Privatization Sales are not Strategic Solutions

The Ukrainian government adopted a new law entitled “The Law on Privatization of State and Municipal Property No. 2269-19”. This law reduces existing categories of assets (e.g. buildings, land) and equity (company ownership) from seven to two: so-called “small objects” and so-called “large objects” of privatization. Small objects are defined as assets or companies (based on balance sheet values) less than 250 million UAH (≈ $1 million). Everything else is defined as large privatization. The government retains ownership of some assets deemed strategic and will undertake some restructuring, most importantly at the State gas company Naftogasukraina.

Almost all small privatization objects are planned to be sold through ProZorro, an online public procurement platform. The idea is that changing the process by which these assets and companies are sold will improve transparency and introduce market pricing by determining effective market price and demand via online bidding. The government also hopes to greatly accelerate privatization activity.

Large objects will be sold with the help of “advisers” who will recommend a starting price for the auction and attempt to attract investors. The idea is that advisors will help government set price and sale conditions that are achievable for a large state company. In some cases, the government will try to sell equity in large state enterprises through Prozorro, using a bidders’ opening price as the starting point.

Although the new law represents an improvement in efficiency and transparency, using an online platform does not itself guarantee a reduction in corruption or an increase in economic benefit for the nation and may or may not raise additional revenue for the government. The reason is that the government’s approach to privatization remains strategically flawed. The fundamental problem is the government’s over-reliance on attempting to sell companies (ownership equity) rather than selling assets, and to do so without first crafting a realistic and effective privatization strategy.

The government has never crafted a privatization strategy whereby the ultimate objective from the sale of assets or companies is to create maximum value for the economy; as measured, for example, by an increase in GDP, business formation, capital investment or employment. Instead, the government produces an annual plan to sell assets and companies for the sole purpose of raising money for the annual budget. A budget is not a strategy.

The government has never set a realistic goal for privatization revenues. In 2016, the plan was to raise 17.1 billion UAH from the sale of share packages and other assets whereas actual sales were only 192 million UAH (1% of the goal). The plan for 2017 was also to raise 17.1 billion UAH but actual sales were only 3.8 million UAH (2% of the goal). For 2018, the goal is 22.3 billion UAH, but this target is also highly unlikely to be met despite using Prozorro. A platform is not a strategy.

A privatization strategy requires government to determine the desired outcome of privatization sales. If the sole purpose is to earn money for the budget and government does not care what becomes of a company after sale (i.e. operation or cannibalization), then no strategy is required. Either the equity share package will be purchased, or if not, it will be included into next years’ unrealistic plan. A fundamentally important part of any privatization strategy would be for government to put insolvent companies (those whose liabilities exceed their assets, often greatly so) into bankruptcy to completely liquidate all liabilities, including current equity. Physical assets could then be sold, preferably after being organized into one or more economically viable asset packages. This would require some legislative changes and would upset certain political and economic groups, which likely explains the government’s reticence.

As an example of recent asset sales: two hydroelectric power stations located in Mykolayiv oblast – which were used by but not owned by the PJSC “Nikolaevoblenergo”, were sold as stand-alone income-generating assets, rather than being sold as part of the company whose equity value is encumbered by large amounts of debt and other liabilities. In auctions in late 2016, one hydroelectric station was sold for 52.5 million UAH (five times the initial asking price) and the second station was sold for 64 million UAH.

By contrast, selling equity often minimizes sales price. If a balance sheet contains liabilities that exceed asset values, the company has a zero business value. This raises a troubling issue. If a buyer is the party responsible for creating the excessive liabilities that drove the business value to zero, either legitimately or illegitimately, then that buyer benefits twice: once from running up the debts — perhaps by selling inputs to the company at above-market prices or selling company products through intermediary companies at below market prices — and then again from purchasing the company at a greatly reduced privatization price. And government revenue from privatization is minimized, not maximized.

The Ukrainian government should be commended for its recent improvements to the process of privatization but it must, after 25 years, finally adopt a privatization strategy that benefits the economy and not just the budget.

Tomas&Simonova 2018©

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