Tim Walker Head of Office – Divisional Director Brewin Dolphin, Exeter Office

Royal Mail and the history of privatisations

The privatisation of Royal Mail last week should present opportunities for private investors, as well as employees and institutions. The chance to buy shares at a discount, the scope for rapid growth following flotation and the injection of private capital and incentives, all contribute to potentially profitable outcomes and the sell-off of such a massive and socially critical institution – must not be held back from the general public – as suggested by some commentators.

Options for raising funds in the pipeline are the sale of its stake in; Royal Bank of Scotland, Lloyds Banking Group, following the rescue packages undertaken during the credit crunch. The Conservatives are in favour of crystallising value from these banking holdings, with George Osborne suggesting that the government could raise funds by selling its £70bn stake in RBS and Lloyds in the form of discounted shares.

Sid’s history

In the 1980s, Margaret Thatcher’s Government successfully developed the policy of selling nationalised industries into private ownership, or privatisation as it became known. However back then the notion of selling national assets to the public was largely untested and there was uncertainty whether the public would support the issues. There were concerns that private investors would not participate extensively in the offerings, leaving large institutional investors to pick up the shares at heavily deflated prices.

Thankfully, this turned out not to be the case. In 1984, BT was the first well known public sector company to be sold and private investors welcomed the offer. More than two million people participated; keen to purchase the discounted shares offered at a price of 130p.

The success of the government sell of BT paved the way for further privatisations during the 80’s and early 90s, the majority of which were floated successfully. The wave of sell offs then presented opportunities for investors; the question is now, how profitable were these issues to the investors that backed them?

We have calculated the returns of a cross section of the most well known privatisations since floatation and compared them to the FTSE 100 over the same period. In the large majority of cases returns were in excess of the benchmark and in some cases out-performance was considerably more.

  

See chart below:

[Returns are calculated at 10^th July 2013 assuming a buy and hold strategy and are based on a capital return basis, which excludes dividends. Holdings have been adjusted for corporate actions and merger and takeover activity. The returns assume shareholders held on to shares in demerged companies, and took all rights issues in cash. Where a takeover has occurred, returns include the cash value for the bid.]

This performance is impressive when you consider the renowned underinvestment in assets prior to privatisation, and the higher levels of staffing at the time of flotation. However, while not actually given away, they were deeply discounted floats and when the companies were exposed to the full force of competition; they certainly improved their performance, resulting in very rapid growth from a low base.

In the majority of cases returns were good with significant out-performance. Furthermore, many of the companies have an average dividend yield exceeding that of FTSE; therefore including income from dividends would have enhanced relative performance beyond that shown in the chart above.

A particularly profitable privatisation was British Gas, which was memorably sold to “Sid” in 1986. An investment of £100 in British Gas would now be worth £1,246, an increase of 1146% and that is not including any dividends.

Strong management assisted in transforming British Gas into a global integrated Oil & Gas company and investors have reaped the rewards. British Gas has had a series of corporate restructurings; in 1997 Centrica was demerged, and in 2000 Lattice was spun out and was later bought by National Grid. This has enabled investors to benefit from the outperformance of two of the UK’s largest utilities, Centrica and National Grid, which contributed to the staggering overall returns.

Many of the other privatised UK electricity, gas and water companies also performed well and have since been taken over by larger European utilities, or infrastructure funds resulting in investors receiving cash, usually on a premium valuation.

Investments in Severn Trent, Powergen and National Power would all have outperformed the market.

However, a buy and hold strategy for the duration would not have worked on all stocks, with the relative return from BT the most disappointing. An investment of £100 in BT at IPO would have been worth £113 at the end of 2011, although the shares did rise to over £10 during the dot-com boom.

Investors would have also underperformed the market had they participated in the British Airways float. Poor relative performance would have been made worse by the below market dividend yield. Why the underperformance? In contrast to British Gas, British Airways faced stiff competition from the industry. The swath of low budget airlines entering the market has restricted the potential for growth. Also British Airways has been troubled by their historically high cost base, left over from their state ownership days. Staff costs are still some of the highest in the industry.

So the Royal Mail will not be a dead cert and indeed we couldn’t even hazard a guess at its merits until we know the terms of the offer – but private investors should be able to share in the opportunity to put up their savings as risk capital for the development of the Royal Mail – if they choose.