Can Privatization in Israel Get Back on Track?

Port

Is privatization in Israel set to get back on track after a long hiatus? With Benjamin Netanyahu back as prime minister — he formed his fourth coalition government in May — the revamped privatization program that was approved by him in October 2014 is expected to gain momentum. If the program proceeds as planned, more state-owned companies will likely move to the private sector this year alone than all of what has been seen since 2010.

But that’s not saying much, since nothing of significance has been sold for many years. The only company the average Israeli might have heard of is Eilat Port, the country’s third-largest port. A rather small one, this port was sold to Papo Maritime, a local company, for NIS105 million (US$30 million) in January 2013 after protracted effort. It will not rank among the landmark events in Israeli corporate history.

The paralysis on the privatization front is all the more surprising because, for six years since April 2009, Netanyahu has been Israel’s prime minister — and he, more than any other Israeli politician, has been the most determined and devout supporter of privatization.

On the Back Burner

The country’s move from a statist-socialist economic structure to a free market began way back in 1985, and its first privatization program was launched the following year. But progress was sporadic for almost two decades. Even Netanyahu’s first spell as premier from 1996 to 1999 saw little action.

However, in 2003, with the country suffering its longest-ever recession, Netanyahu was appointed finance minister by Ariel Sharon and given the mandate to pursue sweeping economic reforms. He immediately launched a privatization blitz that got more done in two years than had been achieved in the previous 18. Between 2005 and 2009, privatization continued under other governments. Yet, back in office as prime minister following election victories in 2009 and again in 2013, Netanyahu lost the momentum on this front.

What was the reason for this? Ori Yogev, head of the Government Companies Authority (GCA), the agency responsible for overseeing Israel’s state-owned firms and privatizing those deemed saleable, identifies several factors that turned tailwinds into headwinds. “First and foremost, when Netanyahu returned to power as premier in 2009, he had to contend with the impact of the global financial crisis and the Great Recession. Although Israel was only mildly affected, at least compared to most countries, it was entirely the wrong environment to try and attract investors.”

Other problems followed. In 2011, Israel was caught in a wave of social protest. Although this was nowhere near the scale of the upheavals that neighboring countries underwent during the Arab Spring, it proved to be a defining event in Israeli socio-economic policy. While the protests focused on very specific complaints — primarily, the high price of buying and renting homes, but also humbler items such as dairy products — they quickly came to be viewed as reflecting something far deeper. The Israeli public, especially the younger generation, launched a strong backlash against what it perceived as widespread corruption in government — in particular, the nexus between politicians and businessmen. The term “tycoon” became a buzzword for leading businessmen and was on par with “oligarchs” in tenor, observers note.

The protest movement caused Netanyahu to reverse his entire fiscal policy. He abandoned the second round of graduated tax cuts that his government passed in 2012. Instead, he increased both direct and indirect taxes in order to fund the higher spending on welfare, health and education that the protesters demanded.

“Most of the potential advantages of privatization can be achieved via a partial sale.” — Ori Yogev

Yogev points out that in the charged public atmosphere of 2011-2012 there was no chance of launching major privatization efforts. Indeed, for the first time in many years, the thrust of public opinion — and with it, of economic policy — had swung from reducing government involvement in the economy to actually expanding it.

That change in the socio-political zeitgeist has not evaporated as yet. On the contrary, it is strongly evident in the ongoing public debate over two important industries based on natural resources. The first is the large offshore natural gas fields discovered in recent years. The first of these fields began production in 2013, and the second and larger one is due to come on-stream in 2018. The fierce public outcry against the American-Israeli consortium that discovered and is developing these fields has resulted in a total revamp of the structure of taxation and royalties to be applied to the hydrocarbons sector. But many Israelis are not satisfied with this. They are supporting the position taken by the Anti-Trust Authority that the consortium represents a monopoly which the public interest demands must be broken up — a view that the new government has rejected, in favor of a negotiated deal with the consortium.

Meanwhile, the much older chemicals sector, built around the chlorine, bromine and other chemicals extracted from the Dead Sea and its environs, has always been the sole preserve of Israel Chemicals Ltd. This was a state-owned conglomerate until its sale in 1996 to Israel Corporation, control of which was acquired in 1999 by the Ofer family — one of the country’s richest families.

In both cases, the populist refrain has been that “the tycoons are stealing our resources, aided and abetted by unscrupulous politicians.” Irrespective of the facts pertaining to these two very different industries and the complex legal, financial, economic and regulatory issues involved, from a political perspective the current environment is such that if privatization is to be pursued, it must be done with more sensitivity toward public opinion than in the past, observers say.

The important question now is: How is privatization to be achieved in the coming years? The simple answer, says Yogev, “is differently.”

A New Approach

The Netanyahu government formed in April 2013 was short-lived and characterized by constant tension between the veteran premier and Yair Lapid, the brash, young media-personality-turned-politician. Lapid’s brand new party, Yesh Atid, swept an extraordinary 19 seats out of 120 and he imposed himself on a weakened Netanyahu as finance minister. However, one of the few subjects the two men agreed about was privatization and the need to get it back on track. Importantly, they even agreed that Yogev was the best person to lead this effort.

Netanyahu had worked with Yogev earlier; he was head of the Treasury’s budget division when Netanyahu became finance minister in 2003, and was instrumental in formulating and executing the reform program of 2003-2005. In 2007, Yogev left public service and became an entrepreneur in areas as diverse as water and telecom software — until Netanyahu and Lapid offered him the challenge of restarting the stalled privatization process.

“We have received expressions of interest in companies that are scheduled to be privatized this year and next.” –Yovav Gavish

“I arrived at the Government Companies Authority to privatize, and also to de-politicize, the state-owned companies,” says Yogev. In his new role, Yogev introduced a new approach to Israeli privatization: partial government divestment and minority private holdings. Before this, privatization had meant complete transfer of ownership and management from the state to the private sector.

Yogev says that he has “a large measure of ownership on the idea of minority stakes in the Israeli context.” But the basic idea, he adds, is far from new. “In Europe, public-private sector partnerships are a commonplace structure, dating back to before the era of privatization as well as becoming a method of privatizing state-owned firms.”

There were strong practical reasons in favor of this approach that helped Yogev persuade Netanyahu, Lapid and the government to adopt it. The most important was that the large, state-owned corporations that remained to be sold were not good candidates for full privatization. For instance, key firms in the defense sector, including Israel Aircraft Industries and Rafael Advanced Weapons Systems, have units or divisions that need to remain with the government for security reasons.

The same is true, albeit for different reasons, for “natural monopolies” such as Israel Post, Israel Railways and the giant Israel Electric Corporation. These provide services that are either essential and demand government control or are uneconomic and require government support. Yogev proposed that for such companies, the government would continue to hold a 51% controlling stake. A minority stake would be sold, either in one shot or in stages, via the stock market or direct sales.

But what is the point of selling, other than raising some funds, if control remains in government hands? “Most of the potential advantages of privatization can be achieved via a partial sale,” says Yogev. He points out that an IPO (initial public offering on the stock exchange) or the introduction of a private-sector investor with a substantial holding will force the company to become more focused on profits, more efficient in its operations and more interested in business development and M&A activity than it would be as a wholly owned government corporation.

“At the same time,” he adds, “the process whereby the company becomes subject to direct regulation by the Securities Authority and to the discipline of the market — because its shares are registered on the stock exchange — automatically reduces political interference in its affairs and the other negative aspects of politicization (such as politically motivated appointments).” Such a company can also avoid the short-term approach that is so common among privately owned listed companies.

However, the partial-sale approach has a built-in flaw, cautions Yogev. “If a company is wholly-owned by the government, it is possible for the government to restructure it. If it is sold in entirety, the new owners can do what they want with it.” But if the government sells part of the company to private investors, he notes, “it becomes almost impossible to implement a restructuring that will satisfy the very different interests of the owners. Consequently, in companies that need to be restructured, it has to be done prior to the partial privatization, both as a condition for making the company attractive and hence saleable, and also because otherwise it will never happen.”

Not Everyone Agrees

Not everyone buys into Yogev’s model. Amir Paz-Fuchs, senior lecturer in law at the University of Sussex in the U.K., is a long-time critic of privatization. Prior to his current position at Sussex, Paz-Fuchs was engaged in research projects at Oxford University and Israel’s Van Leer Institute. One of the research projects he led at Van Leer was titled, “The Limits of Privatization and the Responsibility of the State.”

“I disagree with the assumption that private ownership brings better results than public ownership.” –Amir Paz-Fuchs

Paz-Fuchs is skeptical about the theoretical underpinnings of the case for privatization in general, as well as the specific features of Yogev’s new program. He rejects the idea that a change of ownership from public-sector to private (or even within the private sector) is the panacea for bad management. “The idea that if a company is performing poorly [or] if it is suffering from management failure, [the problem] can be resolved by changing its ownership, is wrong,” he says.

Citing the performance of various Israeli companies that have been privatized over the years, he adds: “I disagree with the assumption that private ownership brings better results than public ownership.” And while Paz-Fuchs agrees with Yogev that politicization is widespread and needs to be removed, he believes that it reflects deep-seated cultural factors that are largely impervious to the formal transfer of ownership.

What is critical, he says, is the regulatory structure that oversees the activities of state-owned firms, especially those in monopoly or quasi-monopolistic positions. “The expectation [prior to the implementation of a large-scale privatization program] was that privatization would lead to intensified regulation conducted by independent experts. But this has absolutely not been the case, as documented in the annual reports by the State Comptroller covering management failures in firms and sectors that were privatized. Yet these reports have, by and large, generated little remedial action.”

Paz-Fuchs says that the problem in the post-privatization situation is that the industry structure is often unchanged, with little or no effective competition to the privatized company. In such circumstances, “a government-owned monopoly is actually preferable to a privately owned one.”

With respect to Yogev’s plan to sell minority stakes and leave the government with a controlling stake, Paz-Fuchs expresses complete disbelief. “We have seen in various instances — such as Bezeq [a telecom firm] and Oil Refineries Ltd. — that the government initially sold only minority stakes, but eventually sold the chunk of equity that represented a loss of government control.”

Paz-Fuchs’s concerns are shared by many others. But under Netanyahu’s premiership, Yogev succeeded in winning the necessary political support to convert his plan into a detailed blueprint. This outlines the process of preparing each of the candidate companies for privatization, together with a projected schedule of sales stretching from 2015 through 2018. The revamped privatization program was approved by the government in October 2014 and it seemed that, after a six-year hiatus and despite the doubts and opposition, Israeli privatization was back on the rails.

Stalled Progress

However, domestic politics stalled any further progress. The government fell in December 2014 and after elections in March this year, Likud, led by Netanyahu, won 30 seats while Lapid’s Yesh Atid shrank to 12 seats. Kulanu, a new party founded by former Likud minister Moshe Kahlon, won 10 seats. At his express request but with Netanyahu’s support, Kahlon has become finance minister in the new government that took office in May.

Meanwhile, thanks to having got their sales program approved, Yogev and his team at the GCA have been able to keep working, despite the half-year hiatus in policy and decision making.

Yovav Gavish, chief financial officer of the GCA, explains that each company will require a separate government decision approving the GCA’s specific proposal on how to sell it. Prior to reaching the approval stage, a lot of preparatory work with regard to accounting, legal, managerial and financial needs to be done. Says Gavish: “Once the government gives the green light to proceed, we can begin a formal sale process, whether via a stock-market flotation or by launching an open tender for offers from investors. But the preparatory work generates its own ‘buzz,’ to the point that we have received expressions of interest in companies that are scheduled to be privatized this year and next, such as Israel Post.”

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