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).