Public Sector Mergers in India: Does Size Bring Synergies?


In June 2017, the $23 billion Vodafone-Idea Cellular merger got the go ahead from the Competition Commission of India. A few days later, the government announced a deal between two public sector undertakings (PSUs) – the Oil & Natural Gas Corporation (ONGC) and Hindustan Petroleum Corporation Ltd (HPCL). The Rs. 28,000 crore ($4.4 billion) merger involves ONGC buying up the 51% government stake in HPCL.

In his Budget earlier this year, the finance minister had spoken of plans to merge the State Bank of India (SBI) with several of its subsidiaries; have four-five large PSU banks through a process of mergers; and a similar proposal to create oil giants. The SBI merger has happened; the first oil giant has been announced; and the other candidates in the size stakes are readying for action. Indian Oil Corporation (IOC) is waiting for permission to acquire Oil India, and the PSU banks — thanks to the new Reserve Bank of India (RBI) norms on bad assets — have begun writing on the same page. In another big league deal – though not a merger — IOC, Bharat Petroleum and HPCL have signed an agreement to set up a $30 billion refinery. The three companies will own 50%, 25% and 25% in the refinery, India’s biggest.

According to assurance, tax and advisory firm Grant Thornton, M&As in India almost doubled in the first half of 2017 to $35.84 billion, over the corresponding period of 2016. This was aided by the Vodafone merger. But, says Prashant Mehra, partner, Grant Thornton India, this is just the beginning.

Beyond the Public Sector

The trend is not just in government companies, where a merger doesn’t necessarily involve a change in management and ownership. It has spread to the private sector, too. Recently announced was a possible combine of IDFC, IDFC Bank and the Shriram Group. Piramal Enterprises chairman Ajay Piramal had acquired a 20% stake in Shriram Capital in 2014. He also owns similar holdings in Shriram Transport Finance and Shriram City Union Finance, effectively making him top honcho of the group. This proposed merger will create a financial services giant with a market capitalization of $10 billion. Other predators have been prowling around. Kotak Mahindra Bank and IndusInd Bank, both in the private sector, have been going up on the bourses after reports that they were wooing private sector financial services players.

Also in the private sector, another lot is seeking the security of mergers. Telecom companies – confronted with one giant (Vodafone-Idea) and another giant in the making (Reliance Jio, which has now upped the stakes by virtually offering free feature phones to its subscribers) — could be joining hands. “The Tata Group and Bharti Enterprises have held exploratory talks to evaluate a mega alliance involving their telecom, overseas cable and enterprise services, and direct-to-home TV businesses,” notes business daily The Economic Times.

Private sector mergers have their own watchdogs – shareholder interest groups, activists et al. Public sector mergers are mostly done just to balance the government’s books; the ONGC-HPCL merger is to meet this year’s disinvestment target of Rs. 72,500 crore. And using this method avoids the “selling the family silver” charges from opposition parties.

“We need to question the logic of public sector mergers,” says Ravi Aron, a professor of information systems at Johns Hopkins Carey Business School. “Usually efficiencies are achieved – if ever they are – by eliminating redundant functions and increasing productivity. To achieve these gains, it is necessary to reduce costs through layoffs. But in India retrenchment is taboo – both politically and through law. The Industrial Disputes Act makes it nearly impossible to effect large layoffs in non-managerial workers.”

“I believe it would be a mistake to only look at recent history … and ask what should be done next.” –Jitendra V. Singh

Exactly what efficiencies will be gained by mergers between public sector companies? “Before we discuss scale economies and synergies, it is important to understand what they mean,” Aron notes. “For scale economies to exist, it is necessary to reduce the average unit cost of production of a product or service with increasing volumes. That reduction in costs of production (more generally operating costs) can happen only if labor costs can be pared down. This is very difficult, given the Industrial Disputes Act. Perhaps they may slow down future hiring and drive some gains through voluntary retirement schemes. These gains are not likely to be very high.”

In a study titled “Making Public Sector Mergers Work: Lessons Learned,” Peter Frumkin, professor of social policy & practice at the University of Pennsylvania, writes: “There has yet to be much systematic thinking about what makes public sector mergers work and how best to carry them out. Beyond the assumption – which remains largely unproven — that government mergers produce greater levels of coordination and lead to cost savings through the reduction of roles and redundancies, the field is still in its infancy.” That is true even today, more than a decade after the study was first published.

But Mehra sees a silver lining. “Since it is all government owned, it helps in leveraging the infrastructure for better returns as it stops the common stakeholder (which is the government) effectively cannibalizing its own business.”

Looking at the Past

Jitendra V. Singh, emeritus professor of management at Wharton, says that one must look at the past to draw lessons for the future. He talks about the proposed sale of national carrier Air India. “I believe it would be a mistake to only look at the recent history of Air India and ask what should be done next,” he explains. “It is particularly instructive to look at a 50-year-plus span and learn lessons from the blunders made along the way. These lessons, if learned well, could be of much value to India in the future, if only so that they are not repeated in other settings.” Singh is referring in particular to the Air India-Indian Airlines merger, a marriage which created a money-guzzling monstrosity.

But Jitender Bhargava, former Air India executive director and the author of The Descent of Air India, feels that it would be the wrong example to draw any lessons from. “The Air India merger shouldn’t be used as a benchmark because it was scripted to fail, hastily pursued with malicious intent,” he says. “It was meant to squeeze whatever value was left in Air India to help private airlines.”

“The merger of the two poorly-performing, medium-sized airlines – Indian Airlines and Air India – did not create a large, well-run company,” says Aron. “It created a large drain on public finances and accumulated operating losses running into billions of dollars over several years.”

“The bigger the bank grows, the less accessible it becomes to the people.” –C.H. Venkatachalam

The other example which case studies are focusing on is SBI. The bank has had repeat experiences; the government had earlier merged it with the State Banks of Jaipur, Bikaner and Saurashtra. Even earlier (in 1969), it was the beleaguered State Bank of Bihar. The more recent mergers are still works in progress. “The merger is seen as a win-win for both SBI and its associate banks,” notes a paper by G.V. Subba Raju of Vasavi College Hyderabad. “There are several economic and strategic advantages to the merged entity. However, it is not free from challenges. In mergers, it is not the two economic entities joining together, but also people with career aspirations and expectations. People’s concerns and their willingness to work with others are mostly ignored during a typical merger.”

HR Issues Sidelined?

”Selecting agencies for a merger, managers (or, in many cases, legislative bodies) need to consider not just the possible short-term cost savings but also the ‘fit’ of the agencies in terms of culture and competencies,” Frumkin notes in his report. “Choosing the right agencies requires careful research and strategic analysis. Public sector agencies provide services and in doing so develop stakeholder groups that demand performance and accountability. Unlike mergers in the private sector, the decision to merge cannot be made by shareholders.”

Expectedly, the SBI merger move has been criticized by the unions fearing automation, redundancy and job losses. According to the All India Bank Employees Association, India needs banks which can touch the common people. Says general secretary C.H. Venkatachalam: “The bigger the bank grows, the less accessible it becomes to the people. Big banks will give big-ticket loans with higher risks. We have seen the Lehman crisis. Lehman Brothers was a-too-big-to-fail bank in the U.S. And it collapsed.”

Mehra agrees on the human side of the picture. “The disadvantages [of a merger] are almost negligible if it’s within PSUs but if it’s between a PSU and a private bank, then cultural issues could bring about post-deal integration problems. Thus, the objective of the merger is defeated.”

Speaking of the Indian context, Aron says that a public sector merger is the wrong solution to the problem of chronic underperformance by government-owned enterprises. “The problem is that the government should exit many of the businesses that it is in.”

The SBI merger “is a case in point,” says Aron. “Consider the vast majority of large government-owned banks in India. In retail banking there is minimal differentiation between them. The banks all offer very similar retail banking products. Why is there so little product differentiation? Four reasons: (1) Incentives – these banks do not have any incentives to compete with each other and target different market segments with different services and prices. They are completely protected and they have access to the public exchequer – the taxpayer’s money. (2) Also incentives. The salaries of the top management are set by the government and not by the market; from there on down to the lowest white-collar worker, almost all salaries are set by bureaucratic procedures. There is no incentive for middle managers to innovate, take risks and try to pull away from the pack. (3) Unions of non-managerial staff oppose cost reduction and headcount-pruning measures – in the late 1980s and early 1990s, when computerization of banking operations began, unions opposed the efforts quite ferociously and delayed every phase of technology implementation by a decade or so. (4) They are controlled by the government – the government uses these banks as a source of cheap capital and for making loans of dubious economic merit but of great vote-buying value; the successive governments in power have converted the paid-up capital of the banks into political capital.”

“The government as the largest shareholder in the boardroom is the 800 pound gorilla that we are afraid to talk about. We need to get that gorilla out of the room.” –Ravi Aron

Aron adds that it is important to distinguish between government ownership and government control. “It is entirely possible to exert control on banks and stop them from assuming too much risk by imposing regulatory control,” he says. “There is no reason for the government to own these banks. Consider the foreign banks in India: Citibank, Barclays, HSBC, Bank of America… They are subject to regulatory control by the RBI and other policymaking bodies.”

He continues: “Then there is the idea that a group of banks if merged will be able to make larger loans (with a larger asset base). This is an odd rationale: the banks are owned by the government, the government is the guarantor of the bank’s finances. So how does the merger change the ultimate risk exposure profile when all risk is borne by the government? Further, in many countries larger loans are raised by groups of financial institutions that can lend money to an entity and apportion the risk appropriately. Consortia of banks have made large loans in plenty of cases. There is no need to have a single behemoth bank to bankroll large capital intensive projects.”

Concludes Aron: “We need to remember a basic tenant of IO (Industrial Organization): Competition between firms benefits consumers and the economy; private sector monopolies benefit owners of capital; and government monopolies benefit their employees.”

According to Aron, the question is not which firms should be merged. Rather it is about which sectors the government should exit. “The government as the largest shareholder in the boardroom is the 800 pound gorilla that we are afraid to talk about. We need to get that gorilla out of the room.”

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