The Supreme Court of Pakistan in its land mark judgement announced on June 23, 2006, cancelled the selloff Pakistan Steel Mills Ltd (PSM), thereby it protected the sale of national asset, the largest steel manufacturing plant, at throwaway price by the Cabinet Committee on Privatisation (CCOP) to successful consortium.
The PSM was incorporated in 1968 as a private limited company at a total cost of Rs 24.7 billion and its 100% equity is owned by the Government of Pakistan (GOP). During the period from 1968 to 2001-02 the PSM continued to suffer losses and was subject to politics.
In the year 2000, it undertook restructuring programme, which was implemented successfully. It started to earn profit from 2002-03 and in the year 2004-05 it had after tax net profit of Rs 3.938 million after it absorbed its accumulated losses of Rs 8,672 million sustained upto 2001-02.
In 2005 the Privatisation Commission Board (PCB) approved the privatisation of PSM despite the fact that it had wiped off losses and was an ongoing profit-earning enterprise of the GoP, having marketable assets much more than the liabilities and liquidated its substantial loan liabilities.
The process of privatisation of PSM was started with the appointment of M/s. City Group as Financial Advisor/Valuer (FA) assisted by their advisors M/s. CORUS to carry out technical due diligence and M/s. A.F. Ferguson & Co, for the purpose of accounting, tax, HR and IT due diligence alongwith M/s.ORR, Dignam & Co advocates for legal due diligence.
The Privatisation Commission (PC) provided guidelines to the FA for preparation of valuation report. The relevant extract is: "The objective is to apply various internationally accepted techniques to obtain valuation range of PSM as a going concern...... the valuation based on comparative pricing analysis will also be prepared. Input of the valuation model and valuation mythology will be reviewed with the PSM management."
The FA submitted the interim report of valuation of shares on October 28, 2005 and the final report on March 30, 2006. According to the summary prepared by PC and submitted to CCOP on March 31, 2006, it reported that the FA has conducted the valuation of PSM using three standard valuation mythologies used in global M& A transactions as under:

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                       The valuation Ranges between US$
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(i)     Discounted Free Cash Flow Analysis      407-464
(ii)     Public Multiple Analysis               307-406
(iii)     Preceding Transaction Analysis        389-501
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The PC Board in their summary also observed that the report of FA reflect core operation of PSM that is value of the surplus land and assets were not added in calculating the shares price of PSM. The non-core land and assets included Steel Town and Gulshan-i-Hadeed land, which have been evaluated at $500 million by evaluators. The replacement value of the plant is estimated at around $500 million.
Moreover the valuation did not include the current market value of downstream industries approximately 5000 acres reserved for NIP. Adding up these elements the value of PSM was in excess of $1.0 billion ie Rs 60 billion.
The above facts are sufficient to draw inference that the valuation conducted by FA, who are international consultants, did not account for the valuable land and assets valuing over $500 in determining valuation of shares, hence it did not reflect a fair value nor a valuation based on recognised accounting principles.
The City Group has committed similar mistakes and has been fined $1.12m by NASD, New York, for providing false data by them. It has been also subject to disciplinary action on similar problem in 1997.
The valuation of the share of the PSM, excluding the value of land and assets, involving considerable amount, was a serious omission which rendered the valuation report false, misleading and disappointing in view of the guidelines given to FA by the PC which prima facie did not restrict their scope of assignment. In the circumstances it is to be seen whether PC/GOP considers this lapse seriously and decide to disqualify them being their valuation report was not in accordance with their terms of reference.
The judgement has stated that FA prepared the valuation report on the basis of the report submitted by A.F. Ferguson, CORUS and ORR, Dignam & Co, without undertaking independent exercise in respect of accounting, tax etc and other aspects of the matter.
AF Ferguson, the advisor to assist FA, were engaged to conduct the accounting tax, HR and IT due diligence who have stated in unequivocal terms that they conducted their due diligence review based on the draft unaudited financial statements of PSM for the year ended June 30, 2005 which were provided to them by the management. They relied upon the said statement of accounts which were copied verbatim by them.
Further the judgement stated that the management has informed the FA that significant adjustments had been incorporated in the financial statements of PSM in the year ended on June 30, 2005 subsequent to the date on which the unaudited financial statements were provided to them for the purpose of their report.
This situation raises several questions, including whether the FA obtained the detail of the adjustments made in the financial statements subsequent to the delivery thereof to them on September 16, 2005 and whether it obtained the copies of adjusted financial statements.
Further whether the FA conveyed this important information or adjusted financial statements to their advisor, AF Ferguson & Co for their review and to modify their earlier report which had become insignificant in view of aforesaid subsequent developments. Moreover whether the FA insisted to the management of PSM for production of audited accounts which were necessary for such important issue of valuation.
The PSM is a private company incorporated under the Companies Ordinance 1984 under which it is mandatory for them to get their accounts audited. However, the Securities Exchange Commission of Pakistan (SECP) is authorised under the said ordinance to probe the transaction especially the matters referred to above.
The relevant issues required to be pondered upon by the SEC and the Institute of Chartered Accountants of Pakistan (ICAP) are that what options are available to the professional advisor where the management provides them inauthentic/unaudited financial statements for their certification or authentication.
Whether certification or report by the advisor/consultant, on the basis of such unaudited account or such other information provided by the management of the company, with disclaimer qualification by them, satisfies the mandatory requirements of the relevant accounting recognised principles.
If allowed such practice, will it not open the doors for the management of the companies to get report of their choice on the basis of garbage in garbage out? The guidelines on the issue by the aforesaid regulators have become necessary in view of emerging scenario of merger and privatisation of the companies.
Further the unaudited financial statements furnished by the PC to FA were prepared on historical cost basis.
The SC in its judgement has disapproved this conventional mode of valuation in the case of privatisation of a company. It emphasised to make efforts to adopt such a procedure on the basis of which fair market value of its assets are determined. This approach is in confirmative with the internationally recognised principle and World Bank Report wherein the principle for assessing the market value of assets for an ongoing concern has been stressed.
The valuation report of FA did not adopt the fair market value mechanism for the assets of PSM rather it relied on book value of the assets. The book value of the assets is adopted by the management in their financial statements where it considers that the entity to continue as a going concern. In case where there is an intention to sell the entity, the assets are evaluated at a fair market value.
International Accounting Standards 10 requires that an entity shall not prepare its financial statements on a going concern basis, if the management intends to liquidate the entity. Valuation of assets at book value means valued them at below their market value, which is tantamount to favouring the buyer. The methodology adopted by FA deprived the people of Pakistan of needed financial resources. The regulators should also consider issuing guidelines on the models of valuation internationally recognised to be adopted in case of privatisation of a company.
Moreover the valuation conducted by FA also appears to have not considered the relevant facts that PSM liabilities were much less than assets as shown in the financial statements in view of the fact that PC allowed the following concessions to the buyer which were not advertised in EOI but extended to them:

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                                      Rupees in Million
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(i)       Stock in trade                         10,000
(ii)      Cash in hand                            8,559
(iii)     Refundable advance tax                 10,000
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          Total                                  19,559
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Thereby the PC allowed total concessions amounting to Rs 42.29 billion to the buyer which were not disclosed to the public. If the effect of these concessions was taken in determining the value of share of the PSM, would increase by Rs 32.72 per share.
BASED ON THE ABOVE DISCUSSION THE VALUE OF THE SHARES OF PSM MAY BE ASCERTAINED AS UNDER:
Besides, allowing the above assets amounting to Rs 19.559 million to the buyer, the PC/GOP undertook the following liabilities of PSM at Rs 22.670 million to be paid by them.

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                                                Rupees in Million
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(iv)     Loan liability to be repaid by GOP                 7.670
(v)      Voluntary Separator Scheme to be paid by GOP      15.000
         Total                                             22.670
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1. The recommendation of FA (value of land and Down-stream industries excluded)

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                                          Ranges between      75%       Value
                                           In million         Stake       Per
                                                                        Share
                                                              Rupees   Rupees
                                            $        PAR                    -
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(i)     Discounted cash flow             407-464    27,840    20,880    16.18
(ii)    Public Multiple Analysis         307-406    24,360    18,270    14.16
(iii)   Precedents Transaction Analysis  389-501    30,060    22,545    17.47
2.      Recommended by Board of
        Privatisation Commission             500    30,000    22,500    17.43
3.      Approved by Cabinet Committee on
        Privatisation                        464    27,840    20,800    16.18
4.      Value estimated in the Summary
        of PC submitted to CCOP includes
        market value of land and down
        stream industries                  1,000    60,000    45,000    34.87
        Add to above value of shares
5.      Estimated value of undisclosed
        concessions detailed above           704      -       42,229    32.72
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The above share value is determined based on the facts and figures given in the SC judgement and reveals vast difference in each case. The difference in value between the value recommended by BPC at Rs 17.43 and approved by CCOP at Rs 16.18 is Rs 1.25 per share, which resulted in total loss of revenue of Rs 1,613.11 million to the GoP. But when compared to the value ascertained taking into count the value of the land and down-streams industries, and concessions allowed to the buyer, the difference comes to Rs 51.41 per share, resulting in huge loss of revenue to GoP which comes to Rs 66,343.95 million as under.
BASED ON BOOK VALUE, IT WOULD INCREASE IF THE ASSETS ARE VALUED AT A FAIR MARKET VALUE: Total Loss to GoP on selloff: Rs 34.87+32.72-16.18 x 1,290,487,275 = Rs 66,343,950,807.70
Interestingly that both, the buyer and the seller, have adopted the same DCF method of valuation which generally favoured the buyer. But the PC did not care about this fact. This method of valuation is not in accordance with the internationally recognised principles that ensure the maximum price to the seller in the case of strategic sale of an asset, hence the SC disapproved it.
Further the SC did not approve the decision of CCOP on the reference price at Rs 16.18 per share on the ground that it was taken disregarding the mandatory rules and also all materials which were essential for arriving at a fair reference price.
At the proposed said value, it would fetch Rs 20,880m, which is less than total assets stood on 30-6-05 at Rs 36,687m and little more than 2% equity was on the said date at Rs 20,419 million.
THE LESSONS: The SC by delivering this judgement has rendered great service to the nation, it protected the valuable national strategic asset from sale at a throwaway price or even at a negative price, if above concessions allowed are taken into account. The outcome of this exercise should be utilised to prevent recurrence of such event in future.
THE FOLLOWING MEASURES ARE RECOMMENDED:
-- The Privatisation Commission Ordinance of 2000 be amended to provide for accountability, responsibility and disqualification of its member, if found guilty of breach of trust and using his office disregard the mandatory rules;
-- The PC has failed to repose confidence and trust in the minds of the people of Pakistan in performing their functions faithfully as evident from the past transactions particularly privatisation of KESC, HBL and instant case of PSM. It, therefore, should be reconstituted enlarging its membership to non-ruling class and intellectuals;
-- The final agreement of purchase and sale of unit to be privatised, particularly in case of assets of strategic nature, should be ratified by a committee headed by a retired judge and comprising members of Parliament.
-- The question now generally asked is that what is next...... and in view of the statement in Press by the Federal Minister for Privatisation Commission that no one can be held responsible for selloff of PSM, a commission be constituted, headed by a retired judge of SC, to fix the responsibility of the PC members who disregarded the mandatory rules in conducting the transaction of PSM and recommend disciplinary action against those who are found guilty; to safe guard such event in future.
-- The SEC may initiate to frame guidelines on the technique of privatisation, on matters concerning accounts, valuation and other related issues.