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The Supreme Court last Tuesday blocked the handing over of Pakistan Steel to a consortium of Ukrainian/Saudi/Pakistani group. The highest court in the land will now ascertain whether the process of privatisation was as per law and rules.
There are two divergent views about government managed businesses. The PPP government in the seventies convinced the electorate that it could do a better job at managing businesses, and that nationalisation of industries was in accordance with the mandate obtained from the voters. The experience of state owned/managed enterprises was led to a negative conclusion.
Mismanagement, overstaffing, poor quality of service, high debts and fiscal losses resulted in production and profits below the potential. The policy was reversed and even the PPP accepted the failure when it came back in power after 11 years in the wilderness. Seen against this backdrop, it is most unfortunate that the privatisation of Pakistan Steel has landed in court.
For the last two years the Supreme Court is still seized with the challenge to privatisation in the case of Habib Bank. It is commonly recognised that court interventions like these can derail and seriously impact future privatisation. Hopefully, the Pakistan Steel issue will be resolved to the satisfaction of all at the earliest.
There are two issues that the court needs to look into: Whether all who filed their expression of interests (EOIs), followed it up with the filing of statements of qualifications (SOQs) - as required under the procedure, and were allowed a fair chance.
Those who were disqualified indeed did not meet the tangibly clear criteria. And, secondly did all the assets offered for on-going sale were valued in accordance with the internationally accepted practice.
Since the Privatisation Commission was not acting as a liquidator the replacement value method in this case could not apply. Instead valuation must have been done by all using of the three commonly used methodologies.
THEY ARE:
(A) PUBLIC COMPARABLE COMPANY ANALYSIS: For a company using this method requires identification of a few public companies engaged in the same or similar business. Calculate the cash flow multiple (company value/cash flow). Take an average (usually median) of the multiples and apply it to the cash flow of the company in question. This yields an implied value for the target company.
(B) COMPARABLE ACQUISITION ANALYSIS: Similar in most respects to the aforementioned method, however, here instead of using publicly trading companies, one selects mergers or acquisitions of companies in the same, or similar business. Identify the purchase price of the proposed transaction and divide it by the cash flow of the company to be bought or sold.
This yields a multiple. Identify a handful of such transactions and average out the resulting ratio (median). Apply this ratio to the target company's cash flow and this yields another data point for valuation.
(C) DISCOUNTED CASH FLOW: Project out the free cash flows of the company in question, over a five or 10-year horizon. To capture the value of the company post the projection period using a terminal value. To calculate the terminal value tale the last year's projection and multiply it by a cash flow multiple derived from comparable company analysis. Discount the cash flows using a discount rate which captures several factors in the analysis (risk of equity and debt, size of the company, country risk, etc).
Aggregate the discounted cash flows to get to the present value of the company.
The three methodologies would yield a range for the valuation of the company. Usually the first methodology yields the smallest value. By comparison the second method yields a higher value mostly due to the fact that in (A) we use public values (ie value per share) but in (B) we use acquisition multiples which usually account for control premiums. Method (C) yields the highest result since usually projections for companies are aggressive and this method works out values of the company in isolation from market movements which cannot be predicted for large time horizons.
The above three methodologies are not easy to understand for a layman. But the lordships will be duly assisted by experts. Even the Federal Cabinet depends on advisors and knowledgeable persons on PC Board for advice. Now the issue is: Has PC followed the same methodology in case of Pakistan Steel as was followed for National Refinery, PTCL and other cases or there is a deviation?
The ultimate responsibility for valuation lies with the Executive branch which is the competent body representing the taxpayers ie the owners of the entity. However, valuation is an art and not an exact science. It is difficult to have a firm value to the last decimal.
Another, aspect on which there are divergent views is the title deed to the land on which the mill is located. While the agreement with the buyers clearly stipulates that this land is only meant for establishment and operation of the steel mill; the lease agreement between the company and the sovereign, though, does not stipulate any such conditionality.
And, this has become a bone of contention with those (in real estate business, who feel that PC has undersold Pakistan Steel). The court has to determine whether a specific contractual agreement over rides a general land lease policy.
There can be and will always be divergent views on the rationale for privatisation, as well as sale of family silver to overseas buyers. You cannot solicit investment from overseas investors and without having a level playing field for them and the local investors.
Discrimination would amount to having the cake and eating it too. But what is upsetting for the local investors is handing government land to overseas investors on a negotiated price and asking local investors to pay market price in auction.
Commercial viability of a hotel project is dependent on the location of pricey land. A Faisalabad investor has paid Rs 5 billion for a hotel land in Islamabad; a Saudi prince is being given a land on a negotiated price by the Government of Punjab.
Let us not swing the pendulum the other way. We have taken away the protection of high tariffs enjoyed by local investors. Let us not start discriminating the other way. After all there are more than an even chances that local investors will keep their profits in rupees in the country. Can the foreigners do the same? Expat Pakistanis may. Others, definitely not!

Copyright Business Recorder, 2006

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