Advocates of the forthcoming round of state-owned enterprise asset sales are working themselves into a frenzy.

The spin is that if we sell up to 49 per cent of each of Meridian, Mighty River Power, Genesis Energy and Solid Energy, and part of the Government's 75 per cent stake in Air New Zealand, this will produce cash for an investment fund to buy schools, hospitals and fund transport projects.

Talk about the warm fuzzies. So forget the European debt crisis, forget the dire state of the world economy. All we need to do is sell off a few of our best investments at what will inevitably turn out to be low prices - investments, incidentally, which have been put together by previous generations of New Zealanders - and all will be good.

Oh, and at the same time we will save the NZ Stock Exchange from terminal decline. Simple, really. Indeed, if you don't give it too much thought, this transaction sounds like a good deal.


But dig a bit deeper - the economics of the transactions, the nature of the transactions, who is selling, who is likely to be buying - and you might just begin to wonder if these deals really are good for the average New Zealander.

Let's look first at the economics. A government can raise money by selling assets or issuing debt. The price we get for assets versus the cost of borrowing the same amount is a good place to inform a view as to whether we sell or hold.

The secondary market in 10-year government bonds prices them to yield 4.4 per cent. The yield on five-year government bonds is just 4 per cent. To get these asset sales, the Government will need to price the companies at price-earnings multiples of somewhere around 14 to 16 times, which implies after-tax earnings yields of 6 to 7 per cent.

In lay terms, that means the Government is proposing to sell assets producing returns of at least 6 to 7 per cent a year after tax plus growth, when it could issue debt costing just 4 to 4.4 per cent. On the face of it, this doesn't look particularly bright, does it?

But don't expect too much negative comment, because many people stand to benefit from these transactions. The management and/or directors of the privatised companies will be looking for share options that will massively reward them if the companies do well.

Investment bankers, brokers, solicitors and financial advisers will all get to clip the ticket as the initial transactions occur, and then have another go when Mum and Dad ultimately sell their shares.

Assuming total asset sales of $6 billion and a sales price implying an after-tax earnings yield of 6 per cent on the assets sold, the assets proposed to be sold will generate profits of $360 million.

The interest saved on $6 billion at 4 per cent is just $240 million, so immediately this transaction would see the Government worse off by $120 million a year if all the SOEs paid out all their profits as dividends.


Again, the economics of the sale option aren't looking all that compelling. But this analysis ignores growth. If the SOEs' profits grow at the rate of inflation plus 1 per cent, the total excess return would be the difference between the earnings yield plus growth of 4 per cent less the cost of debt, which works out to a difference of 6 per cent.

On $6 billion, this translates to $360 million a year, which at current interest rates is well above the cost of servicing the $6 billion in government borrowings. This is a simplistic analysis as it ignores risk and it's possible the Government will be able to sell the assets at lower earnings yields and thus higher prices, but don't hold your breath. Prices could equally be lower.

The other aspect of the great 2012 SOE sale bonanza is, of course, the various fees that must be deducted from what the Government gets. Investment banking and other costs including scoping studies will probably run to at least $180 million.

That's two-thirds of the cost of servicing the interest on $6 billion at 4 per cent. Other estimates of selling costs are as high as $350 million.

In terms of historical performance, the SOEs have been a good investment - Treasury reckons they have returned 17.5 per cent a year during the past five years. From a financial perspective, selling state assets is not a no-brainer. The real tragedy of these asset sales is that the average New Zealander will see his or her equity in these great assets reduced. At the moment, every New Zealander, rich or poor, young or old, has an equal shareholding in the assets proposed to be sold.

While many individuals will buy shares in the new companies either directly or via their Superannuation or KiwiSaver Fund, there will be a much larger number of less well-off New Zealanders and young New Zealanders who won't be able to participate in any way, shape or form.


This sad situation will probably be compounded by the new "private enterprise model and strategy" implemented by the new boards of directors of the privatised assets, which is frequently spin for putting up prices and restructuring the balance sheet to increase borrowings. These two factors mean that, unfortunately, the rich will get richer and the poor will get poorer.

The only rationale for these transactions that might have some validity is that private ownership could introduce a higher level of efficiency into these state-owned enterprises. But is it realistic to think that the current directors and management of Meridian, Mighty River and Genesis are asleep at the wheel?

From reading their annual reports, they sound like they are on to it. In addition, Treasury sees "little evidence of systemic underperformance".

More often than not, the private sector's favourite way of increasing the return on equity of a company is by borrowing more. But as the financial crisis of 2008 showed us, greater borrowing comes with greater risk.

My clients have been investors in the debt of these SOEs for some time and they have been a great stabilising factor in portfolios when everything else was turning to custard. It would be a shame to lose the stability the debt of these companies offers.

Furthermore, all of the above assumes the mistakes of the past will not be repeated. New Zealand governments have a long and consistent history of selling assets at low prices to the private sector. Contact and NZ Rail are a couple of examples. How confident can we be they will get the pricing right here?


Then there is the issue of who the assets will be sold to. I remember not being able to get anywhere near enough Auckland Airport shares for my retail clients. However, one wealthy client who also dealt with a major American stock-broking firm that didn't even have an office in New Zealand was able to get 100,000 shares through the US firm.

So not only was Auckland Airport sold cheaply but, to make matters worse, it appears overseas brokers got large allocations of stock and many New Zealand retail investors missed out.

For all these reasons, selling the SOEs doesn't look all that clever, particularly from the perspective of young people and those other sectors of society who won't be able to participate in the offers in any material way. This is likely to be at least half the population.

Perhaps it's time for a rethink.

Brent Sheather is an Auckland-based authorised financial adviser and his adviser/disclosure statement is available on request and free of charge.