Ruchi Agrawal Moneycontrol Research
The much talked about ONGC-HPCL deal has been in the pipeline since last year, and has been delayed due to clearances, valuation concerns and lack of funds with ONGC to execute the deal. Recently, there have been talks of a near 45-percent premium valuation for the deal estimated at worth over Rs 30,000 crore. This valuation premium seems like a desperate attempt by the government to fund its fiscal deficit gap by burdening ONGC.
Background
The deal in talking is for the government’s 51 percent stake in HPCL which was proposed for sale under the divestment target. A purchase by ONGC provides the government an opportunity to offload the stake without huge dilution to controlling power as the government holds a majority stake in ONGC too. The current market valuation of a 51 percent stake in HPCL stands at roughly Rs 32,000 crore, that too at a time when markets are at an all-time high.
Synergies in the deal
On the face of it, the deal is merely transactional as both companies are already under the majority government holding. With a vertical integration in the value chain between an oil explorer and an oil marketer, the deal provides an opportunity to HPCL for backward integration which would help in sourcing stable crude for its refineries in the current time of rising oil prices and help in protecting margins. For ONGC, it will enable integration with a major OMC (oil marketing company) and provide access to end markets for its products. It will also help them in bidding together for bigger global oil fields which are often outside their reach bringing in economies of scale.
The government side
Amid uncertainty on tax collections post GST and mounting expectations of a fiscal slippage, the deal is single- handedly expected to bring over Rs 30,000 crore to the treasury (without considering the valuation premium). Divestments have so far this year garnered Rs 53,800 crore, translating to a 25 percent shortfall to the targeted Rs 72,500 crore. This deal could help the government bridge the gap.
Deal Valuations
At current market price of Rs 415 the valuation of a 51 percent stake which the government holds in HPCL stands at around Rs 32,000 crore. However, recent estimates indicate a value of Rs 45,000 crore, which is a 45 percent premium over the market. This kind of premium seems heady, more so because the markets are already at an all-time high.
HPCL is currently trading at a 2019E (estimated) PE (price to earnings) of 10.2x and an EV/EBITDA of 7.6x which is much in line with peers. At Rs 45,000 crore, the current valuations of HPCL reflect a price of Rs 577 and a forward PE of 14.5s. This valuation falls close to that of larger international integrated oil companies. However, considering HPCL’s margins are almost half of GRMs (gross refining margins) of international peers, such a valuation for HPCL seems expensive. Moreover, with existing debt on books the EV/EBITDA for HPCL is ahead of that of global peers and a premium valuation would push it further up.
For ONGC, sealing the deal at a valuation of Rs 45,000 crore brings additional pressure in terms of sourcing the funds. ONGC currently has around Rs 13,000 crore cash on the books and assuming the rest has to be raised through debt, the deal would sharply inflate the interest cost burden. If not, ONGC might have to resort to funding the deal by offloading stake in Indian Oil Corporation.
Overall, the deal especially at a premium valuation would noticeably alter the debt-to-equity profile for ONGC and repress future growth. The significant capex planned for HPCL will also call for additional funding, adding to the burden on balance sheet, thereby defeating the short-term synergies.
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