A New Approach to Privatization: The IPO-PLUS

By Itzhak Goldberg, Gregory Jedrzejczak, and Michael Fuchs

Each approach to privatization implies trade-offs among various goals:
• Case-by-case privatization (such as sales for cash or initial public offerings) is characterized by efficiency; it generates revenue, establishes shareholder control over managers, and provides access to capital and skills. But this approach does not promote widespread public participation in the privatization process and is relatively slow.
• Voucher-based mass privatization programs, on the other hand, are designed to promote equity in the distribution of wealth and widespread public participation in privatization. But mass privatization programs don't ensure efficiency; they fail to bring in new capital or skills, create control of shareholders over managers, or generate revenues. (See the World Bank's 1996 World Development Report, chapter 3.)
• Initial Public Offerings Plus, IPO-PLUS, is a new form of privatization that attempts to promote both efficiency, through creating incentives to restructure enterprises, and equity, through widespread participation. IPO-PLUS thus embraces positive features of both case-by-case privatization and mass privatization.

The IPO-PLUS scheme is now being implemented in Uzbekistan (see box) and is being discussed in Turkmenistan.

What Is IPO-PLUS?

This initiative is based on establishing privatization investment funds (PIFs) that are privately owned but licensed and regulated by the government. These funds will be able to purchase at auction shares of firms slated for privatization, for a relatively low price. They will finance the purchases by issuing and selling their own shares (public participation shares). When buying enterprise shares, the funds will also be able to defer payments—a special facility will permit them a long grace period, long maturity, and low interest rate, and possibly a debt write-off.

To ensure broad public participation, the fund shares are sold for a uniform low price and the number of shares to each individual is limited. The risks of fraud and misrepresentation, which have been a feature of investment funds in some emerging markets, are mitigated in the IPO-PLUS by the fact that PIFs do not appear spontaneously as in the Czech or Russian programs, but are a built-in feature of the scheme. Thus, the program cannot start until a coherent legal and regulatory framework for investment funds and for registering and trading enterprise shares is in place.

To promote efficiency in IPO-PLUS and provide incentives for PIFs to restructure enterprises, PIFs are encouraged to buy large stakes in enterprises up front. Ideally, 51 percent of enterprise shares are to be offered to PIFs in special auctions at preferential terms (see below). Thus, PIFs have incentives to be involved in corporate governance of privatized companies. They also have the resources to do so because, in contrast to other mass privatization programs, PIFs collect cash from the population, which can be partly used to pay for management services. Thus, they avoid one of the more serious weaknesses of voucher privatization funds: shortage of liquid resources.

Enterprise shares are offered to PIFs at preferential terms, initially at a fixed low price. If oversubscribed, to prevent bidding up of prices, shares are allocated on a pro rata basis among the funds. If undersubscribed, share prices are allowed to drop below the initial offering price; the remaining shares are sold to the highest bidder. In contrast to the Polish program in which all enterprises are allocated to funds, in IPO-PLUS, PIFs are not obliged to purchase enterprise shares at any price.

Investment and portfolio planning by PIFs require that the list of enterprises slated for privatization be announced at an early stage, before launching the program. After publication of the list, the sale of funds' shares to the public continues simultaneously (say, weekly) with auctions of enterprise shares to the funds. The selection of good companies is important to stimulate further demand for PIFs' shares. Still, the quality of enterprises plays a smaller role than in case-by-case privatization due to the deferred payment scheme and the low initial prices of both enterprises' and PIFs' shares.

In IPO-PLUS, PIFs are exclusive vehicles of intermediation between investors-citizens and the privatized companies. This exclusivity makes IPO-PLUS different from most other mass programs in which funds, although usually considered conducive to corporate governance, are not considered absolutely essential. Two notable exceptions are the Polish and Kazak programs in which funds are exclusive intermediaries. In the Polish case, funds are established by the government. Although eventually privatized through vouchers, government initiation makes for a major difference from IPO-PLUS, in which PIFs are initiated and established by private individuals. This is so because in IPO-PLUS the establishment of PIFs is the first check of the program's viability. Without a sufficient number of private businesses willing to invest their cash in founding PIFs, the program cannot get off the ground. To launch the program, the government must convince a sufficient number of potential fund managers that managing PIFs can be an attractive line of business. The government can do so only by setting attractive credit terms and low prices for company shares and by selecting attractive companies for privatization through IPO-PLUS.

IPO-PLUS is a more commercial program than the other mass programs because PIF managers have to demonstrate marketing skills and build marketing channels that will encourage &127;citizens to invest money—both in the program, in general, and in their PIF in particular. Such marketing savvy is a litmus test of the fund managers' financial capability and business acumen, which will later be critical for restructuring the companies they purchase.

IPO-PLUS allows policymakers to privatize a relatively small number of enterprises at a time and still ensure broad public participation. IPO-PLUS is particularly appropriate where the objective is to encourage the involvement of outside owners, the emergence of stock market intermediaries, and concentration of company shares in investment funds.

Together, these components provide the foundation for enterprise restructuring and economic growth. This method of privatization should be of particular interest to policymakers in China, Viet Nam, and African countries. It offers alternatives to voucher privatization, which may be technically inappropriate or politically unacceptable in these countries. IPO-PLUS allows widespread public participation in privatization, but is more commercially oriented than the mass privatization programs carried out in the FSU and Eastern Europe.

Itzhak Goldberg is Senior Economist, Gregory Jedrzejczak is Senior Private Sector Development Specialist, and Michael Fuchs is Financial Economist at the World Bank.

Uzbekistan Prefers IPO-PLUS

Uzbekistan's President Karimov has made clear his government's intention with regard to privatization: "...to abandon a faceless voucherized proprietor and turn over property to a real owner, capable of using the property and ensuring its efficient utilization." In view of the government's opposition to a voucher-based approach, a joint government-bank team has had to cope with the challenge by developing an innovative approach with the following features:
• The price of a public participation share is 100 sums (around one U.S. dollar, or 10 percent of the minimum wage) and each citizen can buy only up to 100 shares in each investment fund.
• Investment funds pay only one-sixth the purchase price of enterprise shares. The balance is a deferred payment, repayable after a four-year grace period, at seven years' maturity, with low interest. About 300 companies in some of the more attractive sectors, such as food, grain and cotton processing, and edible oils, were preselected and approved in September 1996. (The World Bank's enterprise reform loan, negotiated in September 1996, provided the crucial impetus for ensuring that good enterprises were included on the list of selected enterprises.)
• A presidential decree, adopted in June 1996, established the legal framework for investment funds; thus, supervision and monitoring of the funds' activities—among others, to prevent pyramid-like schemes—could start right away.
• Prior to launching the program, infrastructure for share registration and trade was completed, including computerized screen-based trading and a nationwide system for distributing participation shares, through the local networks of two major banks. An important advantage of the Uzbek program was the use of a centralized stock exchange and a centralized share registry (depository) to conduct the auctions of enterprise shares and facilitate the sale of PIFs' shares to the public.

Progress to date:
• More than fifty PIFs have been licensed, indicating that a large number of local private businesspersons were ready to invest their money in fund management.
• Some twenty-eight PIFs have sold enough shares to the public to purchase enterprise shares in auctions. More than 50,000 citizens have purchased public participation shares, and sales have been steadily accelerating since the beginning of 1997.
• Shares in seventy-five enterprises have been sold in eight auctions since the first pilot auction on December 6, 1996.
• Television and radio advertising has been used to educate the public about investing in securities in general, and in privatization funds in particular. A more intensive campaign, extended to all regions of Uzbekistan, is about to start.

The Uzbek government believes that since IPO-PLUS is more commercially oriented and more gradual than the voucher-based mass privatization programs of other CIS countries, it will provide a more solid and conducive basis for enterprise restructuring and capital market development than voucher programs.