For the next three years, GEO 114/2018 has potential to have a significant negative impact on the performance of companies, including Hidroelectrica, the largest and most valuable holding in FP’s portfolio, says Johan Meyer, CEO Franklin Templeton Investments & Fund Manager Fondul Proprietatea. Successive interim mandates for CEO or Supervisory Boards have become the twisted “normal” that prioritizes political affiliation over professional competence, and the results speak for themselves. The lack of long-term business strategies, damaging contracts meant to serve the political clientele, lack of investments and of transparency in relation to stakeholders affect the companies, says Meyer, in an exclusive interview offered to energynomics.ro Magazine.
We are definitely not “satisfied.” For the next three years, GEO 114/2018 has potential to have a significant negative impact on the performance of Hidroelectrica, the largest and most valuable holding in our portfolio. We have assessed the effect of this normative act on the company this year to be relatively low, but we still do not know what this will be in the following 2 years while the ordinance is still effective. Any impact on the company in terms of the regulated energy price, income tax and dividend distributions will also impact us, as a 20% shareholder and will have a 4-fold more significant effect on the Government, as the 80% shareholder of the company.
Even if the latest amendments to GEO 114/2018 bring about welcome improvements, they are a far cry from the comprehensive steps authorities need to make in order to restore the confidence of businesses, investors and regular citizens alike. What is more, one of the amendments to the ordinance, specifically the exemption of coal-based producers from the 2% turnover tax, creates competition problems. This, coupled with the financial prejudice that is suffered by the companies incentivizes us to potentially pursue legal actions against the State by the through various legal avenues available to us. The best option would be the repeal this ordinance – that would go a long way in showing the private sector a commitment from the Government to restore stability and avoid an internally generated economic slowdown. As we have said on several other occasions, given the current legal and regulatory instability, which is never a good sign for investors, any potential transactions from our portfolio are highly unlikely at the moment.
Ever since Franklin Templeton took over the management of the Fondul Proprietatea, we have advocated for the implementation of sound corporate governance in SOEs, starting with acting as a watchdog for our portfolio companies. And, as you know, there were many cases in which not even basic corporate governance requirements were abided by. Successive interim mandates for CEO or supervisory boards have become the twisted “normal” that prioritizes political affiliation over professional competence.
The results speak for themselves. The lack of long-term business strategies, damaging contracts meant to serve the political clientele, lack of investments and of transparency in relation to stakeholders – we have seen all of them. The worst part is that these factors converge towards financial losses for companies of national strategic importance, which basically means the money of the citizens is being continuously gambled. But these furthermore snowball into the capital market’s low liquidity, as SOEs cannot be listed under the current conditions, and eventually impede Romania from reaching its full potential and achieving Emerging Market status. Nevertheless, FP is encouraged to see that the processes of selection at Hidroelectrica (Directorate and Supervisory Board) and Nuclearelectrica (CEO) have already or are currently being held in accordance with corporate governance legislation. This is exactly what long-term investments require and is an essential criterion for listings.
The capping of gas prices was decided in evident contradiction with Romanian as well as EU legislation. Consequently, as an EU member state, Romania fails to observe the free market principles and liberalize the electricity market, and as such risks being subjected to the infringement procedure by the European Commission.
Essentially, the capping will lead to poorer performances recorded by energy companies, which will lose revenue. Furthermore, this measure discourages investments in exploration, which is critical to ensure Romania’s gas independence over the long term. It may give a temporary sense of protection to household consumers now, but exposing Romania to dependence on imports from Russia and other countries at prices which cannot be controlled by the Government, is not a good measure in the long term. Energy security of the country should be an objective for any Government in power.
The fundamentals of the fund are completely different from what we perceive as a healthy practice in other countries, which choose such funds as savings instruments for future generations, by making use of excess natural reserves or high profits in the economy to diversify the country’s revenue stream. Romania’s FSDI brings under its umbrella SOEs of all kinds – some profitable, some in dire financial situations. Such an odd mix could mask the financial losses of the non-performing companies in the fund by redirecting funds from the performing ones. Obviously, this creates a risk for both categories, with potential cascading effects in the economy as the companies are of strategic importance.
To this we add the risk of management and board nominations that fail to abide by corporate governance procedures, a practice that is common in SOEs and likely to be taken up at the FSDI level, too. Politically linked appointees that have no expertise in running such funds might not invest appropriately and create significant losses for the fund shareholder, the State. It is difficult to assess the impact of FSDI on macro-economic indicators, but clearly the FSDI creates wide risks for the economy and strips the State of RON 4.3 billion in its first year, in terms of the dividends it loses by transferring the SOEs to the fund. And we have noticed that the dividends from profitable SOEs have become an important source of revenue for the state budget and will have a direct impact on the budget deficit
There are plenty of more procedural issues that are questionable, but the bottom line is that the FSDI is more of a risk, as it was designed, rather than an opportunity.
Romania has a great deal of potential to be upgraded to Emerging Market. Nevertheless, the acknowledgement cannot happen without higher liquidity through significant listings, especially of large SOEs. But listings on the one hand depend on political will, while on the other, are possible only in favorable market conditions ensuring legal and regulatory stability, which is not the case at the moment, especially in light of GEO 114/2018, which affected such a wide range of key economic actors and shook the capital market. The Romanian capital market is small – around 10% of GDP. If it increases even to 15-20%, it will have a direct effect on GDP and create a virtuous circle throughout the economy.
In 2018, FP’s NAV per share had an upward trend compared to the end of the previous year, recording at the end of the year a NAV per share of RON 1.4095, higher by 13.9% compared to the end of 2017 (RON 1.2375). The main factors which contributed to the increase include: the positive share price evolution of FP’s listed holdings, especially OMV Petrom SA, the update of unlisted portfolio companies’ valuation and the ninth buy-back programme carried out during the year.
Furthermore, during the first quarter of 2019, the NAV per share continued to increase by 0.7% compared to the end of the previous year. This was mainly due to strong recovery in the share price for the Fund’s listed holdings, especially the 19.4% increase in the share price OMV Petrom, which had a significant stock market decline at the end of last year due to OUG 114.
The continuation of our share buybacks in the market also had a positive contribution in the NAV per share performance.
Since its listing in 2011, Fondul Proprietatea managed to achieve gradual but significant reduction in the discount to NAV which has always remained a key objective for us as fund managers. We have been taking all measures in our power to achieve the objective of a discount below 15%, such as predictable cash distributions, share buy-back programs and promotion of corporate governance, which directly translates into companies optimizing their efficiency and profitability.
On the other hand, narrowing the discount to NAV heavily depends on events – or lack thereof – beyond our control, such as the lack of listings on the BVB, which keep the discount at a higher level than we would like. More listings, beginning with Hidroelectrica, would in our view help us to achieve this objective. So, while we have significant influence, it is very difficult for us to say with a level of certainty that we are going to get below 15%.
As for potential investments and buy-outs, while we continue to assess such opportunities, the current environment is not conducive to executing such transactions. Any potential buyer takes a hard look at the stability and predictability of the legislative and regulatory environment before making a firm commitment. Unfortunately, what investors see at the moment is an increased level of uncertainty in several key markets and in the economy in general.
Looking into 2019, we will continue to do everything that is within our control to keep narrowing the discount to NAV, as well as regularly evaluate the impact of changes in regulation and legislation on the financial performance of our portfolio companies, so that our investors know what to expect and we can have a more clear path ahead of us. Last but not least, we will continue to advocate for the implementation of sound corporate governance practices in SOEs and for the elimination of GEO 114/2018, which more and more companies are revealing is causing them significant financials prejudices, in some instances more than a hundred million lei.