Partial privatisation: Share and share alike

by The Listener / 17 March, 2013
Partial privatisation is a good strategy for taxpayers, investors and companies.
Mighty River Power CEO Doug Heffernan
Mighty River Power CEO Doug Heffernan, photo Ben Fraser/Daily Post.

‘It’s a 10-year journey from strategy to cash flow.” Mighty River Power (MRP) chief executive Doug Heffernan uttered those words at the latest profit announcement to analysts a few days before the Supreme Court gave the go-ahead for the share sales.

He was commenting on the company’s geothermal business, which has grown in value from $50 million to $1.5 billion. It’s not all been smooth sailing, and problems remain. Shortly before announcing an overall positive profit last month, MRP said it was restructuring its international geothermal investments and it declared an $89 million write-down, offsetting a $140 million dividend.

MRP’s strategy for EnergySource involves taking direct control of the US and Chilean projects. The company is positive about the project’s future, but it still has significant risks. Does that mean MRP should not continue to invest in this area?

The company has several New Zealand development options sitting at the starting gates, but Heffernan sees no point in investing while demand is flat. So the company is focusing on international options, despite such headaches as environmental challenges and difficulties raising capital, because of their perceived greater potential returns.

Solid Energy thought its alternative energy projects were on a path to riches, too. Not so. It has taken a bath after adopting a disastrous (in hindsight) strategy. The reasons its investment strategy went so wrong are hard to fully appreciate from the sidelines.

The question for boards and managers with non-performing projects is, when do you pull the plug on a bad investment?

Companies do recover from disasters. Air New Zealand has just produced an excellent financial performance in a struggling industry. But not many years ago the Government had to bail out the airline after its finances went seriously south.

Returning to those opening words about strategy, cash flow and time frames, much can change between choosing an idea and making a profit.

For every successful idea there may be 10 that don’t stack up. The board and management review the options, and make investment decisions based on the information they have and their assessment of the risks. They won’t always get it right.

MRP appears to be doing pretty well and its business model is underpinned by strong cash flows and market share. But it faces operational risks ranging from changes in technology and customer behaviour and demands to political decisions, and stuff we haven’t yet thought about.

The huge change in the telecommunications industry over the past 20 years is a good example of the issues the electricity industry may face.

All this demonstrates business is inherently risky. It’s what makes it exciting, but it’s also why it’s best financed by those prepared to put their money on the line.

There will always be winning and losing investment choices. That’s why partial privatisation is a good strategy for taxpayers, investors and companies alike.

Shareholders (both government and private) help finance the growth, share the risk and, if all goes well, reap the rewards. The Government gets cash to put into state infrastructure, such as schools and hospitals, keeps a share of the potential upside and spreads some of the risk.

The company gets to operate in a more normal commercial environment, scrutinised by analysts and media and armchair critics, rather than being at the behest of bureaucrats and politicians, who are generally not skilled investors.

MRP, in common with every other company, will make its share of good and bad investments. Some companies are simply better or luckier than others at dodging bullets.

Directors and managers frequently make decisions on incomplete information, but if investors waited until they knew everything, they’d never make a decision.

The trick is to know when to cut your losses. MRP has (sort of), Air NZ presumably learnt from its mistakes and Solid Energy dropped the ball big-time.

In decades of observing corporate behaviour and being involved in business, I’ve seen even the smartest directors make bad decisions.

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