Listening to Labour party representatives explain their party’s plans to re-nationalise the water industry is enough to make you squirm. In fact, the debate on how this is costed is a red-herring, the media is creating a false debate. No, the real point is quite different, but there is a phrase, a phrase that in the books of some Labour party grandees is a dirty phrase – a swear word/phrase – that explains why costing a privatisation programme is not the issue.
And that phrase is private equity.
Does Labour need to fully cost its plan to nationalise the water companies and beyond that explain how it can return The Royal Mail, the railways and energy companies into private ownership? No, it doesn’t. But it does need to explain what will happen to the industries once they are nationalised.
Take as an example United Utilities – it has a market cap of £6.89 billion. A PE ratio of 16.13, that means its market cap is 16.13 times projected net profits next year. In 2015, pre-tax profits were £408 million.
Right now, the UK government can go out and borrow by issuing 30 year bonds – carrying an interest rate of just 1.77 per cent. If it was to borrow money to buy the company by issuing 30 year bonds, it would need to ensure that the dividends it pays itself from the profits made by the company in future years are greater than 1.77 per cent of the price it paid – that feels like a modest target.
The last two dividend payments made by the company were 12.95p and 25.64p a share – between them they covered a 12-month period. Together they amount to just under four per cent of the share price.
The point is that the UK government can borrow at an incredibly low level – governments can. That is one of the advantages of governments borrowing to fund investment over companies borrowing, governments can get a lower interest rate.
The fact is that private equity firms apply exactly the same logic when they buy firms – providing the dividends are greater than the interest they pay on the money they borrowed to fund the purchase, they are quids in.
But there is another issue.
Usually, when a private equity firm buys a company it does so because it thinks it can apply its special management techniques to increase profits.
Cleary the Labour party’s objective of having the government buy water companies is not to make massive profits.
But the real issue is not whether such a programme is affordable, providing the management of companies is not messed up post-nationalisation, it clearly is, no the issue is quite different.
Instead, we need to ask why would Labour want to nationalise water companies? What will the benefits be?
The answer to that is to a large extent depends on your ideology.
Do you think public utilities should be state or private owned? Did the Thatcher privatisation programme lead to privatised companies becoming more efficient? Did the consumer benefit or lose out from privatisation? These are the questions that are relevant. The affordability argument is not.