Poor returns, a weak government with no appetite for reforms have scared off many investors, including foreign investors from the stocks of PSUs. In the mid-90s, many savvy investors had met with the same fate and swore not to invest in government company stocks. This only shows how and why even institutional investors repeat the same mistakes again and again

On Thursday 9 August 2012, Jeff Chowdhry of F&C Asset Management, was quoted in by Bloomberg as saying that “We are reducing exposure to state-run companies... Most portfolio investors are saying: I am only going to invest in companies that are private sector, and as far removed as possible from government policy”. Rewind back to 1996, an outspoken fund manager Samir Arora, had made a nearly identical comment and had remarked that he would like to invest in companies that have little to do with the government. He had burnt his hands investing in Hindustan Petroleum Corporation (HPCL). What has changed within a spate of 16 years? What has definitely not changed is the fact that investors, especially institutional investors make the same mistakes repeatedly despite obvious facts staring at their faces.

Foreign investors have been selling stakes in state-owned corporations and have decided to focus on the private sector instead, as they have run out of patience with the Indian government. The fact that PSUs would be bad investments is obvious to anyone who has some idea of how these companies are run. We all know that public sector units (PSUs) have no autonomy and are effectively run by the ministers through the secretaries. It has been so for decades and there is simply no incentive anywhere to change this. Unfortunately, sophisticated investors seem to make the same mistakes over and over again.

Consider the returns that all the PSUs have made in the last one and two years. The Sensex has given returns of 3.59% and -3% respectively. Over the last two years, only 12 out of 60 public sector units were able to outperform Sensex. The statistic worsened when only three companies out of 60 outperformed the Sensex. Such abysmal figures are not surprising given the history and attitude of the government towards economic reforms, particularly PSUs.

In fact, speaking of public sector units, way back in 2000, G Ganesh, former member-secretary, Disinvestment Commission, admitted that the Indian public sector has been made sick “due to the absence of a competition policy with statutory regulators, lack of corporate governance and entrepreneurship and a huge unproductive labour force.” Nobody paid attention and turned a blind eye towards this honest observation. Here is what he remarked then, and it still applies today:

“We need to restructure Public Sector Undertakings on a war footing as most public sector units, barring a few which are monopolies, are bound to report to BIFR within the next two or three years, unless radical steps are taken for reforming them. Restructuring methods should, therefore, encompass the fields of business organization and finance. Today, most restructuring, which is being attempted pertains merely to finance and hence becomes unsuccessful. Corporate governance of public enterprises is the need of the hour. This includes proper autonomy that is permitting public enterprises to function as commercial entities, free from the clutches of the Government to take all investment and pricing decisions, no interference from their owners. This will also entail selection of the right CEO through a transparent, impartial process. This will in turn ensure the accountability of the CEO and the board members.”

Public sector units do not operate like their private sector counterparts, the latter which creates value vis-a-vis minimal use of capital, lean operations, innovation, empowered managers, high quality of recruitment and training programmes. Very few, if at all, government-controlled company have any of these essential qualities. Capital waste, the key value-destroying factor, is a common feature. Instead, public sector companies have been seen as a solution to short-term ills, from helping the government cut budget deficits, to rekindling foreign investors’ love affair with Indian stocks (give it to them cheap, increase FDI limits, etc), to bringing back retail investors (sell it below market price) and to push up the stock market.

Even using tax payers’ money to bailout a flailing airline that continues to make losses is one of the government priorities. There is no clear policy on how such companies ought to be run and managed. Unless reforms take place, public sector will continue to bleed tax payers’ money. Yet institutional investors forget all this and react with optimism when the government talks of reforms.

Consider recent IPOs of PSU undertakings. How have their performances been? Five of the last 10 IPOs have fared worse than Sensex on an annualised basis. Only two have given decent returns. Coal India, one of the most promising public sector units, in terms of resources and scale, has barely given positive returns.

Institutional investors though, as usual, had got carried away with the notion that PSUs are great opportunities. With limited growth prospects, increased competition and managed by remote control, long-term value creation by privatised public sector units will still be elusive. Don’t hope too much as elections draw closer, the chances of government taking bold and uncomfortable decisions looks unlikely. But be certain that 10-15 years later another institutional investor will again think that PSUs are great bets.