PTCL’s Sullied Sale – May Value 1.4 Bln, Not 2.6 Bln

By Dr. Kamal A. Munir

(Published in Jan 2010)

It has been four years now since a 26 per cent stake in Pakistan Telecommunication Company Limited (PTCL) was sold to Etisalat through privatisation. On June 18, 2005 the United Arab Emirates (UAE)-based company, offering 2.6 billion dollars, beat China Mobile’s 1.4-billion-dollar and SingTel’s 1.2-billion-dollar bids for this highly regarded asset.

While the Etisalat’s offer sounds like a competitive one based on these numbers, the post-auction concessions that were made and the performance of PTCL since the privatisation indicate the process has been mismanaged at great loss to the national exchequer.

And since Etisalat was given full managerial control along with its 26 per cent economic stake, the government of Pakistan has very little ability to turn things around.

Before examining these issues, however, one wonders how this transaction can even be called a ‘privatisation’. The usual argument for privatisation is that the state has no business running a commercial enterprise. Private businesses, it is said, are more efficient and fare better because they are independent of political obligations and are accountable to
shareholders.

Etisalat, however, is itself a state-owned enterprise (SOE) and it is unclear how selling a Pakistani SOE to a UAE-based SOE makes sense under the privatisation theory. Furthermore, the UAE government, the majority shareholder in Etisalat, considers it to be a strategic asset and allows only UAE nationals to own shares in it.

A company with extremely restrictive shareholder laws, then, has been allowed to acquire a key strategic asset in Pakistan. More important is the issue of Etisalat’s ability to manage PTCL – the latter is a much bigger organisation and plays in a far more complex and competitive market than the former has ever experienced.

Pakistan’s telecom industry is a cut-throat one with some of the lowest consumer tariffs in the world, requiring a highlyexperienced and competent management team. Etisalat, on the other hand, was until 2004 the only entity in the UAE’s telecom market and operated as both a telecom regulatory body and a service provider.

It was only with that country’s accession to the World Trade Organisation (WTO) in 2004 that the government introduced an independent regulator and even then the UAE was the last country to liberalise its telecom market by doing so. And it was only in May 2005 that the UAE’s Telecommunications Supreme Committee awarded a license to a second company to end Etisalat’s monopoly.

This license was, however, also awarded to another SOE and Etisalat continued to operate without an aggressive, private-sector competitor. The company’s own profits are therefore largely explained by its exorbitant call charges, which are possible because of the lack of real competition, and its size is due to its near-constant acquisition spree of the last five years.

Even more serious are violations that took place during the privatisation. In contravention of international norms and Pakistan’s own public procurement rules, the terms of the sale were changed after the auction.

After winning the bid to buy PTCL and providing the initial 260 million dollars (10 per cent of the total amount owed to the government of Pakistan), Etisalat wanted to back out of the transaction. As this would have left Islamabad in an extremely embarrassing position, it decided to offer more concessions, which Etisalat readily accepted.

Some of Concessions were as following:

• Etisalat was allowed by the Privatisation Commission to spread its payment over five years. While 260 million dollars were paid in June 2005, 1.14 billion dollars were paid in April 2006 – six months after their due date – and it was agreed that the remaining 1.2 billion dollars would be paid in nine interest-free, semi-annual instalments of roughly 133 million dollars each.
  Assuming all payments have been made and will continue to be made on time, the opportunity cost to the government of not receiving the entire 2.6-billion-dollar amount in September 2005 is a whopping 351 million dollars (assuming a conservative cost of capital for Etisalat of 10 per cent; at 15 per cent the loss would be 488 million dollars).
  In other words, Etisalat paid anywhere between 350 to 488 million dollars less just by being allowed to stagger the payment, even if all payments are made on time (and there are some reports – neither accepted nor denied by the government – that only the first three instalments of 133 million dollars have been paid).
• Etisalat was also to receive a technical services fee from PTCL of 3.5 per cent of the organisation’s gross revenue up to a maximum of 50 million dollars per annum for a four-year period. While this fee, charged for providing management services, is not in itself unusual, the fact that it was added after the auction was concluded makes it an opportunistic revenue-generating scheme. At 15 per cent cost of capital for PTCL this has resulted in a loss of roughly 53 million dollars.
• Etisalat convinced the government of Pakistan to bear 50 per cent of the cost of the voluntary separation scheme, a downsizing programme under which employees could opt to leave the company in return for a payout. This scheme was implemented in 2008 with a total cost of 41 billion rupees, of which the government of Pakistan has so far paid 17.4 billion rupees (256.308 million dollars).
• Finally, Etisalat is now interested in acquiring greater control of PTCL properties, presumably to use them for purposes other than what they were acquired for. Privatisation agreements typically contain clauses meant to prevent the buyer from selling off pieces of the acquired entity. In post-auction negotiations, Etisalat seems to have persuaded the privatisation commission to remove this clause: it is no longer present in the latest share purchase agreement but PTCL officials concede in private that it was present in the original version.

PTCL owns thousands of properties that are not meant to be used for commercial purposes since many of them had been provided by the federal or provincial governments on subsidised rates for the specific purpose of building exchanges or other required facilities.

According to industry insiders as well as sources familiar with the company’s assets, the most conservative estimate of the value of these properties is two billion dollars. Etisalat has asked for permission to use them commercially with the implicit permission to sell them.

If the government agrees to this, it could result in a potential loss of 500 million dollars (since Etisalat owns 26 per cent shares, they will be entitled to roughly one fourth of the two-billion-dollar value). At the moment the issue is pending in the Sindh High Court.

Even leaving aside the real estate, a conservative estimate of the other costs the government has incurred due to concessions made after the bid was accepted (payment in instalments, the technical services fee and sharing the burden of the voluntary separation scheme) come to roughly 700 million dollars.

Adding the money Etisalat will earn if it is permitted to sell 26 per cent of the real estate owned by PTCL and deducting this total cost from the bid amount, the UAE based company will end up effectively purchasing the company for 1.4 billion rather than 2.6 billion — about the same as China Mobile’s bid.

Pakistanis would not be remiss to ask how the government can give away a competent and profitable organization such as PTCL for this meagre sum and that too to another SOE whose competence and experience is far from established.

This is an important issue not just because of what it means for PTCL but also becauseof the precedent it can set for future privatisations of state assets.

Far from being an incompetent liability, Pakistan Telecommunication Company Limited (PTCL) was, before its privatization, one of the strongest telecom players in South Asia. It had a large pool of expert technicians, many of whom had even been deputed for short periods to foreign countries to help lay telecommunication networks and create other technological capabilities. It boasted many firsts, making Pakistan the first country in South Asia to switch to Dense Wavelength Division Multiplexing technology, which is critical for meeting increasing demand.

PTCL had an extensive copper and fibre-optic network. To maintain its world-class performance, it had an array of schools that trained fresh recruits and existing employees.

Pre Privatization Financial Performance

And if that was not enough, PTCL’s financial performance was enough to make anyone envious. Every year it contributed tens of billions of rupees to the national coffers.

At the time of its privatization in 2005, PTCL had posted revenues of 84 billion rupees, with earnings before interest, tax and depreciation of 54 billion rupees and net profit of 27 billion rupees.

Undoubtedly there was corruption, much of it carried out by the government itself. Legislators and government officials influenced postings and hiring in the company, commandeered the organization’s rest houses and vehicles and pressured it to establish lines to their houses in remote areas.

Pre Privatization Mistakes

More seriously, the government was forcing PTCL to funnel cash its way in the form of shareholder dividends. In 2004, for example, the company paid out over 25 billion rupees out of a net profit of about 30 billion rupees, with most of this money going to the government, the largest shareholder.

So while the sector boomed worldwide and companies in other countries bought licenses in foreign markets and acquired newer technologies to retain and gain subscribers, PTCL was not able to use these earnings to make strategic investments.

There is reason to believe that, if PTCL had taken a route similar to other state-owned corporations such as SingTel, Etisalat or Telekom Malaysia, it could have become a regional giant by acquiring licenses in South Asian, African and Middle Eastern countries. But instead of building on the company’s strengths and turning it into Pakistan’s first multinational corporation, the government sold it off to an inexperienced operator (see “Sullied Sale”).

Post Privatization Financial Performance

Since it has been under Etisalat’s control, PTCL’s fortunes have declined. In the four years prior to privatization, profits after tax grew from about 18 billion to over 27 billion rupees, a rate equivalent to 11 per cent per annum.

In the four years post-privatization, earnings fell to almost 11 billion rupees, a rate equivalent to a negative growth of 21 per cent per annum. Similarly, the profit margin (based on EBITDA or earnings before interest, taxes, depreciation and amortization) declined from an average of 71 per cent over the four years prior to privatization to 50 per cent over the four years since (based on an average EBITDA of 50 billion versus 43 billion) and continues to fall. This magnitude of change is unprecedented in the telecom sector, whether in Pakistan or internationally.

Etisalat could argue in its defense that the decline has resulted from the reduction in fixed-line operations, which have gone down everywhere due to the increasing popularity of cell phones. While this trend is real, however, fixed-line customers for Pakistani competitors such as National Telecom and Worldcall have grown over the same period and PTCL’s financial performance has compared unfavorably with international peers.

From 2005 to 2009, the post-privatization period, comparable regional telecom companies’ revenue grew at a combined rate equivalent to six per cent per year versus PTCL’s two per cent. The equivalent rates for profit margin, based on EBITDA, were one per cent and negative eight per cent.

Post Privatization Stock Value

No wonder, then, those four years after privatization, the market value of PTCL shares has declined from 358 billion rupees in June 2005 to 88 billion rupees in June 2009.Although the KSE-100 Index as a whole began to plummet after April 2008, it was on a solidly upward trajectory until that point.

PTCL shares, however, started to lose value much earlier after peaking in 2005. This massive reduction has resulted in a 200-billion-rupee loss to the government of Pakistan and the minority investors of PTCL, who together still own 74 percent of the shares.

Post Privatization HR & Work Force Concerns

This is not, however, their only loss. After taking over, Etisalat was keen to shed excess labor. Almost 32,000 employees reportedly left under the voluntary separation programme (VSS), and the government has borne 256 million dollars of the cost of payouts to those choosing to leave. Additionally, it seems that VSS led to many of the best employees exiting the company, which created a veritable human resource crisis at PTCL.

Network maintenance and operation, as well as customer care, seem to have suffered. A PTCL official, who does not want to be named, claims that many of the best linesmen and other technical hands have left and that hundreds of thousands of connections have been lost as a result.

Now What?

But this is not the only issue one needs to be vigilant about now that PTCL is no longer under government control. For instance, the government needs to look at transactions between PTCL and Etisalat, which have spiked to 15 per cent of PTCL’s revenue. It is not clear what services have been bought or sold but since even a little tweaking of prices of transactions between Etisalat and PTCL can easily deprive non-Etisalat PTCL shareholders of their just earnings and the state of tax revenue, this needs to be more transparent.

The above is just one example of the larger issue of conflict between control and economic ownership that this case fundamentally highlights. If a party is allowed a level of control disproportionate to its economic interest in a company, the former will be tempted to divert funds from the latter rather than share them in an equitable manner with all shareholders.

In this case, since Etisalat gets only 26 per cent of the profits, it may be tempted to expropriate funds. This is why regulators in advanced markets such as the UK and the European Union have enacted takeover laws to protect minority shareholders.

For example, in the UK if a buyer acquires a 30 per cent share in a publicly-listed entity, it has to make an offer to all other shareholders. This ensures that a controlling shareholder cannot ride roughshod over the interests of the minority shareholders by virtue of its control.

Perhaps the government of Pakistan should also consider introducing such a law here, especially to protect state-owned corporations which are to be privatized. So what should the government do? It is obvious that PTCL’s fortunes have taken a dip. Through this process, the government has suffered a loss of over 2 billion dollars due to the decline in market value of its PTCL shares (it still owns 62 per cent of the company) and 0.7 billion dollars due to concessions negotiated after the auction.

This cost does not even include the value of PTCL’s real estate, which Etisalat appears to be trying to appropriate for commercial purposes.

Can Government of Pakistan Buy Back PTCL’s 26% Shares?

Given the current state of affairs, the state should consider asking Etisalat to sell back its shares at current market prices. The government should pay in installments, just as Etisalat has done. PTCL can quickly generate whatever this will cost. The government should then staff the company with the enormous Pakistani talent pool in the telecom sector and turn PTCL into a global company.

This is nothing more than what this excellent organization deserves.

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This Article was also Published in “The Herald”, December 2009 Issue.

Dr. Kamal Munir has been a Professor of Strategy and Policy at University of Cambridge from 2000-2009. Prior to that he taught at McGill University, Canada from 1996-2000. He obtained his PhD in Strategy and Policy from McGill University, Canada.

Dr Munir has published several articles in leading organizational and technology journals, including the Academy of Management Journal, Cambridge Journal of Economics, Industrial and Corporate Change, Organization Studies and Research Policy. In addition, he has written numerous articles for prominent newspapers and magazines such The Financial Times, The Guardian, Financial Express India, Dawn, Herald and World Business. His work has been quoted and cited in several forums, including BBC’s Hard Talk, and BusinessWeek.