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.

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

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.

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.