by Brian Kantor and David Holland
We hear frequent complaints from state-owned enterprises (SOEs) that they are struggling to meet their debt obligations and need to be recapitalised. Yet the SOEs are simply not generating enough return on capital invested (ROIC) to justify allocating more capital to them.
Let’s take Transnet as an example. Transnet’s return on invested capital (ROIC) was 1.0% in 2024, which is lower than the miserable ROIC of 1.5% posted in 2023. The cost of debt on long-term South African government debt is 11%. This is the bare minimum cost of capital Transnet should meet. Transnet is destroying over 30 billion rand in economic profit every year when the difference between its return on capital and its opportunity cost is considered. A terrible unaffordable waste.
There are two key value drivers that feed into ROIC: operating margin and asset turns. To improve the operating margin, Transnet needs to increase revenue AND bring down operating expenses. To meet an 11% cost of capital, Transnet needs to generate 47 billion rand in annual operating profit on its invested capital. Its profit from operations was 4.3 billion in 2024 (operating profit is before interest expenses). Assets need to be run more efficiently or sold to private parties that can do so.
The large SA state owned enterprises, Eskom and Transnet, among other SOEs including the Post Office and the trading divisions of most municipalities have not remotely met the requirement for an investable credit rating. They have not been able to contain their costs well enough to cover their interest bills let alone their true opportunity cost of capital. Nor have they properly maintained their Plant and Equipment. Fundamentally they have failed because the bottom line, that is an adequate return on invested capital, has had little influence on their behaviour. Without many eye-watering billions of maintenance capex, their ability to continue to supply essential services, indispensable for economic growth, is severely compromised.
The SA government now recognises that the only practical way to secure the supply of these essential services is to raise large investments of private capital. Of which there is no shortage, provided the terms are regarded as acceptable.
And it would only be a private company, with a bottom line that requires a risk-adjusted return on capital, that could realistically hope to control costs and preserve and improve the capital stock, to reliably supply essential services in the future. Any imaginary mythically reformed SOE –capable of containing costs and operating efficiently – but without the right private incentives- is not a viable option. We’ve been down this track too many times.
The agreed terms for private sector engagement would have to recognise the true market value of the plant (PPE) taken over by the new operator of a network or part of it. Given years of neglect, existing assets might have very little value to any new operator. The potential market value could be exchanged for equity held by the government in the new privately controlled suppliers.
The private operator would have to commit the extra capital required to guarantee a flow of essential services over the long run. And such extra capex, would have to be recognised in the tariffs and or charges made for what could be valuable access to the networks.
Complicated calculations or regulations of appropriate charges or tariffs do not have to be a barrier to private entry. Any private company that won a tender to enter a network, with a degree of monopoly power, would be highly conscious of the impact of the prices it could charge on demand, sensitive to degrees of capacity utilisation and so its bottom line. And would be very considerate of its growth prospects. Becoming a reliable supplier at a competitive price with market-related returns would be a valuable outcome for all stakeholders.
The purpose of any private- public partnership or initiative is a simple one. That is to secure the future supply of essential services for SA users without which SA incomes and output must stagnate or decline. This all-important objective, viewed realistically, must be top of officials’ minds engaged in any negotiation with potential private partners.