A few thoughts on asset sales

I read with interest Gordon Campbell’s ten (eleven?) myths about asset sales. A few thoughts it triggered below.

Storm, teacup

Overall, I think the case for asset sales is better than Mr Campbell maintains but still hardly a slam-dunk. And tragically I don’t think the question of who owns these five companies is actually terribly important to the country’s long-term prosperity, by which I mean our ability to move above 32nd place (behind Greece (presumably soon to move down a bit) according to the IMF and World Bank) on the global income scale, or below 23rd equal place on the global income equality scale). As an election issue, it is all terribly interesting, but hardly something to die in a ditch over, either way. It seems almost tragic that the defining issue of this election is something so relatively unimportant.

Basically three points below – one about the fiscal impact of these sales, one about New Zealand ownership, and one general sum-up point on the overall impact of this policy, plus a question.

Fiscally the question is how much we should fear debt

I had a read of some of the Treasury papers. They put a strong emphasis on the short-term fiscal story (i.e., reducing debt in the near term), along with deepening the capital market as objectives. Economic benefits are said to be “moderate” (and not measured numerically, at least in what I read), primarily because the power companies and airline operate in reasonably competitive environments anyway and and Ministers do not intervene in day to day operations, so state ownership does not make them measurably less efficient.

Mr Campbell’s first point is that we should not sell these assets because they make a good return.

I defer to him and others on the mathematics of whether a sale makes sense financially, i.e., whether it is better to pay down debt now and forego dividends or to keep debt higher and keep the dividends coming. Presumably a lot depends on how important reducing near-term debt is relative to the future stream of dividends, and on whether we risk a sudden crisis of confidence amongst those who are currently inclined to lend us money. Mr Campbell quotes Bernard Hickey and Rod Oram, who presumably should know, saying that the long-term sums favour holding on to at least the electricity companies. Ministerial announcements suggest they are more concerned about reducing near-term debt.

But we shouldn’t kid ourselves. The electricity companies do not look like an excellent investment in themselves.

The NZ Super Fund made 25% in 2010/11 and 15% the previous year (although I see it has had a tough couple of months recently). ACC’s investments are running at just under 11% for the year to date. Against that, the 7.6% Mr Campbell quotes (quoting Bernard Hickey) from the electricity companies looks pretty ordinary. Even buying Auckland Airport bonds (to take one example of many) would return 8%, and without the risks and political complexities of ownership or the need to put up more capital or deal with strategic decision-making.

If this is just about the fiscal picture, the government should sell these electricity companies and put the money into better investments.*

That said, a substantial flow of future dividends would be relevant when it comes to the question of when to sell these assets. It does seem short-sighted indeed to suddenly ditch spectacular earners in favour of paying down debt if our creditors seem likely to continue to be happy to lend to us, and future dividends are both strong and likely, and would otherwise go to foreigners.

In fact, though, I think the companies are quite different from each other when it comes to their value as investments.

Air NZ is clearly the least worthwhile holding on to.

Generally the airline business is a shit one to invest in if one wants to generate a return. No less an investor than Warren Buffet has famously said so – always love a good geocities link – and even he poured some money in to a US airline at one point. Fortunately Air NZ itself seems to be well-managed and provides excellent services (from my limited experience, it is the best airline in the world by some distance), and even then it seems to be a poor investment – Air NZ has lost 10% in value compared with the NZX in the last two years. And to retain access to international air rights granted to New Zealand, an airline needs to be majority New Zealand owned. So fears of a foreign owner seem unlikely to be realised.

The electricity companies are a better bet to hang on to, but even their returns are far from guaranteed. The 7.6% figure that Mr Campbell (quoting Bernard Hickey) uses is based on 2010 results, but such healthy dividends have not always been the rule. Basing a comparison just on 2010 (total dividends 733 million) would give quite a different comparison to 2009 (total dividends 182 million). Total dividends from the four SOEs are given below. You can see they vary quite a lot over time, and that these four SOEs are responsible for most of the SOE dividends overall.

Total dividends from electricity SOEs 2008-2010 ($ million)

2008 2009 2010
Genesis 29 36 39
Meridian 298 30 354
Mighty River Power 56 56 286
Solid Energy 0 60 54
Total 383 182 733
Total for all SOEs 445 245

2008 and 2009 figures come from page 52 of this Treasury document . 2010 figures are from Mr Campbell quoting Bernard Hickey.

On these figures, Meridian looks like the star performer financially. Its 2011 dividend figure is even better – an enormous 684 million.

Also, Mr Campbell compares the dividend flow against the government’s cost of debt at around 5.5%. It is true that any return higher than that means that taxpayers are financially better off from the investment. But that in itself is not a good reason to hold on these assets. The threshold for an electricity investment should be much higher than 5.5%, since it is clearly far riskier as a business than investing in New Zealand government bonds.

Vector claims this threshold level for investment in electricity distribution is is higher than the just under 8% the Commerce Commission has set and will get its day in court to argue that. I am not sure how electricity generators and retailers compare, in terms of risk, but I would be surprised if it were much lower. Certainly things can go badly wrong quickly in the electricity business – witness Transalta, who exited New Zealand after losing many millions extremely fast after what looked like some poor company decision-making.

Wah, wah, New Zealand ownership, wah, wah

Mr Campbell uses Contact Energy as the example of how bad it is that people don’t hold on to shares long-term. To me, the fact that lots of people sold their shares is simply because the initial allocation was so generous.

For Contact (listed May 1999) a share was $3.10 for the public, compared with the $5 price Edison paid for its 40%. Just by flicking off their shares at the $5 price, New Zealand investors could make a 60% return on their investment in a very short time.

Mr Campbell notes that Edison made a lot of money on its shareholding. The 220,000 New Zealanders who bought the 28% of Contact shares available to them would have made more than $800 million if they had all sold at $5. Lots of them did sell early on, by the look of it. Anyone who sold out of Contact early did well, foreigner or local.

Vector was a similar example, more recently, but a partial privatisation and a company that remains majority publicly owned. 25% of the company was offered to the public at a discount price. Again, no wonder early investors would sell out, since they likely only bought in in the prospect of short-term gains.

To me this is not so much evidence that New Zealanders are feckless investors with no eye to the future (Mr Campbell’s apparent thesis) but instead evidence that New Zealanders know a short-term bargain when they see it.

Something similar will doubtless happen this time around if it looks like the power companies are being offered to retail shareholders at a sweet price.

From the point of view of taxpayers, these low sale prices to retail investors should both make us unhappy (because we are selling our silver too cheaply – albeit to fellow taxpayers) but also we personally should celebrate and buy as many shares as possible (because we can benefit financially and fairly immediately if history is any guide).

Perhaps the NZ Super Fund or the ACC will pour in some of their billions, and both New Zealand ownership and government control will continue.

Why bother with state ownership really

From what I have read, the impacts seem to be:

  • lower public debt in the near term – assuming the proceeds are used to reduce or avoid borrowing
  • lower crown revenues (and thus a higher operating deficit or lower surplus) in the medium term assuming the reduction in borrowing is less than the foregone flow of dividends
  • some number less than 10% to 15% of New Zealanders who reportedly currently invest in the sharemarket, will directly own a portion of these power companies
  • some proportion (based on the Contact sale, say 20% or so – Mr English says 15% but this figure could grow over time) of the companies’ shares will be owned by foreigners.

Given how modest these impacts actually are, it seems to me a bit sad that we can’t find something more economically meaningful to argue about with such energy and enthusiasm.

One more comment on government ownership. I find it weird that at the heart of the model we have of government ownership is that the state does not get involved much in running the company. I think this is a good policy for efficiency, don’t get me wrong: I don’t want Ministers deciding what routes Air NZ should fly or how many Grabaseat flights should be offered, anymore than I want Ministers deciding on the retail price of electricity (except for appropriately controlling the non-competitive elements of the system, of course).

But if Ministers are not at all involved politically in decisions by these companies we own, then I wonder why we own these companies. In short, if these companies are just an investment, there are better investments and we could move our money elsewhere. If these companies are not just an investment, why don’t we act like it?

I can understand the political challenges of being involved with these firms. They are substantial commercial enterprises managing the delivery of complex products and services, and carrying significant risks – imagine the political consequences if the company responsible for Pike River had been State-owned. But still, the two coherent options for me are:

  1. Crown investments are just investments, and we should treat them as such and try to get the best financial returns we can. This is, of course, the approach with the NZ Super Fund and the ACC although the Fund has rules on what it invests in and is subject to political scrutiny (it is good to know that someone is paying attention)
  2. Crown investments are for policy reasons, and Ministers should treat them as such. There were shades of this with Whirinaki, which didn’t work so well, I guess, and with the shift of assets to improve electricity market competition. Mr Campbell talks about “strategic planning advantages” of owning these assets. But they are not used, for the most part, for this purpose, it seems to me. The Greens, interestingly, say that this is something they are in to, referring to a “coordinated approach to electricity generation”.

* As a slight side-track on this point about the value of different investments, if the government had bought shares in Apple rather than Air NZ, our fiscal position would be rather different. A sub-eight dollar US Apple share in October 2001 is now worth around $400 – the $885 million would now be worth now worth more than $40 billion. Clearly it wasn’t the prospect of financial returns that motivated government investment in 2001, but the point is that we shouldn’t kid ourselves into thinking that these assets are wonderful investments.