Why Coal India is Not a Child’s Play

Posted on by fundooprofessor

The Children’s Investment Fund of UK is Coal India’s second largest shareholder and owns 1% of the company’s equity. The largest shareholder is The President of India who owns 90% of this $ 41 billion market cap behemoth.

The owner of 1% of this behemoth is now battling the owner of 90%. This “epic battle” has been covered by the media over the last few days.

And how is this “battle” taking place? By the firing of letter missiles by The Children’s Investment Fund to Coal India’s Board of Directors and the Secretary, Ministry of Coal and their subsequent release to the media.

Primarily, this fund accuses Coal India’s Board of Directors of “breach of fiduciary duty” for (1) not resisting government’s ”request” to roll back coal price hikes (it claims that Coal India sells coal at 70% below prevailing international coal prices); (2) refusing to defy the orders of India’s Prime Minister directing the company to urgently enter into fuel supply agreements with electricity generators in order to mitigate the power crisis faced by the nation; and (3) refusal to resist the Draft Mining Bill in India’s Parliament, which the fund claims is highly detrimental to the interests of Coal India.

The Children’s Investment Fund ends its letter by threatening Coal India’s individual Board members with legal action.

Does it have a case? It doesn’t.

Without going into the merits of the arguments made by the fund, I want to point out something it apparently missed. The Children’s Investment Fund bought into Coal India by making an application for allotment of shares under the company’s Offer for Sale made by The President of India in October 2010. It seems to me that the Fund forgot to read the small print in the offer’s prospectus.

Buried inside this 510 page document, however, is a section called “Risk Factors.” Of the seventy risk factors listed, just two are enough to demolish The Children’s Investment Fund’s case.

Risk Factor 17: “We sell our coal at prices lower than the prices otherwise in the Indian and international coal markets. Although pricing of coal in India was completely deregulated with effect from January 1, 2000, we have followed a strategy of focusing on improving cost efficiencies to avoid price increases, and generally consult with the GoI in determining the price of our coal.”

Risk Factor 55: “The interests of the GoI as our controlling shareholder may conflict with your interests as a shareholder. Under the MoU signed with the MoC and our Articles of Association, the President of India may issue directives with respect to the conduct of our business or our affairs for as long as we remain a government owned Company… In particular, the GoI has historically played a key role, and is expected to continue to play a key role, in regulating, reforming and restructuring the Indian coal mining 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 interest and not necessarily to maximize our profits.”

If Children’s Investment Fund was to carry out its threat of legal action, the learned judge would surely throw out the complaint upon reading these risk factors. Her judgment would be brief: Caveat Emptor – a Latin phrase for “let the buyer beware,” meaning that buyers must perform their due diligence before purchasing anything.

Then there is another issue I am highlighting here because The Children’s Investment Fund has kept quiet about it, which is not surprising. This issue revolves around two questions.

First, just how profitable is Coal India?

Coal India is a stunningly profitable company. Over the last seven years, it’s coal mining business has delivered pre-tax operating cash flows aggregating to approximately Rs 91,000 cr ($18 billion) or an average of Rs 13,000 cr ($2.5 billion) a year while employing average operating assets of just Rs 21,000 cr ($4 billion).

That translates into a stunning pretax return on capital employed of 62% a year on average, which makes Coal India not just the largest, but also the most profitable coal mining company in the world. When it comes to profitability, other global coal mining companies do not even come close.

Second, what causes Coal India to be so stunningly profitable? After all, this is the same company which is “run to serve the public interest and not necessarily to maximize its profits” according to its majority owner. And this very company also has a Board whose members are in “breach of their fiduciary responsibility” according to a minority owner.

How can such a company become the world’s largest and the most profitable one in its industry, one with zero debt, and one in possession of more than $10 billion of cash?

You see, the Lord (“President of India”) that Taketh is also the Lord that Giveth. Coal India is stunningly profitable because the “Lord” grants it coal exploration rights, mining rights, acquisition of land and surface rights, and many other rights at throwaway prices. If Coal India was required to pay market prices for these rights, it’s super profits would turn into horrendous losses in no time.

It cuts both ways. A minority shareholder mustn’t complain about the majority’s interference with free market forces, without willing to sacrifice the profits sourced from that very interference.

You can’t have your cake and eat it too.

Note

I would like to thank Ravi Purohit for helping me in the research for the above post and also in formulating my thoughts on the subject.

Published by fundooprofessor

I am Distinguished Adjunct Professor at Flame University, Pune. Previosuly, I was Adjunct Professor at MDI, Gurgaon, where I taught MBA students two popular courses titled “Behavioral Finance & Business Valuation"(BFBV) and Forensic Accounting and Corporate Governance (FACG) for many years. I am also Managing Partner at ValueQuest Capital LLP— an investment advisory boutique which helps its clients invest their capital in good quality businesses.

5 thoughts on “Why Coal India is Not a Child’s Play”

  2. I think the minority shareholder has a right to complain. But the threat of legal action etc. is dangerous because it misuses the major pain imposed by the legal system in India (time/money etc) on a director, even if he is in the right. Still, a clarification from the government that it will fully back directors on their stand and even pay for their legal costs and effort will go a long way in telling such investors to back off.

    There is a murmur going around that coal mining licenses may no longer be a CIL monopoly, that they may be auctioned, in which case, the argument that CIL should charge market rates will also be valid. I don’t know if it will happen, but surely, it will help a CIL case to raise rates.

    This is the kind of subsidy that hurts our economy needlessly. Today the government has a huge deficit, and one way to bridge that deficit is through higher taxes. The other way is to auction stuff it owns (like coal mining licenses). Let Coal India bid, and pay higher, now that it’s not a monopoly. Then let it raise coal rates to international levels.

    This creates a problem with power purchase agreements with power plants that have been offered coal at fixed rates. Use some of the income received from the auctions to honour those guarantees for a fixed period, but ensure that the operators buy coal at market prices after that. This creates a feedback cycle – the higher price of coal will deter investment into coal projects and perhaps move people into using gas as a fuel instead. Importantly, this raises government revenues so they don’t have to tax the life out of us, and the subsidy impact is lower (it is always lower to subsidize only the end-user than to subsidize the entire chain).

    Finally, I don’t like the fact that the fund is trying to arm-twist the government using the investor’s protection part of the treaty with the UK. But like you said, the risks were not hidden – they were well known. In the recent ONGC auction, the risk remained that the government could palm off substantial parts of the subsidy into ONGC’s books, which is why no one bothered to subscribe (other than LIC).

Comments are closed.