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Privatization Becoming Popular Worldwide
The Washington Diplomat / April 2000

By Larry Luxner

Bolivia's not exactly a household name in Baltimore, and when Constellation Power began scouting around for overseas acquisitions in the early 1990s, most of the company's officials didn't know a thing about the landlocked South American nation.

"We looked at Europe and the Pacific Rim, but finally decided to focus on Latin America," said Douglas Perry, Constellation's vice-president for development. "For one thing, there's a distinct advantage in being in the same time zone. Bolivia came on the scene about the time we were beginning our efforts."

Those efforts paid off in 1995, when Constellation closed on its first foreign investment ever -- a $34 million chunk of ENDE, the formerly state-owned Bolivian power entity. Once the deals were finalized, Constellation and its partners -- along with Energy Initiatives, Dominion Energy and Liberty Power -- suddenly found themselves controlling 90% of Bolivia's total electricity generating capacity.

"It was a relatively small investment, our first step," said Perry. "We've subsequently made other acquisitions in Gautemala and Panama."

This trend of U.S. or European multinationals buying money-losing, poorly run state entities in developing countries has been repeated throughout the world. While it's often led to improved service at lower prices, the privatization trend has also sparked resentment in many countries -- and in some cases even violent demonstrations.

In Puerto Rico, workers nearly shut down the water system in 1995 to protest the government's plan to turn over management of the Aqueducts & Sewer Authority to Houston-based PSG for $200 million.

In Panama, several workers were killed when the government put the state-owned phone company, Intel, up for sale. Similar violent protests erupted in Brazil two years ago, though the government later pulled off the largest privatization in history -- the auctioning off of state-owned phone monopoly Telebras.

While the sale of government enterprises has taken place in over 100 nations, Great Britain has established a clear reputation as the leading source of expertise in the field, according to "Guide for Divesting Government-Owned Enterprises" by Henry Gibbon.

"Working with financial advisors, British public officials devised innovative privatization procedures, starting with little or no historical precedent," writes Gibbons.

"From legalities to logistics, from the wide vision of large-scale marketing activities to the fine detail of documentation, the U.K. has spent over a decade and a half refining privatization processes. The level of expertise developed in privatizing industries -- in sectors ranging from airports to water supply, from electric utilities to rail services, from telecommunications providers to R&D laboratories -- has lent itself to wider application. Almost every country in the world is now following the British lead in privatizing its state-owned industries."

At the moment, hundreds of government-owned entities have been earmarked for divestment around the world, ranging from Albania's national phone company to Royal Jordanian Airlines to state-owned fisheries in Peru.

According to World Bank data, some 88 countries sold $135 billion worth of state assets between 1988 and 1995. Latin America and the Caribbean led the globe in privatization, with total sales of nearly $54 billion (46% of the total amount of proceeds from privatization). East Asia was next with sales of $28 billion (25%), followed by Europe and Central Asia -- which includes the formerly planned economies of Central and Eastern Europe, and the former Soviet Union -- with $20 billion (17%). Africa was responsible for only 12% of the value of sales.

In 1998, the Argentina 2000 consortium agreed to pay the Argentine government $5.3 billion over a 30-year period to manage 33 airports throughout the country -- marking Latin America's largest single privatization transaction ever. Of the total, $1 billion is going to modernize Ezeiza International Airport outside Buenos Aires.

That topped even the $4.985 billion which a consortium led by Spain's Telefónica paid to acquire Telesp -- São Paulo's fixed-line telephone company -- as part of the $19 billion breakup and subsequent privatization of Brazil's Telebras in July 1998.

As an indication of privatization's importance in the region, state-owned companies accounted for just 19.1% of total 1998 sales by Latin America's 500 largest companies -- down from 27.3% in 1997.

Because state ownership represents about 10% of GDP in developing countries on average, this suggests there are still a lot of assets in state hands. Nevertheless, privatization is very much in vogue throughout the world, and particularly in countries that favor free-market policies. Interestingly, the value of privatizations as a proportion of GDP of the privatizing countries has remained fairly stable at 0.5% from 1988 to 1995.

"Many of these companies were nationalized in the 1960s and 1970s, but now capitalism has blossomed," said Washington trade attorney Judd Kessler. "These governments have realized there is no other way to go but to reform their economies and open their investments to private capital."

In Honduras, for example, legislators are currently trying to sell 51% of the government's inefficient telephone monopoly, Hondutel. The move is backed by the private sector but was initially opposed by the telco's 3,800 workers, many of whom were wiped out in 1998 by Hurricane Mitch.

"We've had meetings with union officials that represent the workers and have come to an agreement," says Hondutel official David Rivera, who is responsible for preparing the company for privatization. "Most are no longer opposed to the process."

Eight companies have so far purchased prequalification packages, including Teléfonos de Mexico, Spain's Telefónica, France Telecom, four local firms and India's Videsh Sanchar Nigan Ltd., which operates 18 million phone lines in the New Delhi area.

Rivera said there's a good chance at least one of the four local companies would partner with an American company such as MCI WorldCom, though no U.S. firm wants to buy Hondutel. "There's no interest by American companies. We don't know why," says Mario Agüero Lacayo, chief of the Honduran government's privatization program at the Ministry of Finance.

A 1996 study by Price Waterhouse estimated the book value of Hondutel at $632 million. The company -- which until the late 1980s was run by the Honduran military -- reported 1999 sales of 2.8 billion lempiras, or about $193 million. Most of that revenue is generated by long-distance phone calls to and from the United States.

At the moment, Hondutel has 370,000 lines installed but only 260,000 actually in service, translating into a teledensity of only 4.3 lines per 100 inhabitants -- one of the lowest in the Western Hemisphere. Rivera says the government's goal is that under new ownership, Hondutel will boost coverage to 600,000 lines by 2005.

Handling the privatization process is British investment broker N.M. Rothschild & Sons Ltd., which will receive a fee of 1.98% of the proceeds when Hondutel is finally sold in late June.

"This is primarily a capitalization process rather than an outright sale," says Rothschild representative Christian Pedemonte. "The operators will be injecting money in a company that they will control. Number two, it's an underdeveloped market, so the prospects for growth through expansion of the network are very strong. Thirdly, the transaction comes with mobile PCS licenses, so there's a lot of business potential there. Fourthly, it has an exclusivity period until the year 2005."

In pursuing the sale of Hondutel, local officials might learn some lessons from Juan José Daboub, the privatization czar of neighboring El Salvador.

In 1995, El Salvador's state-owned phone monopoly, Antel, had 175,000 fixed and 50,000 mobile lines. Today, there are 500,000 fixed and over 400,000 mobile lines. By the end of this year, says Daboub, El Salvador will boast more than a million lines in service for its six million inhabitants -- a teledensity of over 15 per 100.

What triggered the turnaround was the sale of 51% of Antel in July 1998 to France Telecom for $575 million. Another 10% was offered to the workers at book value, and at preferential financing rates, and 14% was sold to individual stockholders. The remaining 25% remained in government hands.

Prior to the sale, Antel derived 60% of its revenues from phone traffic to and from the U.S. -- which was quite substantial given the fact that over a million Salvadorans live and work in the United States -- yet there was no competition in the market.

"In 1995, to call your brother in the U.S. you had to pay at least $2 a minute. Now, it's between 10 and 20 cents," says Daboub. "In August 1996, local calls were 0.7 cents a minute. Now it's 1.2 cents. To get a line, you used to pay 20,000 colones (about $2,300) in the black market because there were hardly any lines. Today it's free, and you can choose your own number."

Daboub thinks the Honduran government is making a big mistake by offering six years of exclusivity.

"The idea is to minimize regulation and maximize competition," he said. "We eliminated the word exclusivity from the dictionary. I would not have been involved in the process if we had done it that way."

In Jordan, where until recently the government owned everything from a cement factory to a vegetable-oil processing plant, an ambitious privatization program is well underway.

"Over the past several decades, Jordan's public sector has been the dominant player in the economy," says financial analyst Abdulla Shahin of Atlas Investment Group Ltd. in Amman. "The Jordanian private sector, like most Arab countries, was characterized by its small size and general ineffectiveness. As Jordan strives to maintain its regional competitiveness, the country's new leadership is looking for the private sector to assume a more active role in the development of the economy."

In February, that effort got a big boost when France Telecom -- in the largest privatization in Jordanian history -- agreed to buy a 40% controlling interest in Jordan Telecommunications Co. (JTC) for $508 million, which was the minimum price set by the government.

France Telecom Chairman Michel Bon said the acquisition would boost his company's regional presence -- it already has operations in Egypt and Lebanon. He also said France Telecom would invest over $400 million between now and 2003 on modernizing and revamping Jordan's inadequate telecom infrastructure.

At the moment, JTC has 510,000 fixed lines and a teledensity of just under 11 per 100. In 1996, the company was valued by U.S. consulting firm Arthur Andersen at $1.26 billion, yet analysts say JTC has become a burden on the government's treasury because of the continual need to upgrade and expand the network.

"With privatization, there'll be a lot less bureaucracy," says Marwan Faraj, general manager of National Electronic Systems, a leading computer software firm in Amman. "France Telecom is an excellent company to have a partnership with. In two years, we'll have a definite improvement in the telecom infrastructure."

Adds Shabib Ammari, the new chairman of JTC: "Privatization will put Jordan Telecom at accepted international standards of quality, expediency and variety of services."

The benefits of privatization transcend national boundaries, according to :"Trends in Privatization," by Mary M. Shirly.

"Privatizations have a particularly strong influence over decisions to invest, and each dollar of privatization revenue generates an extra 38 cents in new investment -- with financial and infrastructure privatizations having the most positive effect on other foreign direct investment," she wrote.

Luis de Lucio, manager of international financial services at Ernst & Young, offers some specific tips for companies about to bid on state-owned firms:

* Evaluation. Take a careful look at how much the government is asking for what it's selling, and how much you're willing to pay.

* Terms. What is the government requiring in addition to your purchase of the facility, what levels of service does the government expect, and how many employees are they asking you to keep?

* Sources of financing. Your company can finance the transaction with its own equity, or turn to domestic markets (for smaller firms) international markets (for larger firms) or multilateral investment agencies such as the World Bank's International Finance Corp., the European Bank for Reconstruction and Development or the Inter-American Development Bank's Inter-American Investment Corp.

* Legal and tax requirements. Carefully study rules on setting up the company, possible limitations on foreign participation and reciprocity with the United States on tax issues.

Once the winning bid is in hand, De Lucio advises, don't fire top personnel who may be indispensable to the smooth running of the enterprise. "Most of these companies are burdened with too many workers, especially railroads," he says. "But there are some employees you don't want to do without."

Aileen Pisciotta, chief of planning and negotiations at the Federal Communications Commission's International Bureau, says executives should also give some thought as to what's behind a given selloff -- particularly in the field of telecommunications.

"Argentina's privatization of Entel was motivated by the need to retire public debt," she said. "It was very different in Venezuela, where the sale of CANTV was motivated by a desperate need to improve service. In Nicaragua, it was a pure political problem."

She added that the sale of government phone companies generally requires a law, and sometimes a constitutional amendment.

"The position of unions is also a major problem. In Uruguay, a public referendum rejected the whole notion of privatization, and in Colombia, workers sabotaged the network." Part of the reason, said the FCC expert, was that although "telecom itself is an engine of economic development, a lot of people think privatization is synonymous with competition, but that's often not the case."

For more information, check out the following resources:

* Center for International Private Enterprise, 1155 Fifteenth St., N.W., Suite #700, Washington, DC 20005. Tel: (202) 721-9200. Fax: (202) 721-9250. E-mail: cipe@cipe.org. Website: www.cipe.org.

* Privatization News, 818 Eighteenth St., N.W., Suite #940, Washington, DC 20006. Tel: (202) 785-0811. Fax: (202) 785-5370. E-mail: pn@privatization.net. Website: www.privatization.net.

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