Wednesday, May 30, 2012

TCI sues Coal India-morally and legally flawed

For the past few months, one of the UK activist hedge funds TCI(The children's investment fund) and Coal India have been locked in a tussle, with TCI objecting to the Central Government directives to Coal India on pricing, fuel supply agreements and the like. Following standard corporate governance principles, TCI feels that a third party(the government) should not interfere in the commercial matters that are in the domain of the board. However, as my IIM Ahmedabad Professor Dr TT Rammohan commented while lambasting TCI on his blog investors cannot expect a PSU to follow a private business model. Investors were well aware of this while investing in Coal India, and indeed the issue was considered underpriced by global benchmarks for many reasons including this one. Legally, the government plays the triple role of the sector regulator, majority owner of Coal India and the sovereign. These roles are often contradictory and lead to conflict of interest when 'populist' decisions/'national interest decisions' taken as a soverign/regulator conflict with the interest as a shareholder. In the prospectus risk factors(who really reads that but still its here, there were multiple warning points including on the very topic(public interest versus company interest) as below

  • Risk factor 14- Our business, operations and prospects may therefore be affected by various policies and statutory and regulatory requirements and developments that affect the thermalpower industry in India in general or public sector power utilities in particular, including those introduced oradministered by the Ministry of Power, GoI and the Central Electricity Authority ("CEA"). 
  • Risk factor 17- The price of raw coal sold under our FSAs does not fully reflect market prices for coal in India or in international coal markets. Inaddition, in the event that our production costs or other costs associated with the purchase of our coal that arepayable by our customers, such as transportation cost and statutory levies, were to increase, there can be noassurances that we would be able to increase the price of coal to offset any such increases. For policy or other reasons, we may not price our coal at levels that would adversely impact the power sector or the Indianeconomy. 
  • Risk factor 55- The interests of the GoI may be different from our interests or the interests of our other shareholders. As a result, the GoI may take actions with respect to our business and the businesses of our peers and competitors that may not be in our or our other shareholders' bestinterests. The GoI could, by exercising its powers of control, delay or defer or initiate a change of control of ourCompany or a change in our capital structure, delay or defer a merger, consolidation, or discourage a mergerwith another public sector undertaking.In particular, given the importance of the coal industry to the economy, the GoI has historically played a keyrole, and is expected to continue to play a key role, in regulating, reforming and restructuring the Indian coalmining industry. The GoI also exercises substantial control over the growth of the power industry in India which is dependent on the coal we produce and could require us to take actions designed to serve the public interestand not necessarily to maximize our profits.
 The above risk factors made it explicit(especially risk factor 55) that the Government of India could, had and intended to act like a robber baron(as perceived by private investors). If TCI had any concerns, it should have raised it before purchasing the shares. I'm sure the Goverrnment would have been much more receptive to concerns raised during the road shows. But instead, like the anecdotal eternally optimistic wife who marries a man hoping to change him, TCI purchased Coal India shares, took the high risk approach of moral suasion/persuading the Government to change its policy, and when it failed hired its top legal gun Luthra & Luthra to try recouping its losses! One who plays with fire should not complain of getting burnt. And that is the moral side of the issue-of all people, an activist hedge fund cannot take the plea of ignorance of law/not having read the prospectus! And as Prof Rammohan points out, Coal India's high ROE shows that perhaps the customers are getting gouged not the shareholders!!!

As an aside, as pointed out in the economic survey Chapter II, In a market where all dominant players are public-sector companies, ‘market price’ is not a very meaningful concept. It is easy for government to control state-owned companies through nods and winks. Hence, even if TCI wins an injunction for stopping such actions(very unlikely), the Government can still get its way. Hence, Luthra & Luthra will laugh its way to the bank, but TCI is not likely to see a single rupee of compensation.