VALUING STATE-OWNED ENTERPRISES FOR PRIVATIZATION: THE NEPAL PROJECT

By Nevin Sanli, ASA

The Government of Nepal retained Sanli Pastore & Hill, Inc. to provide business valuations for the privatization of three government-owned enterprises.

This is a two-part article. Part I is a general overview of the assignment. Part II covers the technical aspects of the valuations of the three companies. 

PART I of II

INTRODUCTION

Nepal

The Kingdom of Nepal is a landlocked Asian Country in the Himalayan mountain ranges. Neighboring countries are Tibet (or China) to North, and India to the South, East and West. Nepal is slightly larger than Arkansas and is inhabited by about 20 million people. Approximately 300,000 people live in Kathmandu, the capital.

The government of Nepal is a constitutional monarchy. The King has close to absolute veto power on all government decisions. At the time of SP&H’s mission, there were two political parties: the ruling social democrats and the communists.

Nepal’s gross domestic products is about $2.5 billion (the GDP of the US is $5,500 billion) and the average income per capita is about $200 per year. Over 90% of the population are engaged in agricultural production. The major industries of Nepal are rice, jute, sugar, oilseed mills, cigarette and brick factories and tourism. Perhaps Nepal’s most valuable resource is its scenic beauty, which draws foreign tourists.

Nepal is the only Hindu Kingdom of the world; 88% of the population are Hindu believers while the remainder is split between Buddhists, Muslims and Christians. Even though the official language is Nepali, in excess of 20 languages with several dialects are spoken.

Overview of Assignment

SP&H’s assignment was to value businesses and provide economic advice for the privatization of three state-owned enterprises: a textile manufacturer, a film maker and laboratory, and a raw hide collection business. Privatization is the transfer of economic authority over an enterprise out of government’s hands into the hands of investors. Its objective is to achieve economic benefits by exposing the enterprises to market forces. Privatization sorts out between private enterprises and government what each does best.  Of concern to all parties – the government, the public, investors ant the political opposition, is fair business valuations and modalities of the process: how does one guarantee a fair privatization in which all parties benefit?

Because a privatization assignment often involves traveling overseas, the consultant should start work at the home office and while traveling. Historical financial statements, pictures of facilities and other printed company materials are often available and can be mailed. This appraiser analyzed financial statements, entered data into his notebook computer, built valuation models and identified issues before arriving in Nepal. This is also good insurance against unforeseen circumstances such as sickness, natural disasters, cultural barriers and political unrest.

The consultant must be a well-traveled culturally-versatile, experienced and creative individual who can find solutions to new and highly uncommon problems. Furthermore, the consultant must be able to coordinate teams of experts and understand the principles underlying the various disciplines required by the assignment. In Nepal, a thorough understanding of real estate, equipment, mergers and acquisitions, and of laws and regulations proved helpful in giving instructions to real estate and equipment appraisers and understanding the privatization process.

The credibility of the appraiser is also important in countries where corruption may be taking place and the public and the political opposition are not trusting of the government. Credibility in foreign countries can be difficult to gain because of cultural barriers and because the professionals of the host county often lack knowledge about the specialized and relatively new field of business valuations. Membership in the American Society of Appraisers and affiliation with an international organization can be helpful. Most effective at gaining credibility is the ability to communicate clearly with the host county counterparts.

THE ASSIGNMENT

An essential aspect of the privatization assignment is to determine which standards and definitions of value are most applicable and are recognized by local investors. For this, one must consider the political, economic, and social environments that create the premises of value. The appraiser must comprehend the factors that allow value to be recognized and accepted. An analysis of the laws and regulations, business customs, cultural (and religious) attitudes towards value and accumulation of wealth (which is one of the determining factors of value), competitive behavior and ethics, and of the industry and economy must be performed. A good understanding of financial reporting rules and other business practices is necessary. The appraiser must also cope with the lack of or the dubious quality of financial, industry and market data.

The political aspect of communicating valuation opinions is the driving force: which standards and definitions of value will be acceptable to all parties and will be applicable to credible business valuation methodology?

Coordination and Selection of Experts

Experts including auditors, business appraisers, attorneys, and equipment and real estate appraisers, investment bankers and specialists in the privatization process must work together. Later, at the implementation stage, it is recommended to consult with reorganization and strategic management specialists.

In Nepal, SP&H worked with auditors from Deloitte Touche Tohmatsu of New Zealand, privatization specialists, and equipment and real estate appraisers. A law firm had also been consulted earlier. It is preferable that the experts have international experience, are creative, and knowledgeable about privatization. European and American experts are brought in because of their inherent credibility with the general public, their affiliations with international organizations and their independence from the local power elite. Real Estate and equipment appraisers, however, are retained locally because their work focuses on local market conditions and relies heavily on a priori knowledge of the history and specifies of the properties.

Interaction with the Business Community and the Government

In most cases, the appraiser is retained by the host country. Therefore, relations with government officials tend to be warm and cooperative. However, the business community is a good source of information. They can provide good market and industry information and their opinions of the values of the businesses to be privatized. They can point to the problems and obstacles of privatization. In Nepal, these contacts were facilitated because of the widespread use of English.

Modalities of Transaction

• Can government-owned enterprises be effectively transferred to the private sector? Can this transfer eliminate monopolistic behavior, allow free competition and reduce prices?
•  Will it be necessary to break up the company in order to achieve this goal?
• Or will transition from monopoly to competition require regulatory control?
• If so, which regulations? Will regulations ultimately defeat the purpose of privatization by over-regulation and, therefore, restricting market activities?
• Oftentimes,one of the conditions of privatization is that the newly privatized companies do not engage in massive layoffs of former government employees. Can privatization and the desired economic efficiencies be achieved with such a constraint?
• How will the public benefit? Lower prices? Better quality products? Increased product availability?
• The public must be thoroughly educated through a public relations campaign, which includes speeches, advertising, seminars and new articles written by government officials, attorneys and other experts. Other means of communications such as infomercials and town meetings can also be effective. The public support of prominent members of society can be instrumental.

Financial Feasibility of Privatization

•  Are the companies subject to privatization large enough to attract private investors?
• The subject companies must exhibit attractive historical financial performance. The product lines must be of interest to the general public. Industries that are known to attract public attention include entertainment, transportation, tourism, publishing, tobacco and alcohol, defense, public utilities and higher education.
• Do the subject companies have the potential for sustained and impressive future growth?
• How much efficiency and improvement adjustments can be incorporated into financial projections because of potential for better results under private ownership?
• If so, is the public large enough, wealthy enough, well-informed and trusting of the government, which is the guarantor of the fairness and stability of a public market, for an IPO to be successful?