UPDATE 2-ONGC auction debacle batters India divestment hopes
* May hurt prospects for upcoming share sales
* Market slams pricing, bad management
* State investor LIC likely bid for more than 50 pct of offer - source (Adds bid price details)
By Tony Munroe and Prashant Mehra
MUMBAI, March 2 (Reuters) - India's failure to sell all of the shares in its $2.6 billion auction of a 5 percent stake in Oil and Natural Gas Corp is an embarrassing setback in its effort to revive stock sales in state companies to trim a yawning fiscal deficit.
The government's handling of the share sale, seen as a litmus test for its stalled privatisation agenda, was widely slammed as being aggressively priced, poorly marketed and shoddily executed, with bid details plagued by confusion.
ONGC shares fell more than 2 percent on Friday, a day after the government sold just 98.3 percent of the shares on offer.
State-run Life Insurance Corp of India (LIC) took up more than half the offer, a banking source with direct knowledge said, while some media reports said the insurer had bought close to 90 percent of the shares.
A senior official at LIC declined to comment.
"It is bad management, and should not have happened. No one wants this mess happening again," Pronab Sen, principal adviser at India's Planning Commission, told Reuters in New Delhi.
"They have to tighten how the disinvestment happens," he said.
The government hoped to follow up the ONGC sale by unloading shares in Bharat Heavy Electricals Ltd, Steel Authority of India Ltd and Oil India but will need to rethink how it manages and prices those deals.
The floor price for the ONGC auction, set at 290 rupees late on Tuesday, was at a 2.3 percent premium to the day's closing price, prompting widespread criticism that it should have been priced at a discount.
Analysts blamed the deal's bankers and the stock exchanges as well as the government for poorly managing the auction.
"The pricing was not favourable in terms of the market scenario we are operating in. They should have left something on the table for investors," said Jigar Shah, head of research at Mumbai's Kim Eng Securities.
The government said it received valid bids for 420.42 million shares, at a volume weighted average price of 303.67 rupees per share, raising a total of 127.67 billion rupees ($2.57 billion). The government had offered 427.77 million shares.
A lack of clarity on how much of India's hefty oil subsidies would be borne by ONGC was a key deterrent to more interest from foreign institutions, bankers and analysts said.
In future deals, the government will need to address the concerns of overseas instititional investors about regulatory risk associated with investing in state companies, they said.
Earlier this month, the government decided state-run oil and gas producers such as ONGC would share nearly 38 percent of revenue losses on fuel sales during April-December, up from the 33 percent share in the first two quarters of this fiscal year.
The resulting higher provisions drove down ONGC's third-quarter profit below market estimates, and its chairman said provisions would remain high in coming quarters.
"Our reading is there must have been stock-specific issues. The challenge would be to deal with the subsidy overhang," said Sudhakar Shanbhag, chief investment officer at Kotak Mahindra Old Mutual Life Insurance.
The auction itself drew wide criticism. The websites of the two main exchanges failed to update bid activity after 3:20 p.m., 10 minutes before the close of the auction, leaving investors in the dark on the bidding outcome for several hours.
TV stations initially reported that two-thirds of the shares had been bid for, but there were no official confirmations.
The result was finally announced about seven hours later by the exchanges, which said some buy orders had been erroneously rejected by custodians and that their own systems "operated normally and smoothly and there were no glitches."
On Friday, the finance ministry said bids worth roughly 37 billion rupees ($747 million) were cancelled or rejected due to insufficient funds.
"Perhaps the fatal misunderstanding was, I think, the government banked on a couple of large investors to come in as anchors so to speak and lift a lot of that stock," said Saurabh Mukherjea, head of equities at Ambit Capital in Mumbai.
"Those guys failed to materialise, perhaps without assurances from the government on subsidy sharing," he said.
Citigroup, Bank of America Merrill Lynch, HSBC , Morgan Stanley, Nomura and India's JM Financial advised on the ONGC deal.
The government, which is widely expected to miss its target to trim its deficit this fiscal year to 4.6 percent of GDP by a percentage point or more, is desperate to pare stakes in state firms but has been thwarted by weak markets.
In a move that expands its options, New Delhi on Thursday allowed cash-rich state companies to buy back shares, with the cash proceeds going to the government.
The ONGC deal would bring its total share sale haul for this fiscal year to about $2.75 billion, far short of its target of $8.1 billion. The government's direct holding in ONGC will fall to about 69 percent with the sale of the five percent stake.
"Had this ONGC issue got a healthy response, it would have added a positive flair to market sentiment and future disinvestment proposals," said Jagannadham Thunuguntla, head of research at SMC Capital. ($1=49.51 rupees)
(Additional Reporting by Manoj Kumar in NEW DELHI and Manoj Dharra in MUMBAI; Editing by Ted Kerr)