SOE's - taking the fear out of the future

- Mark Weldon, CEO, NZ Exchange Ltd


Equally, however, the world has changed, and remaining stuck in the politics of the past and ignoring opportunities in this critical area is similarly against the national interest.

This article outlines a new SOE+ model. It represents a necessary update to the current model that reflects today’s social and economic needs but has none of the negatives of 80’s style privatisations. This model is not intended to replace, but augment the current SOE model. Added together with the “Super Sub” model outlined by Trevor Mallard in 2006, we have a spectrum of workable options against which each SOE can be assessed to determine the structure under which each will deliver the best longterm value to New Zealand. As there are a wide spectrum of businesses in the SOE portfolio, this a la carte approach (with full privatisations off the menu) is the optimum approach.

Increasing debate on SOEs began last year with the Minister for SOEs, Trevor Mallard, indicating that subsidiaries of SOEs were free to pursue growth plans and opportunities, and if listing was the best way to raise capital to do that, then such subsidiaries were free to pursue that route. Reopening the national conversation was a bold and positive step, and everybody looks forward to some growth-focused SOE subsidiaries coming to market and being available for investment by New Zealanders.

For this to be the right option to fuel growth there are some simple factors that must be present. First, the SOE must have an identifiable skill or product set which can fill a meaningful regional or global niche. Second, the skill or product set must make sense on a stand-alone basis.

Around the same time as the Minister made his comments, the New Zealand Institute identified the criticality of offshore growth by New Zealand’s at scale businesses specifically SOEs  if we are to address our long term structural issues in the Balance of Payments and other key areas. Simply stated, our largest economic problems can not be solved without addressing the role and goals of SOEs in our economy.

Failed SOE privatisations such as Tranz Rail have so scarred those in the public eye that, to date, the “no more Tranz Rails” argument has trumped all others. The consequence is that, while it’s clear that the structure and the role of SOEs needs to be refreshed, they have become the big white elephant in our political economy.

Logic drove the original design, when creating, corralling and commercialising this country’s assets to protect them from rort and ensure a healthy dividend flow to government was a pragmatic response to what was then a pressing problem. But time, and this country, have moved on and the SOE model hasn’t kept up. For those experiences to provide a rule of thumb for time immemorial lacks logic. It’s like a kid who gets horrendous sunburn never being allowed out in the sun to play again when really the answer is not avoidance, but care (smother the kid with sunscreen)!

The past, and the rhetoric around it, has thus shut down our ability to think critically and innovatively about this area. We must move forward and figure out, for SOEs, what the “sunscreen” solution is. We need to start again by asking the simple question: For New Zealand, what is the best thing we (i.e., our government) can do with each of these businesses? This question requires brave leadership and clear thinking; which is what we expect.

The remainder of this article assesses the forces for change, the opportunities, and the “no-fly” zones. It emerges that there are meaningful opportunities for a sensible upgrade, if appropriate, on a case-by-case basis.

Forces for change to the SOE model

The forces for change are compelling, and increasingly urgent. They are as follows:

(a) Value creation
A number of our larger SOEs have credible international ambitions, but lack the capital flexibility to pursue them at a time and scale that will achieve the most profitable outcomes. It’s those ambitions that Minister Mallard encouraged them to consider. Some clearly have the skills and capabilities to do so. It’s indisputable that the future value of many SOES, and the economic fate of New Zealand, depends on some SOEs becoming truly global companies. Their current capital structure is a constraint on global strategy. Taxpayer funding and debt runs up against its limits quite soon in a global growth path. Could an SOE make a multibillion dollar investment in China, for example? Not sensibly under today’s structure. Yet, like Fonterra, some of them should be doing just that as their skills (e.g., renewables) are of huge value in such a market, and offshore monetisation of those skills requires action soon.

(b) Health of the New Zealand economy
SOEs are a major part of the New Zealand economy, representing some of our (unfortunately) very few “at scale” businesses. From the perspective of the structural issues in our Balance of Payments (where the Australian banks alone take out more in profit from the New Zealand economy than all New Zealand companies combined bring back to New Zealand on the investment account), we simply cannot have 15%+ of our economy with a domestic-only focus. Put bluntly, if this model endures the structural imbalances and economic ills that are hindering our growth will only continue to multiply. At the same time, it doesn’t make sense for taxpayers to fund the growth risk of overseas business expansion. Thus, we have a conundrum we need to solve.

(c) Transparency
Having a transparent decision-making structure and process that eliminates politics is important. It would eliminate the challenges and risks the government faces as an owner in the (increasingly frequent) situations when having a political owner is suboptimal for decision-making and accountability. The benefits of continuous disclosure are clear. Any material change in position must be disclosed to the public. As all New Zealanders have a stake in the SOEs, honest disclosure of material matters is in the public interest.

(d) Performance
Many of the SOEs underperform relative to their private sector comparable companies. The focus on dividend, and returns against the book value of assets is misleading. Many commercial SOEs report results that would be unacceptable in a listed environment. A sharpening of performance scrutiny can only be positive, as there will exist incentives to reduce unnecessary fat (while building muscle), and to ensure that there is a growth agenda as well as an operating one.

(e) Savings
There’s a growing recognition of New Zealand’s savings problem. KiwiSaver is designed to address this. However, there is a paucity of investments available for New Zealanders to invest into in their own currency. To build the robustness of the capital market (as important to national welfare as Telecom, but with 1/100th of the attention), including the capital market skill base, scale is required. New Zealanders need an opportunity to be able to coinvest directly alongside the government in our iconic SOE businesses.

(f) Governance
A publicly listed environment provides many governance benefits to the government. The listed environment would also bring increased disciplines, and attract the highest quality available directors to the candidate pool. Any perception that political appointees are made under the government-driven process would diminish.

(g) Cost
Transparency and shareholder votes would replace the function of CCMAU  entailing a material cost saving for government in the Treasury.

“Not negotiables”
Out of the previous failures, and from forward thinking, there are a series of factors that must be viewed as “not negotiables”; and we certainly don’t propose to argue with them. The following factors must all be addressed:

(a) Long-term government control
 The government should not relinquish full control over the asset they have created. However, there are ways to maintain control under capital structures quite different, and significantly improved, from those that exist currently.

(b) Superior rights
The government created the SOEs. As such, under any alternative capital structure, the government deserves long-term entitlements to superior voting and other rights over those who didn’t “create” the company. This isn’t unusual around the world (e.g., New York Times, and many other companies have a structure where a cornerstone investor determines key strategic decisions that go beyond purely commercial matters).

(c) New Zealand owned
It’s also an important element of an ownership culture, and to ensure that there are great jobs and talent retained in New Zealand, that these companies remain in New Zealand.

(d) Remove the fear
As growth strategies have to be approved by government, that very fact creates a moral hazard for SOE Boards. As there will never be any political risk for an SOE that does not look to grow overseas, political ownership becomes a constraint  and SOE Boards are implicitly incentivised to keep their heads down and stay quiet. It is critical, under whatever model, that this fear disappears. So, these are the issues. Let’s look for an answer.

Three SOE models: Current, SuperSub, and SOE+

In the interests of pushing the debate to a solutions focus, and moving beyond the rhetoric, I suggest there are three options to consider that achieve all the above criteria. First, the current model. Second, the “Super Sub” model outlined earlier.

The third model is the SOE+ model. It represents an upgrade to the current model along many of the key dimensions identified, but retains the key control and protection rights important to long-term government ownership. Hence the term, SOE+.

The SOE+ model also provides much better protection against rort than the current model. In particular, under the current model an SOE could be fully sold with nothing more than a change of heart. With a series of embedded mechanisms, companies under the SOE+ structure would be permanently grounded in the New Zealand economy  to our long-term benefit.

The SOE+ Model
The model is outlined in some more detail, as the detail matters. Under this model, the government is a permanent controlling long-term shareholder, but capital is raised, a savings instrument for New Zealanders provided, and performance, transparency and governance improved.

Share classes and voting rights
There will be two classes of shares: A and B shares. Voting rights allocated to these shares would be:
•    Each Class A share of common stock carries one tenth of a vote. These would be issued to the public.
•    Each Class B share carries one vote. These would be retained by the New Zealand government under the SOE Act.
•    Class B shares can never have less than a majority of voting rights. This would be in the SOE Act, and in each company’s constitution with a 99% super majority voting provision including the role of Class B shares.
Voting rights - exceptions
The above voting rights would not apply in three specific areas, when both classes of share would vote together on an equal “one share one vote” basis. These are non-strategic areas, and areas where the skill base of the public, if utilised to the full extent, will result in better decision-making than the government alone. They are:
•    election of directors;
•    matters of executive remuneration (including issuance of stock to executives);
•    the appointment of an auditor.
Listing
The Class A common stock shares would be listed.
IPO
At IPO the government would raise capital by selling common stock to the public for a minority economic stake (e.g. 30%).
Share Issuance
Any future capital raisings from shareholders must be offered on an equal basis across Class A and Class B shareholders. If the government (Class B) declines to participate economically, its rating and control interests are unaffected.
Economic rights of share classes - dividends
The government as founder has a legitimate right to a higher level of economic interest in the capital payments of the company than new shareholders, reflecting the work done establishing the franchise, and the opportunities created by the government’s capital investments over the years. The structure of returns below recognise this.
•    Class A Common Stock. Each Class A share would receive 100% of all dividends of capital payments made.
•    Class B shares. Each Class B (government) share would be entitled to 110% of the aggregate of all dividends declared on a share of Class A common stock.
The short story is, we’ve thought about these things and there’s more than one way through any impediments, real or perceived. The motivation must be simply to find a way for New Zealanders to own directly some of their country’s core assets, to take on some of the risk and to benefit from the returns, whether these are generated onshore or in the global arena. The choices should be there for SOEs to make, and for New Zealanders to share. SOEs are so important that a constructive debate, not a negative one based on fear, is required.

This article was first published in Issue One 2007 of Open, the magazine of New Zealand Exchange Ltd. See http://www.nzx.com/aboutus/publications/open