Legal Practice Briefing
15 December 1993
PRIVATISING GOVERNMENT BUSINESS ENTERPRISES
Government privatisation of assets has increased substantially. In recent years, the Commonwealth has moved to privatise a number of GBE assets including Qantas, the Commonwealth Serum Laboratories, the Moomba-Sydney Gas Pipeline, the Snowy Mountains Engineering Corporation, and approximately 20% of the Commonwealth Bank of Australia.
Privatisation presents a number of different and unique challenges compared with other commercial agreements. Managing the change of ownership from the public to the private sector raises numerous Government issues that are not faced in traditional mergers and acquisitions, for example, industrial arrangements for transfer of staff from the public to the private sector.
This paper gives a brief overview of some of the issues to be confronted, including:
- key methods and procedures for privatisation of GBEs;
- important Government factors when preparing a GBE for privatisation; and
- common issues establishing an ongoing 'regulatory framework' for the GBE after privatisation.
Privatisation methods which are considered in this paper are:
- public offerings of shares (full or partial);
- private sales of shares (full or partial, otherwise more generally known as 'a trade sale');
- individual sale of assets;
- introduction of new private investment into a GBE; and
- management/employee buy outs.
Public Offering of Shares
Under this approach, the Government sells to the general public and institutions either all or large blocks of the stock it holds in a wholly or partly owned GBE, which is assumed to be a going concern set up as a public limited liability company. This amounts to a secondary distribution of shares (as only existing shares are sold), as opposed to more traditional capital raising exercises involving an issue of new shares for public subscription.
While technically the public offering is a secondary distribution of existing Government held shares, it is generally handled as if it were a primary issue. As with the recent Commonwealth Bank of Australia offer, a prospectus is usually prepared for the offering. The Government has to determine:
- whether the offer will be underwritten;
- how the shares will be priced (for example, fixed price, tender, open price offer);
- who the shares should be marketed to (retail sector, domestic/ international institutions);
- the type of marketing campaign;
- what advisers need to be appointed; and
- whether the shares will be listed overseas.
The offering may involve, apart from sales to the general public, incentives for employee participation. There also may be restrictions on the size of individual shareholdings.
To be eligible for a public offering, the GBE must comply with certain legal, financial and disclosure requirements as required by the Australian Securities Commission and the Australian Stock Exchange. This raises the following issues for consideration:
- The condition of the GBE. If the GBE is not a strongly performing public limited liability company with a reasonable trading record, a public offering is probably possible only to the extent that primary restructuring and a turn- around in operations are a realistic option.
- Targeting Ownership. If the objective is to achieve widespread share ownership or to target certain segments of the investing public, specific mechanisms (incentives, restrictions, etc) need to be introduced to ensure those objectives are obtained and maintained.
- Valuation and Price. These issues need careful handling to ensure that the Government receives full value.
Private Sale of Shares - Trade Sale
This is one of the most common privatisation methods. It involves the Government selling all or part of its shareholding in a wholly or partly owned GBE to a pre-identified single purchaser or group of purchasers. It assumes that the business enterprise is a going concern set up in the form of a Corporation represented by shares. The transaction can take various forms, for example, a direct acquisition by another corporate entity or a private placement targeting a specific group (such as institutional investors). A private sale may be carried out before, or simultaneously with a public offering.
The principal advantage of a trade sale is that prospective owners are known in advance and can be evaluated. They may be selected based on their ability to bring to the GBE benefits such as management, technology and market access. In many instances, the future success of the GBE may be as important to the Government as the proceeds from the sale. In some cases, a partial private sale may be a necessary first step to full privatisation, because it brings in a leveraged party who is able to turn the company around so that it becomes attractive to investors.
The sale of Government shares in a GBE in this manner can be handled in a variety of ways. One common way is through a full competitive process, with pre-qualification of bidders. This maximises both the proceeds and chances of success of the privatised enterprise. Another is sale by direct negotiation, with ad hoc procedures for identified potential buyers (often involving a wide investor search).
When deciding whether to transfer ownership of the shares, the Government will look at the purchasing party's general business reputation, financial strength, record of performance, etc.
Sale of Government or Enterprise Assets
A number of implementation issues arise with this approach. The GBE concerned may be in need of financial restructuring, such as alleviation of liabilities. Mechanisms for handling employment issues, particularly job loss and Government benefits, may need to be designed as most will carry some cost. To ensure Government objectives are met and the public interest is served, mandatory procedures may need to be introduced to govern valuation, purchaser selection, etc. In partial privatisation there may also be a need for the Government to allay investor fears of continued interference.
Under the two previously discussed methods of privatisation, the private sector would be purchasing shares in a GBE that is a going concern. Here the transaction consists basically of the sale of assets, rather than shares in a going concern. The Government may sell the assets directly or the GBE may do so itself. The decision depends largely on the structure of the actual GBE.
Generally, while the purpose may be to hive off separate assets representing distinct activities, the sale of separate assets may be only a means of selling the enterprise as a whole. Thus, the assets may be sold individually or be sold together as a new corporate identity.
By definition, a sale of assets involves a known party and in that sense it has the same advantages as a trade sale. In addition, it offers additional flexibility in that it may be more feasible to sell individual assets than the whole business enterprise, or it may permit the sale of a business enterprise that might be extremely difficult to sell as a going concern. However, this approach may often result in residual liabilities for Government, for example, not all of the assets of the business enterprise may be able to be sold.
The main implementation issue is how to handle existing liabilities. Unlike the sale of a going concern, assets are often sold without their corresponding liabilities.
This method of sale permits piecemeal privatisation, in particular the privatisation of component parts where there is no potential buyer for the whole company. For example, in seeking to privatise a company, it is not unusual to find that some activities are more attractive to buyers than others.
There are several possible ways to proceed that will depend on the legal structure of the enterprise. The options include:
- breaking up the GBE into several legal entities;
- transforming the GBE into a holding company that acquires the shares of the subsidiary companies which have taken over the assets and liabilities of the original GBE;
- hiving off of some activities, with the Government retaining others.
New Private Investment in GBE
A Government may wish to add more capital to a GBE and achieve this by a capital increase opening up equity ownership to the private sector. The main characteristic of such a privatisation method is that the Government is not disposing of any of its existing equity in the GBE. Rather, it increases the overall equity of the GBE and causes the dilution of the Government's equity position. The resulting situation will be joint private/Government ownership of the enterprise.
Normally a new equity raising does not result in sales proceeds for the Government. Rather the capital is returned to the company through recapitalisation.
This directly addresses the funding problems of an undercapitalised GBE or permits rehabilitation or an expansion of the capacity of a GBE. This type of privatisation is accomplished through a capital increase of the GBE. The new share issue of the GBE may be handled through a public offering or private sale. In some instances, various classes of shares may be issued depending on the objectives of the parties involved.
Management/Employee Buy Out
The term management/employee buy out refers generally to a transaction where employees, or management and employees, acquire a controlling interest in the GBE for which they work. The leveraged management/ employee buy out involves the use of credit to finance the acquisition. The assets of the acquired company are generally used as security.
A management/ employee buy out is a relevant means of transferring ownership to management and employees with little wealth or knowledge of share ownership. It may be a solution for GBEs not otherwise saleable. It also may constitute a substantial incentive to productivity.
Preparing GBES For Privatisation
Few business enterprises are in a condition to permit sale or other transfers to the private sector to take place without preparatory measures. Based on a detailed legal and financial analysis which will proceed just about any divestiture (for example, 'a scoping study') it frequently will be determined that the business enterprise is not saleable on an 'as is' basis and that a number of preparatory restructure methods may be necessary. Common steps in this process are:
- corporate financial and legal analysis (that is, due diligence);
- alteration, amendment or conversion of the legal structure of the business enterprise;
- modification of the overall legal framework within which the business enterprise operates;
- financial restructuring including measures with respect to excess liabilities;
- rehabilitation of assets;
- changes with respect to staffing; and
- ensuring management co-operation.
Relationship with Government
The nature of the ongoing relationship between the Government and a GBE after privatisation is a difficult issue. Normally, as part of the initial 'scoping study' there is a detailed examination of the regulatory environment in which the GBE operates.
Such a study can then give rise to a number of issues. For example, if the GBE is operating as a virtual monopoly, the question of whether the monopoly should be removed after privatisation will arise. If the GBE performs a number of community service obligations the Government would have to decide if it requires the privatised GBE to continue to perform the services after sale. If so, it must be determined how the GBE is to be compensated if the performance of those community service obligations is non-profitable.
Getting the regulatory environment right is often the key to ensuring that a successful privatisation occurs. Purchasers are anxious to know and understand the nature of the relationship that will exist between the privatised GBE and the Government after sale. This is particularly so where the GBE has operated in a very protected environment.
Perhaps one of the most difficult areas to deal with is where the Government itself will continue to retain an interest in the privatised GBE. The relationship between the Government as shareholder and its role as a regulator of the industry in which the company concerned operates may create obvious tensions.
Care needs to be taken to delineate the Government's role in this regard. It may be necessary for the Government to consider entering into a form of 'shareholder agreement' with its private sector partner, setting out the manner in which the jointly owned GBE in question will be run in the way in which the Government as shareholder (as opposed to regulator) will act.
Techniques sometimes referred to as privatisation, or which are linked to it but not specifically covered in this paper are:
- introduction of competitive features into a GBE's operation (eg performance related incentives);
- economic policy reforms such as demonopolising certain activities or reducing regulatory constraints on business, possibly in specific sectors;
- use of private sector funding for new activities;
- revenue participation, certification or revenue bonds issued by the Government itself or by Government-owned bodies;
- switching the source of financing for the supply of goods or services to user charges;
- contracting out and franchising.
Major Privatisation Projects Undertaken by The Legal Practice
The Privatisation Group within the Legal Practice has been involved in some of the largest sales of Australian assets. The following list indicates the range of this activity.
- Qantas sale of Australian Airlines to Qantas, sale of 25% of Qantas to British Airways, and preparation for float of residual Commonwealth holding. This included due diligence of both Australian and Qantas, sales legislation, public interest protection, post sale memorandum and articles and complex trade sale negotiations and documentation.
- Commonwealth Bank float of approximately 20%, negotiations with Bank board, ASC and ASX, difficult Corporations Law issues, novel pricing structure.
- Second Telecommunications Licence sale of licence and Aussat to Optus, together with establishing an appropriate regulatory structure for competition in the provision of telecommunications services.
- Chifley Square, Sydney long-term lease which achieved Australian record value for CBD.
- Tokyo Embassy sale and redevelopment with complex contractual structure providing for land swap, major construction, and environmental and heritage protection. Also involved issues relating to domestic land law and sovereign immunity.
- Williamstown Dockyard, Melbourne sale of business with major industrial issues, documentation of existing arrangements for ship construction, foreign ownership and other public interest issues including the use of a 'special share'.
- Air Terminals long-term lease of domestic air terminals with provision for third carrier access, lessor development, and continuing performance of Commonwealth regulatory functions.
- Commonwealth Serum Laboratories currently preparing for float, including due diligence, sales legislation, and establishing appropriate contractual arrangements for the delivery of services to Government after privatisation.
- Defence Service Homes Loan Scheme sale of mortgage portfolio to Westpac together with arrangements for the delivery of Defence Service Homes benefits through the Westpac branch network.
- Moomba-Sydney Gas Pipeline currently engaged in trade sale negotiations for the sale of this pipeline and the establishment of appropriate third party access and other regulatory arrangements for the post sale operation of the pipeline network.
- Commonwealth Accommodation Catering Services Ltd sale of catering and hostel company, involving company conversion, contracts for future government services, and complex industrial issues.
- Snowy Mountains Engineering Corporation Ltd management buy out with sales legislation and issues relating to contingent liability.
- Hollywood Repatriation Hospital, Perth contracts signed for sale of Hollywood Hospital and for the provision of ongoing hospital and medical services by the purchaser.
ISSN 1448-4803 (Print)
ISSN 2204-6283 (Online)
The material in this briefing is provided for general information only and should not be relied upon for the purpose of a particular matter. Please contact the Legal Practice before any action or decision is taken on the basis of any of the material in this briefing.