvestment process. The number of bidders for equity has been small not only in the case of financially weak PSUs, but also in that of better-performing PSUs.Instances of insider trading of shares have also come to light. All this has led to low valuation or under pricing of equity.
Further, in many cases, disinvestment has not really changed the ownership of PSUs, as the government has retained a majority stake in them. There has been some apprehension that disinvestment of PSUs might result in the crowding out of private corporate (through lowered subscription to their shares) from the primary capital market.
An important fact that needs to be remembered in the context of divestment is that the equity in PSUs essentially belongs to the people. Thus, several independent commentators have maintained that in the absence of wider national consensus, a mere government decision to disinvest is not enough to carry out the sale of people.s assets. Inadequate information about PSUs has impeded free, competitive and efficient bidding of shares, and a free trading of those shares. Also, since the PSUs do not benefit monetarily from disinvestment, they have been reluctant to prepare and distribute prospectuses. This has in turn prevented the disinvestment process from being completely open and transparent.
It is not clear if the rationale for divestment process is well-founded. The assumption of higher efficiency, better / ethical management practices and better monitoring by the private shareholders in the case of the private sector all of which supposedly underlie the disinvestment rationale is not always borne out by business trends and facts.
Total disinvestment of PSUs would naturally concentrate economic and political power in the hands of the private corporate sector. While the creation of PSUs originally had economic, social welfare and political objectives, their current restructuring through disinvestment is being undertaken primarily out of need of government finances and economic efficiency.
Lastly, to the extent that the sale of government equity in PSUs is to the Indian private sector, there is no decline in national wealth. But the sale of such equity to foreign companies has far more serious implications relating to national wealth, control and power, particularly if the equity is sold below the correct price!
If the disinvestment policy is to be in wider public interests, it is necessary to examine systematically, issues such as - the correct valuation of shares, the crowding out possibility, the appropriate use of disinvestment proceeds.
Method of Disinvestment [/b]
The following are the three methods adopted by the Government of India for disinvesting the Public sector undertakings. There are three Methods of valuation approved by the Disinvestment Commission [/b]
1. Net Asset Method:[/b] This will indicate the net assets of the enterprise as shown in the books of accounts. It shows the historical value of the assets. It is the cost price less depreciation provided so far on assets. It does not reflect the true position of profitability of the firm as it overlooks the value of intangibles such as goodwill, brands, distribution network and customer relationships which are important to determine the intrinsic value of the enterprise. This model is more suitable in case of liquidation than in case of disinvestment.
2. Profit Earning Capacity Value Method:[/b] The profit earning capacity is generally based on the profits actually earned or anticipated. It values a company on the basis of the underlying assets. This method does not consider or project the future cash flow.
3. Discounted Cash Flow Method:[/b] In this method the future incremental cash flows are forecasted and discounted into present value by applying cost of capital rate. The method indicates the intrinsic value of the firm and this method is considered as superior than other methods as it projects future cash flows and the earning potential of the firm, takes into account intangibles such as brand equity, marketing & distribution network, the level of competition likely to be faced in future, risk factors to which enterprises are exposed as well as value of its core assets. Out of these three methods the Discounted cash flow method is used widely though it is the most difficult.
Recent Trends in Disinvestment Process
[/b]
The change process in Indian begun in the year 1991-92 and in that year 31 selected PSUs were disinvested totaling an aggregate equity of Rs.3,038 crores. In the decade 1991-92 to 2000-01, the total rose to Rs.20,506 crores as against the target of 54,300 crores. In the year 2000-01 itself the government was able to raise Rs.1,868 crores against the target of Rs.10,000 crores.
As per the Economic Survey – 2001, the government was set out the following policies towards PSUs :-
i. Bring down the Government equity to 26% or lower.
ii. Re-structure the potential and viable PSUs.
iii. Close down PSUs that cannot be revived.
iv. To protect the interest of the workers.
[/b]
In business, disinvestment means to sell off certain assets such as a manufacturing plant, a division or subsidiary, or product line. Some people use the term divestiture, or to divest when discussing disinvestment.
For example, an electric generator manufacturer might sell off its consumer generator product lines and manufacturing facilities in order to raise money that can be used to expand its industrial generator product line.
Another example is a consumer products company selling off a profitable division that no longer meets its long range goals. The proceeds from this disinvestment are then used to improve the company’s financial position by reducing its debt.
Investment refers to conversion of money or cash into securities, debentures, bonds or any other claims on money. At the same time, disinvestment involves the conversion of money claims or securities into money or cash.
Disinvestments, also known as divestments, are processes utilized by companies when there is a need or desire to initiate a reduction in capital investment. Essentially functioning as the polar opposite of an investment, the process of divestment involves selling off current investments in order to generate assets that can be used to better advantage in some other manner. Businesses sometimes use disinvestment as a means of changing the direction of the company in order to meet changing consumer needs and remain competitive.
One of the easiest ways to understand divestment is to think in terms of a company that has successfully produced a product for many years. However, changing technology is shrinking the demand for the company’s product. A new product is developed that is anticipated to recapture the interest of consumers. However, this will leave the company with several physical facilities and a great deal of equipment that is not required for the production of the new product.
In order to generate revenue that will aid in the manufacturing of the new product, the company will undergo a period of disinvestment. The plants and other facilities that are no longer required for production are sold off, along with the now obsolete equipment. By generating income from the sale of these divested holdings, the company creates resources that constitute a capital investment in the new product.
At times, a company may choose to sell off a subsidiary or business unit as part of a disinvestment strategy. Doing so allows the company to begin the migration from focusing on one market sector to a different sector that holds more promise. In some cases, disinvestment involves selling the business unit to another company. At other times, the business unit is spun off into a separate company altogether.
Disinvestment can also occur when there is a decision to make changes in the regulation of an industry. Perhaps the most well known example of this type of disinvestment application would be the deregulation of the communications industry in the United States during the 1980’s. As part of the process, the Bell System was completely divested and emerged as eight different entities: the new AT&T, and seven regional Bell companies that were known collectively as the Baby Bells.
Because disinvestment does involve the sale of resources, companies often look very closely at the process before actually implementing any type of divestiture action. It is important to make sure that the investments that are released are not likely to be required in the future, and that the revenue generated from the sale of the investments is highly likely to result in increased profitability for the company in the long run.
Objectives of Disinvestment[/b]
The following are the main objectives of disinvestment policy of the government.
Reasons for disinvestment
[/b]
The public sector in India at present is at cross roads. The new economic policy initiated in July – 1991, clearly indicated that the public sector undertakings have shown a very negative rate of return on capital employed. On account of this phenomenon many public sector undertakings have become burden to the government. They are in fact turning out to be liabilities to the government rather than being assets.
This is a sector which the government clearly wants to get rid off. In this direction the government has adopted a new approach to reform and improve the public sector undertakings performance i.e. 'Disinvestment policy'. This has gained lot of importance especially in latter part of 90s. At present the government seriously perceives the disinvestment policy as an active tool to reduce the burden to financing the public sector undertakings.
Disinvestment of Public sector undertakings
[/b]
Disinvestment is a wider term extending from dilution of the stake of the government to a level where there is no change in the control to dilution that results in the transfer of management. The transfer of ownership may occur when in an enterprise the dilution of government ownership is beyond 51 percent. The disinvestment implies that the government will sell to public or private enterprises / public institutes part of its holding in public sector enterprises.
The functioning of many public sector units (PSUs) has been characterized by low productivity, unsatisfactory quality of goods, excessive manpower utilization, inadequate human resource development and low rate of return on capital. For instance, between 1980 and 2002, the average rate of return on capital employed by PSUs was about 3.4% as against the average cost of borrowing, which was 8.66%. Disinvestment (or divestment) of the PSUs has therefore been offered as one of the solutions in this context.
Disinvestment involves the sale of equity and bond capital invested by the government in PSUs. It also implies the sale of government’s loan capital in PSUs through securitization. However, it is the government and not the PSUs who receive money from disinvestment.
The fixation of share/bond price is an important aspect of disinvestment. Now, the Disinvestment Commission determines the share/bond price. Disinvested shares are listed, quoted and traded on the stock market. Indian and foreign financial institutions, banks, mutual funds, companies as well as individuals can buy disinvested shares / bonds.
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. This in turn would enable the much needed revenue generation by the government and help reduce deficit financing.
However, to date the market experience has been otherwise. The large national budgetary deficit on revenue account has been increasing. The government has not used the disinvestment proceeds to finance expenditure on capital account; i.e. the disinvestment policy has resulted in capital consumption rather than generation. Administrative costs of the disinvestment process have also been unduly high.
The actual receipts through disinvestment have often fallen far short of their target .During the period 1991-92 to 2002-2003, the government had targeted the mobilization of about Rs. 78,300 crores through disinvestment, but it could actually mobilize only Rs. 30,917 crores.
Problems of Public sector undertakings[/b]
The most important criticism levied against public sector undertakings has been that in relation to the capital employed, the level of profits has been too low. Even the government has criticised the public sector undertakings on this count. Of the various factors responsible for low profits in the public sector undertakings, the following are particularly important :-
i. Price policy of public sector undertakings
ii. Under – utilization of capacity
iii. Problem related to planning and construction of projects
iv. Problems of labour, personnel and management
v. Lack of autonomy
The government in order to put an end to these problems, decided to disinvest its stake in the PSUs. The companies traditionally established as pillars of growth have now become a burden on the economy. Except few mighty oil and petroleum companies, almost all other PSUs are incurring losses. The national gross domestic product and gross national savings are also adversely effected by low returns from PSUs. About 10 to 15 % of the total gross domestic savings are reduced on account of low savings from PSUs.
A number of problems and issues have bedevilled the disinvestment process. The number of bidders for equity has been small not only in the case of financially weak PSUs, but also in that of better-performing PSUs.Instances of insider trading of shares have also come to light. All this has led to low valuation or under pricing of equity.
Further, in many cases, disinvestment has not really changed the ownership of PSUs, as the government has retained a majority stake in them. There has been some apprehension that disinvestment of PSUs might result in the crowding out of private corporate (through lowered subscription to their shares) from the primary capital market.
An important fact that needs to be remembered in the context of divestment is that the equity in PSUs essentially belongs to the people. Thus, several independent commentators have maintained that in the absence of wider national consensus, a mere government decision to disinvest is not enough to carry out the sale of people.s assets. Inadequate information about PSUs has impeded free, competitive and efficient bidding of shares, and a free trading of those shares. Also, since the PSUs do not benefit monetarily from disinvestment, they have been reluctant to prepare and distribute prospectuses. This has in turn prevented the disinvestment process from being completely open and transparent.
It is not clear if the rationale for divestment process is well-founded. The assumption of higher efficiency, better / ethical management practices and better monitoring by the private shareholders in the case of the private sector all of which supposedly underlie the disinvestment rationale is not always borne out by business trends and facts.
Total disinvestment of PSUs would naturally concentrate economic and political power in the hands of the private corporate sector. While the creation of PSUs originally had economic, social welfare and political objectives, their current restructuring through disinvestment is being undertaken primarily out of need of government finances and economic efficiency.
Lastly, to the extent that the sale of government equity in PSUs is to the Indian private sector, there is no decline in national wealth. But the sale of such equity to foreign companies has far more serious implications relating to national wealth, control and power, particularly if the equity is sold below the correct price!
If the disinvestment policy is to be in wider public interests, it is necessary to examine systematically, issues such as - the correct valuation of shares, the crowding out possibility, the appropriate use of disinvestment proceeds.
Method of Disinvestment [/b]
The following are the three methods adopted by the Government of India for disinvesting the Public sector undertakings. There are three Methods of valuation approved by the Disinvestment Commission [/b]
1. Net Asset Method:[/b] This will indicate the net assets of the enterprise as shown in the books of accounts. It shows the historical value of the assets. It is the cost price less depreciation provided so far on assets. It does not reflect the true position of profitability of the firm as it overlooks the value of intangibles such as goodwill, brands, distribution network and customer relationships which are important to determine the intrinsic value of the enterprise. This model is more suitable in case of liquidation than in case of disinvestment.
2. Profit Earning Capacity Value Method:[/b] The profit earning capacity is generally based on the profits actually earned or anticipated. It values a company on the basis of the underlying assets. This method does not consider or project the future cash flow.
3. Discounted Cash Flow Method:[/b] In this method the future incremental cash flows are forecasted and discounted into present value by applying cost of capital rate. The method indicates the intrinsic value of the firm and this method is considered as superior than other methods as it projects future cash flows and the earning potential of the firm, takes into account intangibles such as brand equity, marketing & distribution network, the level of competition likely to be faced in future, risk factors to which enterprises are exposed as well as value of its core assets. Out of these three methods the Discounted cash flow method is used widely though it is the most difficult.
Recent Trends in Disinvestment Process
[/b]
The change process in Indian begun in the year 1991-92 and in that year 31 selected PSUs were disinvested totaling an aggregate equity of Rs.3,038 crores. In the decade 1991-92 to 2000-01, the total rose to Rs.20,506 crores as against the target of 54,300 crores. In the year 2000-01 itself the government was able to raise Rs.1,868 crores against the target of Rs.10,000 crores.
As per the Economic Survey – 2001, the government was set out the following policies towards PSUs :-
i. Bring down the Government equity to 26% or lower.
ii. Re-structure the potential and viable PSUs.
iii. Close down PSUs that cannot be revived.
iv. To protect the interest of the workers.