July 29, 2001

Welcome to the Irish economic fantasy world of Bostlin

Posted in Banks ·
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A lucky group of former public sector workers (many of whom fortuitously took up guaranteed positions in the Post & Telegraphs back in the 1970s and 1980s rather than, for example, Irish Lights or Bord na Mona) this week appear to be intent on dictating to shareholders (who own the company) at what price Eircom should be sold.

Many questions arise from the ESOT/eIsland/Valentia wheeling and dealing; however, let us deal with just three. First, why are the workers supporting O’Reilly? Second, what will any “sweetheart” deal say about Irish corporate finance practices? Third, does the emergence of worker-ownership at Eircom tell us anything about our proximity to Boston or Berlin?

So what are the workers up to? This week the Eircom workers, in a clear conflict of interest with the board of the company and its shareholders, voted by over 80 per cent in favour of the Valentia bid, despite it being lower than the eIsland offer. A representative of the workers indicated that this was because the eIsland bid contained too much debt and such debt would, in some as yet unspecified way, be problematic. This line is either disingenuous or a smoke and mirrors exercise.

Debt is not a problem. Using debt to finance a corporate takeover is precisely the same as taking out a mortgage. If you are confident that house prices will at least stay in line with inflation, interest rates will not change dramatically and you are not likely to lose your job, then debt financing means you can buy a �300,000 house for �30,000 cash upfront. And, if house prices rise by 10 per cent in a year, the house is worth �330,000. This is a 100 per cent return on equity on the original �30,000 investment.

Similarly, if the workers of Eircom believe that the business is strong, cash flows are stable and predictable, and the management knows what it is doing, shareholders will do very nicely with no growth. If the new management can grow the business, the shareholders will do extremely well, just like the guy in the housing example. It is fair to conclude that the debt argument put up by the workers is not serious. Unless of course, they think the business is going to contract, cash flows dry up and interest rates double, in which case they would be better advised to get a new job.

Another hole in the workers’ debt aversion argument is that there is unlikely to be any manifest difference in the amount of debt financing used by either bids.

In fact, both Valentia and eIsland have stated that the bonds both are using to finance the takeover will be of investment grade. If there is no difference in the quality of the bond, the workers’ argument can’t hold water.

Another question the workers do not seem to have considered is what sort of investor would not seek to maximise debt financing, ie, what financial incentive would there be for the Valentia consortium to use equity over debt? At the moment, as equity values have tumbled (particularly in strong monopoly telecom companies such as Eircom) debt raiders can pick up formerly expensive assets for a song.

The sale of Eircom will be a straightforward transfer of wealth from those gushing, ordinary shareholders who stumped up cash two years ago, to those savvy investors who are now in the position to borrow. With global interest rates falling and Eircom’s monopoly under no real threat, debt — not cash — is king. Therefore, both consortia should aim to maximise leverage. Failure to do so would not be their interest. Yet again, the workers’ contentions fail to stand up to scrutiny.

Maybe the honest reason is that the workers are, like the rest of us, self-interested. Possibly for fear of bad press, they are unwilling to admit it. They understand the dynamics of debt financing and realise that if they can get their increased shareholding cheaper from O’Reilly, any growth in the company will accrue directly to them.

With 30 per cent of the new company, this will be a bonanza for ESOT. In a breech of all normal corporate finance rules, which state that all shareholders should be treated alike, the workers are the only shareholders allowed to participate in the new deal and are shafting other ordinary shareholders by siding with O’Reilly. A couple of cents saved today, falls straight into ESOT’s bottom line tomorrow. No other answer is plausible or credible.

Having cut through the spin, we should assess what this “sweetheart” deal says about Irish corporate finance. For future privatisations, the message is very clear: workers will do better than owners. This is fine as long as a company and its sector are performing well in the market, but when that company’s performance slips, shareholders pay. Workers get a free lunch; they share in the upside and are insulated from the pain on the downside.

For the government, privatisations can be regarded either as a simple tax-raising exercise or in the greater ideological context of creating a shareholder democracy. From the revenue point of view, privatisation will always be good value but as a central plank of changing the economy’s ownership structure and building a shareholding democracy, Irish corporate finance practice appears to explicitly favour the workers over shareowners. Such a bias will definitely retard any moves towards spreading share ownership throughout society.

If we are not to be a shareholding democracy like the US, into what type of society will we mutate? Will we be closer to Boston or Berlin? The Eircom saga indicates that we are neither, unfortunately. We do not have the benefit of the US-style pure attachment to shareholder value, where corporate control is complete and stock market valuations determine success or failure. Nor do we have the German model of stakeholder democracy where management, workers and shareholders work together for the long-term good of all. The institutions of state — political, economic and social — hang together in an interdependent web and there is formal power sharing where everyone is striving to be a stakeholder, not a shareholder. Ireland is very far away from this Rhineland model.

Instead, we have a sham called partnership, which doesn’t even control wage bargaining, never mind act as a focus point for social, political and economic policies to interact. We have a government so petrified of the workers that it allows small shareholders to be shafted.

Meanwhile, we have workers so terrified of the media that their straightforward shaft of small shareholders in Eircom has to be couched in adolescent spoof and spin that any Leaving Cert student could see through. And we have two tax exiles, one of them poised to make millions from a great asset built by taxpayers. Welcome to “the third way”, Irish style, welcome to a strange economic fantasy world, welcome to Bostlin.