Privatization Plan Gets Cold Shoulder From Israel's Capital Market

Institutional investors say state-owned companies are poorly managed, worry over minority shareholders’ rights

Tal Cohen

Two weeks ago, some of Israel’s leading institutional investors met in Jerusalem. The meeting was called as the government readied a plan to sell about 19 state-owned enterprises over the next three years, many of them through initial public offerings of stakes ranging between 25% and 49%.

The plan, approved on Sunday by the social-economic cabinet, would take public such leading government companies as Israel Electric Corporation, Israel Aerospace Industries, Israel Post and the arms maker Rafael. It would mark the first time that Israel experiments with public-private corporate partnerships, where private investors are joint shareholders with the state.

Top treasury officials asked investment managers from Clal Insurance, Psagot Investment House, Menorah Insurance and the pension fund Amitim, among others, if they would be interested in holding shares in the companies when they are listed on the Tel Aviv Stock Exchange. If so, which companies interested them the most and under what circumstances would they agree to hold the shares?

The answers they got back were far from encouraging. Some asked why the government was interested in having them invest in the companies at all. Other wondered why they should be at all interested in such poorly managed, low-margin businesses that have no vested interest in changing.

The institutional investors explained that without the ability to influence the company – after all, they would at most hold a minority position – none of the companies on offer looked at all attractive from their perspective.

“There’s an essential difference between completely privatizing a government company, where the government surrenders control, and a situation in which it retains control of the company,” Amir Gil, deputy CEO for investment at Psagot Provident & Pension Funds, told TheMarker. “The companies that the government is proposing to sell aren’t sexy or exciting. Many of the candidate companies for privatization aren’t in good condition and are losing money.”

The fact that the government will continue to control them only ensures that there will be little opportunity for private investors to impose change. “As an investment, they don’t look that interesting to us,” said Gil.

That attitude strikes at the logic behind the endeavor, which is to use the market to improve transparency and operating performance at state-owned enterprises. “The plan we approved will be a real revolution, making government companies more efficient, successful and independent,” explained Finance Minister Yair Lapid after Sunday’s vote. “It will mark another step in ending the politicization of these companies and corruption.”

In fact, some companies will be wholly privatized under the plan – those where the government has decided it has no strategic interest. These include the Haifa and Ashdod ports and Israel Military Industries, as well as a host of smaller businesses.

But the biggest companies have been deemed too important to privatize fully. The plan – urged by Ori Yogev, head of the Government Companies Authority – aims to retain government control while imposing business discipline by exposing them to the capital market.

The state will issue up to 30% of the companies’ equity capital or bonds convertible to shares. All told, the government aims to raise 15 billion shekels ($4.1 billion) from selling all or part of the companies.

Ronen Vinograd, an attorney specializing in corporate and investment law, said the plan as now formulated was designed to ensure that the government’s vital interests in the partially privatized companies were protected. But that will hurt minority shareholders from the private sector, he said.

Under the terms of the plan, the state will be able to make decisions as controlling shareholder without having to ensure a majority of shareholders support it, as the law normally would demand, explained Vinograd.

The government will be entitled to appoint all the directors and give it control over terms for executive compensation. “There’s a very problematic message arising from all these terms, which hurt the principle of corporate governance,” he said.

He offered a scenario where IEC, the utility, is compelled to sell electricity at a loss because the government deems it a national interest. Minority shareholders would have no ability to block such a move.

Vinograd also warned about the power of the workers’ committees at state-owned companies like IEC and IAI. “The Histadrut [labor federation] won’t ever agree to unilateral measures that may harm workers at government companies,” he said.

Even with those encumbrances, Gil said many of the companies operate in sectors that would interest investors, but only on condition that the companies reform themselves.

“We’re talking about companies in stable businesses,” Gil said, pointing to IEC, Israel Railways and the ports. “If as part of the privatization process they were able to undertake a business overhaul and showed better financial performance, these companies could be of interest to investors.”