Where now for privatisation?

Posted on April 1, 2012 · Posted in AB Public

One word sticks out from Chancellor George Osborne’s Budget speech by its omission – privatisation. Yet just days later the Financial Times reported Treasury negotiations that are intended to generate £3bn in capital receipts from the sale of the Government’s share of the tri-national Urenco uranium enrichment company.

It may be true that the easy – and some not so easy – privatisations have been completed. However, there are pressures on the Government to embark on a new round of privatisations – partly because of the size of the debt and deficit crisis, partly in the hope that outsourced functions will operate more cheaply and efficiently, but also because many in the Conservative Party are determined to further reduce the size of the state.

Urenco is apparently at the top of the list for privatisation, though the Treasury did not respond to requests for confirmation of the intended sale. The UK has one third ownership of the uranium enrichment business, with its co-owners being the Dutch government and the German energy companies RWE and Eon. Urenco is one of the few parts of the nuclear energy business in which the UK government retains an equity stake.

Given the state of the Government’s finances – public sector net debt was £1,162bn at the end of February – it is unsurprising that asset sales are on the agenda. A second currently active disposal is a portfolio of £900m of loans issued by the Student Loan Company.

Royal Mail is another sale target, having last year been separated from the Post Office – which is to be mutualised, with staff to take an ownership stake in the business. Goldman Sachs and Bank of America Merrill Lynch were engaged at the end of last year to advise on the sale, which is expected to see staff granted a 10% ownership stake in the business.

The separation from the Post Office was a key preparatory step for Royal Mail’s privatisation, as was making the business profitable. Royal Mail reported an operating profit of £144m on revenue of £4.4bn for the half year ending September 2012. All its main businesses are now profitable, after several years of focused business transformation.

The most desirable and rewarding privatisations would be the Government’s stakes in the rescued banks RBS and the Lloyds Banking Group – which cost £66bn to rescue. While some divisions and activities – including portfolios of RBS and Lloyds TSB branches and RBS’s Direct Line insurance operation – are being sold, this is largely the result of demands from the European Commission, implementing state aid regulations. It had been hoped that privatisations of the banks could begin in 2014, but given the slow progress in returning the banks to profit this now looks unrealistic.

A 2010 report, ‘Privatization Revisited’, from the Adam Smith Institute shows the extent to which there remains a privatisation agenda in parts of the Conservative Party. The ASI is a think-tank that strongly influenced the Thatcher government and the report’s author is Nigel Hawkins, a former senior official at 10 Downing Street for Margaret Thatcher and ASI senior fellow.

The report proposed the privatisation of dozens of public bodies, of varying degrees of political controversy. Proposed sell-offs include BBC Worldwide, Channel 4, Scottish Water, Network Rail, the remaining state-owned shipping ports, CDC (formerly known as the Commonwealth Development Corporation) and, in the longer term, London Underground and Northern Ireland Water. The report also points to the book value of £337bn of property assets held by government, some of which might be sold.

One possible asset sale flagged by the ASI, but not regarded seriously by them, is the road network. Although not treated as a realistic privatisation prospect by ASI, the CBI supports the idea.

The CBI’s report Bold Thinking: A model to fund our future roads, published at the end of last year, calculated that the UK economy loses £8bn a year through road congestion, with this potentially rising to £22bn a year by 2025 without adequate improvement and investment. The CBI proposes the introduction of road user charges in place of road taxes, with the charges controlled by a new independent regulator. The user charges might over the longer term be supplemented by additional tolls to attract private investment and pay for borrowing.

CBI Director-General John Cridland argues: “With public spending checked, the case for new funding solutions is even more compelling and the Government recognises this. Infrastructure matters to business, and delivering upgrades to our networks is one of the highest priorities for the CBI to get the economy moving again.

“It’s clear we need a gear change in how we manage and pay for our road network in the 21st century. A lack of investment means we are really struggling to increase road capacity, let alone adequately maintain what we already have.”

But while the Government is interested in road privatisation, Chris Paton, director of Deloitte’s corporate finance, government and infrastructure team, doubts whether the various piecemeal proposals add up to a coherent and realistic agenda that can address the scale of public debt.

“Beyond the sale of Government’s stakes in RBS and Lloyds TSB, the proposed sale of Royal Mail and possibly Government’s stake in Urenco, I don’t see there being a privatisation programme on the scale of the last Conservative administrations,” says Paton. “There are relatively few government owned businesses that could easily be sold ahead of the 2015 election. Equally there are few businesses that, if sold, would make a significant dent in the public sector net debt.

“What I do see, is the increasing involvement of the private sector in providing public services – be it through a form of private sector business partner arrangement, as seen with Defence Infrastructure Organisation; the retendering of the rail franchises, which will return the East Coast franchise to the private sector; and the continued support for the public service mutuals programme.”

There are also signs that government departments are looking keenly at property asset disposals. Admiralty Arch was recently sold for £60m to a Spanish property development company that wants to convert it to a hotel. The Old War Office in Whitehall is also expected to go onto the market soon, with an asking price of around £100m.

Paul Davies, a corporate finance partner at PwC, believes that as well as disposals of government property assets, there could be increased pressure on local authorities to engage in sale and leaseback arrangements of their office accommodation. This will reflect a trend towards re-evaluating existing business models and to restructure operations to generate capital receipts.

“When you are selling assets unless they are positive revenue generators you won’t get much positive return from them,” Davies stresses. “There are still things to sell, but it’s slightly hard work,” adds Davies, pointing to the difficulties in restructuring public sector activities.

While some observers speculate that the roads network could be sold for a value of £90bn to £100bn, the reality is, says Davies, that it has no value to a potential buyer unless it can be restructured to produce a revenue stream. “Railtrack was only able to be sold because of the revenue streams created under franchising,” Davies explains.

Today, suggests Davies, the focus on privatisations is increasingly on reducing revenue costs, rather than generating capital receipts. “The question is much more about whether there are things that would be much better served by the private sector delivering it? Should we be running hospitals or courts? Should we own the student loan book when the opportunity costs are so high?”

Davies believes that it is clear from experience that privatisation works in cases like the utilities, where there is certainty, clear rules and a regulator, with this framework leading to competition and investment that benefit consumers. But privatisation has failed to work where the Government has sought flexibility from contractors that involves repeatedly changing requirements, as with the outsourcing of major IT projects.

Yet even if the privatisation agenda today is much smaller than it was in the 1980s, in one respect Conservative ministers are trying to directly connect with the past. Almost two million social housing tenants bought their homes under Margaret Thatcher’s Right to Buy programme that she introduced in the 1980s. This was described by housing academics Ray Forrest and Alan Murie as “the biggest privatisation of them all”.

Under Labour, the Right to Buy became less important, with purchase incentives cut back. Now, though, the Government is keen to accelerate it again, supported by much stronger incentives announced in the Budget.

More social housing tenants are to be able to buy their homes, with the tenancy qualification period dropping from five years to three years and the maximum discount cash cap in London rising to £100,000 from £75,000 – itself a big increase from the cap under Labour, which ranged from £16,000 to £38,000. The additional capital receipts – projected in the Budget papers at £185m to the end of the 2017/18 year – will be used to pay down housing debt and help finance new home building.

Whether the Right to Buy is an example of successful privatisation that supports an aspirational society, or merely undermines a socially important public sector role while indirectly boosting the private rented sector is a political fault line between right and left. (See box.) But the Right to Buy revival does underline the reality that privatisations are returning to the headlines – and that many Conservative politicians will very happily invoke the memories of Margaret Thatcher in doing so.

Right to Buy

One in three former council homes sold in the 1980s under the Right to Buy is now owned by a private landlord, according to a Daily Mirror investigation. Most of those homes are now let at above social housing rents, with a large proportion of those rents subsidised by taxpayers through housing benefits, the Mirror reports. The transfer of properties from public to private ownership has contributed to a doubling of the private rented sector in the last decade.

In many cases, purchasers under Right to Buy bought the leasehold of flats, with the council retaining freehold ownership. This enabled the Mirror to establish through the Freedom of Information Act the percentage of leasehold properties bought under Right to Buy that are now owned by absentee landlords.

In the Royal Borough of Kingston, 46% of leaseholds are owned by absentee owners; in Kensington & Chelsea, the figure is 43%; in Nottingham it is 42%. While the Right to Buy has enabled many long term social housing tenants to become owner occupiers, it has also, ironically, contributed to a significant increase in taxpayer subsidies to private landlords paid for by housing benefit.

A history of privatisations

1981 British Aerospace

1983 Associated British Ports

1984 British Telecom

1986 British Gas

1987 British Airways

1987 British Airports Authority

1989 English and Welsh regional water companies

1990 English electricity companies

1993 British Rail