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Why the Government Wants More PSU Share Buybacks and Dividends

Editor, TRANSFIN.
May 31, 2020 7:00 AM 5 min read
Editorial

The Government is an unenvious position right now. The COVID-19 pandemic and the ensuing nationwide lockdown have crippled the national economy and derailed all Budgetary math. 

A lot has been announced in stimulus packages to shore up things but the broader hope is for an automatic resumption in consumer demand. Meanwhile a dwindling tax revenue would inadvertently mean the fiscal deficit would likely go for a toss this fiscal. 

The Government is thus looking at alternative, non-tax means to fill in the fiscal gap and raise revenue. We have already explored the route of direct monetisation by the RBI in a previous article. Today, we’ll explore another avenue being reportedly considered - a ramp up of share buybacks and dividend payments by Government-owned companies or Public Sector Undertakings (PSUs).

 

Back to Basics: What are Share Buybacks and Dividend Payments?

There are basically two ways in which a company - private or public - rewards its equity investors. 

Dividends are a particular amount of money per share paid to shareholders. The corpus for this comes from the company’s distributable surplus. 

Point to note: Until recently, dividend payments were taxable at the corporate level (read Dividend Distribution Tax). But in Budget 2020, the onus for this tax was moved away from companies to the shareholders themselves.

A buyback on the other hand is when a company offers investors the option of selling their shares at a premium (so, stock price + added amount as an incentive to sell) back to the company. This therefore would lead to the number of outstanding shares going down and earnings per share going up, and can have a positive effect on the company’s valuation. 

Point to note: As per SEBI guidelines, companies can offer buybacks to their shareholders only once in 12 months.

Both buybacks and dividends are usually signs of mature and free cash flow generating companies. It underlines a choice made by the companies of returning some excess cash to shareholders instead of reinvesting that capital to grow their businesses more quickly.

 

Now, Let’s Talk About PSUs

PSUs are companies where the Government (Central or State) has a majority stake (51% or above). While their dominance has dimmed since the economic liberalisation of the 1990s, PSUs remain important pillars of the economy. The public sector employs c. 30m people and PSUs contribute ₹3.5trn ($46.5bn) to the public exchequer.

Below is a list of the top 10 PSUs in India as of 2019 (source):

Why the Government Wants More PSU Share Buybacks and Dividends
Top 10 PSUs in India, as of 2019.

If a PSU decides on paying a dividend or buying back the Government’s shares (which is the majority shareholder for them), it would effectively be paying the Government. In case of a buy back, the Government is “divesting” its stake i.e. Returning its shares to the company, which then cancels them. This is how PSU buybacks and dividends are a source of revenue for the Government.  

Since 2015-16, share buybacks by PSUs have been counted as part of the annual disinvestment proceeds by the Government. In FY17, the Government further emulated the private sector and mandated that those central PSUs with a net worth above ₹2,000cr ($266m) and cash and bank balance of over ₹1,000cr ($133m) should exercise the option to buy back a portion of their shares from the Government.

Point to Note: In FY19, a total of 63 companies launched buyback offers, with PSUs dominating the list.

 

PSU Buybacks vs Buybacks by Private Firms

One: The dynamic between the Government and PSUs is not exactly similar to that between usual shareholders and private companies. Shareholders can’t demand buybacks if they are cash-strapped: companies offer buybacks to them. But the Government can demand buybacks and dividends from PSUs if it finds itself in a fiscal bind.

Two: Buybacks tend to shrink a company’s equity base and thus enhance the value of the remaining shares. Generally, this has a net positive effect on a company’s financials. But this is not always true when it comes to PSUs. An FE analysis found that many PSU stocks fell drastically following buybacks, with some plummeting as much as 54% in value! 

This could obviously be because investors are also gauging other parameters such as the PSU’s past performance. But the spectre of Government interference (i.e. PSUs can’t really say “No” if the Centre demands a buyback, can they?) can cloud any company’s perception.

 

Back to the Present: Why the Government Wants More PSU Buybacks

Now that we know that PSU buybacks and dividends can be sources of revenue for the Government, let’s look at the extent of capital that can be raised from such divestment proceedings. 

In the last three FYs, non-financial PSUs alone have contributed over ₹40,000cr ($5.3bn) each year in revenue raised through divestment. The share of buybacks from these proceedings varied in 2017-18, 2018-19 and 2019-20 at 5.4%, 11.3% and 1.6% (last year, only three PSU buybacks went through - MOIL, MDL and SPMCIL).

For FY21, the Government has a high divestment target for non-financial PSUs: ₹65,747cr ($8.7bn). And the sentiment in official circles is reportedly one of going back to the glory days of PSU buybacks i.e. 2016-17, when PSUs like Coal India, NLC India, NHPC and NMDC bought back shares held by the Centre worth ₹18,963cr ($2.5bn), which made up almost 40% of that year’s divestment proceeds.

The argument is that since there is low demand and economic activity right now, PSUs are spending less on capex requirements. Thus they must have some extra cash lying around. The Government would rather this cash be sent to the Centre rather than sit idly around.

 

Enter, COVID-19

The Centre’s logic sounds good on paper but how feasible is this? Firstly, many PSUs aren’t particularly cash-heavy right now themselves: they are companies after all, and the lockdown-induced fall in demand has hit them hard too. In addition to this, their reduced capex is more a function of the environment rather than appetite or intent to deploy capital in high net present value investments.

And the Government's disinvestment targets are known to be ambitious - which is good - but also to frequently fall short. For the last fiscal, the targets were far from achieved and now thanks to COVID-19, the Government might have a greater appetite for divestments but PSUs may not have the same enthusiasm, having too many other concerns on their plate. 

May god bless (and save) PSU minority shareholders!

FIN.

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