Privatisation: private equity's next big opportunity?

Alice Murray
25 February 2014

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As Europe recovers from years of financial instability, many governments across the continent are looking to offload assets in a bid to reduce deficits. Could these potential upcoming state sell-offs provide an opportunity for private equity? Alice Murray reports

Europe has seen waves of privatisations in recent decades. Most prominent perhaps were the UK's efforts in the 1980s when large public sector companies including British Aerospace and Cable & Wireless were denationalised following the 1970s crisis. By the late 1980s, the country saw its most aggressive period of privatisation, with the sales of British Steel, British Petroleum, Rolls Royce and British Airways, as well as water and electricity utilities.

During the 1990s, following the demise of socialist rule, central and eastern European countries underwent a major privatisation programme; by 1994 this group of countries had counted a staggering 45,300 divestments of large and medium-sized enterprises, as well as hundreds of thousands of sales of small companies.

Also in the 1990s, Sweden sold 35 out of 70 state-owned assets, including the Swedish State Power Board, the Swedish Forest Service, the National Telecommunications Administration (now Telia) and Sweden Post (now Posten).

However, the financial crisis brought about a reversal of privatisation, with European government investing in private assets to bring them under state ownership – notably the bail-outs of Lloyds and RBS in the UK. This rescue programme saw the state becoming part-owner of previously private entities.

Back on the rise
But, the UK, far from seeing the pendulum swinging in completely the private-to-public direction, has recently experienced a return to privatisations, and commentators expect state sell-offs to increase once again. Indeed, last year brought the headline-grabbing sale of Royal Mail, and the sales of the Student Loan book and potentially the Royal Mint are expected to follow after George Osborne's announcement in early-December 2013 that he would raise £20bn from the sale of government assets.

The UK is not alone in raising cash through sell-offs. Following its post-crash bail-out, Greece has been engaged in a privatisation programme since 2010, which is aiming to raise €24bn by 2020. So far, the country has seen the sales of its video lotto license to OPAP for €560m and real estate assets totalling €960m. However, the privatisation process has hit a few speed bumps such as the divestment of natural gas business DEPA, which has failed to attract any binding offers.

According to Ajay Rawal, a managing director at Alvarez & Marsal, it is the limited level of organisation that presents one of the main challenges for this type of transaction: "There is not much transparency in this field, it's not easy to find a clear inventory of state assets." The UK is one of the more organised governments, with the Shareholder Executive responsible for overseeing publicly-owned assets, and UKFI responsible for the shares held in the banks. "It is one of the countries better able to act on privatisation opportunities," says Rawal.

Understandably, valuations are tricky when it comes to privatisations. "Pricing is one of the main challenges. Working out an asset's valuation needs to take into account how the asset will be managed; if the government will hold onto a stake; the speed of the sell-down and the scale of the investment required as well as the level of restructuring required," explains Rawal.

Indeed, recent revelations over the sale of Royal Mail highlight the difficulties of pricing state-owned assets. In early February, the Business Department revealed that 21 City advisers valued the company between £4bn and £4.8bn prior to its listing. When the government sold its stake it achieved a valuation of £3.3bn.

Nudge, nudge, say no more
The UK government's recent and controversial part-privatisation of its Behavioural Insights Team (BIT) – dubbed the "nudge unit" because it gently alters the public's behaviour – could stand to generate impressive revenues and provides a neat example of the unusual opportunities that can be weeded out of state control, as well as highlighting that privatisation opportunities exist at every level of the market, from small- to large-cap.

BIT's work includes testing ways to encourage the public to act in a more responsible and law-abiding manner. For example, one of its most recent projects was finding out ways of persuading people to sign up to the organ donation register when applying for vehicle tax on the DVLA website. BIT's offering is no longer free for the UK government to use but is commercially available to foreign governments, local authorities and the private sector. The team, which comprises 16 behavioural psychologists and economists, has received a £1.9m financing package from Nesta so that it can commercialise its offering.

With record levels of dry powder desperately seeking deals, buyout houses are increasingly turning to more complex transactions in order to get cash out of the door. Without neat catalogues detailing exactly what governments own, it will be an almost Herculean task to first find these deals and then to get them done, and no doubt a lengthy process. But with a decent level of imagination and even more patience, European government's positivity towards denationalisation should not be ignored by the asset class.