On Epsom, and dodgy aspects of the asset sales programme

epsom tea meeting tapes, teapottapes, john key, john banks
Illustration by Tim Denee – www.timdenee.com

So last night, even Peter Dunne – always a reliable weathervane on which way the political wind is blowing – came out to say the contents of the Epsom tape should be released. That leaves only Don Brash and the Maori Party in John Key’s corner. Not for the first time when the going gets tough, Key has got going – and is now refusing to take questions on the tape, citing the desire of New Zealanders to talk instead about “the important things that matter” in this election. You know, like trade and the economy.

Wow. Those important things being exactly what Key has systematically avoided discussing in prime time for the last three years, as he has relentlessly pursued every soft focus Breakfast TV interview and women’s magazine cover opportunity on the block – while at the same time, routinely refusing multiple invitations from the likes of RNZ’s Morning Report to discuss the serious issues he now claims to prefer to discuss.

Normally, Key prefers fluffy morning television outings and blokey radio chats – or shows like Q&A and The Nation that get screened well outside prime time, and are watched only by political junkies. Yesterday, even after Key belatedly became the champion of the public’s interest in things that matter, the underlying arrogance was not far from sight. This, Key said, was the time to discuss the things that matter to New Zealanders. Subtext: you’ve got three allocated weeks of democratic inquiry, folks. Better make the most of it, before things revert to business as usual.

There is such karmic justice to the Epsom fallout. Spare a thought for minders such as chief press officer Kevin Taylor, who have tirelessly primped and posed Key for these past three years – to L’Oreal levels of cosmetic lustre – only to have it all start to unravel now, only ten days before the election.

Yesterday, the NZ Herald’s Brian Rudman pointed out the hypocrisy of the Epsom tape being handed over for a Police investigation into its possible illegality – given that only a couple of months ago, Key was trying to bulldoze Parliament into bestowing on the Police and other state agencies sweeping powers to tape the public covertly, while simultaneously exonerating the Police for any illegal taping they may have carried out in the past. What goes around, come around.

At this point, the Epsom tape isn’t about media ethics or privacy or whether Don Brash has passed his use by date. It is about the Prime Minister’s lack of judgement, and (lack of) composure under pressure. The right man for a crisis? Not so much, not this week.

Asset Sales : Too Much of a Good Thing

Trouble is, if Key really did want to talk about serious matters, the asset sales programme offers him no relief. This is something of a nightmare, too. Or would be, if anyone looked closely at it. To date, the political focus has been on the wisdom of selling down the dividend stream to pay for the day to day running costs (ie, schools, hospitals) of government.

The less publicised flaw in the plan is that there are four of these energy companies going on the auction block. Arguably, that is simply too much of a good thing. The need for the available investors to diversify their portfolios cannot help but affect the price, and will reduce the size of the hoped for return to the government. That estimated $5–7 billion return is not looking like a credible figure.

Let me explain. The sharemarket in New Zealand is worth about $55 billion. Finance Minister Bill English is expecting – nay, he is banking on – getting $5–7 billion from these sales. Sure, an Air New Zealand selldown is in the mix, too. But even if we take the low end return as likely (ie, the $5 billion figure) that would be still be 10% of the value of the entire sharemarket. Add in the fact that other energy-related companies (Vector, Trustpower, Contact Energy) are already in the mix and you’re facing an outcome where – as Milford Asset Management analyst Brian Gaynor pointed out to me – it would mean that investors would have 14–15% of the money in the New Zealand sharemarket tied up in electricity companies. Which would not only be unwise, but unlikely.

Therefore, English has a job on his hands, to show us where the money will be coming from. Locals simply can’t be that into it, and foreigners won’t want to be investing in them, Solid Energy excepted. Gaynor again: “I genuinely think there would not be a lot of offshore interest… Even if the government do pursue it [the sales programme] I don’t think they’ll be able to get any more than one, they could possibly get two. It’s very hard to sell three electricity companies in New Zealand. There isn’t the appetite for it.”

Does that mean the $5–7 billion return that Finance Minister English has been touting looks overly ambitious? “Oh God, yes. It may be achieved over a five year period if everything goes well with the early ones that they do. But there are a lot of “ifs” in achieving that $5 billion. Its more of a possibility than a probability.” Yet, I point out to Gaynor, the government is treating the $5 billion figure as the low end, and $7 billion as the achievable high end scale of return. From what Gaynor is saying though, $5 billion is more like the ‘lucky if they get that’ optimum? “Yes. I would say $5 billion would be [the optimum.] ”

Much of the political concern about the asset selldown has been over the spectre of foreign ownership. Gaynor believes that with three of these companies – Meridian, Mighty River and Genesis, which are generator/retailer companies – there will be very little foreign interest. Solid Energy, the likely last cab off the rank strikes him as an entirely different type of company, being more of a commodity producer – with coal mines, lignite deposits and coal to gasification & coal to fertiliser potential. For that reason, international interest is likely to be strong. Because with Solid Energy, New Zealand’s finite extractable commodities will be on the auction block.

That’s one reason why the selling down of Solid Energy is likely to be left to last, to minimise the political fallout from a sell-off of our natural resources to foreign interests. It explains why the company has this week been publically agitating to be last in line for sale.

Given that John Palmer, the chairman of Solid Energy is also the chairman of Air New Zealand, his views on the sequence in which these asset sales should unfold will carry a lot of weight. Perhaps in order to sweeten that Solid Energy deal even further – as I will explain later – the government is also quietly working on an IRD review of tax rules around mineral extraction, which appear likely to end up by offering tax breaks to the coal industry that could well mitigate the perceived downsides to foreign investors of government keeping a 51% controlling stake. The National Business Review certainly thinks so – since on page nine of its November 11 issue (not online) it headlines the news of this IRD tax review as “Tax Changes Could Boost SOE Value”.

Back to the other state energy companies ahead of Solid Energy in the sales queue: “The other electricity companies will be dressed up,” Gaynor says. “You’ll remember Sean Fitzpatrick sold Auckland International Airport, he was in all the ads. It is not that difficult to butter something up, and sell it to the New Zealand public. Overseas people though, aren’t going to be interested by a Richie McCaw or a Dan Carter. They’re going to look at it much more rationally.”

Domestically, the money to invest is not the immediate problem. There are small Kiwi investors who may well be charmed by the likes of a Richie McCaw fronting the share issue. Also, there are the Kiwisaver funds, 48% of which are currently invested offshore. That’s a lot when compared to the much larger pool of superannuation funds in Australia, only 17% of which are invested outside Australia. “The reason for the difference,” Gaynor says, “is that [New Zealand] investors don’t have a lot of opportunities. But that doesn’t mean they will buy three electricity companies. They’ll buy one…and a lot will depend on how that first one [which is almost certain to be Meridian] performs.”

Even with the pool of Kiwisaver funds though, he warns, there’s a limit, driven once again by the way that diversification will constrain the bidding. “For Kiwisaver, it would be totally inappropriate to hold more than 7–8% in [all the] electricity companies [combined.] We have to be prudent, and we do have to diversify the portfolio.”

Foreigners are likely to be even more gun-shy. An electricity company in New Zealand, Gaynor believes, would not be an appealing type of investment to foreign investors. For one thing, there’s not much more room left to chase profits by hiking up electricity prices. “In recent years, prices have already been quite high.” Secondly, the takeover code here means that minority investors will bump their head against the ceiling once they’ve reached a 19.99% stake – because they then have to go all the way to 50.1% in the next step. That’s unless a special shareholder meeting is held and passes a vote – and guess who owns most of the shares? – to give them a special dispensation to take higher stakes, incrementally.

Sure, a 19.99 % stake can be powerful if the shares are widely dispersed among all those mythical Mum and Dad investors, and if no-one else has more than 3–4%. Even so, this 19.99% ceiling will still act as a deterrent to foreign investors, especially when coupled with the fact that the New Zealand government holds the big card of the 51% majority stake.

That’s the third hurdle. These are long term investments. And the government that happens to be in power in New Zealand may not always smile kindly on the extraction of maximum profits from the hapless electricity consumer. This raises the prospect of regulation by a future centre-left government. In the recent past, Labour’s regulatory response to the predatory actions of Telecom proved to be enough – in Gaynor’s words – to “absolutely bloody annihilate” Telecom’s share price. There are a lot of power companies around the world. Some of them may be easier pickings than New Zealand could prove to be, under a future Labour/Greens government.

All up, that’s why, Gaynor concludes, “this [sales process] is going to be less attractive to overseas people. I think these will mainly be sold to Kiwisaver funds.” Foreign investment is unlikely to materialise on a major scale with Meridian, Genesis and Mighty River Power at least. Local ownership and control is likely to continue to be the norm – much as already occurs with Vector, which remains 75% owned by a consumer trust elected by the ratepayers of Auckland, and with only a tiny ratio of overseas investors in it. Or the Port of Tauranga, which is owned by a regional trust. “They haven’t sold down. Vector haven’t sold down.”

Thankfully, New Zealand is no longer a predator’s playground. That new maturity will deter some foreign investors and further drive down the price, and the related returns that Bill English is hoping to get. The $5–7 billion slush fund for financing schools, hospitals and irrigation schemes seems like a pipedream. It looks more like $5 billion at the very most, with the real prospect of considerably less. All of which makes the case for hanging onto the assets – and keeping the full dividend stream from them – even stronger.

Solid Energy = Foreign Bidders = Tax Breaks

To repeat. The only one of these four energy companies that foreign investors will be chasing hard will be Solid Energy – and to minimise the political risk involved, that asset will be put at the back of the queue. What has Solid Energy got to offer? For starters there’s the four opencast and two underground coal mines on the West Coast, in Southland and near Huntly. Lignite in Southland is being readied for use in a coal-to- fertiliser plant, and (maybe) a coal-to-diesel plant in projects which even the company has boasted, could top $10 billion in value – twice the likely best outcome return from the entire asset sales programme.

Even then, fear of government regulatory interference might scare off the likes of the Asian investors who would otherwise be keen to get their hands on those commodities, to fuel their own plans for economic growth. Enter the IRD tax review. The mid-November NBR offline article I cited earlier has this to say:

Inland Revenue is reviewing the specified minerals regime set up in the 1970s, which allows tax concessions for mineral prospecting. The review has not been formally announced and was quietly added to the IRD’s work programme recently. The coal industry has been pushing to be added to the regime for some years, and any change in the industry’s tax status could push up the value of shares in government-owned Solid Energy…

The specific areas of interest with the review are to do with the rules around the tax deductibility of capital expenses. As NBR says, this specified minerals regime “allows firms to deduct exploration expenditure as an expense – and includes buildings, mine shafts, plant and machinery where in other industries this would be classed as capital spending and depreciated, rather than deducted as an expense.”

Right. Worried about regulatory costs to the coal industry that may emerge from the Pike River inquiry? Scared that the 51% stake held by governments may deter foreign investors who would otherwise love to own a major stake in our coal/lignite deposits ? No worries, Mr Foreign Investor. To re-assure you, the Key government appears to be laying the groundwork for a substantial tax break to sweeten the Solid Energy deal for you, and thus drive up the sale price.

In doing so, the government will keep its 51% stake in the interim while – on the side – it will not only sell down part of the revenue stream from Solid Energy, but also give away further tax revenue from its related activities. Truly, its time the Key government put all its cards on the table. What are all the costs and all the benefits from this asset sales programme?


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