Financial Management (II) MFM Sem IV

DISINVESTMENT AS A STRATEGY
One of the easiest ways to understand divestment is to think in terms of a company that has successfully produced a product for many years. However, changing technology is shrinking the demand for the companys product. A new product is developed that is anticipated to recapture the interest of consumers. However, this will leave the company with several physical facilities and a great deal of equipment that is not required for the production of the new product. In order to generate revenue that will aid in the manufacturing of the new product, the company will undergo a period of disinvestment. The plants and other facilities that are no longer required for production are sold off, along with the now obsolete equipment. By generating income from the sale of these divested holdings, the company creates resources that constitute a capital investment in the new product. At times, a company may choose to sell off a subsidiary or business unit as part of a disinvestment strategy. Doing so allows the company to begin the migration from focusing on one market sector to a different sector that holds more promise. In some cases, disinvestment involves selling the business unit to another company. At other times, the business unit is spun off into a separate company altogether. Disinvestment can also occur when there is a decision to make changes in the regulation of an industry. Perhaps the most well known example of this type of disinvestment application would be the deregulation of the communications industry in the United States during the 1980s. As part of the process, the Bell System was completely divested and emerged as eight different entities: the new AT&T, and seven regional Bell companies that were known collectively as the Baby Bells. Because disinvestment does involve the sale of resources, companies often look very closely at the process before actually implementing any type of divestiture action. It is important to make sure that the investments that are released are not likely to be required in the future, and that the revenue generated from the sale of the investments is highly likely to result in increased profitability for the company in the long run. Difference between Disinvestment and Divestment Both private and public organizations choose to divest or disinvest assets for many reasons. One of the most common reasons for both is to raise capital. Other common reasons include social or political pressures from third parties. There is very little difference between divestment and disinvestment, and both achieve the same goal of reducing and not replenishing capital.

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Financial Management (II) MFM Sem IV

Divestment

When a company divests, the company disposes of part or all of its business. Divestments commonly occur when a particular division of a company does not live up to its expectations. This can result from financial reasons or because the division has violated the principles of the parent company. Another common reason for divestment is social pressure placed on a company conducting business in or with a country that has an unfavorable political climate.

Disinvestment

Disinvestment, also known as divestiture, occurs when an organization liquidates or sells part of its assets or an entire division without the intent of reinvesting in it. The divestiture typically occurs so that the organization can use the assets to improve another division. A disinvestment can occur with the sale of capital goods or closure of a division.

Disinvestment in Indian Scenario Most public sector undertakings (PSUs) were set up in India in a complex situation where there was a dearth of industrial participation in the Indian economy. These companies had been the pillars of the great Indian economy, but at the wake of economic policies in 1991, they had a negative rate of return on capital employed. This was not a good sign of a thriving economy coupled with the policy of globalization. The government had to get rid of these companies or at least handover a part of holding to private persons. Thus came about the birth of disinvestment policies in India. In general terms, disinvestment is simply selling the equity (share) invested by the government in PSUs which are either owned completely by the government or whose shares are maximum owned by the government (51% or above). Examples include BHEL and ONGC. There are two main reasons in support of disinvestment. One is to provide fiscal support and the other is to improve the efficiency of the enterprise. The argument for fiscal support emphasizes that the resources raised through disinvestment must be utilized for retiring past debts and there by bringing down the interest burden of the government. The second argument in support to improve the efficiency of public enterprises through disinvestment is the contribution that it can make to improve the efficiency of the working of them. Methods of disinvestments: 1. Purchasing the stake or acquiring the company by opening the membership for all 2. To sell shares through

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Financial Management (II) MFM Sem IV

a. fixed price b. book building c. auction where the highest bidder would be accepted Now that an overview of disinvestments has been established, we must concern ourselves with the advantages and disadvantages of disinvestments. Advantages of disinvestments In an ever growing economy, investment by the government alone would not suffice. It is of absolute necessity that even private capital is entertained at the maximum level. The most economically successful country has the highest amount inflow of private capital. After 1991, the private inflow of capital has been high. And the phenomena of disinvestment have constantly supported this inflow of private money. The money received from the process of disinvestment can be utilized to compensate the deficit finance. The market thrives if there is sufficient amount of competition. If new firms enter into the market, then the competition increases which in turn makes the companies more competitive an advantage for the consumers as they may experience choice. The PSUs which have undergone this disinvestment were (prior to the disinvestment) low productivity companies. Thus when the decision making capacity was given to private players, there has been a huge turn over with respect to optimum utilization of resources, capacity to invest, and profit. This is because the focus has been shifted to the PSUs as a profit making company. Disadvantages of disinvestments India is slowly shifting its base from a welfare and socialistic state to a capitalistic economy. Government companies or even PSUs are the heart of any socialistic state, the interest of the public is protected through these organizations. Unlike private companies who thrive for profits and strive to infringe the rights of people, PSUs were started for the people. Thus disinvestments are certainly against the interest of the people but it is a necessary evil. Foreign direct investments in these companies would mean more foreign control. This would mean that the sovereignty would be hampered. Selling equities to foreign companies result in serious consequences shifting the nation's wealth, power and control to outsiders.If a company is privatized, the job security would not be same as that of a PSU. Thus the risk of being unemployed if not proven to be useful to the company is high. Considering the advantages and disadvantages of disinvestment in a weighing machine, it can be construed that this is a necessary evil. There have been many instances where fundamental rights have been violated because of privatization (for example, the closure of mills in Mumbai), but it has caught like wildfire in India.

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Financial Management (II) MFM Sem IV

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