Fran O'Sullivan on business

Business analysis and comment from Herald columnist Fran O'Sullivan

Fran O'Sullivan: The State goes capitalist

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There are high hopes the forthcoming IPOs will result in good returns for the Government, as well as for small investors writes Fran O'Sullivan

John Key is enthusiastic about the potential for partially privatised state-owned companies to emerge as national champions on the international stage.

In Singapore last month, Key talked to Temasek Holdings about the potential for it to underpin some of the funding Mighty River Power will require to take major positions in Indonesia's planned geothermal expansion programme and elsewhere in Asia.

The former investment banker clearly believes companies like Mighty River Power will be able to spread their wings offshore and grow significant returns for their major Government shareholder - as well as retail investors ("moms and pops"), the Super Fund, iwi, and other institutions including KiwiSaver providers that buy shares in the upcoming IPOs - once they are put on a better commercial footing.

Key's talks followed immediately on from his official visit to Jakarta where the New Zealand and Indonesian Governments agreed to work together on geothermal energy through investment and technical co-operation.

Indonesian President Susilo Bambang Yudhoyono praised New Zealand's superior technological capabilities in geothermal energy, and indicated Indonesia would be actively developing geothermal energy over the next 5-10 years.

Key later told the Herald that Temasek was also keen to look at other co-investment opportunities within Asia. He did not go into the detail. But officials from the Singapore Government's giant investment fund are understood to be making their own investigation and it is likely to feature when Singapore Prime Minister Lee Hsien Loong visits New Zealand later this year.

The fund already has 20 per cent of its asset base in Australasia and is keen to get more exposure to growth stocks, including renewables and dairy which are among the services and products in high demand in a rapidly-growing Asia.

The Treasury has also given some thought to establishing a "Temasek-type" fund in New Zealand to hold a bunch of the Government's stakes in partially-privatised SOEs and other government-owned companies that could be primed with outside capital to expand further offshore.

Among such companies are Asure Quality and Airways Corporation.

Asure Quality's services in the food quality assurance area would find a ready market offshore with the right capital backing.

The notion goes that a Temasek-style holding company would hold the Government's stakes and trade within ministerial-imposed parameters.

Auckland University has done some work on a "holdco" model.

But Commerce Act provisions would stop all three of the proposed partially privatised electricity generators being held within the one structure." Ironically, this model is also said to be favoured by Labour leader David Shearer.

Key's ready promotion of Mighty River Power underlines why it has been chosen as the first cab off the rank for his Government's partial privatisation programme - also dubbed "MOM" (mixed ownership model).

But market players say Mighty River Power's board needs to ensure its CEO is appropriately incentivised to lift EBIT - rather than revenues - if a successful offshore expansion in the geothermal space is to occur.

The Government plans to sell-down its 100 per cent holding in state-owned power generators Mighty River Power, Meridian Energy and Genesis Energy, and in resources company Solid Energy in the next few years, retaining at least a 51 per cent stake for itself. It will also sell-down its majority holding in Air NZ. All up the Government expects to net $5 billion-$7 billion from the IPO programme, depending on demand and market conditions.

Treasury's John Crawford, who is deputy secretary in charge of commercial transactions, says the first IPO is important as it will set perceptions for the overall programme. Mighty River Power was selected as it had a good board led by chairman Joan Withers, a solid management under Doug Heffernan, good growth prospects, and was perceived as occupying a strong niche as one of the world's top 10 geothermal companies.

The other four SOEs were examined. In Meridian Energy's case its chief executive Mark Binns has just recently come into the role and potential investors will want to see how the company does under his leadership. The international coal price has dropped 30 per cent due to reduced steel demand which affects Solid Energy's financial prospects. Air NZ is coping with a cyclical low in the international aviation industry and with CEO Rob Fyfe due to depart this year, investors will want to run their ruler over the new boss.

Mighty River's cachet in the trendy renewable energy space also provides a better platform to excite international interest than Genesis Energy.

Treasury is now working with its adviser Deutsche Bank/Craigs on how to maximise the return to the taxpayer from the IPO.

It is a difficult balancing act.

Crawford acknowledges the Government faces an over-riding objective to maximise its own return during tight fiscal conditions.

But it also has to ensure there is enough liquidity so that the Mighty River share price trades well post-float and investor appetite is whetted for subsequent IPOs.

This is not a simple task.

But Finance Minister Bill English underlines that the programme is also important for the development of New Zealand's capital markets.

Four investor "pots" have been identified.

* First-time New Zealand share buyers who will acquire shares through a public pool;

* Broker firms' clients;

* New Zealand institutions such as the Super Fund, ACC, KiwiSaver funds and iwi as well as institutions such as AMP and Tower;

* Offshore investors such as Australian institutions.

The Treasury has also established a website at governmentshareoffers.govt.nz, which State-Owned Enterprises Minister Tony Ryall says is designed to give factual information about the programme.

Ryall underlines that the Government will retain at least 51 per cent ownership of each company; expects 85-90 per cent New Zealand ownership "which means Kiwi investors will be at the front of the queue for shares"; and that no investor will be able to own more than 10 per cent of each company.

Market sources suggest the offshore investors will want to see sufficient liquidity before they invest as there will be no potential to launch a takeover with individual ownership capped at 10 per cent and the Government determined to retain a majority stake.

The Mighty River float is not expected until the latter part of this year.

Legislation clearing the way for the partial privatisation programme is expected to be passed in mid-July. Audited half-year accounts have to be produced, due diligence has to occur and a prospectus issued.

The Government faces strong opposition from its political opponents. But it is notable that the mixed ownership model is widespread throughout the OECD - including Norway which Labour's Shearer has posited as an economic mode for this country to follow.

Deutsche Bank AG (NZ) chief executive Brett Shepherd says the overall programme will energise the NZX's free float by 10-15 per cent.

Shepherd expects stocks will be attractive to international investors seeking exposure to high quality New Zealand assets.

Other players say "renewables" are seen as important around the world.

Shepherd also believes the programme will improve New Zealand's capital markets and competitive edge: "New Zealand's cost of capital will go down as the additional liquidity drives down the cost of funding for companies, and NZ's potential advantage for sourcing capital from the equity markets will improve."

He believes there is a chance to craft a new "New Zealand Story" for offshore investors to view New Zealand as a standalone investment destination instead of an appendage to Australia, and says once the Fonterra shareholders' fund is launched it will add a novel element to the mix.

First NZ Capital's Scott St John maintains the Crown is not always the best owner of assets because it faces competing claims for investment capital.

St John expects the shift from a corporatised model to a commercial model then a listed model will improve the SOEs' prospects.

St John welcomes the fact that the state floats will provide a new home for New Zealanders to invest their funds and increase overall household savings.

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