Blasé Capital MERGER SHOCKS

In her budget speech this year, there were times when the finance minister was a bit unclear. For example, Nirmala Sitharaman cryptically announced, “The vision for NBFCs for Viksit Bharat has been outlined with clear targets for credit disbursement, and technology adoption. In order to achieve scale, and improve efficiency in the Public Sector NBFCs, as a first step, it is proposed to restructure the Power Finance Corporation (PFC) and Rural Electrification Corporation (REC).” Most people understood the second proposal as operational restructuring, rather than a mere financial jugglery. Experts felt that both PFC and REC will take measures to boost credit.

It was not like this. When details crept out, it turned out that the mere intention of the Government was to merge the two NBFCs, which operated in a similar area, yet with distinct aims and objectives. According to the proposal, PFC, which already owned more than 50 per cent, or a majority stake in REC, would acquire the remaining stake in REC by swapping its shares. REC will graduate from being a subsidiary of PFC to becoming a 100 per cent subsidiary, and the two companies will continue to exist as they do. Earlier, when PFC acquired the 50 per cent stake, it purchased the government’s stake.

Clearly, it was not a case of restructuring as understood by corporate and business managers, but an ownership rearrangement. Like in the past few years, PFC and REC are likely to be managed independently. The holding firm, PFC, may have more decision-making powers in the subsidiary, REC, but that is it. Experts do not feel that the operations of either firm will change in the future. Since there are no operational or business benefits involved, the stock prices of both PFC and REC suffered once the merger was announced. In the past five trading sessions, both stocks came down; PFC by 0.5 per cent, and REC by a higher nearly eight per cent. Over the past six months, the declines were 0.7 per cent, and 8.5 per cent, respectively.

According to one of the brokerage houses, the merger, by itself, does not materially alter the underlying business prospects of either PFC or REC. Both firms will remain heavily exposed to the country’s power sector, particularly the state utilities, and conventional thermal power projects. “There is likely little scope in terms of efficiency gains (which Sitharaman mentioned), as these entities entail employee and establishment expenses” that are low. Thus, any meaningful re-rating of the PFC stock in the future will not depend on this form of corporate and ownership restructuring, but more on the revival in state-utility-led capital expenditure in thermal power, which remains the primary growth driver for the lending activities of both the entities.

The fact is that even before the proposed merger, REC was a subsidiary of PFC since the latter owned more than 50 per cent stake that it purchased from the Government in 2019. With additional purchases of the shares, the nomenclature remains the same, and REC may become a 100 per cent subsidiary. If scale and efficiency was the issue to merge the two entities, these were already available in the earlier holding company-subsidiary arrangement. The merger signals more of the same. If the two entities did not scale up, and improve efficiency in the past seven years, how will they do it in the future? And, if they did this earlier, what is the purpose of the proposed merger?

However, there is a bigger twist in the merger tale. After the merger, the Government stake in PFC will be down to just over 40 per cent. But under the Companies Act, the holding needs to be 51 per cent and above for a firm to qualify as government-owned. In addition, the change in nomenclature may require legislative and legal measures. Thus, the state will need to opt for one of the three scenarios, as per the brokerage house quoted above. The first is buyback by PFC, in which the Government does not participate, and which reduces the equity capital, and enhances the state ownership. This negates the need for capital.

Still, while this route is balance sheet-neutral for the Government, the scale of the buybacks will be huge, n out PFC’s cash reserves. It will make less capital available for future lending, and limit the size of the balance sheet. In essence, it will defeat both the purposes, scale and efficiency, mentioned by the finance minister in her budget speech. Scale will be diminished because of a smaller, rather than larger, balance sheet. Efficiency will be impacted because of lower cash reserves, which will limit the funds raised for future lending.

The second option is for the Government to infuse huge sums into PFC. At current prices, according to some estimates, this may entail an inflow of INR 35,000 crore, which may be an obstacle. In the recent past, government revenues were hit, which forced reduced expenditure. Then, there is the third option. This year’s Economic Survey argues for a redefinition of a government company to one where the state holds 26 per cent. The Survey feels that this level of holding is enough to retain and exercise effective control. This route will, however, depend on legislative changes, which will need political will.