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State of the Nation’s Assets

insurance policyThe National Commission of Audit proposed in 2014 that the Federal Government privatise numerous companies, with combined revenue of $10.6 billion and over 43,000 direct and indirect employees. Most of these companies provide vital public and strategic services. In light of the potential developments to come, IBISWorld has prepared an exclusive spotlight release on privatisation – its benefits, risks and future impacts, particularly in relation to Medibank and Australia Post.

The 1990s was a phenomenal period for privatisation. The micro-economic reform agenda of the late 80s and early 90s spilled over into a series of asset sales, and numerous government assets – including electricity generators, banks and telecommunication providers – were privatised. The past five years have echoed that era, with the privatisation of Port Botany, QR National and now, Medibank – Australia’s largest health insurance provider.

What is privatisation? 

In its simplest form, privatisation involves the government selling assets to the private sector. Such assets may include infrastructure or government bodies/companies that subsequently become privately owned. The government can sell its assets directly to the public by issuing shares on the stock exchange (as is to occur with Medibank), or may sell the asset to a private company. The latter option occurs more frequently in sales of infrastructure assets. For example, Port Botany and Port Kembla were purchased by Industry Funds Management for a reported $5.07 billion in April 2013.

Medibank

The Australian health insurance industry is forecast to generate $20.6 billion in 2014-15, with premiums rising to just over $20 billion. Health insurers in Australia are estimated to employ just under 13,000 staff and pay more than $970 million in wages, and the industry is an important aspect of the Australian healthcare system. The Private Health Insurance Administration Council (PHIAC) reports that more than 12.7 million policies are currently held, covering 54.9% of all Australians. Medibank, BUPA, Hospitals Contribution Fund of Australia and NIB Holdings are the largest companies operating in the industry, which is forecast to grow at the rapid annualised rate of 4.2% in the next five years.

Health insurance is highly regulated, with the key piece of legislation being the Private Health Insurance Act 2007. Under this legislation, private health insurers are unable to discriminate on the basis of age, sex, sexuality, and health status or claims history. PHIAC ensures that insurance companies comply with these laws. 

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Privatisation 

Medibank is scheduled for an initial public offering in late November, and its sale is expected to generate around $5.0 billion for the Federal Government. This will make it one of the largest privatisations of the past five years. A large portion of these funds is expected to go towards new infrastructure projects. The efficient allocation of funds is crucial, since Medibank also generates substantial profits (NPBT of $315.0 million in 2012-13), an income stream that the Federal Government will lose once the insurer is privatised.

The privatisation of Medibank has prompted discussion regarding its implications for the Australian health system. This has centred on the likely effect of privatisation on insurance premiums and the subsequent costs of healthcare for consumers. Proponents of the initial public offering argue that the industry is already sufficiently regulated, and that Medibank will have no more control over its premiums in private hands than it does under public sector ownership. The Private Health Insurance Act 2007 states that any premium increases must be approved by the Minister for Health, and must not be contrary to the public interest. This effectively ensures that every health insurer – public or private – is subject to the same regulatory factors.

However, opponents of the privatisation suggest that as the government relinquishes control of the health insurer, it is effectively losing control of the industry. It is further argued that premium prices could be controlled via competitive pressures. Should any of the private insurers raise their prices, the government could offer lower premiums through Medibank, making the private companies less competitive. The true potential of this (so far, latent) tool to influence pricing is difficult to quantify.

Winners and losers

A key question is whether or not consumers will come out on top after the privatisation of Medibank is complete. Concerns include the future growth of premiums, appreciation of the stock price (since retail shareholders have been actively invited to participate in the offer) and the quality of service.

The immediate winners of the privatisation are consulting firms, brokerage firms and investment banks. Any institutions involved in the preparation of the enormous float will enjoy a healthy flow of revenue from fees, as well as the intangible benefits to their reputation for handling such a high-profile transaction. Macquarie Capital, Deutsche Bank AG and Goldman Sachs Australia are the joint lead managers on the deal.

However, not all involved parties will benefit from the privatisation of Medibank. In this regard, it is difficult to look past the company’s employees. Improving operational efficiencies will now become a key management objective. Such changes often come at the expense of headcount. Given that the overall potential for revenue growth is limited, improving management expense ratios will be key to growing shareholder value over the medium term.

Changed circumstance

With the industry’s largest health insurer now focusing more on its bottom line, competition within the industry is likely to increase (which is a positive for the average consumer). In a heavily regulated industry where the scope for increasing premium prices is capped, the best alternative means of increasing revenue is to take market share away from other players. Assuming Medibank reduces its management expense ratio and consequently improves its profit margins, the insurer will be able to reduce its premiums and increase its service offerings to attract a larger share of the market. This could spark higher competition among existing private health insurers, further increasing the benefit to the everyday consumer.

Why sell?

Privatisation provides governments with an option to recycle capital – that is, to invest the proceeds from the sale of the asset into new projects. This allows governments to invest without raising debt and putting additional pressure on their budgets. Historically, governments (in Australia and other western nations) have held a monopoly on infrastructure assets such as electricity grids, roads, ports and energy generation plants. Selling some of these established, blue-chip assets allows governments to raise funds for new social and economic infrastructure projects.

Governments may also decide to privatise state-owned enterprises in a bid to achieve cost reductions and efficiencies. It has been argued that, due to competitive forces, privately run enterprises are more efficient than state-run enterprises. By privatising state-owned enterprises and making them bid for government contracts, services costs are effectively reduced. Such an approach has been used in transport infrastructure and operations, through public-private partnerships.

What’s at stake?

One of the most fundamental issues regarding privatisation is the trade-off between recycling capital and a potential decline in the provision of community services. Opponents of privatisation argue that due to the misalignment of incentives of the public and the private sector, private companies will prioritise profitability over the quality of community service provision.

This means that essential, but loss-making services may disappear once the government privatises its assets. An example of this trade-off was evident during the privatisation of Qantas. As a state-owned airline, it serviced many routes to regional communities. Generally, these routes are economically unviable due to low demand. Since these routes are loss-making, there was a possibility that they would be shut down when the company was privatised, which would have been detrimental to regional communities. The situation was resolved through an agreement by the government to subsidise the newly privatised Qantas on these vital routes. Privatisation of assets may also carry some economic pitfalls. All is well if the proceeds from the sale flow into new investment projects. However, if they are instead used to pay out benefits and fund temporary social programs, there is effectively no recycling of capital.

Recent developments

The National Commission of Audit proposed that the Federal Government privatise a number of large companies that provide important services. A sample of the enterprises, and the IBISWorld industry reports that contextualise their performance, is in the following table.

table

Where would the money go?

Where the money goes is important. The proceeds from the sale of Medibank Private have been earmarked for the Federal Government’s Asset Recycling Initiative. Under the initiative, the Federal Government will provide a bonus of 15.0% of the selling price of an asset sold by a state or territory government if the proceeds are used to fund further infrastructure projects. To be eligible for funding, state and territory governments must invest the funds in projects that demonstrate a clear cost benefit, that enhance productivity in the long run and that enhance the involvement of the private sector in infrastructure funding.

This initiative is designed to spark a wave of investment in new projects across Australia, and increase the role of the private sector in operating existing assets. If state and territory governments can qualify for all of the $5.0 billion allocated to the Asset Recycling Initiative, close to $40 billion will be spent on infrastructure in the coming years, to the benefit of businesses in advisory and construction industries.

State and territory governments with a mandate to privatise assets are likely to be the first to access these funds. The system that the Federal Government has put in place appears to apply on a first-come, first-served basis. States and territories could miss the benefits of the initiative if they do not have suitable assets to sell and projects in which to reinvest proceeds.

Who will benefit?

The immediate beneficiaries from the use of the sale proceeds are expected to be professional service firms. Both the private and public sector are expected to turn to expertise in the following industries to pave the way for asset sales and identify the business cases for new projects:

Investment Banking and Securities Brokerage
Legal Services
Management Consulting
Accounting Services
Public Relations Services
Architectural Services
Engineering Consulting
Specialised Design Services
Environmental Science Services

As funds from federal (and subsequently state) privatisations start to flow into new projects, the Construction division is expected to be the primary beneficiary. The bulk of this work is expected to fall outside of the next five years, due to the long lead-time required for major projects.

Construction
Institutional Building Construction
Road and Bridge Construction
Heavy Industry and Other Non-Building Construction
Site Preparation Services
Concreting Services
Bricklaying Services
Roofing Services
Transport Equipment and Large Vehicle Rental
Machinery and Scaffolding Rental
Gravel and Sand Quarrying
Rock, Limestone and Clay Mining

Up next: Australia Post

In the medium term, Australia Post is another privatisation target. The organisation is Australia’s largest logistics company, employing just under 37,000 people including sub-contractors and turning over $6.4 billion in 2013-14. The company was formed at a time when letters were the dominant form of communication in the economy, and Australia Post’s services were considered essential. After decades of stable growth as a regulated natural monopoly, Australia Post’s business model has come under pressure from technological changes over the past 10 years. Business and social communication have migrated online, and demand for the company’s core service, letter delivery, has declined. Letter delivery has changed from a profit centre to a loss maker, as the company is mandated to provide frequent delivery services to a wide network even as volumes decline. 

Australia Post has adjusted its strategy to move with the times, investing heavily into parcel delivery services, which are outside of its community service mandate. Australia Post, in competition with the private sector, has managed to generate profit from these activities. Nevertheless, letter delivery activities are forecast to contribute an increasingly smaller share of revenue and larger share of loss. As Australia Post increasingly focuses on providing parcel services, the need for government ownership will weaken. In 2014, calls for privatisation of postal services are growing.

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Privatisation

In 2014-15, the combined market for postal and courier services is expected to be worth $11.6 billion. It is expected to expand to be worth $12.7 billion by 2019-20.

The sale price of Australia Post would depend on the structure of the sale. The business operates under community service obligations that dictate the size of the delivery network and the frequency of delivery. These features of Australia Post are likely to be unattractive to the private sector, as they are unprofitable.

To maximise the value of the entity in a future sale, the frequency of delivery or the size of the distribution network could be altered. The viability of reducing the number of delivery points has increased in recent years, as internet coverage in regional areas has improved. Additionally, the company could be permitted to offer tiered delivery services, similar to the current express/normal services, where users could be charged a premium for more frequent services.

Another option is partial privatisation. Australia Post currently aggregates postal items from collection points into distribution centres, before sending them through the delivery network. Other countries, such as the United Kingdom, have attempted to introduce competition in delivery networks that were run as regulated monopolies. This opened Royal Mail up to competition in this area of its activities as a precursor to privatising the delivery part of the business.

A final option is the sale of Australia Post’s profitable activities that are outside of the company’s regulated monopoly services. The challenge with such a sale would be in managing the relationship of the existing network of retail post offices – which operate in a way similar to franchises – with the new entity.

Australia Post currently has a major advantage in the size of its network, which generally makes it the most convenient option for consumers. The structure of this network may present challenges during privatisation. The company’s retail network is dominated by licensed post offices (LPO), which account for over 65% of establishments. LPOs have a franchise-like relationship with Australia Post, which introduces a degree of uncertainty as to the value of the network. Any potential buyer that valued the size of the current network would need to find a way to work with current LPO owners, many of whom provide postal services alongside other activities such newsagency operation.

Winners and losers

Parcel services users could benefit from more transparent competition in parcel delivery. A private operator could have more flexibility to trial new products or adopt practices from overseas. Cheaper or more efficient parcel services would lower transaction costs for growing areas of the digital economy, such as online retailers.

Telecommunications companies could be big winners, as a reduction in the service quality of mail is likely to accelerate the adoption of internet-based services and use of their products.

Some households and businesses still rely on hard-copy delivery of information like bills and invoices. These users could be adversely affected by a reduction in services. Those in areas of low population density – generally rural or regional users – would be most exposed, as their services are the least profitable to provide. 

Existing employees could struggle, as new operators are likely to try to improve labour efficiency. The sub-contractors who currently work for Australia Post in areas like delivery have highly transferable skills, and so are likely to be absorbed by the larger Integrated Logistics sector. 

For a printable PDF of this release, click here.

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