Why Eskom should sell its plants — but still operate them
The physical ownership of manufacturing premises or plants does not necessarily define the business — and so it could be with Eskom
Now that President Cyril Ramaphosa has appointed a task-team to advise government on the restructuring of Eskom, it should expect unsolicited advice from the likes of us — mostly as concerned citizens and self-anointed experts in various fields.
This should not be surprising as the current Eskom leadership members came up with a plan for the government to take up Eskom’s debt of R100bn. After nearly a year in charge, they were probably restricted by political sensitivities, as seems to be the norm in state-owned enterprises (SOEs). The plan was subsequently rejected by the National Treasury and further admonished by ratings agency Moody’s. It was, after all, in addition to the existing guarantees to Eskom and other SOEs, with the country teetering on the brink of junk status.
The president himself recently announced on radio that Eskom is, to date, indebted to the tune of up to R475bn. This is a huge gearing by any standard, and begs the question as to how it got there in the first place. It is worth noting that some of this debt was incurred in 2018, under the current president’s watch. To be fair, it was an earnest effort to address the entity’s financial distress situation, however, it became a classic case of digging oneself out of a hole.
Further talk of bonds and other methods of debt are also concerning, and should be to all South Africans. If Eskom were an individual consumer governed under the National Credit Regulator (NCR), it would have long failed the affordability test. Its lenders would possibly have been hauled before the NCR, needing to explain why this should not be considered reckless lending. Fortunately, it’s an entity with a strong state backing.
South Africans should therefore welcome the appointment of this task-team, which includes some stalwarts from the industry and labour. It has a strong operational and organisational bias, which is a welcome relief. There are, however, various dimensions to a turnaround strategy, including operational, organisational and financial aspects.
The debate to be held, rather, is whether Eskom needs to actually own the assets it uses, in a similar mode to property ownership among institutions and individuals ... I have been exposed to numerous manufacturing businesses and have found it an acceptable practice that many do not own the factories from which they operate
The committee seems to be well balanced with regards to the former two, hence I will limit my observations to the third, financial aspect.
Any credible restructuring strategy should bring down the entity’s debt to manageable levels, as a starting point. Debt servicing for an entity such as Eskom is a huge cost, and reducing it, as well as managing the gearing ratio, would place the entity on a stronger footing financially.
I therefore read with interest the views recently expressed by the CEO of the FirstRand Group, Alan Pullinger, that government should consider selling its new power generation plants, in particular Medupe and Kusile.
Of course, working against this suggestion is that both plants are probably overpriced due to price over-runs since the commencement of construction, and that they have not yet been completed.
However, their level of completion since they are both fairly advanced, makes them marketable, and at a cost of nearly R300bn (for both) a realisable value cannot be insignificant. Bear in mind that this suggestion was made by a seasoned banker, who probably sees value in the assets and understands the available structuring options that could go with such a transaction. I sense an opportunity here that should not be missed.
The debate to be held, rather, is whether Eskom needs to actually own the assets it uses, in a similar mode to property ownership among institutions and individuals. To drive the point home, it is an accepted reality that most people don’t actually own the houses they live in and the cars they drive — even if they claim them as their own. I have been exposed to numerous manufacturing businesses and have found it an acceptable practice that many do not own the factories from which they operate.
It may well be that in some cases both the factory premises and the operations are owned by same investors, often as separate entities; however, this does not diminish the argument that operators don’t have to be owners of the properties they operate. The physical ownership of manufacturing premises or plants does not necessarily define the business. I believe that desperate times do call for innovative and “out of the normal” thinking. Perhaps the time has come for the custodians of Eskom to begin thinking more innovatively about the “obvious” solutions around them so as to emerge from its deep quagmire.
Unions and privatisation
Pullinger stopped short of suggesting the various options of going about this because he believed it was probably politically sensitive. The political sensitivity is, simply put, the unions’ opposition to privatisation. This is not limited to Eskom, but an across-industries issue. The concerns are legitimate, because a new, disaffected owner would not hesitate to rationalise the business acquired, which may include reducing the size of employees. However, Eskom has reached a point of no return in its downward spiral, and requires an urgent turnaround strategy. In fact, if it was any other company and so without government support, it would have been at a point of entering the business rescue stage, if not winding up already.
The one thing we can all agree on is that Eskom’s balance sheet is heavily geared and needs restructuring. This brings me to Pullinger’s point, which is the sale of Medupi and Kusile on a lease-back basis. In my view, this means Eskom sells the assets to investors who are looking to earn rental income, possibly as property investors. The sale would be concluded with an option to repurchase at settlement value at the end of the leaseback period. The latter is not normally applied in an operating lease, but can be done.
In the meantime, the properties would be leased (back) by Eskom on an operational lease basis, meaning Eskom continues to operate the assets in terms of its normal operating standards, that is, without operational interference, including staff complement, etc. Power plants often have a long useful life, thus the lease agreement would be on a long-term basis, say 25 years or so. Acquiring the assets back at the end of the lease term would still leave Eskom with power plants that have an operational useful life.
The whole exercise would have the effect of releasing the much-needed cash immediately for Eskom. Even if Eskom does not recover the full R400bn already spent on the power plants, the realisable sale amount would still manage to substantially reduce the R450bn debt and the related debt-service cost, so releasing operational income to fund normal operational expenses, including the initial lease payments.
The only role for operators should be as maintenance contractors to the lessors, as their specialised knowledge may be useful ... Besides, Eskom has hardly shown its mettle in plant maintenance
Obviously, the numbers would have to make sense, and this has to tie in with the entity’s turnaround plan projections. Without the benefit of studying the financials of Eskom and working out its cash-flow projections, I am not in a position to determine the extent of the feasibility of this process. The financial team within Eskom should be able to do a scenario analysis and be in a position to package the power plants for such a sale to potential financial and/or property investors.
Where I differ, probably significantly, with Pullinger is that operators should be kept out of this sale process, since they may have conflicting interests. Giving operational control to private operators is precisely what could irk the unions. The only role for operators should be as maintenance contractors to the lessors, as their specialised knowledge may be useful. This is standard practice in various specialised sectors, such as mining, aviation, shipping, and so on. Besides, Eskom has hardly shown its mettle in plant maintenance.
Packaging this deal for the financial services and property sectors would still leave operations in Eskom’s hands, and all it would be doing is renting the property with a full maintenance lease. This is a fairly simple concept though quite complex in execution, and can be done without alienating labour. But, as they say, the details lie in the numbers. Eskom number-crunchers should get to work.
• Mkhondo is a certified turnaround professional and business rescue practitioner, and a former investment banker.