The Risk of Investing in State Run Institutions at the NSE

I came across the article below which is a great read and makes excellent subject for discussion, have reprinted here with express permission of the author.

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Authored by George K’Opiyo

Co-investing with government should be considered a risk

The government of Kenya is one of the largest sovereign investors on the Nairobi Securities Exchange (NSE). This situation developed over a period of time, as the government partly divested from State owned enterprises through privatization. One of the ways of ensuring that the public was given an opportunity was to float part of the shares on the Nairobi Securities Exchange.

This is how previously owned state enterprises like Uchumi Supermarkets, Kenya Airways, ICDC (Centum), Kengen, Kenya Power, Safaricom, Mumias Sugar and Kenya Commercial Bank found their way as publicly listed companies at NSE.

During the initial public offer, the government, as the sponsoring investor, retained large shareholding even after listing. This enabled the government to appoint permanent secretaries and other private citizens to the boards of these companies.

Many of these hitherto state enterprises have emerged some one of the worst performers at the bourse. Uchumi Supermarkets, is not being restructured and seeking a financial bailout for the first time. It has sought financial assistance from the government, many times over.

Mumias Sugar has been a perennial laggard at the stock exchange. The sugar miller has been bogged down by plain looting of company revenues, careless investments in capital projects, political interference, fraudulent accounting and external factors including the competition from global and local sugar millers.

Safaricom has been spared from these shenanigans and has emerged as one of the largest telcos in East and Central Africa. It is a rare success story for a former state owned entity. It is a market leader in its sector and has a very robust management, largely driven by Vodacom, the strategic investor in Safaricom.

Kenya Airways was once billed as one of the best public enterprise restructuring effort it Kenya. Coming from a place of mismanagement, the carrier, fondly referred to as KQ, had previously been used by senior government officials as a “free global bus company”, where no bus fare was paid by travelling passengers. The restructuring brought much hope and dutch airline KLM as the strategic pre-IPO partner.

KLM was supposed to inject technical and operational expertise into the airline. They had seats on the board and recruited CEOs and fleet directors for the intial years of public trading. After Titus Naikuni took over the helm of the airline, and started an ambitious fleet expansion project, dubbed “Project Mawingu.” The project at the time, looked very good on paper. It provided an illusion to management of transforming KQ into a global airline.

The cornerstone of the project was fleet expansion and modernisation. The airline hurriedly acquired new passenger jets from Boeing. The finance for these purchases was largely arranged by global banks. The EximBank of the US also played a very big role in these transactions.

The airline also acquired short haul jets from Embraer, the Brazilian aeronautical manufacturer. The growth of the fleet was not commensurate with the growth in passenger numbers. On many routes, Kenya Airways was over capacity. Cabin factor numbers were not impressive.

The airline had other internal problems as well. It had a bloated staff and was suffering internal theft as well. At some point, Kenya Airways flights could not keep up with the published schedule. The turning point was the crippling strike by members of staff against a planned retrenchment exercise. Sensing that he was about to exit the airline as CEO, Mr. Naikuni played a key role in ensuring that Mr. Mbuvi Gunze succeeded him as CEO.

Once Mr. Naikuni left, Mr. Ngunze was appointed CEO as per the succession plan put in place by Mr. Naikuni and the airline’s board. It is on Naikuni’s exit that the actual rot at Kenya Airways become apparent. First, the airline was bleeding money.Loan repayments to the banks for new aircraft was taking a toll on the bottom line. The airline has no money to pay a bloated workforce and many of the new routes launched under Naikuni’s leadership were not breaking even.

The KLM code sharing arrangement was not proving economical for KQ. Then there was the fuel hedging strategy to shield the airline from future fluctuations on aviation gas prices. Fuel is one of the largest individual cost component in running an airline. Kenya Airways got it all wrong. The hedging numbers were largely off the mark and not in tandem with what is now the falling oil price. What that meant was that KQ continued to pay a higher premium on Avgas, even when the price of the commodity was falling.

As we speak, the share price of the airline is taking a beating and shareholders are losing money. Kenya Airways has asked the government for a bailout. It is down sizing fleet and staff (the second time in a few years). It has even sold its landing slot at Heathrow to Qatar Airlines.

Many Kenyans are of the opinion that the the National carrier is too important to fail. Nairobi has become an important aviation hub and losing KQ would deal a large blow to the government’s ambition to have Nairobi as the most efficient aviation hub in East and Central Africa.

The only person who has paid the price for mismanagement at Kenya Airways is the former Finance Director Alex Mbugua. He has since lost his job. There is an ongoing audit at Kenya Airways to try and unearth internal malpractices.

The same malaise is seen replicated at Mumias Sugar. The sugar miller has been involved in all manner of management malpractice. From dodgy accounting, tax evasion through fake sugar exports and theft of company money by senior management.

Uchumi Supermarkets is another public listed company currently struggling to stay afloat. The supermarket chain has been looted dry by former management and employees. There immediate former CEO has been accused of being part or facilitating the current problems facing the retailer. Some of the retailer’s outlets have been shut down and staff send home in a bid to contain costs to prevent the business from going back into receivership.

The common thread in Uchumi, Kenya Airways and Mumias is that the government appoints a large portion of the board of directors of these companies. Company boards largely provide strategic direction for listed companies and sign off on any large capital expenditure projects. The board members of Uchumi, Kenya Airways and Mumias are partly or wholly responsible for the malpractice in these public traded companies.

The board members appointed by the government usually include representatives from the relevant government ministries and private individuals from the public. Many of these individuals are, in many instances, political appointees. They are appointed through political influence peddling and horse trading.

Many do not have any previous experience in the sectors to which they are appointed. Company chairmen are picked from old retired civil servants, politicians or party activists to reward loyalty. This is one of the reasons why there is such mismanagement in part-state owned publicly traded companies.

Co-investing with government must be considered a risk when selecting where to invest. Many of these companies where the government has significant shareholding are bleeding and losing money due to theft and mismanagement. The Capital Markets Authority, the regulator is seemingly incapable of intervening to save investors from this agony by enforcing proper corporate governance. The laissez faire attitude on corruption is slowly permeating to the boards of listed companies.

Just this week, although not listed, National Bank of Kenya issued a profit warning on the back of an explosion of a non-performing loans book. Privately owned banks, like Family Bank, are meanwhile declaring billions of shillings in profits for the same trading period.

I believe that co-investing with the government in public listed companies is akin to gambling in Las Vegas. A game of chances.

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This article first appeared on facebook authored by George K’Opiyo

 

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