Acsa could put Eskom on the right path

This piece was published in the Business Day on 22 September 2014:

THE Treasury’s package of measures for dealing with Eskom is like the curate’s egg — it is good in parts. The Treasury has devised a package of measures to sustain Eskom. Some will be welcomed, others not. Unfortunately, the government, sole shareholder of this failing corporation, is not willing to recapitalise Eskom fully so it can complete its build programme without further harm to hard-pressed electricity users.

According to the announcement by the Treasury last week: “First, government will support Eskom’s application to Nersa (the National Energy Regulator of SA) for tariff adjustments in line with the regulatory process.” Thus, users mostly have to cover the higher costs Eskom has incurred in producing electricity in recent years — with the blessing of the government, Nersa and Eskom. This raises the issue of Nersa’s independence to pursue a broad public interest, which is its remit. The justification for recovering these much higher costs by way of a 16% annual increase over five years was partly rejected by Nersa last year as an unjustified burden on electricity consumers. Nersa gave Eskom an 8% annual increase over the five-year tariff adjudication period.

The difference between 8% and 16% has become Eskom’s cash-flow problem, which higher tariffs will now largely resolve.

After Nersa’s ruling was announced in February last year, allowing a 3% real return on the additional capital to be invested by Eskom in Medupi and elsewhere, we wrote: “We have pointed out before that the less Eskom charges, the more debt it or the state will have to issue to fund its heavy and essential expansion programme, absent a willingness to sell off some of its generating capacity to private owners.

“In Eskom’s case for 16% annual increases, it had estimated that about R350bn of debt would have to be issued by 2018. We have calculated that this debt would rise to more than R500bn if price increases were confined to 8% and similar operational and capital costs were incurred. Nersa is of the view that these costs, as estimated by Eskom, should be better controlled. If Eskom achieves these cost controls, it would improve cash flow and reduce the volume of debt finance.

“The budget and borrowing plans have factored in about R330bn of Eskom debt. This will have to be revised higher. And with the extra government borrowing requirement now running at about R190bn a year, this additional debt of about R30bn a year for five years will not be welcome to the Treasury or the bond market.”

If Eskom were a private business it would be shareholders who would have to recapitalise the business, or allow it to go out of business and sell off the viable assets to other operators. But a government-owned and sanctioned monopoly has price-setting powers that make a mockery of shareholder responsibilities when operations turn out badly. Prices can be set high enough to solve all potential financing problems. Higher prices have profoundly important influences on both the capacity of households to spend and the capacity of factories and mines to compete on local and foreign markets. But this takes second place to the short-term debt management concerns of the Treasury.

Capitalising Eskom means either the Treasury raising more debt, or selling off some of its underperforming assets. The latter option would not only help to avoid more debt but, more important, would lead to more efficient operations and lower electricity costs. This is not by some kind of alchemy but because private owners have very different incentives to the government as shareholder. They do not have the power simply to pass on the costs of failure to a compliant consumer, and so are more likely to avoid them.

There are some helpful aspects to the Treasury plan. In addition to the government guarantee for R50bn of additional debt to be issued by Eskom, there will also be an injection of equity capital to be funded by proceeds of privatisation (called “leveraging non-strategic government assets”). There is also the prospect of much greater private production of electricity to come, especially through foreign-owned and -funded nuclear power plants on a large scale.

There is now a growing recognition in policy circles of what private production and its foreign funding of future electricity generation can provide for the economy. Determining the right mix of privately owned additional generating capacity (coal, gas or nuclear) and the degree to which the government (taxpayer) will have to stand as guarantor of the revenue to be received from the providers of additional capacity, will no doubt exercise all the negotiating capacity of our energy planners in the years to come.

However, for now, the issue is how to best manage Eskom. According to the media statement: “Equity injection: An allocation of funding will be given to Eskom to help relieve the impact on electricity consumers, as well as add additional support to Eskom’s balance sheet, which needs to be strengthened. This will be funded from leveraging nonstrategic government assets. Details in this regard will be provided by the minister of finance as part of budget announcements.”

The rating agencies have inquired about the assets that might be sold to support the Eskom balance sheet. Let us suggest just one: the Airports Company SA (Acsa). This is a highly profitable, wholly owned government business generating impressive amounts of cash from a largely completed capital expenditure programme. The cash generated is being used to repay debt at a rapid rate, leaving the balance sheet strong enough to support offshore expansion that can hardly be regarded as strategically important.

Acsa had a book value in March of R23.57bn and net debt of R10.9bn — a net gearing ratio of 48%. Net cash generated in operating activities grew from R1.17bn in 2010 to R4.12bn this year. Profit after tax was R1.7bn this year, and R97.52m was paid as dividends. That is a very conservative payout ratio of 17.5 times that no activist investor would regard as satisfactory, particularly in light of the balance sheet strength.

What could Acsa be worth on privatisation? A comparison with Ferrovial (FER), the Spanish company that owns Heathrow, among other airports, might provide some ball park indicators. According to Bloomberg, FER’s book assets are $23.71bn, with a debt ratio similar to Acsa’s.

But FER’s recent operating performance, as seen in cash from operations, has been highly variable. It is not an obvious growth company in the way Acsa is. By contrast, FER has been on a vast asset and debt reduction programme since 2011. These actions, while limiting growth, have been regarded as adding value for shareholders. According to Bloomberg, FER, of great strategic importance in the UK and Spain, had a recent market value of $11.52bn, trading on 1.81 times its book value, or 10.5 times its cash flow and 18.8 times its earnings at a dividend yield of 3.7%. The same multiples applied to Acsa would make it worth about R50bn.

Clearly, it is a valuable asset to SA. An initial public offering of even a non-controlling share would help to establish its value to its shareholders. Until then, a demand from the shareholder for a larger flow of dividends — up to R2bn a year — would not strain the balance sheet but would help immediately to close government revenue shortfalls. It is surely, given the strained state of SA’s finances, more important for Acsa to pay up than to expand abroad. And it may well be a similar story for some other state assets.

• Kantor is chief strategist and economist at Investec Wealth & Investment.