Brian Fallow: Asset sale arguments on wobbly ground

The Government sees potential to make more of our intellectual capital - such as Mighty River's geothermal expertise. Photo / APN

The Government's case for selling down its stakes in the three state-owned electricity generators, Air New Zealand and Solid Energy sits on a three-legged stool. On examination it is not particularly sturdy.

The first leg is fiscal: the Government is borrowing too much and here is a way to reduce that.

The second is an efficiency argument: the private sector is better at running businesses than the state is.

The third leg is that partial privatisation would add liquidity and depth to New Zealand's rather puny capital markets.

There is no question the Government cannot continue to borrow hand over fist as it has since the global financial crisis struck. Not with the country's external accounts in the state they are in and with the fiscal strain of an ageing population looming ever larger on the horizon.

But it matters how the reduction in borrowing is achieved.

To address the problem - the Government's contribution to woefully inadequate national saving - it has to reduce borrowing the hard way, the real way, by reining in its spending.

Reducing borrowing the easy, soft, cosmetic way by selling assets and shrinking both sides of the Crown's balance sheet will make little or no difference to its net worth or its operating deficit.

'As long as we get a fair price we will be no worse off' isn't much of an argument for selling anything.

It would reduce the Crown's future interest bill (all else being equal) but reduce its future revenue at the same time. The net effect might be positive, or negative, but either way it is unlikely to be material in the context of a $70 billion budget.

Using the valuations put on the five corporations in the December accounts, selling down to 50 per cent would raise $7.8 billion. That would cover exactly half of this year's cash deficit.

But then what?

The Government argues that asset sales would allow it to recycle the capital released into new capital expenditure. It plans $33 billion work of capex over the next five years.

That investment might generate higher returns than the returns from SOEs, the Treasury says, "although this is hard to assess".

The Government can borrow at the moment at between 4.5 and 5.5 per cent depending on maturity.

It would be a poor lookout if the boards and managements of the energy SOEs could not manage a higher return than that on the taxpayers' investment in the enterprises entrusted to them.

Which brings us to the second leg of the case for selling.

Treasury advice recently released takes it as a given that in the case of enterprises operating in competitive markets (as those proposed for sale are) their efficiency and performance are likely to be lower under Crown than private ownership.

"The commercial disciplines that come from investors risking their own money are difficult to replicate in the public sector."

But it is a fair bet that most of the shares in semi-privatised SOEs would end up being held by institutions like fund managers, iwi, the Cullen Fund, and overseas investors likewise entrusted with other people's money.

They can hardly be said to be "risking their own money".

The SOE model requires their boards to run the enterprises as if they were privately owned. Where is the evidence in the case of the energy SOEs that the boards have failed in that statutory duty?

The Treasury, which might be thought to be predisposed in favour of asset sales, concluded in a "think piece" last December that "there is little evidence to suggest privatisation would significantly improve the financial performance of many of the SOE companies".

In the electricity sector in particular investment in new generation has been sufficient to keep the lights on.

"This investment is funded from the SOEs' own balance sheets, whilst maintaining dividends, indicating that Crown ownership is not starving these enterprises of capital."

It is difficult to compare the performance of the SOEs with private-sector competitors such as Contact and Trustpower.

Measures like return on equity don't really work. The shareholders' funds of the SOEs are not anchored in any market transaction. They reflect the value ascribed to them when ECNZ was broken up, revalued from time to time by one of the big accounting firms (plus, of course, retained profits).

To the extent that those revaluations are based on protecting future profits and discounting them back, it imparts a certain circularity to a measure such as return on equity.

One piece of analysis the Treasury cites, commissioned to compare the electricity SOEs with Contact and Trustpower, concludes that overall there was no conclusive evidence to suggest systematic under-performance by the SOEs.

Another argument is that the SOE model makes the electricity companies more risk-averse, with lazy balance sheets that retain more cash in case they need it. But the Government's appetite for special dividends (like $150 million from Mighty River Power last year) suggests there is not a lot of spare cash left lying around.

And in any case one might think that a degree of risk aversion is no bad thing in companies we rely on for something as essential as electricity.

In particular it is argued opportunities to invest overseas, and so make more of intellectual capital - Mighty River's expertise in geothermal generation, for instance - go begging because of the difficulty of persuading shareholding ministers to put Crown capital at risk in that way.

But that did not stop Meridian from an extremely profitable foray into Australia (the $600 million special dividend would fund a lot of hip replacements). And under the mixed ownership model proposed the Government would still have a majority stake. Is the argument that it would be more inclined to countenance expansion if it only bears half the cost, or would the same fiscal constraints become an argument for further dilution of its stake?

As for the potential shot in the arm to the sharemarket, it is true that in principle deeper and more liquid capital markets should lower the cost of capital for New Zealand companies. In theory. But as the Treasury notes, sharemarket liquidity is heavily concentrated in the big-cap stocks. Adding a few more of them would not do much for the smaller fry.

Nor would it make the market more diversified and representative of the economy as a whole.

On the contrary it is already somewhat top-heavy in electricity related stocks - including Contact, Vector, Infratil and Trustpower. What is missing is the agricultural sector.

"We think the gains would be modest," the Treasury concludes.

The Capital Markets Development Taskforce made clear the more important drivers are lifting household savings and removing tax distortions and other regulatory impediments.