Leasing a better option than privatisation

Dr Jamal Khan :
PRIVATISATION refers to the transfer, both total and partial, of ownership and control from the public to the private sector with particular reference to asset sales. Not necessarily involving payment or sale, the concept has been employed to describe more general structural changes embracing tools, such as leases, management contracts, franchising-out or contracting-out, the general contract of the public sector and reassessing property rights from the public sector to private individuals and entities. In another context, privatisation is the process of introducing and internalising the discipline of market forces, and is akin to marketisation embracing the removal of monopolies or the attenuation of entry barriers. In many countries including Bangladesh, privatisation describes the transfer of ownership or control from the public to the private sector.
Historically, questionable enterprises have been liquidated as a result of being unviable, turning out to be profitable enterprises, such as financial institutions, were also privatised. Contracting-out has been a widespread practice. Adjustments and readjustments, especially the restructuring of enterprises, were made. Performance contracts were introduced and supervisory councils came on board. Enterprises’ technical, managerial and financial skills were targeted and beefed up. To order to hone managerial skills, some enterprises were placed under holding companies. Attention was paid to ensuring that the performance contracts were effectively executed. However, regulatory and policy measures failed to yield substantial improvements in enterprise performance.
For the record, the rationales underlying privatisation are several. One, a known conduit of privatisation entails the share sale to the public – seen as a tool of reversing historical dependency, correcting some of the imbalances in wealth and ownership of productive assets, and a counterbalance to the domination of family-owned businesses. Two, the attitude to privatisation has been influenced in part by the winds of philosophical, ideological and cultural change sweeping the world. Three, the recognition that ownership does not necessarily ensure control has been a contributory factor. Four, a major influence has been the declining capacity of the enterprises to generate and deliver outputs. Five, privatisation is supported by some enclaves who identify constraints on their ability to increase their compensation benefits and to attract and retain high-level skills. Six, there has been some public pressure for share ownership.
The pressure grows in direct relation to the rise of aspiration and the degree of inequality of wealth and income. Seven, with the losses of enterprises being funded by public finances and bank borrowing, privatisation is seen as a tool of disburdening the financial load. Eight, with the burden of foreign obligations arising from devaluations and debt rescheduling being onerous and the discounted future income stream being negative, the enterprises became candidates for divestment and privatisation. Nine, it may be driven by expected benefit flow, such as the transfer of liabilities, the introduction of structural change and a long-term increase in productivity.
A range of disposal tools are available, viz. asset sale, joint venture, equity acquisition, share issue, liquidation, management contract, lease/rental, going concern and closure. Of these, asset sale is most frequently used. Such sales are via public tender or private treaty. The use of the other privatisation modes is determined by capital market and current policies. In many countries, the choice of a mode is not a problem because the limited capital market and insufficient domestic savings rule out some of the share issue options. While sometimes share issues tend to be undersubscribed, there are instances where shares have been successful.
It is contended that equity is not an effective tool because of its emphasis on control, investment return and quick payback instead of return on sales. If the option is equity, the parties should hold equal shares. Joint ventures and debt-equity swaps are tried. In pursuing joint venture, the option with a few exceptions has not taken off, for example, investors are not enthusiastic, fails to attract much interest, it is unstable than other options, it requires long-term trust and mutual effort, it tends to be financially and operationally weak and unbalanced sharing of the costs and benefits. Debt-equity swaps fail to make a mark primarily as a result of financial squeeze, indebtedness and low repayment capacity. It may be considered if linked to additional capital inflows and fiscal and monetary targets. Leasing appears to work reasonably effectively.
No less than nine discrete sets of tasks may have to be completed with respect to each targeted enterprise to be divested and privatised, viz. defining the objectives of the specific privatisation exercise; selecting the privatisation team; operational and financial review including external audit; financial restructuring and legal regulations; prospectus preparation; discussions with and presentations to investors; preparing bidding documents; sale negotiation; and sale finalisation and transaction closure – signing, payment, registration, etc. Crucial to the success of an exercise are an informed assessment of the financial and operational credentials of buyers and accurate and timely information on the enterprise to be privatised.
The need for assessment is clear. With a straight sale of assets, an elaborate background check of a buyer is unnecessary. But when an entity of strategic, productive or employment value is sold, buyer credentials must be ascertained. National interest may not be served if a buyer is incapable of delivering outputs, a fair price is not obtained or asset-stripping occurs. To this end, a buyer’s financial and technical capacity, transparency and accountability record and industrial relations history need to be checked. Failure to check facts carefully would be politically and financially unwise and in terms of policy naïve.
It is often difficult to verify definitively and inexpensively the financial credentials of buyers. Some needed information are: examining an enterprise’s financial and physical operations; establishing initial value of assets; checking approaches to divestment; compiling legal issues, such as asset ownership and land titles; and ascertaining right of shareholders and employees. The information required, for instance, for valuation includes: a company’s history and nature; the background; explanations for poor performance; tangible and intangible asset values and goodwill; earnings record; previous stock sale and sale size; and market price of a comparable company. The shortage of skills and experiences stands in the way of buyer assessment, including checking the data sources and verifying data reliability.
External assistance is helpful but costly. Raising professional fees for pricey consultants is difficult. The time and effort required for quality work during the preparatory phase is underestimated. Membership of international institutions can be useful in providing information and expertise.
In preparing information for buyers, the objective is to capture the interest of investors by highlighting a company’s positive features and growth potential. If sale is not emphasised, the offer may attract a few takers and those who want bargain basement deals. An aggressive approach to a sale, preparing an appropriate prospectus and turning around an unviable company would require skills and resources, such as auditing, accounting, negotiating, advertising, law, marketing, finance, management, cleaning up balance sheets, transferring obligations and workplace/plant rehabilitation. Some even argue for a company restructuring prior to privatising, which imposes cost burden. Selling can, of course, get complicated when many assets assumed to be the property of the sellable entities are found not to be on their books and hence not theirs to sell, or land has been compulsorily acquired for public purposes and the government is not free to dispose of this land.
Privatisation is effected primarily by way of private placement and tenders in developing-country systems marked by monopoly, monopsony, sketchy skill base, underdeveloped capital market, fragile liquidity situation and a relatively slow-moving red-tape-riddled management system. Often, the bids provide for no ineligibles, the response for real estates tends to be low, sometimes very few offers are received, negotiations for larger enterprises tend to be limited to a single potential buyer, the two-stage bidding process is not popular, low offers or bids persist, and disputes occur. Also, where potential bidders are technological or market rivals, the process is fraught with the risks of retaliation and non-cooperation. When this happens, it discourages other potential buyers and partners who see one company having an unfair advantage because of the inside track that it enjoys. When there is no competition for an enterprise, the government is forced to make a choice between a low offer or enterprise closure.
Where management contract is under consideration, the buyers do not beforehand commit themselves to equity. The public sector tends to appoint one or two directors to the directorial board. The downside is that the information base – asset value, priority, etc – is captured by the contracted enterprise management.
The larger management system can be hurt by low-key communication campaigns, tentative deadlines for the completion of discussions put more pressure on the government than on the buyer, and increased transparency that is required in decision-making has been more challenging than expected. Notable, too, is that the interests of the investors may not coincide with the needs and priorities of the public sector. Generally, interest tends to be negligible in closed entities, small entities and non-tradables. Pressure is exerted on the public sectors for the divestment of the most profitable enterprises. Eventually, the most profitable ones find their way to divestment and privatisation. Indeed, increased profitability and attractiveness, future investibility, the visible success story and credibility can swing the reasoning for privatising more enterprises in developing countries.
Market economy and its nature and rationale being what they are, the fiscal concessions sought by almost all investors pose challenges.
Insistence on 25- and 50-year tax holidays and 10- to 40-year monopolies are not uncommon even when the enterprises being acquired are profitable. Basically, the public sector maintains that once an enterprise is privatised without handicaps, they ordinarily warrant no special concessions. But the downsides are changing ministry-led negotiation positions, poor state of infrastructure in the country making investments risky, investors paying cash and completing payments within a year or so, investor reluctance to take on enterprise liabilities including payables, and more concessions being sought by investors.
Minimising such concessions turns on the resoluteness, practicality, expertise and exposure of public sector negotiators. Fiscal concessions, negotiating success and deal completion rest on realistic deadlines for the completion of the process.
(Dr Jamal Khan was professor of public sector management at the University of the West Indies. jamalabedakhan@hotmail.com)
 (To be continued)