OREANDA-NEWS. September 5, 2011. All analysts tracking it have a strong 'buy' call on it, but that didn't prevent India's largest oil producer ONGC from underperforming in the past three trading sessions, even as the broader equity market recovered. It was ironic since the company had held its ground for more than a month, when the broader market was tumbling. Interestingly, it was the news of its long-awaited follow-on public offer (FPO) that caused a selloff.

ONGC's FPO has been talked about for almost a year now and was postponed at least twice before. In February '11, the company also issued 1:1 bonus shares and halved the face value to 5 in a bid to make its shares more affordable to retail shareholders. Still, the share price has not gone up anywhere since then.

For investors, if an FPO is just round the corner, which in all probability will be priced at a discount to the market price, it makes little sense to buy the shares from the open market. They would rather wait and buy in FPO at a discount. This is what caused a 4.3% fall on Tuesday. Investors have been avoiding the company for more than three months now. Since May 2011, the average monthly turnover in the ONGC scrip has steadily declined. For August, the average turnover in the scrip was less than half of that in May.

The price that the government sets for the FPO will be disclosed just a couple of days prior to the opening of the issue, which should happen sometime in September. However, that leaves little time to straighten out the key issue of subsidy sharing. Moving on to a formula-based subsidy sharing rather than the current ad-hoc system was considered essential for obtaining a better valuation at FPO. In its absence, the government will have to settle for a compromise - lower pricing.

Nevertheless, the second problem that needed to be fixed before FPO has been solved favourably. The Cairn Group has indicated that it will submit to all government covenants and share royalty burden with minority partner ONGC for Rajasthan's oil fields. This certainly has a positive impact on ONGC's future earnings.

If fundamental analysts held the company undervalued earlier, it was more so after the recent fall. A flat share price since February means even the potential benefits of reduced subsidy burden in Rajasthan haven't been priced in yet. In other words, ONGC's FPO has every reason to be successful whenever it opens.