Privatization a delicate deal

Privatization a delicate deal

By Winarno Zain

JAKARTA (JP): Former president Soeharto once said the
Indonesian people did not have to worry about their foreign debt.
He said that because the country had so many state-owned
enterprises, it would have enough money to pay the debt simply by
selling some of them.

It indeed has happened. By selling part of its stakes in
telecommunications companies PT Telkom and PT Indosat in 1996,
the government was able to make earlier repayments on its nearly
US$1 billion loan, carrying high interest, to the World Bank and
the Asian Development Bank. By paying the debt before it fell
due, the government made some savings on interest costs.

Efforts to sell state-owned enterprises are becoming more
relevant because the ability of the government to collect
revenues from existing sources is more limited.

Their privatization is becoming more urgent as the debt
service obligation has mounted recently. The government will not
be able to finance debt servicing from existing revenues. The
government budget, weakened by the economic crisis, can no longer
rely on conventional sources of revenues, including income taxes
and revenues from oil and gas.

Last year, government revenues from income tax were well above
the budget, but it was due to higher taxes from deposit
interests. Now, when annual interest rates on deposits have
fallen from 70 percent to 20 percent, the bonanza from such
revenue has plummeted.

Deputy managing director of the International Monetary Fund
Stanley Fisher and managing director of the World Bank Sven
Sandstorm, during their visit to Jakarta recently, warned the
government not to rely too much on foreign debt in the next
fiscal year budget, but instead consider domestic sources of
revenue.

In the recession, what source of revenue can the government
count on?

Selling government shares in the state-owned enterprises will
become a major revenue source. Although the government has
started privatization programs, progress is slow. The target of
$1.5 billion will not be met in the current fiscal year. Up to
now, the government has received only $800 million from selling
stakes in several enterprises, including port authority companies
in Jakarta and Surabaya, East Java.

Although some of the enterprises have promising business
prospects and are attractive to foreign buyers, generally the
problem is that the government has to sell its assets in an
economic recession, which has depressed asset value to low
levels. It also weakens the bargaining power of the government.

Efforts must be made to enhance the asset value to be offered
for sale to investors. It is for this purpose that the government
is restructuring 144 state-owned enterprises with combined sales
of Rp 144 trillion ($21.5 billion) in 1998. Key to the
privatization is restructuring the firms into several holding
companies.

According to the plan released by the government recently, the
144 enterprises, excluding state oil and gas company Pertamina,
will be grouped in 10 holding companies to be set up immediately.

The objective of setting up holding companies, besides
enhanced efficiency, is to gain higher company value to allow the
government to earn higher revenue by selling shares of the
holding companies rather than the individual companies.

But whether a holding company yields higher value depends on a
variety of reasons. Prominent among them is whether the selection
of companies operating in several different businesses to form a
holding company could generate synergy to improve earning growth
prospects. Hence, selecting and determining which companies
should be merged into holding companies is crucial in the
valuation.

The setting up of a holding company is bound to present
practical problems resulting from the wide diversification of
businesses that the government has been involved in the past. It
might be unclear whether merging several companies, seemingly
having related businesses, would automatically create synergy,
which could create better value.

It is not easy to identify which companies should be included
to ensure their combination of businesses generates maximum
value.

The problems are reflected in the composition of some holding
companies. For instance, the "logistics" one -- consisting of 32
companies operating in several unrelated businesses, such as toll
roads, surveying, trading and shipyard -- appears superficial and
difficult to achieve a solid business entity. It is hard to
imagine how a prospective buyer would make an assessment to
arrive at a realistic company value. It is one of the reasons why
a holding company is not particularly attractive to investors.

A strategic investor, who is involved in a core business, is
likely to avoid buying a holding company as it generally has some
unrelated businesses of which the investor is unfamiliar. A
strategic investor would be more interested in acquiring
individual company with a strong core business, similar to its
own business.

It should be recognized that foreign companies as direct
investors are more interested in having majority stakes. They
want to have roles in the management decision making, especially
if these are related to strategic decision making. They prefer to
have full control of the management because only in this way will
they hold enough authority to integrate the operation of the
enterprise with the operations of their companies in other
countries.

From the state-owned enterprises' point of view, the
integration of their operations into global networks could bring
large benefits for marketing expertise, technology and exposing
them to the international issues which would make them a fully
developed firm.

Another benefit is they would hold greater reason to avoid
intervention from the government, which generally is not directly
related to commercial or professional considerations. Under
direct control from the new foreign owner, the management of the
enterprise could be more professional, would be put under strict
discipline and have to work under strict professional standards.

Investors being sought by the government should be
distinguished between strategic investors and portfolio
investors.

Strategic investors are companies operating in several
industries as their core businesses, with reasonable world market
share. They are more or less prominent in their field of
business. They possesses global networks in the sense of having
subsidiaries in several countries.

They are interested in acquisitions, through buying majority
holding or even total ownership of other companies operating in
similar or related industries. The motives behind their
acquisition could be diversification of business, expanding
market shares or the deepening of their global corporate
structure. They prefer buying existing corporations because they
do not have to start from scratch -- the companies have
infrastructure, manpower, supply and marketing networks.

Portfolio investors are interested in buying shares with the
objective to gain higher value for their shares. They are not
interested in exercising management control. They constitute
institutional investors, such as pension funds, insurance
companies and, more recently, fund management firms which manage
funds belonging to institutional investors as well as
individuals. Their portfolio is diversified into several
companies and industries.

Since they buy shares through capital markets, it is important
that the state-owned enterprises go public. The advantage of
privatization through the capital market is that the government
could retain majority ownership, and could sell the volume of
their shares up to the limit, and also exercise management
control. Whether government shares of the enterprises could
realize the best price would depend, of course, on the
expectations of the market of their sales and earning growth, and
also the general market condition.

It is not clear at this stage whether the privatization would
be done through selling shares of individual holdings, or whether
it is still possible to sell shares of each individual company.
But if privatization were done through selling shares of each
holding company, then the government must have assumed that
higher value would be realized by combining several firms.

There is no legal limit on foreign ownership of the
enterprises, except for those state-owned firms involved in
strategic and security fields.

As selling majority stakes of every state-owned enterprise
might be politically unacceptable at this stage, the government
has to decide which holding companies would be 100 percent
privatized, which would be partly privatized and which it would
still wish to retain majority ownership.

The policy has to be based on clear criteria, but the ultimate
objective is to obtain maximum value from the privatization.
Eventually, the most important objective for the restructuring is
to achieve better operating efficiencies to enable the firms to
increase their earnings and dividends and contribute more to the
government's budget.

The privatization would be better served if higher value of
the companies could be achieved through improved performance of
the individual state-owned enterprises.

The writer is director of the Institute for Policy Studies
(IPS).