Monday, 20 April 2009

Eircom: topsy-turvey economics

Paul Sweeney: The bid last week for Eircom is yet another nail in the coffin of the Anglo Saxon model of liberal economics. Even Fine Gael called for its nationalisation. In the same week, 20 economists, some of them on the hard Right, called for all Irish banks to be nationalised!

The bid of a mere €95m for Eircom is in stark contrast to the market value of €8.4bn when it was privatised almost ten years ago. The taxpayer got €6.2bn on an investment of only €562m (plus a pension contribution of €1bn)

The low offer price is because Eircom is now laden with debts. This is in stark contrast to the debt free, rapidly growing and heavily investing state enterprise which Mary O’Rourke stupidly privatised. Of course, O’Rourke was not alone in 1999. The whole country was gripped by the privatisation hysteria. Nearly everyone with money wanted to make a profit from the sale of the company they already owned. Nearly all got badly burnt and so learned a hard lesson about stock markets.

But the real lesson was strategic. Sadly, it has not yet been absorbed by official Ireland, constrained as it is by ideology. Eircom, as a state company, was investing massively. Broadband was vital for the knowledge economy. The second set of new owners, private equity firms, led by Tony O Reilly and George Soros, sweated the company and used its cash to pay off the cost of buying it. (The new bidders are proposing similar moves, hence the opposition by the unions). The rapidly growing mobile arm was flogged off to Vodafone.

On an investment of €676m, the private equity firm (and the ESOT) made a gain of €954 in a few years (for the details see Chapter 3 of my book Selling Out? Privatisation in Ireland). These gains included huge dividends on losses. Investment was cut to one-third of its peak when it was a state enterprise.

When Forfas, the intellectual arm of the Department of Enterprise and Employment, made a study of the deficiencies of Irish broadband, the strategic error of the privatisation was not mentioned, even in a footnote! This indicates that official Ireland does not learn lessons which are not ideologically acceptable. With mass nationalisations, will Forfas and this government now learn to put aside its out-dated ideas?

The ideology of privatisation and marketisation has collapsed as a panacea for economic efficiency. The state was portrayed as inefficient, plodding and bureaucratic. Commercial State companies, which have contributed much to Ireland’s economy and society since 1927, are not perfect. But they still have a major role to play in the economy, especially given that it is small and open. Ireland, unlike some countries, has some very fine and well-run state enterprises. With some minor changes, the lagging state companies can be made much more efficient.

With the collapse in the Anglo-Saxon model of Capitalism, will a new government learn that commercial state enterprises still have a major role to play in our future economic well being?

Fine Gael, in addition to nationalising Eircom, recently proposed setting up a State Holding Company, (remarkably similar to Congress’ proposal of some years ago). This shows that some Irish politicians are finally shaking off the defunct Anglo-Saxon economic ideology and are being innovative.

One thing is sure. We have seen clearly that banking, as the artery of capitalism, is too important to ever again to be left in the hands of the private sector. When this crisis is sorted out, it is vital, in my opinion, that one substantial Irish bank must remain in state ownership, run at arms length from the government.

In the meantime, we should re-nationalise Eircom. It’s a steal at €100m. We are spending more on subsidies to private firms on haphazard broadband provision.


Tomaltach said...

An interesting and provocative post. Certainly the panacea of the free market being a driver for efficient outcomes has been shattered.

I would share your hope that the general crisis leads to a re-evaluation and abandonment of the strain of Anglo-Saxon capitalism that has emerged which is driven soley by short term shareholder value, short term incentives for senior executes, poor oversight by boards, and a detachment from broader societal and environmental objectives.

Having said that, while any serious re-evaluation of the model would examine the ownership and governance structure, regulatory framework, and accounting practices, I'm not certain it would automatically lead to a recommendation of state ownership. Or if it did, would we not want to overhaul our governance structures and lines of responsibility for state owned enterprises too? Does our record in Ireland not show a trail of political interference, appointment of favourites of those in power, and a relatively nasty legacy of incompetence.

It is true that Aer Lingus and Eircom both became focused and efficient towards the end of their term under government ownership. But perhaps some or much of their performace was driven by the impending privatisation. Political interference had to be seen to be absent and efficieny and strategy had to be seen to be right or the market wouldn't have taken them on. How much of their good behaviour therefore was because the head master was watching?

I don't intend to suggest that the market is a benign force that drives positive outcomes (clearly we have seen its monumental flaws) but it does drive certain disciplines and practices that are desireable but often difficult to achieve in state owned enterprises.

The danger I would see is that without serious thought about how state owned enterprises are governed and operated that we would lapse back to a model where these organisations became big, tardy, politicised, slumbering monopolies.

That said, I'm not ideologically opposed to state run companies. I don't care who runs them in fact. What matters is that the appropriate accountablity, governance, and regulatory frameworks exist to make them operate in a way that is compatible with long term social, environmental, and economic objectives.

Donal Palcic said...

€100 million euro sounds like a good price for Eircom but we must ask the question: what exactly would the Government be buying for such a price? Eircom’s net debt stood at €3.33 billion at 31 December 2008. Tangible fixed assets were valued at just over €2 billion at the same date, however the true economic value of these assets is likely to be far less with much of Eircom’s network infrastructure in need of significant upgrading after years of underinvestment, as evidenced by the considerable increase in network faults experienced over the last few years. In order to facilitate the rollout of next generation infrastructure, significant investment would be required to upgrade Eircom’s existing copper wire infrastructure to fibre optic cable. The funding of such investment would be made difficult if Eircom were nationalised along with its already considerable debts. The Government should also be wary of taking over a highly unionised company whose Employee Share Ownership Trust (ESOT) holds a 35 per cent stake in the company. Eircom’s ESOT has effectively acted as a wealth maximiser since 1999, approving a number of changes in the ownership of the company that were not in the best interests of wider stakeholders in order to increase their shareholding in the company and generate higher returns for members.

Why spend billions of Euros on a company riddled with debt for a technological legacy network that requires billions in future investment and an active unionised workforce? The Government can spend the same money investing in a new future proof national network that will ensure Ireland’s long term competitiveness. A new state-owned telecoms network utility could take charge of all the existing state-owned telecoms assets (such as those held by the ESB, Bord Gáis, the newly constructed Metropolitan Area Networks etc.) and commence investment in a national next generation network. Such an entity was recently suggested by Fine Gael and mirrors the proposals put forward by Forfás and others as part of the DCENR’s consultation on next generation broadband. The case for creating such a company is overwhelming and requires immediate implementation. Bundling these assets together and allowing other operators access to these ‘backhaul’ connections in a less fragmented manner would significantly reduce the cost of deploying next generation services.

Moreover, if the Government creates a new holding agency for SOEs, as put forward by Paul Sweeney of ICTU a number of years ago, the civil engineering costs of constructing such a network can be minimised through the coordination of overlapping SOE infrastructural projects. In addition, future large-scale transport and other infrastructural projects can be utilised to install ducting at the construction phase, lowering the cost of developing a national next generation network even further.

Given the importance of next generation broadband infrastructure to a modern ‘smart’ economy such as Ireland, there is now an unassailable case for the Irish government to take radical action and provide this infrastructure directly itself. It must be borne in mind that this does not have to cost the taxpayer much money. A commercial state-owned network utility will have the ability to finance all of its investment through its own borrowings. When Telecom Éireann was first corporatised from the Civil Service in 1984, it was forced to take on the massive debts incurred by the Department of Post & Telegraphs in the preceding decades. As a commercial SOE, Telecom Éireann transformed the national telecoms operation from a chronic loss-maker to a profitable company and invested heavily in its network so that by the mid-1990s Ireland enjoyed world class telecoms services. At the same time, Telecom Éireann managed to reduce the company’s debt considerably, all without any assistance from the Exchequer. Given the debt burden placed on the company from inception and the poor state of the network it inherited in 1984, these achievements were simply remarkable.

Turn to today and look at the recent investment plans announced by both the ESB and Bord Gáis. The ESB plans on investing some €22 billion and creating close to 4,000 jobs between now and 2013 while Bord Gáis has been investing heavily in electricity generation. Both companies have financed their investment programmes through their own borrowings and both still pay significant dividends to the Exchequer each year. Far from being a burden on the State, these companies are providing a much needed stimulus to the economy. In these gloomy economic times, we need more ‘national champions’ such as the ESB.

If the Government is serious about creating a knowledge based, innovation driven, services intensive economy, radical action is now required. With or without a nationalised Eircom, the Government can no longer afford to wait and see whether the private sector will make the required investment in high speed broadband infrastructure. This clearly didn’t work from 2001 onwards when Ireland fell behind her competitor countries in terms of the availability (and price) of even basic broadband services due to a lack of investment. The longer the Government prevaricates, the more we fall behind our competitors and the further damage we do to future FDI, employment and economic growth. A state-owned national telecoms network company with a mandate to roll-out a fully open access next generation network across Ireland is the only solution to the current broadband market failure. The State has already made some of the required investment in next generation broadband infrastructure through the Metropolitan Area Networks programme. It now needs to capitalise on this investment and ensure Ireland’s long term competitiveness once we emerge from the current economic crisis.

Paul Sweeney said...

On Tomaltach's comments that "Does our record in Ireland not show a trail of political interference, appointment of favourites of those in power, and a relatively nasty legacy of incompetence" I think he is correct on the second point but wrong on the first and third. Political interference is near non-existent today due to the fiduciary duties imposed on directors under company law, but it could be reduced to zero with a non political board appointment system.

Interestingly, the political appointment system has got worse since FF/PD came to power in 1997. Before this run of FF governments, there was an understanding that if a director appointed by a different party was competent, then they were left in place for a second term. This changed and it is now purely Party political with few exceptions. On the third point, there is no more nasty incompetence in commercial state companies than in the private sector. In fact, I can safely say, looking at the formerly “private” banks, that there are far less and much less in scale and scope!

In my opinion, based on analysis, Irish state companies are well run and have been for 10-20 years. They are in the marketplace (few are monopolies) and seek profits, but like many German and Japanese firms, they are not full profit maximisers and do still provide social and region roles, to some extent. We can afford this, I think.
The State Holding Company idea would provide a new lease of life to the best companies to expand largely abroad. We need to focus seriously on building our indigenous companies, and less on FDI.

I agree with much of what Donal Palcic says, including his point that “Eircom’s ESOT has effectively acted as a wealth maximiser since 1999.” I am highly critical of the ESOT in my book. I also think Donal makes some really excellent points on the performance of some commercial state companies, an area on which I know he has considerable expertise.

On his point that “The Government should also be wary of taking over a highly unionised company whose Employee Share Ownership Trust (ESOT) holds a 35 per cent stake in the company,” does he show certain prejudices? He mentions his hostility twice to this “active unionised workforce.”

What is wrong with a highly active workforce? It exists in most of the top private sector firms here and in Europe too. Is the alternative - the Ryanair/Walmart model of treating workers like dirt - the preferred route? When there are IR problems, it is my experience that it is usually (tho not always) poor management that is at issue.

Yes Donal has a point on the government taking over a company with a major 35% active ESOT as shareholder. It could buy out the ESOT or do a robust deal with it. I think the key problem with the Eircom ESOT model (when it became more a profit maximiser than an employees’ interest body) was that the majority of members are not actually employees (being retired or exits). This meant that the interests of workers were not as well aligned with those of the company as they might have otherwise been.

Tomaltach said...

Paul Sweeney writes "Political interference is near non-existent today due to the fiduciary duties imposed on directors under company law, but it could be reduced to zero with a non political board appointment system.". The point is we don't have a non political board appointment system. That is one of the major issues. And as the system currently operates the releveant minister appoints board members. Even in non-fully state owned companies, such as Aer Lingus, where the government holds a large stake, there is clear political interference. The minister stated that the government would use its shareholding to protect landing rights etc. In reality, where the government has a major or full stake in a company and appoints board members those board members are currently there at the pleasure of the government, and indeed on their behalf as shareholders. It is impossible to imagine that any instruction or advice they might receive, or pressure they might come under, wouldn't be guided as much by what is in the interests of the governing party, in terms of votes or popular decisions like retaining a landing stop, instead of being purely stratgic.

There is a conflict here. In some ways the whole point of state ownership is to have political interference, so that, in theory, the strategy of a company can be guided by the force of the democratically expressed will of the people via representatives. (That is not the only reason to have state ownership). This is fine in theory, in practice, I fear, the interests of the people or the 'common good' often come down the list.

Anonymous said...

You wrote:
"The second set of new owners, private equity firms, led by Tony O Reilly and George Soros, sweated the company and used its cash to pay off the cost of buying it."
I think the mot juste which escaped you was "looted". 'Asset-strippers' doesn't even begin to describe these people...