ONGC oil platform
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When the going gets tough, the tough get buying -- as long as they are solvent. ONGC (Oil and Natural Gas Corporation) is moving in for the kill just when oil prices are recouping in the $44-$47 per barrel range. ONGC has found its operational overheads soaring while hunting for oil in the past two decades, and swallowing a rival whose share price has held steady against most headwinds (see chart) would be no less easier -- but for the huge funds it can tap in the process without imploring the market for exigency cash.

The government's decision to bring two state-run oil giants under one roof amounts to enabling ONGC's, and well, its own enablement -- mediating stronger and consolidated control on the assets of both entities; while, thanks to the open offer being waived off, ONGC will not have to fork out the extra money needed to buy additional equity shares beyond the 51.1 percent controlling stake it will acquire from the government.

The long-pending decision has led to what leaves the oil trading community a wee bit shocked under the circumstances. The same can't be said for HPCL's minority shareholders. They seethe in quiet frustration. ONGC has been bleeding serious money for quite a while, and HPCL's shareholders are understandably not cheering the buyout when they see no potential gains in it for them. HPCLs' share closed down at Rs 367.35, or 4.34 percent below its previous close on the Bombay Stock Exchange on Thursday.

For ONGC, in which the government holds 68.07 percent stake, raising funds for the transaction may not be a stretch. The Rs 29,000-crore deal may not trigger an open offer as specified by SEBI, since the ownership of HPCL remains with a state-owned entity. This will save ONGC some much-needed cash which it would otherwise spend on buying additional equity shares beyond the 51.1 percent controlling stake it will acquire from the government. The HPCL shareholder gets no gains out of the deal, when an open offer has been dodged under the garb of state immunity.

Whether the deal, in particular the waiver of the open offer, is a clear violation of set processes followed in large buyout deals in India and globally is a question for the government to ponder, unless all its grandstanding on "level playing fields" is not applicable to its own corporate actions.

Since HPCL was widely expected to outperform other PSUs in the medium to long term, the valuation of the deal has raised questions among HPCL shareholders. ONGC's middling track record in capital allocation has not been factored in. Besides, ONGC Chairman D K Sarraf's comments on Wednesday that there will be no independent valuers for the deal, and no approval from the minority shareholders would be sought, raises enough red flags to block out the sun.

While ONGC's current cash surplus of Rs 10,000 crore will come in handy, the oil prospector may likely transfer its 71.62 per cent stake in Mangalore-based refiner MRPL to HPCL before acquiring the latter, a move that could fetch it around Rs 16,500 crore. HPCL already has around 17 per cent in MRPL, so market borrowings if any, by ONGC to lap up HPCL stake may be minimal.

The deal reduces the government's stake in HPCL to 35 percent from 51.11 percent, though a smoother level of control for ONGC over HPCL can be expected, going by their complementary investments held in different asset classes across the country.

The grand plan is to create a true oil behemoth, which could be to the benefit of both companies in terms of lesser business risk, but can fall short of many global oil giants when it comes to size.

ONGC-HPCL stock price comparison chart
Raghavendra N

Benefits, and riders

ONGC's buyout of HPCL at its current share price will help the government meet as much as 40 per cent (Rs 30,000 crore) of its target for raising Rs 72,500 crore in fiscal 2018 through stake sales. Industry watchers expect the deal to sprout new blockbuster mergers in the domestic oil sector this year, as energy giants snap up reserves that their cash-strapped owners cannot afford to develop.

Offshoot deals on the block could be Indian Oil Corp (IOC) buying out explorer Oil India Ltd or Bharat Petroleum Corp Ltd (BPCL) merging with gas utility GAIL.

In recent years, India's state-owned oil majors have become more acquisitive of oil block assets abroad as well. Earlier this month, cash-strapped Venezuelan oil firm Petroleos de Venezuela SA proposed selling a 9 percent stake in the San Cristobal field to ONGC subsidiary ONGC Videsh (OVL).

The benefits of all these deals, including the ONGC-HPCL démarche will lie in strong downstream augmentation, with ONGC benefiting from the huge fuel retail network of HPCL. But it will have to contend with HPCL's liabilities in the region of Rs 34,655 crore which almost match its assets of Rs 33,116 crore. HPCL's debtor days at the end of the last fiscal were 9, while ONGC's were at 27. Additional liabilities in this direction will not help ONGC, unless it has a clear debt management plan in place.

While the government's assistance will help ONGC gain leverage in funding the buyout using debt, challenges like HPCL's long-term debt of Rs 21,747 crore and the oil marketer's huge forex bleed down the years are of concern. HPCL had a negative forex account to the tune of Rs 27,560 crore at the end of fiscal 2017 ended March 31. These can stress the combined entity's balance-sheet in the short-to-medium term.

But the positives are that HPCL can make ROCE (return on capital employed) of around 20 per cent and also help ONGC in its efforts towards vertical integration and smoothening its profit streams in the future.

Another silver lining, despite HPCL's negatives on the forex front, is that the ONGC-HPCL combine would be able to hedge more effectively against volatility in oil prices, which will help it take the private players head-on. The future depends on how sensibly the merger is executed, and the amount of operational leeway it is given by the government. Otherwise, strategic rethinks will be imminent once the combined entity goes into business.