RM sell-off proposals wouldn't make it through Dragons Den

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Royal Mail sell-off proposals wouldn't make it through Dragons' Den

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The planned part-privatisation of Royal Mail is lacking any sort of sound economic argument, Roger Berry says. The BERR Select Committee member dissects the government's 'highly unconvincing' argument

There is much agreement about the challenges facing Royal Mail: a legacy of under-investment, a declining mail market as people switch to digital technology (such as the internet, email, mobile text and broadcasting), and the need to sort out the pension fund deficit. At the same time, it is widely accepted that the universal service obligation – whereby letters are collected and delivered anywhere in the UK, six days a week, for a single, affordable price – must be maintained.

The Hooper Report, 'an independent review of the UK postal services sector', commissioned by the government, was published in December. It was established to examine how best to maintain the universal postal service, which delivers items to 28 million residential and business addresses, and which is threatened by the declining mail market.

In its response to Hooper, the government made three main proposals:
• That a new regulatory framework be put in place, including abolishing the industry regulator Postcomm and transferring its responsibilities to the communications regulator Ofcom;
• That the government take over the responsibility for the Royal Mail Pension Fund's deficit;
• That an invitation should be issued to 'other postal or network operators to come forward with proposals for developing a strategic partnership with Royal Mail, including taking a minority stake in the company's letter and parcels business'.

I will not dwell on the regulatory regime. It is widely recognised that the government's proposal to abolish Postcomm and to give Ofcom the responsibility for regulation of the industry makes sense. The relationship between Postcomm and Royal Mail has not been the most productive. More importantly, Royal Mail is firmly in the communications industry and is affected by changes elsewhere in that industry.

Royal Mail's pension deficit at the time of the Hooper Review was estimated to be £5.9bn. More recently, the government has suggested that it could be £9bn. Current measures to reduce this deficit are costing Royal Mail £280m a year, but can be expected to rise. A large part of this problem is due to the contributions holiday introduced in the late 1980s. Since taxpayers benefited from this decision, it is only right that taxpayers should now take responsibility for correcting it. The government is therefore right to propose that they take responsibility for the historic liabilities.

This brings us to the need for a capital injection. We can only speculate how different the situation might have been if Royal Mail had not been required to hand over in excess of £2.3bn in profits to the Treasury between 1984 and 1998. The company could have been ahead with modernisation instead of lagging behind. But there is no doubt that a significant capital injection is now needed for modernisation.

How much does Royal Mail need? All we know is that Royal Mail's Chief Executive, Adam Crozier, has said 'hundreds of millions'. Dealing with the pension deficit would yield more than £280m a year. Changes in access pricing might generate another £100m. How much more of a capital injection Hooper, the government or Royal Mail have in mind is unclear because none of them has said.

Hooper and the government argue that 'a strategic partnership between Royal Mail and one or more private sector companies with demonstrable experience of transforming a major business' is necessary. The problem is that no evidence has been provided to support this assertion. I accept that it might be the case. And, of course, Post Office Ltd, which both say should 'remain wholly within public ownership', has developed a very successful joint venture with the Bank of Ireland, to provide a range of financial services through the extensive Post Office network.

What I find entirely unconvincing are the arguments that a 'partnership' must take the form of part privatisation of Royal Mail and that the three elements of the package – reforming regulation, the government taking responsibility for the pension deficit, and part privatisation – must be taken together as the only alternative to the status quo.

Interestingly, in the 19 headline points at the beginning of the Hooper Report, summarising the outcome of the review, no mention is made of the need for a minority private equity stake in Royal Mail. Nor is such a proposal to be found in the more extensive Executive Summary. Instead, we are told: 'The precise nature of such a partnership...should be a matter for the government to negotiate.'

Moreover, in his recent evidence to the House of Commons Business and Enterprise Committee, Crozier called for more equity capital for the company (to avoid the burden of debt repayment). But he did not call for private equity in Royal Mail. He too felt that this 'was a matter for the shareholder', ie. the government.

The proposed part privatisation of Royal Mail does not seem to many to make the best of sense at any time. However, when the private sector is seeking unprecedented investment from government because it can't generate the finance itself, it is an odd time to argue that selling minority equity in Royal Mail to a private shareholder is the key to success.

We are told that this is the only way to improve management skills and lever in modernisation expertise from elsewhere in the industry. However, why such expertise cannot be bought in by Royal Mail isn't clear. The use of consultants and partnerships, without a change in equity arrangements, is common in both the private and public sector.

Then we are told that private equity will change the culture of Royal Mail. I am sure that full privatisation would. But the government is totally opposed to that (rightly, in my view). What I don't understand is how cultural change, which may well be necessary, can be achieved by a minority private equity stake in the company.

Finally, we are told that private equity is the best way to finance the necessary capital injection. But again, neither Hooper nor the government provides any evidence of the level of capital injection required, nor that private equity is the best way to do it. This is hardly surprising. Private finance is more expensive than public finance (hardly a novel observation, but just think about the current financial crisis). And where are the companies falling over themselves to buy equity in Royal Mail?

TNT is reported to be interested. But what would it expect to gain from injecting a significant capital investment for a minority shareholding? We do not know.

We do know that TNT spent a year contesting the German government's introduction of a minimum wage for postal workers. And we do know from press reports that TNT has had some difficulty with paying the tax authorities on time. And, despite this, we know that TNT has suffered a massive fall in profits.

The fact of the matter is that there is no business plan on which we can judge the government's proposal. Or, if there is, it is not in the public domain. Parliament is being asked to agree a pig in a poke.

Then there is the politics of this. Hostility to part privatisation from many Labour MPs, party members, trade unions and the public is not only the result of the absence of any sound economic argument for it; it is because it is contrary to what the government promised.

The Labour Party manifesto of 2005 said, with reference to Royal Mail: 'We...have no plans to privatise it. Our ambition is to see a publicly owned Royal Mail fully restored to good health... .'

More recently, at Labour's annual conference in September last year – just five months before the Secretary of State for Business and Enterprise, Lord Mandelson, announced his part privatisation plans – delegates endorsed the statement: 'We have set out a vision of a 'wholly publicly owned', integrated Royal mail Group'.

Barely was the ink dry on the Hooper Report before the Business Secretary announced that his package was non-negotiable and it was not possible to consider separately each of the three main recommendations. The lack of consultation on the Hooper Report before announcing a new policy was unwise. The assertion that one could not 'cherry-pick' Hooper's recommendations was silly and without any justification.

The real problem, though, is that there is no business plan to justify Hooper's conclusions. This set of proposals would certainly not make it through 'Dragons' Den'. An investment idea that is business ready this is not.