Friday, 21 February 2014

Road Plans for Privatizations

Probably the most discussed issue in bail-out agreements is that state-owned organizations in the countries receiving the Troika money should be privatized. The issue was first presented in Greece, where the country had to present a plan to fully privatize, among others, the state-owned post-office  (ELTA) and the water and sewage (EYDAP) companies. The same has been asked for Cyprus, and in order to avoid a bail-out, Slovenia is planning to privatize many of her companies in 2014.

There have been many arguments against these actions, most of them pondering about the job security of the companies' employees once they have been privatized or whether natural monopolies (such as EYDAP) should be privatized. Yet, even though these questions are obviously of great importance (especially since they both affect the welfare of the citizens), the biggest question comes when the decision for a sell-off has been made: at what price should these companies be sold off so that the state will not lose any money as a result of the distressed sale?

For example, consider the following (very simplistic) scenario: a state-owned company is currently (year 0) earning 200m per annum and is expected to earn the same ad infinitum. If the discounting rate is, say, 2.5% the price for that organization would be 8 billion (200/0.025). Yet, if the earnings are now depressed because of a recession (as is the case in most countries forced to sell-off their state-owned companies) or next year (year 1), due to increased marketing efforts or less competition increase to 230m a year, with the discount rate at 2.75% and are expected to remain at that level for years to come, then the company is worth 8.363 billion, which if brought to year 0 is 8. 16 billion, resulting in a loss of 160 million for the state (obviously depending on the amount of shares it sells).

In order to avoid this situation, the state will have to take specific measures, meaning that it should impose a clause which will entitle it to any profits over and above a threshold which will be considered as hurting state finances. For example, let's assume that the threshold is set at 4%, meaning that a fluctuation in permanent earnings under 8 million in the example of the previous paragraph, will cause no claim of funds from the state and that the state sells off 40% of the firm including management. Yet, if profits in year 1 rise to 220 million, then the discounted value is at 214 million (220/1.0275) and the excess of 6 million should be paid to the state, over and above the required dividends of the 60%.

What happens if things go bad one might ask. In the case where permanent decreases in earnings are made, then these will be offset by any future proceeds until one exceeds the other by some extent at which both are satisfied with. An additional issue which often arises is who should purchase these companies. My take is that their employees should have the first take in purchasing these shares, either directly through personal accounts or indirectly through provident/pension funds. This is mostly a sign of trust: if an organization's employees do not trust that their company is worth something, then nobody else will. In addition, these companies should be made publicly traded in the country's exchanges, allowing the markets to reflect their own valuation in the stock price, indicating whether the increase in profits has been considered as a permanent or a temporary situation.

Summing up, it is imperative to safeguard the state's interests when it comes to selling off assets. The fact that the timing of the sale occurs in a recession means that the price will be less than what it is really worth and the state will stand to lose a significant amount of money. Under the proposal described above (even though many details still have to be spelled out), the state will be sure that it leaves no money at the table, while at the same time the interests of the buyer are only harmed by little.

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