APPROACH TO DIVESTMENT OF PUBLIC ENTERPRISES
- 5.1. In General
- Based on a classification of each enterprise, and the priority assigned it by Government,
those enterprises identified for priority divestment will be treated according to the
methodology discussed below. Attachment 7 presents a useful schematic critical path
diagram of the steps required in the divestment process.
- Priority enterprises will already have been well studied. Below are discussed the
necessary steps in the process of divestment.
- 5.2. Developing Divestment Strategy for each Enterprise
- Having developed a benchmark on each of the enterprises and a benchmark on the
investment environment, and having evaluated the possible privatization options
realistically available in the country, it will be possible to develop a divestment strategy
for each enterprise. This process will involve the following steps:
- * Identify viable options (and explain rejection of others)
- * Deal with case specific constraints and impediments
- * Establish timing priorities among enterprises
- * Agree order of privatization and timeline for each
- * Produce Final Short List of enterprises to be privatized
- * Implement pre-privatization Value Enhancement Action Plan for short listed enterprises
- 5.3. Value Enhancement
- In some cases, a strategy to increase value will be implemented before divestment. In
most cases, it will be left for the investor to make such changes. However, in certain
circumstances, such as enterprises intended for public float, or changes which are easily
effected, a value enhancement strategy may be implemented prior to divestment.
- 5.4. Seek Government Approval for Divestment
- Final approval for divesting of any company will be in the hands of the Government. The
project team would assist the Executing Agency in preparing recommendations for
presentation to Government. Once Government approval is had, the project team can
assist in preparing for privatization.
- 5.5. Preparing for Divestment
- Preparing enterprises for privatization will involve implementing the value enhancement
action plans developed for each. When that work is completed, or substantially
completed, (or earlier, in certain cases, if overriding considerations intervene), the
enterprises will be readied for sale. Actual responsibility for marketing of each enterprise
will need to be determined. It may be the shareholding ministry, the relevant line
ministry, the holding companies or the Executing Agency.
- The privatization options and the appropriate marketing strategy for each are discussed
below.
- 5.5.1. Sale of Units or Operating Entities as Going Concerns
- Enterprises can be sold as going concerns. Depending on the privatization strategy
employed, a full and complete marketing approach may be necessary. This will be true in
the case of a sale by tender or share issuance. It would also apply in the case sale of an
operating unit within an enterprise, which could be spun off from its parent and privatized.
Operating entities such as marketing and service are often candidates for this treatment.
- Steps to a successful marketing of the enterprises, whether they are sold by tender to one
investor, through the share market, or by the granting of shares to certain parties, are
basically the same. They are described below:
- * Valuing
- A value must be placed on the enterprise. This is a delicate balance between book and
market value of assets on the one hand and projected earnings stream on the other. The
art of the investment banker, investor and funds manager comes into play here. Too low a
price and the process can be criticised for giving away public assets. Too high a price and
no assets will be sold.
- * Method of Sale
- A determination will be made as to whether to sell by tender, by total share issue, or
partial share issue. Underwriting panels may need constituting.
- * Terms of Sale
- Price, method of settlement, deposits and other details of the sales process must be
agreed and communicated.
- * Preparation of Offering Documents
- An offering document must be prepared, describing the enterprise, and the terms of the
sale. Relevant issues to be considered are, among other things:
- * Full disclosure;
- * Disclaimers;
- * Description of business;
- * History of Unit;
- * Management (if appropriate);
- * Markets and Marketing:
- * Size of market;
- * Unit's share;
- * Marketing and sales strategy;
- * Future plans;
- * Financial analysis:
- * Historic;
- * Pro forma;
- * Projected;
- * Future outlook and risk analysis;
- * Details of offering; and
- * Application.
- * Organising Selling Group (if appropriate)
- In the case of a public issue of shares, a selling group must be organised to underwrite,
promote and sell the issue. This group may vary from issue to issue, but would probably
contain many of the same members, pension funds and provident funds, insurance
companies and other institutional investors, the development banks, the national
commercial banks and the private sector local commercial banks.
- * Secondary Market Support (if appropriate)
- To ensure a buoyant market and enhance subsequent privatization, some formal
mechanism may be installed to support the secondary market in shares. This may be a
responsibility of the underwriting group, or it may devolve to one party. This must be
investigated and recommendations made. A suitable mechanism must be put in place to
ensure that this market exists and that share prices fairly reflect the value of the
enterprises.
- * Offering
- Timing and execution of the offering must be closely managed to ensure a successful
issue. This would be the responsibility of the selling group. However, the Government
would want to maintain close control over this process to ensure that the offering goes
smoothly and that the issue is appropriately promoted and supported.
- * Financing
- Section 5.7 below discusses the various methods of financing the sale of a public
enterprise.
- 5.5.2. Sale of Assets
- In some cases, an investor will prefer to buy only the assets of the enterprise. In this
case, some of the legal details will be different. If a new company is formed to buy the
assets, the analysis discussed in Section 5.5.1 will apply.
- 5.5.3. Management Participation
- Management may participate in the purchase of shares, or assets. Discounts may be
possible to encourage investment.
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- 5.5.4. Performance and Management Contracts
- While no sale of an enterprise would occur, a marketing strategy would nonetheless be
required in this case. Identifying, qualifying and negotiating with a potential management
company, etc would be required. Other issues would need to be addressed as to value,
terms and conditions of the management contract. This option is discussed in Section 6.6,
below.
- 5.5.5. Leases
- While no sale of an enterprise would occur, a marketing strategy would nonetheless be
required in this case. Identifying, qualifying and negotiating with a suitable candidate is
necessary. Other issues would need to be addressed as to value, terms and conditions of
the lease.
- 5.6. Developing Linkages with Potential Investors
- For the divestment process to be successful, it will be necessary to forge linkages with
potential investors. Linkages will have begun to develop during the process of evaluating
the local capital markets (discussed above). These linkages will become stronger as it
becomes more clear which enterprises are likely to be privatized and when.
- Linkages will need to be formed with:
- * Local investment companies
- * Private sector industrialists
- * Indigenous businessmen
- * Non-resident nationals
- * Provident funds
- * Development banks
- * Commercial banks
- * Off-shore sector investors
- * Off-shore funds managers
- * Other domestic institutional investors
- * Multilateral and donor nation investors (World Bank, IFC, ADB, EBRD, UNDP, ODA,
CDC, OPIC, etc.)
- 5.7. Financing Sales of Public Enterprises
- 5.7.1. In General
- Divestment of public enterprises will require adequate levels of both equity and debt
financing. These will depend on the local investment climate and the attractiveness of the
particular enterprise being sold. Often the Government can assist by providing debt
finance, guarantees or even by holding some portion of the equity and gradually selling as
the market grows larger. Sources of financing are discussed below.
- Several particular governmental policies can have a significant and do impact on the
investment climate. These include:
- * Government Borrowings
- The Government may be a large borrower in the local capital market. In so doing, it is
competing with private sector investment and effectively driving the private sector out of
the market. High Government borrowings and at high rates of interest makes it very
difficult for private investors to finance their activities. This competition, when combined
with extremely high borrowing rates , a high inflation rate and steadily depreciating
foreign exchange rates often combine to make the investment climate more difficult than
it might otherwise be. While we recognise that high levels of Government borrowing, high
interest rates, inflation and a depreciating currency are all manifestations of the same
economic phenomenon, they are often seen as separate events which impact on the
private investment market.
- * Infra-Structure
- Well developed local infrastructure will greatly enhance a nation's investment climate.
First impressions are lasting. A potential investor's (or tourist's) first impressions come
from arrival at the airport, in transit to his or her hotel, in using the telephones, etc.
- Improving these to an acceptable international standard represents (relatively)
straightforward and inexpensive administrative and engineering tasks. Such
improvements can impact significantly to enhance the investment climate.
- * Regulative Ambiguity
- The clear and unambiguous local investment regime is desirable. Issues of land
ownership, repatriation of capital, foreign exchange regulations, incentives to foreign
investment, etc must be straightforward.
- 5.7.2. Local Investors
- A significant pool of capital generally exists in the hands of private investors.
- * Indigenous Businessmen
- The indigenous population will have capital at its disposal. This group of investors has
less geographic mobility and a greater commitment to the nation. As a result, capital from
this source is possible. Public floats and private placements in widely held issues would be
suitable to this group.
- * Non-indigenous Businessmen
- Non-indigenous residents generally contain a large group of successful investors. These
people can be attracted to certain investments. This group would be especially interested
in investments in which they have control or significant influence.
- * Non-Resident Nationals
- Nationals working abroad and earning relatively attractive salaries are generally
interested in suitable investments in their home country. While it is not usually possible to
gauge the size of this potential market, it is often sufficiently large to supply capital to a
Government's privatization strategy.
- * Parallel Market Funds
- Despite the freeing up of foreign exchange laws, there are often large pools of "grey
market" funds, which would be available for investment. While it is usually impossible to
estimate the amount of such monies available, it can be considerable. These monies
would be available for suitable investments, especially if investors felt comfortable that
their source of funds was not closely examined.
- * Funded Pension Schemes
- Many major corporations and multinationals establish funded superannuation funds and
pension schemes which can be considered potential investors. These managed funds will
be interested in attractive investments, especially if their local investment choices are
limited. The funds are usually cashed-up and invested in liquid securities which do not
provide a satisfactory hedge against inflation. The fund managers would prefer more
attractive hedges to inflation than is provided by cash.
- * Other Institutional Investors
- Insurance companies represent another potential investor group, from which there should
be interest. A survey of this market is generally a straightforward exercise.
- * Local Banks
- We would not expect commercial banks to be equity investors in their own rights. Their
pension funds represent a separate possibility discussed above.
- Commercial banks are rarely equity investors, even in the best of times. However they
are typically looked upon to support national investment by providing debt financing. This
is discussed below. The strategy of many banks at this time is to stay with short term
(cash or Government bond) investments, because of their extremely high liquidity.
Market volatility affects their funding base. The power of the central bank to change
liquidity requirements dramatically makes them wary of anything but short-term
investments. They are reluctant to invest long term in the face of the possibility of a new,
high, liquidity ratio requirement.
- The banks, however, might be induced to lend against outside support. Such outside
support might come from a strong offshore investor, a foreign guarantee scheme (such as
MIGA or OPIC) or a Government guarantee.
- * Methods of Organising Local Investment
- Local investors could be attracted either to a public float or by means of a private
placement. The former is better suited to attract a large number of small investors. It is
an ideal way of broadening the share-holding in a company and in the county. It would
also be expected to increase public support for privatization.
- A private placement would place large blocks of shares on a negotiated basis with larger
investors (principally pension funds, insurance companies and other institutional
investors). This method is less complex, and hence less expensive. Because investors in
private placements tend to be sophisticated, there is less need to educate them and less
risk of recrimination if the investment does not prove to be attractive. Likewise, because
a smaller number of investors is required to raise the necessary level of money,
administrative costs are lower.
- * Managed Investment Fund
- It is possible to create an investment fund to own particular privatized assets. This is
viewed in many nations as a suitable intermediate step to broad public ownership of
shares in public enterprises. Such funds have merit, and provide some degree of
protection to the small investor. However, we believe more direct and less complex
methods of raising local capital. If such a fund were established, it might represent a
source of available funds.
- 5.7.3. Offshore Investors
- A range of offshore investors may be interested in owning public enterprises, given
attractive opportunities.
- 5.7.4. Foreign Government and Multilateral Support
- A number of programs exist to reduce a foreign investor's risk of investing. Guarantee
and insurance Programs exist to protect both equity and debt investments. The World
Bank's MIGA and the US's OPIC Programs are examples. This will provide a strong
level of support to a privatization strategies.
- Additionally, the IFC is often interested in looking at equity roles in countries where
privatization is underway.
- 5.7.5. Debt-Equity Conversions
- In many counties, where blocked funds are held, a swap of blocked debt funds into equity
in a public enterprise represents an attractive "win-win" structure for privatization.
These transactions are complex. A high degree of determination is needed to complete
such transactions, which underscores the need for experienced, sophisticated advisers.
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- 5.8. Executing Sales of Public Enterprises
- In order to execute the sale of a public enterprise, certain steps must be taken. Among
those most critical to the process are:
- * Governmental approvals;
- * Negotiation and final deal;
- * Documentation;
- * Payment and settlement;
- * Closing details; and
- * Underwriting fees, sales commissions, etc;
- An experienced investment banker and lawyer are recommended at this stage.
- 5.9. Supervision and Monitoring of Divested Enterprises
- 5.9.1. Supervision during Divestment
- The process of divestment can be a complex one. It can be a stressful time for
management, staff, the bureaucracies and ministerial officials. Supervision of the
transition period is important. A strong divestment unit or Board of Directors is needed to
provide the necessary level of supervision during this transition period.
- Supervision is needed in a number of areas. The most important are discussed below.
- * Maintaining Orderly Business Practices
- During the process of divestment, a high level of supervision is required to ensure a
smooth and speedy transition to the private sector. This supervision will ensure that the
enterprise continues to preform its normal commercial functions during the potentially
ambiguous transition period. Management must have a clear understanding of the
enterprises objectives and goals during this period. Reporting lines (whether to a line
ministry, a special divestment unit or a Board of Directors) must be clearly communicated
and understood by senior and middle management of the enterprise.
- * Providing Support to Potential Investors
- At the time of divestment, investor groups are likely to visit the enterprise with detailed
inquiries and inspections. Management and staff must be prepared for such visits and
should be cooperative and supportive of potential investors. This requires supervision to
ensure that unwilling or uncertain management does not frighten potential investors or
mislead them.
- * Transformation of the Enterprise
- The move from public ownership to private is often accompanied by significant
commercial activities. Assets are sold. Redundant staff are retrenched. Lines of business
are closed or spun off. This often puts undue stress on a management structure unused to
significant changes in business procedures. Supervision and guidance is necessary to
ensure an orderly transition.
- * Preventing Abuses
- The transition period between public ownership and private ownership can be ambiguous
and may provide ample opportunity for abuse and personal gain. A mechanism should be
put in place to guard against financial abuses and personal prerogative, which often mark
the behaviour of public enterprises in ordinary times.
- 5.9.2. Supervision after Divestment
- Once privatized, the enterprise needs no more supervision than any other private sector
company. This understanding is often resisted by Government officials whose careers and
raison d'etre have often centred around the supervision of a particular public enterprise
or industry. Therefore, a clear policy must be communicated and understood that the
supervisory regime of the line ministry, government holding company or other officials
will terminate once the firm is privatized.
- There are several exceptions to this rule: natural or statutory monopolies may be under
an ongoing regulatory regime to protect consumers. Moreover, Golden Shareholdings
require some level of ongoing supervision. These two special cases are discussed below.
- 5.9.3. Monitoring Privatized Enterprises
- There may be good reason to continuing to monitor the performance of recently
privatized enterprises and to monitor the provision of services of these enterprises. The
literature on divestment and the empirical results of privatizations undertaken thus far
have generally indicated that the very act of privatizing has proved positive to the nation.
Continuing observation of privatized enterprises will provide additional data for the
benefit of the nation undertaking the divestment, and for the benefit of general
understanding. The multifaceted impact of divestment on the nation should be monitored
and reported.
- 5.9.4. Regulation of Privatized Enterprises
- Certain enterprises operate in areas of natural or statutory monopoly. These may require
an ongoing regulatory regime to protect the consumers. To the extent that competition
can be and is encouraged, the need to regulate is minimised.
- Regulation of monopoly powers represents an alternate to retaining control of strategic
enterprises. Our experience in this matter is extensive and includes several statutory and
natural monopolies, including telephone companies, commodities boards, post offices and
public works departments and extensive discussions with the New Zealand Treasury
relating to Telecom, Electricorp, Airways Corporation, NZ Rail, the State Insurance
Company, Coal Corporation, the nation's airports, hospitals and schools. This has
provided a sophisticated understanding of these issues.
- 5.9.5. Golden Shareholdings
- When strategic enterprises are privatized, the government may want to maintain some
control over the enterprise to protect what it considers its legitimate national interests.
Such interests may be to ensure that ownership remains in the hands of Nationals or
particular investors, that the line of business is not abandoned, that head offices remain in
the country, that the company's name and trade style do not change without Government
approval, and a variety of other reasons. In such circumstance, the Government may take
one Special Share (often called a "Golden Share") in the enterprise. This Special Share
is often not be entitled to share in the profits of the enterprise nor to vote. Its
shareholder, usually a Government Minister, is allowed to speak at shareholders' special
and general meetings and has the power to veto any activities specifically proscribed in
the enterprise's Articles of Association or by laws. Use of a Golden Share is a more
powerful mechanism than the granting of a license or other contractual methods of
protecting the government's interests. This technique has been successfully employed in
Divestment programs in countries such as Canada, the United Kingdom, France, New
Zealand, Turkey, Brazil, Malaysia and Senegal.
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