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Asia-PacificJuly 1 2016

Mixed results mire Pakistan's privatisation drive

After success stories in bank privatisation, Pakistan is now turning to ailing state firms in the airline, electricity and steel sectors. But large losses, competition and social unrest are making for a bumpy ride. Edward Russell-Walling reports.
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Nawaz Sharif, the prime minister of Pakistan, likes to invoke the spirit of Thatcherism, so privatisation would have a natural place in his government's reform plans, even if the International Monetary Fund (IMF) was not insisting on it. But political and trade union opposition have forced it to slow down its once ambitious programme of asset sales.

Mr Sharif pursued privatisation in his previous incarnations as prime minister, when he was accused by opposition parties of cronyism and selling state assets on the cheap. This time around the process is more transparent, and the government originally identified 68 companies whose sales could raise $5bn over two years.

A private return

Those two years have passed and only a relative handful of disposals have been chalked up, to raise some $1.7bn. The great success stories have been the banks, whose piecemeal return to the private sector over a period of years has been accompanied by increased profitability and efficiency. 

The state's remaining 19.8% stake in United Bank was sold off in June 2014, with more than 80% going to foreign investors. It raised $388m. The last 10% of Allied Bank was sold in December 2014, fetching a better-than-expected $144m. But the big one was Habib Bank (HBL), where the state's outstanding 41.5% holding was sold for a little over $1bn in April 2015, making this Pakistan's largest privatisation deal for a decade and the largest ever equity offering from an Asian frontier market. 

The government also sold a 5% slice of its 78% holding in listed Pakistan Petroleum for $153m in June 2014, just in time for the end of its financial year. Those, as it turned out, were the straightforward deals.

Bumps on the road

Muhammad Zubair, Pakistan's minister of state for privatisation, had always said that listed assets would make for easier transactions than strategic sales, but perhaps even he underestimated how difficult the latter would be. The first of his strategic sales went through smoothly enough in August 2015, when Saudi Arabia's Al Mosaid Group won the tender for 88% of National Power Construction Corporation, for which it paid the equivalent of $25m. But then things started to go wrong.

There are two troubled companies that the government would dearly love to get rid of – Pakistan International Airlines (PIA) and Pakistan Steel Mills (PSM). Until recently, they have been losing $1bn a year between them. Ministers are even keener to find alternative homes for the state-owned electricity generating and distribution companies, which collectively lose an annual $4bn.

PSM has been in a particularly desperate state. Hammered by heightened Chinese competition and poor plant maintenance, its Karachi facility has produced no steel since June 2015, when its gas supplier cut off supplies because of unpaid bills. More than 12,000 employees have been turning up for work without any pay since February 2016. Cumulative losses and liabilities now reportedly exceed $3bn.

Early attempts to find a trade buyer were not helped by the world steel glut, and in 2015 finance minister Ishaq Dar ordered that PSM should be offered to the provincial government of Sindh, where it is located. The provincial government (run by the opposition Pakistan Peoples Party) has been doing its own due diligence on PSM, and was required to make up its mind by June 10. Since the national government had declined to retain the company's liabilities, as Sindh had requested, it is thought that the offer will be declined.

"If [Sindh doesn't] take PSM, it goes back to the cabinet committee to allow us to restart the privatisation process," says Mr Zubair, adding that a Chinese buyer could be a possibility. "I was in China in September, and there was interest from Ansteel and several other companies who want to transfer [an underutilised] plant out of China." Pakistan already imports a lot of cheap Chinese steel, prompting a recent hike in import duties.

PIA debacle

While PSM has been disappointing so far for Mr Zubair's Privatisation Commission, attempts to prepare PIA for market have had tragic consequences. The airline is criticised for perceived inefficiency, nepotism and corruption in Pakistan. It has been criticised for handing out too many free tickets and hiring staff through personal connections. 

The number of PIA employees per aircraft is roughly twice the level of more efficient airlines – and Pakistan's open skies policy means that it must now compete with them. Even as falling oil prices have boosted earnings at other airlines, PIA has continued to make substantial annual losses, though recent cost-cutting is starting to take effect. 

Earlier this year, the Privatisation Commission moved ahead with a plan to sell a 26% strategic stake to a foreign airline partner, and a parliamentary bill was passed turning PIA into a public limited company. Then the PIA labour union went ahead with a full-scale strike, grounding most of the airline's domestic and international flights.

The effect on business and tourism in Pakistan was enormous. Protesters clashed with riot police at Karachi's Jinnah International Airport airport and two employees were killed. The PIA chairman took responsibility for the situation and resigned. 

The airline is already rationalising its route network, abolishing flights to destinations such as Amsterdam and Kathmandu, and doing more code sharing flights with other airlines. Mr Zubair says that it made an operating profit in its most recent quarter (the third quarter of financial year 2016). To get a subsequent enabling bill through parliament, the government had to include a ban on selling more than 49% to a third party. Mr Zubair says that the airline will continue to get rid of waste, and is still hoping for a November sale of the strategic stake. Emirates is thought to be one of the front-runners.

Hurdles to privatisation

One of the headwinds faced by Mr Zubair is that government ministers are not unanimously in favour of privatisation. Another, not unrelated, is that the deeper the government gets into its term of office, and the closer to the next election, the less political courage it has for sensitive asset sales.

A wave of strikes has also forced the government to delay the sales of a number of companies in the power sector. Investors should have been invited before May to look over the distribution companies in Faisalabad, Islamabad and Lahore, as well as generators Kot Addu Power and Northern Power. However, as the protests got under way, the government thought better of taking on the industry's 400,000 unionised employees. The plan now is to bring in independent boards of directors to improve management, in the hope of a sale at a later date.

Mr Zubair notes that the main objective with the distribution companies (discos) is to restructure them as well as privatising them. "Where privatisation is not possible, we must restructure them so that the bleeding stops," he says. Reducing transmission line losses is another priority.

IPO solution

"For some discos, we will be going ahead with an initial public offering [IPO] rather than finding a strategic buyer," says Mr Zubair. "One year later, we can look for a strategic investor and it will be a better proposition. We have shared this plan with the employees and they are OK with it."

Listing 10% to 20% of a company's shares would bring it under the eye of the Securities and Exchange Commission of Pakistan, exposing it to general financial and governance scrutiny. That in turn would help to increase productivity and value.

"Once a company is listed, it must follow a code of corporate governance, so transparency improves significantly," says Nasdeem Naqvi, managing director of the Pakistan Stock Exchange, which recently brought together the stand-alone exchanges of Karachi, Lahore and Islamabad. "And it improves the liquidity of the stock market."

The next big deal anticipated by the equity market is State Life Insurance Corporation, which is to be listed for an IPO of 10% to 15% of its stock. HBL, Bank Alfalah, Arif Habib and Elixir Securities have been approved, though not yet contractually engaged, as lead managers and bookrunners. 

Elixir, which has been a regular adviser on recent bank deals, has also been approved but not yet confirmed as financial adviser on the privatisation of SME Bank, together with local advisory firm Bridge Factor.

The government had asked the State Bank of Pakistan to recommend options for loss-making SME Bank. The central bank's favoured option was privatisation by acquisition. Others were a fresh injection of equity by government, merger with the National Bank of Pakistan or liquidation. As well as losing money, SME Bank falls woefully short of its minimum capital requirement. By looking for a private sector buyer, the Privatisation Commission is embarking on its toughest bank sale yet.

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