Privatizing public assets

A common method used for valuation is to calculate the net present value of future cash flows discounted by the cost of capital (as in Sri Lanka, Turkey). However, other methods are used, including using the net asset value and the operating cash flow, together with an assessment of the market situation (Finland); as well as the asset value, the profits earned, the stock market share value, the existence of subsidiaries and future prospects (France, Morocco). Forecasts of earnings are based on projections submitted by potential investors (Ghana). In the case of public utilities, the valuation includes three basic elements: the expected price, the scale of future investment and the tariffs that can be applied (Argentina). The book value may also be used; however, it has the disadvantage that it does not always represent the true value, for example, in terms of future income streams.

Market valuation is difficult to achieve in those developing countries or countries in transition where capital markets are weak or absent. In such situations, the bidding procedure provides a useful instrument for giving market forces a say in the valuation of assets to be sold. Bidding, generally applied to small and medium enterprises, has the added benefit of providing transparency. However, where the enterprise is large or complex, valuation cannot be avoided. Even so, bidding may be used for certain parts of the enterprise to be sold; this can help to identify where the viable assets are located. Valuation is essential where there is only one prospective buyer. An effective organization of different types of auctions and tenders is necessary in order to prevent corruption in the privatization process.

There is a range of options open to governments wanting to dispose of their enterprises or parts thereof. These include: public or closed auction: usually for small firms; direct negotiated sales to general investors, with or without prior competitive bidding; private placement with "strategic" investors ([ie] investors operating in the same industry or joint venture partners) with or without competitive bidding; public share offer, full or partial; sale to management teams or employees; sale to investment funds; and liquidation followed by the sale of assets. A sale option may also be combined with a contracting out arrangement; agreement on such an option at the beginning of the contract can give an incentive to the contractor to improve the efficiency of the enterprise.

Some particular techniques are also used. In Malaysia, for example, the private sector may initiate privatization of projects that are unique by submitting proposals. Such proposals are considered on a "first-come, first-served" basis in order to encourage innovation and entrepreneurship. If a proposal meets the guidelines regarding privatizability and uniqueness ([ie] it provides an unique, cost-effective solution to an economic problem, it brings with it certain patent rights or particular know-how, or an additional asset, to make privatization viable), a letter of exclusivity is given to the private sector party to conduct a feasibility study and to submit a complete proposal to the Economic Planning Unit in the Prime Minister's Department. Should the proposal, after evaluation, be found to be acceptable, negotiation will follow and an award will be made when agreement is reached. In Argentine in order to resolve as many issues as possible in the bidding documents, bidders are required to provide a signed copy of the contract together with the bid. Further, the bid is reduced to one figure -- the highest price or lowest tariff or subsidy. Bidding based on the lowest subsidy is used, for example, for railways where subsidies are granted, particularly for suburban railways, to be used for investments.

In Hungary, the State Property Agency has developed a model for self-privatization. Certain enterprises (with a staff of fewer than 300 and a turnover and gross property value of less than 300 million forints) can initiate privatization themselves provided that they employ one of the independent consulting and property evaluating companies selected by the Agency and do not violate legal regulations. However, the Agency, as the holder of the ownership rights of the state, needs to give its permission before an actual transaction can take place.

While the public offering of shares is commonly used, particularly for large enterprises (where the size of the sale justifies the additional cost involved and where transparency is a particularly important consideration), there are important variations in practice. One concerns the fixing of the share price, which can range from a fixed price offer to a tender offer to a combination of a price and a tender offer (as in the UK, which pioneered an international global tender and domestic pricing arrangement for the sale of shares of British Telecommunications). An other concerns the targeted buyers, involving a variety of incentive schemes for small investors (different versions of bonus share schemes for long-term retention of shares by small portfolios, as in France and the United Kingdom) and for employees (ranging from limited allocations of free shares, as in Slovenia, Sri Lanka, Tunisia, and the UK to a fixed percentage, usually 10%, of shares for employees, as in Brazil, France and Venezuela). There are also differences in approach in terms of small buyers, institutional and "core" investors. In the United Kingdom, in the case of some offerings, the "claw back" method allows the number of shares allocated to small investors, if they subscribe in very large numbers, to be increased at the expense of institutions.

In France, subscriptions of small investors receive priority treatment and free shares are granted for shares held for more than eighteen months after full payment for them has been made. However, in some other countries like Sri Lanka, the allocation to small investors is invariably a fixed percentage of the public offering. As regards "core" investors, the practice in France is to sell blocks of shares, representing 20-30% of the total, to several "core" institutional investors, selected on the basis of open public tenders. However, in Sri Lanka, where such operations are smaller, the majority holding is sold to a "core" corporate investor. In fact, the authorities in Sri Lanka seem to have settled on a fixed 60 : 30 : 10 formula for the public share offering of their PEs, [ie] 60% to be transferred to a corporate investor through competitive bidding (the latter being an axiom of the country's privatization policy), 30% to small investors and 10% free to employees.

Broadly speaking, there are three forms of restructuring of a public enterprise: organizational, sometimes involving the splitting up of the enterprise into smaller units and often associated with corporatization and some labour shedding in the process in order to enhance its net worth or sales value before divestiture; financial, involving the treatment of the debts of the enterprise in order to provide a "sweetener" or to ensure the success of its sale: and operational, involving new investment in order to upgrade the enterprise's physical capacity or its technology. Organizational restructuring with corporatization has helped to increase the net value of the public enterprises concerned (as in France, the Netherlands and New Zealand); however, it is not clear what the cost of such restructuring has been. As indicated below, financial restructuring may be needed because of heavy debts before sales can be contemplated. Where the debt liabilities are large, the state may have no choice but to absorb them or a major part thereof in order to safeguard the healthy development of the banking system. However, operational restructuring should be avoided; if it is needed but can be avoided before divestiture, it would be better to allow the buyer to do it. The simple reason is that the government cannot "second guess" what the potential inve9tor would do, and may therefore make the wrong kinds of decision9 leading to costly losses. In New Zealand, for example, after NZ$2,300 million had been spent restructuring a steel company, it was subsequently sold for NZ$ 300 million.

In practice, important debts of public enterprises have led to financial rehabilitation prior to sales. In Bulgaria, where the public enterprises are heavily indebted, it has been decided to convert part of government credits into public debt. The State Fund for Reconstruction and Development provides funds for the consolidation and technological innovation of some public enterprises prior to privatization. In Argentina, public enterprises have been rationalized or restructured prior to privatization through the cancellation, consolidation or refinancing of their debts; in some cases, the state has assumed some of the debts in order to facilitate sales. In Tunisia, the case-by-case treatment of debts by the Fund for the Restructuring of Public Enterprises has helped to reduce the impact of the debt, for example, on banks and small suppliers In Portugal, financial rehabilitation for some banks has been undertaken, including the injection of new capital, in order, inter alia, to create the necessary reserves for "credit risks" and to provide adequate financing of the pension fund.

In Germany, the Treuhandanstalt in principle takes over all old debts of public enterprises, as well as 90% of past environmental burdens. Preference is normally given to selling the viable assets of a public enterprise and writing off its debt than to transferring the debt and the assets for a lower or even negative price.