The curious case of Children’s Investment Fund vs Coal India

Not the fans, but U.S. investors may turn out to be the ones who help the UK-based 'soccer' club and its owners, the Glazer family, raise up to $333 million in its IPO.

A Dreamliner in Air India colours at an airport in Washington
A Dreamliner in Air India colours at an airport in Washington

UK-based hedge fund Children Investment Management Fund (TCI) has dragged Coal India Ltd (CIL) to court over illegal interference of the government in the functioning of the public-owned company. TCI is a minority stakeholder in CIL owning little over 1 per cent in the public sector unit (PSU), while the government owns 90 per cent.

The basic premise of TCI’s argument is that the Centre has “illegally” interfered with CIL’s functioning. As TCI says in a press statement, “Ministry does not have legal authority to interfere with the discretion with CIL as it has been doing on a regular basis.”

But is the Indian government really, ‘illegally’ interfering with CIL’s operations? Here is your ten point cheat-sheet on the matter.

1) TCI has alleged that it is “seeking to quash the letter dated 25 January 2012 written by the then coal secretary, Mr Alok Perti, to CIL instructing it to revise the price hike CIL made in December 2011.” Interestingly, the secretary of any ministry is appointed by President of India, and so is the chairperson of a PSU. Secondly, the Central government nationalized coal mining between 1971-73, giving the Centre absolute power in the sector.

2) When TCI invested in Coal India’s initial public offering, the international hedge fund, as a prudent investor, was aware of the inherent risks in the investment mentioned in the “Red Herring Prospectus” (RHP).

3) Point No. 14 of the ‘Risk factor’ in the RHP says, “Our operations are extensively regulated by the GoI (government of India), state governments and various statutory and regulatory authorities. The compliance costs, liabilities and requirements associated with existing statutory and regulatory requirements and adverse regulatory or policy developments can have a significant impact on our operations.”

4) Similarly, point No. 17 clearly talks about pricing regime in India. “We sell our coal at prices lower than the prices otherwise in the Indian and international coal markets,” it says.

5) Also, TCI in its letter to the Coal India chairman talks about wage bill of CIL going up by Rs 6,500 crore.  But even this risk in investment was highlighted by Coal India in its RHP. “Significant increases in our employee remuneration and benefits may adversely affect our expenses and may adversely affect our financial condition,” the RHP says.

6) The Delhi High Court has issued notices to Coal India and the Central government. However, seeing the facts, it looks like government can fend its case in court easily. TCI has repeatedly claimed a loss of opportunity of $1.5 bn because of regulatory interventions. But being an international hedge fund, TCI was expected to go through these facts thoroughly before making any investment.

7) TCI argues that Coal India can supply electricity worth $18 billion through the dividend it can pay to government if the coal prices are aligned with international prices. Indian households, on an average, consumer 195 billion units of power annually. Its rationale is that, with a higher price of coal, CIL’s earnings will grow along with a subsequent rise in dividends. With higher dividend (annual and interim), govt can afford to supply subsidised power with that fund. But then Coal India has already aligned its coal prices by introducing the Gross Calorific Value (GCV) price mechanism in January this year from the earlier useful heat value (UHV) mechanism.

8) However, TCI alleges that the then coal secretary asked CIL to roll back the price hike after the implementation of the GCV regime. But a minute reading of the grade of coal gives a clear picture that prices actually went up. The number of grades of coal went up from seven (under UHV) to 17 grades under GCV and the price went up by at least 9 per cent. Also, formally one of the major subsidiaries of Coal India, Western Coal Fields Ltd (WCL) hiked the prices again, formally, from June 21, 2012. So TCI’s claim of not hiking the price seems little misplaced.

9) Of course, one of the arguments can be that there is a direct relationship between the shortage of electricity in India and a lack of commercial incentives for coal and power companies. Indian coal miners are not incentivized to expand production due to capping of coal prices. This results in a lack of coal availability to power companies, which, therefore, have limited incentive to build new power stations. Also, as far as CIL is concerned, there is no question of pricing freedom to the company.

10) Nevertheless, TCI has surely highlighted some of the crucial issues related to the interest of minority shareholders and corporate governance of the PSUs. Also, cases like this will surely work as a deterrent for the foreign investors. In a similar case, Goldman Sachs in 2009 had pointed out increasing government interference in ONGC’s functioning by asking it to share the subsidy paid to its downstream oil PSUs—IOC, BPCL, HPLC. Though the allegations were promptly denied by the then-ONGC management, the fear of foreign investors became evident in ONGC’s divestment last fiscal where finally PSU giant investor and India’s leading insurer LIC had to bail out the issue. Similarly, the government can argue in the case of Coal India that TCI should have not invested in CIL IPO, that too knowing the risks highlighted in the RHP.