Prime Minister John Key faces a challenging second term in office. This is because his Government is running huge deficits and he has no option but to pursue its highly controversial asset sale programme.
The Key Administration has had a total budget deficit of $35.5 billion in its first three years. This comprises a $6.3 billion deficit for the June 2010 year, $18.4 billion for the June 2011 year and a forecast deficit of $10.8 billion for the current year.
The June 2010 year is considered to be the National Government’s first full year – as far as this analysis is concerned – because it was elected in November 2008 and the Budget for the June 2009 year was put together by the previous Labour Government.
Key and Finance Minister Bill English have a reputation for being prudent financial managers yet their three-year deficit of $35.5 billion compares with a $35.6 billion surplus by the previous Labour Government and a $5.7 billion surplus by the 1990 to 1999 National Government.
As a result gross Government debt has blown out from $43.5 billion to a forecast $79.8 billion in June 2012 under the Key Administration, whereas it increased from $36.6 billion to $43.5 billion in nine years under Prime Minister Helen Clark.
The biggest blowout in Crown debt, in percentage terms, occurred under the Muldoon Government when gross debt surged from just $5.6 billion to $28.2 billion.
But the best way to look at Government debt is as a percentage of GDP. The last two Labour Governments reduced Government debt as a percentage of GDP but only one of the three National Governments – the Bolger/Shipley Administration – has produced a similar result.
Gross Government debt as a percentage of GDP went from 49.4 per cent to 69.1 per cent under Muldoon and has increased from 23.4 per cent of GDP to a forecast 37.7 per cent in June next year under the present Government.
The latter figure may be higher because GDP is expected to grow more slowly than Treasury forecasts and the budget deficit for the first three months of the current year was slightly higher than forecast.
New Zealand’s government debt of 37.7 per cent to GDP is still well below Greece at 132 per cent of GDP, Italy 129 per cent, Portugal 107 per cent, France 97 per cent and Spain 72 per cent.
However, our debt is climbing, lenders are more cautious about sovereign debt and small commodity-dependent countries may find it difficult to access credit if commodity prices decline.
The Key Administration has three major alternatives: Raise taxes, slash expenditure or sell assets.
National Governments do not raise taxes, with the notable exception of Muldoon.
National Governments always promise expenditure cuts but they rarely implement these.
Capital Properties, the former listed company that owned a substantial number of Government-tenanted commercial properties in Wellington, used to reassure investors that they shouldn’t fear National Governments because they didn’t reduce the size of the public service, they only reduce the rate of growth.
Thus the current Government is relying on asset sales as an important part of its fiscal strategy because it doesn’t want to cut taxes and finds it difficult to reduce government expenditure.
It is expecting to raise between $5 billion and $7 billion from the sale of a minority stake in the following assets:
* Mighty River Power, which is valued at $3.8 billion by First NZ.
* Genesis Energy valued at $1.7 billion by First NZ.
* Meridian Energy which is valued at $6.3 billion by First NZ.
* Solid Energy valued at $1.7 billion by Forsyth Barr.
Thus the four companies have an estimated total value of $13.5 billion. Assuming these valuations are correct the Government will have to sell, on average, between 36 per cent and 50 per cent of these four companies to reach its $5 billion to $7 billion target. By comparison Contact Energy has a current sharemarket value of $3.8 billion and TrustPower $2.2 billion.
As the NZX has a total market capitalisation of $55 billion then electricity generators will represent more than 25 per cent of the total value of the domestic sharemarket assuming Mighty River Power, Genesis Energy and Meridian Energy list at their current values and all other values remain unchanged.
As there is limited investor appetite for low-growth electricity generators, particularly with the regulatory overhang, the sale process will have to be carefully organised to achieve the $5 billion to $7 billion target.
This is where the conflict arises between the Crown’s desire to maximise the sale price and its objective to sell minority stakes in all four companies.
It is obvious that the first sale will have to be a success, as far as investors are concerned, for the other three partial privatisations to be successful.
This success will be dependent on a large number of issues including; earnings forecasts, the quality and experience of directors and executives and the issue price.
Mighty River Power would appear to be the frontrunner as chairwoman Joan Withers is highly regarded and four other directors, including chief executive Doug Heffernan, have listed company experience.
By contrast Genesis Energy, which could be the other initial IPO, has far less listed company experience.
Chief executive Albert Brantley does not have a listed background and chairwoman Dame Jenny Shipley is not highly regarded by retail investors because of her role as a director in the highly controversial Richina Pacific. In addition former politicians have a disastrous record as directors of listed companies and other public issuers.
The Treasury is expected to make a recommendation to the Cabinet in the next few weeks and following this a number of investment banks will be appointed as lead and co-lead managers to the first float. They will act as agents of the Crown to assist in the sale of a minority shareholding.
The best option is for the lead and co-lead managers to work with the Treasury to determine the marketing, distribution, pricing and other aspects of the first IPO.
Unfortunately the Treasury was completely dominated by the investment banks in the 1980s and 1990s to the detriment of New Zealand investors.
The first IPO will be heavily promoted to individual investors and it would not be a surprise to see Richie McCaw or Dan Carter being used, as was Sean Fitzpatrick with the Auckland International Airport IPO in 1998.
Pricing will be critical and the QR National IPO in Australia would be a good example to follow as far as the first float is concerned.
QR National, which was owned by the Queensland State Government, is a freight railway company that carries enormous quantities of coal and iron ore to export ports in the state.
Twelve months ago the State Government sold a majority stake at $2.55 a share to institutional investors with retail investors paying $2.45, a pre-determined 10 cents a share discount. This compared with an indicative price range of between $2.50 and $3 for the new shares.
In addition, a retail investor who continues to hold their shares after 12 months will receive one loyalty bonus share for every 20 shares up to maximum of 500 bonus shares.
QR National shares traded at $3.40 this week, representing a 39 per cent gain for retail investors since last November, excluding dividends and the loyalty bonus.
If Mighty River Power delivers a 20 per cent plus return in the first 12 months then Genesis Energy and Meridian Energy will be much easier to get off the ground. However, if the first IPO doesn’t produce positive returns then the $5 billion to $7 billion asset target realisation will be extremely difficult to achieve.
Crown fiscal balances and gross debt; Asset sales to reduce debt
|Net Budget balance||Crown gross debt as a % of GDP|