The Postal Services Bill - Business and Enterprise Committee Contents


6  A private sector stake in Royal Mail

Current power to privatise

125.  Undoubtedly the most controversial aspect of both the Independent Review and the Government's response to it is the proposal to sell a stake in Royal Mail to a private sector partner. This section of our report asks what is the evidence that underpins the specific judgements reached by the Government in putting forward the proposal for a minority private sector stake in Royal Mail Group.

126.  The Government already has powers to bring forward a private partnership with Royal Mail Group. Although section 66 of the Postal Services Act 2000 provides that the Secretary of State, the Treasury or the Post Office (which later became Royal Mail Group) shall not dispose of any shares, this restriction is lifted if they have prior approval for the disposal. Under section 67, approval has to be given by resolution of each House of Parliament, and the motion moved must specify:

(a) the size and nature of the proposed issue or disposal,

(b) the person to whom the proposed issue or disposal is to be made, and

(c) the purpose of the proposed issue or disposal.

There is no limit on the proportion of the company which can be disposed of, although the requirement that such disposals can be made only if the Post Office (ie Royal Mail Group) is to enter into a joint-venture with another body presumably means that some government holding would have to continue.

127.  The regime proposed by the Postal Services Bill [Lords] in one sense restricts the government power to dispose of assets, by explicitly requiring the Government to maintain a majority stake. There is no such provision in current law. However, we note that the definition of a majority holding would be satisfied by holding 50.1 percent. This new restriction is balanced by the removal of the requirement for each disposal to be approved by resolution. When it discusses the relevant clauses of the Postal Services Bill [Lords], the House should bear in mind that the law already provides for private sector partnership in Royal Mail Group, and would even permit a majority shareholder from the private sector. However, as the law currently stands, Parliament has to approve each disposal of shares, and has to be given details of the proposed disposal.

The rationale for a minority private sector stake

128.  It is clear from the work of the Independent Review, and from the Government's responses to it, that private sector involvement in Royal Mail Group is promoted for a variety of reasons. It is hoped that it will inject capital into the business, bring new management expertise and improve labour relations. Proponents of such a partnership accept that a share of any profits Royal Mail makes will go to the private sector partner, but also expect that profits overall will increase, and that the public sector will benefit from that far more than it would from retaining all the profits of a less successful business.[108] In this section, we will look first at the non-financial arguments, before examining the financial benefits expected from a partnership.

MANAGEMENT EXPERTISE AND COMMERCIAL CONFIDENCE

Management expertise

129.  A private sector partnership is not promoted simply or even primarily because it would bring capital into the company. As we have explored above, there is no doubt that Royal Mail Group is significantly less efficient than its competitors. The company itself agrees it is inefficient, and industrial relations are poor. A private sector shareholder would make it clear that the Government was not a party to negotiations between the management and the workforce. It is also claimed that it would inject expertise more quickly and effectively than any other method. As Lord Mandelson said to us, a private sector shareholder would:

bring a breath of fresh air - breath, well, hopefully gale force fresh air - into the management and culture of the Royal Mail because I think that is needed in order to continue modernisation.[109]

Mr Hooper also considered that such a partnership would transform the company:

This is not about just replacing individual members of the management. This is about feeding in at senior, middle and junior management level, expertise, people who have actually done this level of transformation. That is behind our thinking on the strategic partnership.[110]

Commercial confidence

130.  The injection of private expertise would not be limited to direct management issues. Mr Hooper gave a still broader picture of the advantages:

We talk in the report about the three things which we believe are the requirements for modernisation to happen. The first one we talk about is commercial confidence. That has two arms to it. It is a requirement for the management to be able to make commercial decisions about the future of the company without what we call in the report the spectre of political intervention; that is the ability of the management to make commercial decisions in a confident way. That is linked to something we talk about a lot in the report which is the lack of engagement between the unions and the management about the future of the company. It is a fact of life that neither the management nor the unions have found ways of sitting down together and looking at what the long-term Royal Mail looks like in terms of its network and so on. That has not happened. Both parties have talked to us and the panel and both have been unable to get that level of engagement. Those two together will give you commercial confidence.[111]

He gave an example of where he considered a minority shareholder had been able to make a real difference to operations:

In Belgium you have a minority private sector shareholder. What they have achieved with that shareholding is an agreement about the future strategic plan for the modernisation of the Belgian Poste and an agreement not to get in the way of that modernisation through political intervention. So there is what we call in the report political separation. That is part of that story of having a strategic partner. It is not just about management expertise: it is about political separation, it is about engagement with the unions, it is about capital requirements - which we will no doubt come on to - and also about experience.[112]

THE ROLE OF THE TREASURY

131.  While the Government has not taken a dividend from Royal Mail Group since 1999, government influence has not always been so benign. The evidence given to the Trade and Industry committee showed that, between 1984 and 1998, £2.312 billion was removed from the company, reducing the amount available for investment.[113]

132.  Some might argue that a private sector shareholder would demand a clear agreement about the rights and responsibilities of each party. Such an agreement would almost certainly limit Government's ability to take cash from the company if investment was needed, and reduce the temptation for a cash-strapped Government to regard Royal Mail as a source of savings, or even of revenue.

The case against a minority private sector stake

A CAPITAL INJECTION

133.  Opponents of a share sale do not accept that sale of equity is the cheapest or most efficient way to raise funds, particularly in current economic circumstances. They argue that the proposals put forward by Government effectively ensure that the public purse bears all the costs of investment made to date, and of addressing the pensions deficit, while the private sector risks are limited. (It should be noted, though, that the price paid for any stake should also reflect the strength and financial position of the company.)

MANAGEMENT EXPERTISE AND COMMERCIAL CONFIDENCE

134.  Those who consider a partnership which involves share transfers to be unnecessary would argue that disposal of shares is not the only way to buy in expertise. Indeed, Royal Mail Group's submission to the Independent Review said extra capital would "enable Royal Mail to compete for the best management talent" [our emphasis].[114] If it was felt that buying in management talent was not sufficient, it would be possible to work in partnership with the private sector through joint ventures, such as those between Post Office Ltd and Bank of Ireland.

135.  Although labour relations have clearly been an issue in the past, it is legitimate to question whether a private sector partner would really produce an improvement. As Mr Crozier told us, significant changes have taken place:

We have 50,000 fewer people. Those who remain are all working much harder. Their future pensions are reduced. Their pay has been substantially increased and they now work five days and not six, so there have been good things for them too.[115]

The current business plan assumes there will be a £1.5 billion reduction in costs over the next five years. Central management has reduced from 11,000 people to just over 200.[116] Lord Sawyer summed the argument up in the second reading debate on the Bill in the House of Lords:

In 2001-02, the business was bedevilled by unofficial strike action, losing more than £1 million a day and failing every single quality standard. In six years, that loss has turned into a profit of £255 million in the first nine months of this year. The business is on track, as the noble Lord, Lord Clarke, has already said, to stay in profit. Customer quality of service is the highest in a decade. Negotiated agreements between the business and the union have improved efficiency remarkably. It is almost impossible to comprehend 50,000 people having left the business through voluntary redundancy and natural wastage; that is an alarming figure. Parcelforce itself went from having 11,500 employees to 5,000 in one year; that is one hell of an achievement.[117]

136.  As we have seen, some witnesses ascribed Royal Mail inefficiency to lack of investment, and considered it unrealistic to expect that the £1.2 billion in loans to Royal Mail could be spent instantly. We note that when we visited the European Commission in February, officials considered that Royal Mail, up until the early 1990s, had been one of Europe's leading postal operators. Opponents of privatisation could question whether it was sensible to sell a stake in Royal Mail before the benefits of recent and ongoing investment could be assessed.

A capital injection?

137.  We have not yet examined the extent to which a partnership will inject much needed capital into the business. The difficulty is that it is far from clear that the private sector partnership proposed will in fact do this. All parties are being very coy about the amount of capital Royal Mail needs to modernise; in evidence Mr Crozier pleaded commercial confidentiality, and would indicate nothing beyond "hundreds of millions."[118] Mr Hooper also declined to give a figure, beyond saying there was a need for a significant capital injection. When pressed, he said: "I am really not going to be drawn on it. We have not done that analysis".[119] We note that in 2005 Royal Mail told the Trade and Industry Committee it needed £0.6 billion to replace current equipment or vehicles which were obsolete or at the end of their working life, and a further £1.6 billion for new machines.[120] A significant part of that requirement has already been provided through the Government's loan of £1.2bn and investment from profit.

138.  Some argue that considerable sums would be available if the intended efficiency savings were achieved.[121] If the pension deficit were removed, Royal Mail Group would have an additional £280 million per year; if access pricing was set at a level which covered Royal Mail's overheads as well as its marginal costs, it might have another £100 million a year. It may be possible for Royal Mail to generate much higher levels of profit to fund its investment requirement and, if so, we have difficulty in seeing why a private sector partnership is essential as a means of injecting capital.

139.  There is a limit on how fast money can be spent. We know Royal Mail Group has not yet been able to spend the Government's £1.2 billion loan, although it says all the money is allocated and will be spent in an orderly and appropriate fashion. It appears from this that simply removing the pension deficit and undertaking regulatory reform - both on access pricing and claw back - could give Royal Mail the capital it needs to finance modernisation at this stage. Indeed, we note the original comments by Royal Mail to the Independent Review that the company required:

Access to equity capital to de-risk delivery of the plan, provide the crucial risk capital Royal Mail needs to take long term decisions with confidence, facilitate accelerated operational and cultural transformation[122]

The source of the capital, Government or private sector, was not, at that stage, discussed.

Will Royal Mail get the money?

140.  There are indications that Government may hope that addressing the pensions deficit and reform of the regulatory system will give Royal Mail all the capital it requires. The table of costs associated with the Bill contained in the Impact Assessment[123] notes:
Financial costs of transforming the network: No additional spend planned


While this may well refer to Government expenditure, the Government will presumably, at least initially, receive the proceeds from any share sale. The Future of the Universal Postal Service in the UK is disturbingly coy about the destination of the proceeds from the share sale:

The Government intends to use the money received from the minority share sale to benefit Royal Mail Group including Post Office Ltd. It may be used to partially offset the cost to Government taking on the pension deficit and potentially to make available capital into Royal Mail to increase the investment available for modernisation and diversification. The Government will inform Parliament of the payment for the shares and how it will be distributed when the consideration is received.[124]

141.  We think it is significant that witnesses' later submissions about the dangers of pressing ahead without a private sector partner are put in terms of regulatory or efficiency risk, rather than the risk that capital will not be sufficient. Royal Mail Group's latest submission to the Committee says "even if the historic deficit is removed Royal Mail may not receive the full benefit as there is a risk that it could be clawed back under the regulatory regime so there would still be a need for new capital to help speed up modernisation."[125]

142.  The text accompanying the table in the Impact Assessment parallels the fears of Royal Mail Group that benefits from reducing the pensions deficit might be subject to regulatory clawback, but in this case the concern is that without a private sector partnership, money for Royal Mail investment will be diverted to other purposes, or spent less efficiently. The text says:

Restructuring Royal Mail's national network of mail centres, distribution centres and delivery offices will require investment and staff time. Royal Mail is already expecting to invest significantly in new machinery and improved facilities over the next five years.

In the absence of intervention, it is possible that some of this money is diverted to keeping the company afloat (by funding increased deficit recovery payments for example); and this money is spent less effectively without the experience of transformation which a private-sector company can provide. As a result, there are not expected to be any additional costs associated with modernisation under the proposed package of measures.[126]

143.  When he gave evidence to us on 14 January, Lord Mandelson linked the private sector funding to a capital injection for Royal Mail, saying the company needed "Hundreds of millions of pounds of additional investment to modernise" and "the taxpayer alone cannot be expected to foot the bill for that modernisation."[127] But, as we have seen, the documents accompanying the Bill are unclear about the destination of the cash from any sale of shares. We cannot reach a safe conclusion about the ability of Royal Mail Group — with or without a partner — to fund its future investment needs.

144.  It is entirely unacceptable for Parliament to be asked to approve such fundamental changes to Royal Mail Group when there is no indication of how much money Royal Mail Group needs for investment and while the Government appears to have no business plan and has not indicated the use to which any private sector cash would be put. In fact any partner may see the need of considerable investment above and beyond that capable of being generated by Royal Mail Group. The House is entitled to demand clarity on these points before the Bill receives its second reading.

Conclusion

145.  There are a variety of reasons why private sector partnership could be promoted. It could be argued that it would:

a)  Inject cash into the company;

b)  Inject management expertise;

c)  Improve "commercial confidence", primarily in labour relations,[128] and

d)  commit the Treasury to a long-term approach to the company's financial requirements.

146.  The first issue is whether these are really all part of the same package. Mr Hooper and Lord Mandelson assured us that they were:

You are asking the taxpayer to take on a great deal now in underwriting that pension fund deficit. If, in addition, you are asking the taxpayer alone to foot the bill for the investment in the modernisation and at the same time losing Royal Mail's access to that much needed, in my view, management expertise and experience of turning round the postal operator that a minority stakeholder would bring, I think that is asking too much and I do not think the public would stomach our cherry-picking the Hooper Review recommendations and saying, "We will take on the pension deficit, we will fix the regulator, but broadly speaking leave the Royal Mail operation as it is". I do not think that is an acceptable deal or an acceptable bargain for the taxpayer.[129]

147.  We are unconvinced by the argument Lord Mandelson put forward for seeing the proposals of the Postal Services Bill [Lords] as a package. The regulatory framework needs to be changed as a matter of urgency and in its own right. Similarly, the problem of the pensions deficit needs to be addressed. However the Government already has powers to dispose of shares in Royal Mail, and would have those powers even without the Postal Services Bill.

148.  There might be a case for seeing the deal as a package if it were clear that Royal Mail would need more funding even after reform of the regulatory system and removal of responsibility for the pensions deficit. However, there are grounds for believing that the reforms in Part 2 (Royal Mail Pension Plan) and Part 3 (Regulation of Postal Services) of the Bill, particularly the potential elimination of access headroom, would release enough cash to fund Royal Mail's modernisation, and that the proceeds from any sale are very likely to go straight to the Treasury. It would be helpful to know if any prospective partner shared that view.

149.  Whatever other arguments there might or might not be for private equity stake in Royal Mail Group, a capital injection cannot be relied upon. The question the House must then address is whether the partnership with the private sector is still worth it because of the non financial benefits it will bring. There is a consensus on the need to protect the universal service obligation: the question is how to fit Royal Mail for this obligation. There are underlying differing political and commercial perspectives which inevitably shape reactions to the government's proposals for a strategic partner for the company. Some will say that Royal Mail, while being a vital public service, is in competition with a host of privately provided services, whether postal or electronic, and should therefore be given the full freedom that they believe only the private sector can offer. Others will say, with equal conviction, that precisely because it is such a public service it should be owned by the public sector.

150.  It is also true that even advocates of a private stake in Royal Mail may have doubts about the timing of this particular move in the depths of a recession, when other European mail services are losing significant amounts of money, and before other regulatory and structural changes - especially addressing the historic pension deficit - have had a chance to work through. It is unlikely that the best price for any shares in Royal Mail would be obtained now, although we acknowledge that the deal could be structured over several years and payments could reflect current market conditions as those payments were made.

151.  We therefore believe that the following questions need to be addressed before any further action is taken in relation to the involvement of a strategic partner in Royal Mail.

152.  Whatever one thinks of a private sector partnership, is the Government's position, which is to say that there will be no removal of the pensions deficit until such a partnership is concluded, justified? Is it in fact more rational to remove the deficit as quickly as possible and revisit the question of whether a private sector partnership is desirable when there has been time to see if Royal Mail (and its workforce) can continue to improve their performance?

153.  The next question is what is the justification for the size of the partnership. Thirty per cent was the figure cited by Lord Mandelson at second reading, but why? It may be that it is linked to the provisions requiring companies with shares to offer to buy out other shareholders; but that would not apply in this case. Although Mr Hooper cited a case where a minority shareholder had produced beneficial effect, in many cases minority shareholders find themselves in the frustrating position of providing cash without effective control. Interestingly, no one appears to be putting the case for a sale of a majority stake in Royal Mail.

154.  The third question is how much openness there will be about the partnership agreement which will set out such controls as the minority partner will have. This is likely to include the right to appoint a certain number of directors. However, the influence available by this route will presumably be limited by Lord Mandelson's undertaking to the House of Lords that "public ownership carries with it the voting rights and economic benefits appropriate to a majority shareholder."[130] The agreement will also, we presume, set out arrangements for the partnership to be dissolved if the minority partner wishes. Normally this would be done either by selling shares on the open market, or by a firm undertaking that the majority stakeholder would buy out the minority partner if that was desired. Such agreements can also include clear statements as to whether and how the minority partner can increase its stake in the future. What will be the arrangements here? What will be the arrangements for GLS, the most profitable part of Royal Mail's business? Under the current scheme, Parliament will not have any right to see that agreement before the Government enters into it (or indeed, afterward). Is the Government prepared to make such details public before a partnership is agreed? Why does it feel it needs to change the law so that specific Parliamentary approval for each disposal is no longer needed?

155.  In the proposals to separate Royal Mail and Post Office Ltd, account must be taken of the operational independence between Post Office Ltd, Royal Mail and individual postmasters. At the moment the Post Office provides access and delivery points to Royal Mail Group letters and parcels. Will this continue if the proposal to separate them takes place?

156.  When the Government announced its acceptance of the proposals in the Independent Review on 16 December, it also made it clear that TNT, a major competitor to Royal Mail, had expressed an interest in entering a strategic partnership with the company. The fifth question is whether if the recommended partner turns out to be an existing major competitor of Royal Mail the loss of competition that would inevitably result is a price worth paying for the equity stake?

157.  Finally, the challenges faced by Royal Mail are huge — the decline in the letters market is enormous. That is why the Government is inserting a provision for a possible future levy to fund the USO. It is an heroic assumption to imagine that cash generation or debt finance will be attractive routes for securing the additional investment that will be needed in the medium term to open up new markets and diversify, even with a profitable letters and parcels business. The House should not make that assumption without firm evidence.

158.  More money may well be required. This can really only come from three routes — cash generation within the business, debt finance or new equity injections from the public or private sector. But if additional equity investment is needed, with a 30% partner, either the Treasury will still provide 70% of that investment — which will then be subject to all the same state aid rules which we are told the company is seeking to escape — or it will come entirely from the private sector partner, who will expect an increased stake in the business as a reward for the extra risk capital supplied to the business. We note that the definition of "publicly owned" in the Bill would apply even where the private sector held a 49.9 % stake. Some will have no problem with this steady increase in the privately owned proportion of the company — but others will.

159.  We are left with the conclusion that either the Government has not fully thought through its position about future share sales, or that it has done so and is refusing to reveal its hand. Either case is worrying. In any event, if shares are sold to a new strategic partner, a stake of 30% does not look like an end-game to us.


108   Department for Business, Enterprise and Regulatory Reform, Impact Assessment of the Postal Services Bill, para 5.2.45 ff Back

109   HC 143-i, Q 16 Back

110   Q36 Back

111   Q 35 Back

112   Q 37 Back

113   HC (2005-06) 570-II, Ev 118 Back

114   Phase Two of the Independent Review of the Postal Service Sector, Royal Mail;s Response, p13 Back

115   Q275 Back

116   Q 300 Back

117   HL Deb 10 March 2009, c 1085 Back

118   Q 320 Back

119   Q 50 Back

120   HC (2005-06) 570-II, Ev 118. Back

121   See para 135 Back

122   Phase Two of the Independent Review of the Postal Service Sector, Royal Mail's Response, p13  Back

123   BERR, Impact Assessment of the Postal Services Bill, 26 February 2009, Table 2, p 18 Back

124   Cm 7560, para 4.18 Back

125   Royal Mail, update and analysis of major changes Back

126   Impact Assessment of the Postal Services Bill, p 18, para 5.2.43-4 Back

127   HC 143-i, Q 18-19 Back

128   Q 35 Back

129   HC 143-i Q52  Back

130   HC Deb, 10 March, c1066 Back


 
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