Privatisation of the Forestry Corporation of NZ
The Privatisation of the Forestry Corporation of New Zealand Ltd
The Forestry Corporation of New Zealand Ltd (FCNZ) sale provides a powerful example of the risks government can avoid by not owning commercial businesses. The government sold FCNZ for around $2 billion in 1996. The new owners subsequently wrote off over $1.2b of their investment and the business is in receivership.
By selling the shares in FCNZ, the government has avoided a capital loss of over $1.2 billion. Further, it has made net interest savings conservatively estimated at around $50 million in 2003/04.
The success of a privatisation, however, should not be judged by whether, with the advantage of hindsight, the value of the assets rose or fell in the years after the transaction. Rather, the measure should be the contribution the sale makes to overall economic welfare.
The FCNZ sale was a success because it meant the taxpayer no longer faced the ownership risks associated with a large block of commercial forestry, the government was no longer both player and referee in respect of the central North Island forests, and the proceeds from the sale were appropriately maximised because the sale was conducted in an open and competitive manner.
The Forestry Corporation of New Zealand Ltd was formed as a state-owned enterprise (SOE) in the mid 1980s from large parts of the commercial forests of the former Forestry Department. The principal assets of FCNZ were forests, forest cutting rights and processing operations in the central North Island.
Following the sale of several of its forestry interests during the early 1990s, the Crown sold its shares in FCNZ in 1996. The total paid for FCNZ’s assets was around $2,000 million with around $400 million going to re-pay FCNZ’s external liabilities. The sum received for the Crown’s equity interest in FCNZ was $1,600 million with the proceeds used to retire government debt.
The Crown’s shares were effectively sold to the Central North Island Forest Partnership (CNIFP), a consortium of Fletcher Challenge Forests Division (37.5 percent partner), the Chinese-government-owned Citic (37.5 percent) and Brierley Investments Ltd (BIL) (25 percent). The government retained ownership of the land under the forests for future Treaty of Waitangi settlements.
Commentary by financial analysts at the time of the FCNZ sale was generally favourable. The government was seen to have received a good price for the assets and the process was considered competitive. However, there were critics. For example, Labour’s forestry spokesman Jim Sutton declared the sale a “botch”, concluding the Government had undersold the assets by half a billion dollars. New Zealand First’s leader, Winston Peters said that if elected to government, his political party would buy the forests back and return the cash to the buyers. Jim Anderton of the Alliance party was highly critical of the sale.
After the privatisation of FCNZ, international timber prices fell. Critically, prices for Douglas-fir, wherein much of the early cashflow and assessed value of FCNZ was expected to lie, were well below expectations.
With the value of the investment falling, BIL exercised its right to an early exit and sold its stake to the other two CNIFP consortium partners in 1998. The partnership continued to struggle despite receiving further financial support (including additional equity and subordinated loans) from the two remaining partners.
Primarily as a result of low log prices, the partners’ equity and debt investments in CNIFP were progressively written down over the late 1990s and early 2000s. In December 2000, CNIFP breached its external loan ratios and covenants, putting the senior bank debt facility of approximately $US650m in default. In February 2001 the lending banks appointed receivers to manage the sale of the CNIFP assets.
The CNIFP partners’ investments (both equity and debt) were eventually fully written off, with severe consequences for the ultimate shareholders of the respective partners. Indeed, the purchase of FCNZ was a significant factor in the decline of Fletcher Challenge Ltd, once New Zealand’s largest company.
Since CNIFP was placed in receivership, there have been several attempts to sell and/or restructure the assets of the former partnership. To date a sale has not been achieved despite the readiness of receivers to accept an offer that simply covered the business’ remaining bank debt of around $US650m (around $NZ1.1b) in 2002. Since then, international timber prices have fallen further.
While the acquisition of the FCNZ was a financial disaster for the purchasers, the sale was, with hindsight, a considerable financial success for taxpayers. The Crown has avoided the commercial risks associated with owning a major forestry business. These ownership risks were substantial: from 1996 to 2002, the CNIFP partners recorded capital write-downs of over $1.2b. The savings in interest payments alone to the Crown from the sale are, on conservative estimates, around $50m in 2003/04.
It has often been claimed that the New Zealand government sold its assets too cheaply during the privatisations of the 1980s and 1990s. As noted above, such a claim was made by some at the time of the FCNZ sale.
Sometimes this claim is based on the argument that it is better to delay a sale in the hope that prices will be more buoyant in future. However, the FCNZ sale demonstrates that market timing is very hard to gauge, even for experts in the industry who are putting their own shareholders' money on the line. It is not plausible to expect any greater ability from governments that are motivated by politics rather than commerce and who lack industry expertise.
More commonly the claim is simply that the price at the time was too low. However, the proper test here is whether the government could have got someone to pay more at the time of the sale. It is unlikely the government could have got more, given that the assets were almost invariably sold through competitive sales processes that were open to anyone in the world. If potential bidders thought the assets were worth more at the time (and were prepared to stake their money on that judgement) they were free to do so.
Ex-post, it is inevitable that the buyer of a privatised business, like any investor, will sometimes make above-market returns and in other cases below-market returns. The commercial reality is that neither buyers nor sellers can predict with certainty the future path of asset prices. In the case of FCNZ, the Crown clearly did well by happening to exit the industry when forest prices were at a cyclical high. Looking at the privatisations in New Zealand over the period 1988-1999 as a whole, however, there is no evidence that the government systematically sold its assets at too high or too low a price.
Further, even if a buyer of a privatised asset does better than expected, it cannot be assumed that the business would have done as well had it stayed in government ownership. The private owners are likely to have added value. In a competitive sales process, much if not all of the expected gains from private ownership are likely to be capitalised into the sales price. For that reason, the government’s financial position (in terms of the underlying net worth of the government) is likely to improve with a sale of a commercial business. In addition, the competitiveness of the market the enterprise operates in is likely to improve once the government withdraws from being both player and referee, further boosting overall economic welfare.
25 September, 2003