How to Carry Out Privatization: Three Categories of State Assets

On Privatization in Kazakhstan

Only the lazy are not talking about a second wave of privatization. Everyone talks and talks about it, yet hardly anyone knows how much has been sold and how much is still to be sold. I barely noticed the first wave. I don't know when it began or when it ended, what was sold as a result and what was kept. All I remember is that a couple of companies were floated in IPOs, and not very successfully at that.

Now we are hearing about large-scale privatization of state property. The clever Western term being used is "Yellow Pages Rules," the essence of which is to transfer to private ownership everything that can operate under private ownership and does not threaten national security.

There is no clear line between what should be state-owned and what should be private. For example, KazMunayGas could be a private company, and so could Kazatomprom. Why not privatize them in full?

This whole privatization is an opaque process in which neither the goals nor the objectives are clear, nor is it clear what exactly is wanted.

Let us consider the main problems of privatization and the goals the state sets for it, or should set.

Going through various media quotes from officials, one comes to understand that the state wants to:

1. Sell off problem assets. A great many of these have piled up, and since the core business can no longer carry such ballast, it has been decided to dump it.

This raises two key problems:

• The book value of such ballast is much higher than the market value of the assets (there are many reasons, mostly inefficiency), but an official cannot sell below cost, since that would immediately raise suspicion as to why the asset's value is below market. So the bigger the asset, the harder it is to hide the losses and sell it.

A private investor, naturally, will not buy at an inflated price.

• There is no money to buy such assets. By throwing a large quantity of illiquid assets onto the market, the state increases supply, but the private sector simply does not have the money to buy all of this, especially at an inflated price. There are no loans, and its own funds will certainly not be enough.

For this reason, a program is needed to work out what to do.

2. Improve the quality of management and increase the returns on assets transferred to the private sector. The idea is supposedly that the private sector is a more efficient owner and will cope better with the assets on offer. But the crucial point is that the private owner must use the property for its intended purpose and aim at long-term rather than short-term profit, and that is hard to achieve when assets are transferred into sole ownership without proper guarantees.

Another, and the main, problem with this case is that for the most attractive projects the state wants to sell only a small stake and retain control. This is an absurd decision, because:

a portfolio investor taking a long-term view understands that nothing will change just because the state has kept control, the quality of the asset will not improve, and it is impossible to make money in a falling market.

3. Fill the budget with proceeds from asset sales. This is unlikely, since there is currently no money in the country to buy with, and foreign players, especially after the rating downgrades, are hardly likely to come to us.

What should be done in this situation?

All assets need to be divided into three groups:

1. National companies, where the state should reduce its participation to that of a portfolio shareholder (which is supposedly the main task of Samruk-Kazyna). To do this, 51% or more must be sold. I think the optimal option is to place 75% minus one share. The state keeps a blocking stake, and the remaining shares are distributed among many shareholders. Some of them can be sold abroad and some at a discount to the domestic population. Here it must be thought through so as not to end up with a situation where our citizens then resell everything to speculators, so probably without the right to resell the stake within three years, and if sooner, then with payment of the difference between the market price at the time of resale and the purchase price. The discount must be substantial in order to encourage the population to buy shares. And part should be sold to institutional investors in Kazakhstan.

This will increase the transparency of the national companies, strengthen the role of boards of directors and bring in best corporate governance practices. Under this scheme, KazMunayGas, Kazatomprom, Samruk-Energy, KEGOC, Air Astana and Tau-Ken Samruk can be sold.

2. Non-core assets of the national companies that generate cash, can be valued and can be absorbed by private companies. These are the mid-sized subsidiaries of the national companies with clear economics and a realistic valuation. They should be sold at auction and for real money. Another option is to allocate funds to second-tier banks specifically for such assets, with mandatory equity participation by the buyer. The state receives part of the money immediately (in the form of the buyer's own contribution), and the second-tier banks serve as a tool for selecting genuine bidders for these assets.

3. Junk assets that require additional capital investment or a complete reorientation of the business. There will be many such assets. These are all the initiatives that do not work for one reason or another and simply hang around as ballast. Such assets can be sold simply as scrap metal or as fixed assets, but there is no guarantee that this will be done efficiently and properly. In this case, the best option is a sale to an investor on long-term installments, against a business plan or a vision of how the new investor intends to turn the asset around. Collateral from the investor and a minimum equity contribution will be required.

Discounting the installments makes it possible not to recognize the real losses on such assets, but to move them into the discounting of cash flows.

That, roughly, is my vision for privatization.