Melding all their assets
The news that the management of copper-mining giant KGHM Polska Miedź promised workers a zł. 80 million ($20 million) performance bonus made a bad impression on investors and analysts last month. For investors, the company's growing debts meant that payments to creditors would take priority over a dividend payout for 2001. Analysts said KGHM's management decisions would fuel union demands for wage increases at a time when KGHM should be cutting costs and increasing productivity to cope with increasingly volatile prices on the world copper market. "Consecutive boards of KGHM have met with defeat after defeat ... by agreeing to the exaggerated pay demands of labor unions, reflecting negatively on the company's costs," said Paweł Puchalski, an analyst at Austrian Bank Raiffeisen. " ... the management is clearly keen to please employees and trade unions, not shareholders. Government-managed companies do not usually aim at steady shareholders' value growth." Although KGHM, like many of Poland's big state-owned companies, badly needs to cut costs and restructure to meet the demands of the global market, the Democratic Left Alliance (SLD)-led coalition has cast doubt on their ability to compete long term. In its first six months of power, the government has spoken in favor of sector-wide consolidation and stalled or slowed privatizations. Since 1999, staff costs at KGHM, the world's seventh-largest copper producer and second-largest silver producer, have risen by zł. 165 million ($41.25 million), growing from 29% to 33% of total costs.
"The payout of the bonus will depend on our situation, which is difficult to predict," said Wojciech Marciniak, director of investor relations at KGHM. He said the company has yet to set the level of the bonus, which would only cost zł. 80 million ($20 million) if each miner's bonus was equivalent to the average monthly wage. "Perhaps we will be able to pay it, but whether this will be the equivalent of a monthly wage or a symbolic bonus remains an open issue." Analysts blame the company's debts on management generosity toward KGHM's fixed-line telecommunications subsidiary Telefonia Dialog (TD). "This business will never yield any returns because fixed-line telephony, the segment it operates in, is declining," Puchalski said. "But it has taken enormous investment to get it running. KGHM capitalized it but also underwrote its loans because it has access to cheaper credit than TD." Last year KGHM underwrote TD debt worth zł. 1.1 billion ($275 million). KGHM's consolidated balance sheet shows that debt grew from zł. 574 million ($143.5 million) in 1999 to zł. 1.7 billion ($425 million) in 2000. Analysts expect KGHM's debt problems to worsen in the next two years: While the company's debt represented 12% of its equity in 2000, Puchalski predicts it will leap to 36% in 2001 and 48% by 2003. Analysts blame the growing costs and inefficiency on the meddling of the KGHM's largest shareholder, the Treasury Ministry with 44.28%. "The problem isn't the number of miners but the unnecessarily expansive administration, which is just pure bureaucratic parasitism," said a Warsaw analyst who asked to remain anonymous. He added that the company's annual revenue of more than zł. 5 billion ($1.25 billion) has enabled management placed by consecutive governments to swell the administrative staff with their party fellows - appointments based on political affiliation rather than effectiveness. "This shows that state-owned companies the size of KGHM are always in danger of being used as political trophies and will be used by local political groups to realize their own goals," the source said. "The stronger the treasury is in a company the more problems there are."
Iron grip of the treasury But while analysts trace KGHM's problems to excessive government influence, Treasury Minister Wiesław Kaczmarek has moved to tighten its grip on the state sector. Although the government has declared an aim to complete the privatization process - pledging to reduce state ownership of the economy to levels similar to European Union countries, which the treasury estimates at 10-15% - Kaczmarek has signaled a prudent approach to the privatization of state assets, with the government taking charge of the consolidation and restructuring of entire industries rather than individual firms. Accordingly, the government set a privatization revenue target of just zł. 6.8 billion ($1.7 billion) in its 2002 budget, a conservative figure compared to the zł. 26.6 billion ($6.65 billion) achieved by the Solidarity Election Action (AWS)-led coalition in 2000. The first sign that the government was reasserting control over its assets came in October, when the SLD halted the sell-off of the nation's largest bank, Powszechna Kasa Oszczędności Bank Polski (PKO BP). The treasury canceled the tender for an adviser in the privatization, which was to see 30% of PKO BP stock floated in an initial public offering this year, claiming that the bank could not be privatized without a global strategy for the banking sector, though not ruling out the sale of a minority stake at a later date. Since then the SLD government launched a purge of top executives installed by the AWS coalition in state-controlled companies, most notably Polski Koncern Naftowy Orlen (PKN Orlen) President Andrzej Modrzejewski, who was placed under temporary arrest in February by armed officers of the State Security Office (UOP). After appointing its own management at the nation's top oil refiner, the government was quickly condemned by political observers.
"I'm not saying that this didn't happen under the previous government, because it did," said Wiesław Walendziak, an MP with the Civic Platform (PO) party and head of the Sejm Treasury Committee. "But this process has only gained strength under this government. Today nobody even tries to pretend it to be otherwise." The plans to slow privatization and consolidate state companies have worried observers, who fear that by barring the injection of capital and expertise from strategic investors, the government's plans will serve to sustain the ineffective management and unprofitability of state-owned companies. "The overall perception of state enterprises is that they are almost universally managed worse than privately owned companies," said Mateusz Szczurek, senior economist at ING Bank Śląski. A March inspection report by the Supreme Chamber of Control (NIK) highlighted the problem of cost effectiveness in the 100% state-owned Polish Post Office (PP). After inspecting 60 contracts and 100 orders made by the company, NIK blocked payments worth zł. 97,000 and questioned expenditures totaling zł. 1.5 million ($375,000). "The strategy to first consolidate and then privatize, from the point of view of long-term efficiency and growth is clearly not that good, to say the least," Szczurek said. The government also refused to relinquish control of Poland's largest insurer, Powszechny Zakład Ubezpieczeń (PZU), ending negotiations with a consortium headed by Netherlands-based insurer Eureko for the sale of a 21% stake in the domestic insurance giant, with assets valued at zł. 26 billion ($6.3 billion). The Treasury Ministry is currently preparing the stake for a public offer, of which a part is intended for Eureko, although the public offer will not be made until next year. Since his election last October, Kaczmarek delayed permits needed by Eureko to own property in Poland and fired and replaced top management at PZU. His actions, which led Eureko to apply for a hearing at the International Court of Arbitration in Sweden, earned his government criticism from international and domestic circles. "The government has virtually begun a crusade against foreign capital ... presented as an oppressor of the Polish economy, whereas Poland's shortage of capital is visible with the naked eye," Walendziak said. "It is also evident that thanks to privatization and FDI the competitiveness of the Polish economy ... companies with Western capital and technology are increasing their exports."
Diverse portfolio The Treasury owns shares in 1,789 companies and has a majority stake in 106 and a minority stake in 1,184, according to figures from December 2001. It also has a stake in 89 companies quoted on the Warsaw Stock Exchange (WSE) while the remaining 499 are wholly government-owned corporations. The value of government corporate assets was estimated at zł. 106 billion ($26.5 billion) in June 2001 by the Treasury Ministry. Observers have also been critical of the halting of the sale of 17.6% of refinery group PKN Orlen last month. Bidding refinery groups OMV of Austria and MOL of Hungary were not asked to extend their offers while the government overhauls its plans for the petrochemical industry, which should be completed in July. The Treasury has said that if the talks ended in failure, it would consider consolidating PKN Orlen with its smaller counterpart Rafineria Gdańska, a move strongly supported by Zbigniew Wróbel, the president of PKN Orlen who was controversially installed by the SLD in March. But the plan to create a monopoly for PKN Orlen would further reduce the efficiency of the company, which would reduce the need for restructuring by removing competitive pressure. "If they merge PKN Orlen with Rafineria Gdańska they will construct a big company with almost no competitor on the domestic market," said Jacek Wiśniewski, head of research at Bank Pekao. "I don't believe that will make the firm more competitive. It will just be bigger." Analysts have also criticized the government for delaying the restructuring of PKN Orlen by stalling its privatization. "This was a political decision more than a financial and investment decision, driven by the current government," said a London analyst who asked to remain anonymous. "It also slows down the privatization process. PKN Orlen is not moving anywhere in the meantime and is not going to make any progress."
Consolidating an empire A more recent government proposal is the consolidation of the pharmaceuticals sector, focused around a merger of three state-owned manufacturers: Polfa Warszawa, Polfa Pabianice and Polfa Tarchomin, announced last month. The merger, which analysts predict would create a company with turnover of more than zł. 700 million ($175 million) and some 10% market share, has met with the approval of economic and political circles. "It seems obvious that the consolidation of the Polfas will make it easier to increase their value as it will represent the sale of a part of the market." PO's Walendziak said. Analysts said the consolidation will create a company that will be large enough to withstand foreign competition. "Leaving these companies in their current state would be problematic," said Tomasz Sujka, analyst at DM BGŻ brokerage. "These companies are very small, while the biggest has a highly specialized product range, so they are on the margins of the market. The idea itself is good, but it has come very late. This should have been done five years ago ... today it is difficult to say whether such a consolidation will be a success." It is also doubtful whether the merger will make the resulting company more attractive to foreign strategic investors, said Bogusław Tażbirek, analyst at PBK Asset Management. "This is a move that is motivated by politics rather than the market because it sounds better politically that Polish pharmaceutical firms are being consolidated so they can produce Polish drugs," he said.
The wider impact of the consolidation of state-owned industries has divided economists, who see medium-term benefits from the government's approach only if it is followed by successful privatization. "The privatization model I prefer is privatization to strategic investors who will bring in management skills and capital and not just selling them off to a whole bunch of small investors where the corporate governance will often not be addressed," said Erik Nielsen, economist at Goldman Sachs bank in London. "Because of this preference I would quite like to see consolidation because it increases the probability of a big external taker." But economists also point to the negative short-term effect of the slowdown in privatization while the government prepares sector-wide strategies. "Right now it looks like the government would like to preserve its influence on these companies forever and it's happy about the fact that it can provide members of the ruling party with nice cozy jobs," Szczurek said.
