Royal Mail privatisation: pros and cons

Background to privatisation

Margaret Thatcher first considered privatising Royal Mail during the original programme of asset sales during the 1980s - supposedly balking at the idea of selling something with 'Royal' in the name. Successive governments of all political hues have resurrected the idea before running into seemingly insurmountable difficulties - including opposition from the trades unions and the organisation's crippling pension liabilities.

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The coalition government came to power in 2010 with the Conservatives having promised a sale in its manifesto and the Liberal Democrats having committed to a partial privatisation. Legislation passed in 2011 paved the way, hypothetically, for privatisation, but it was the government's subsequent decision to transfer Royal Mail's pension scheme to the state that removed the final obstacle to the sale.

The privatisation was formally announced in July 2013, but remains politically controversial. It is bitterly opposed by the unions, while Labour is also against a sell-off, at least at this point in the organisation's evolution. The current proposals value Royal Mail at around £3 billion - Labour insists it might be possible to get a much higher price in the future.

Likely timetable

Business secretary Vince Cable says Royal Mail is now on an 'irrevocable course' towards privatisation and has promised to get the organisation across the line by April 2014. However, the precise timing is not yet finalised and depends on several factors.

Not least, there's the stockmarket environment to consider - the government will not want to sell Royal Mail into a market heading in the wrong direction. There is also more work to be done on the detail of the sell-off, though investment bankers have already been hired to do that (at an estimated cost of £30 million).

Finally, there's the trade union dimension - the Communication Workers Union is fiercely opposed to the privatisation and is threatening industrial action to derail it. That could cause delays.

Still, privately at least, ministers are hopeful of getting the privatisation done before the end of this year. Expect a progress update in September.

Likely method of privatisation

The government is committed to an initial public offering through which both retail and institutional investors will be able to apply for shares in Royal Mail. It is not yet clear what the terms - or, crucially, the price - will be.

The sale could be significantly oversubscribed. The government intends to keep a minority stake in the business while Royal Mail staff will be invited to acquire up to 10% of the company free of charge, though they'll be required to retain their shares for a minimum period - probably three years.

Should you invest?

That question is impossible to answer until a price is announced. If the privatisation mirrors many of the sell-offs of the 1980s, when sales were routinely priced at heavy discounts in order to encourage take-up, it may make sense to invest simply in order to turn a quick overnight profit.

This time around, however, most analysts think the opportunity to 'stag' the shares will be smaller. In which case, investors will need to make a more nuanced decision about Royal Mail's business and its opportunities to shine in the years ahead.

Factors in favour of investing:

• The bullish case is that after years of difficult modernisation processes - including 50,000 job losses - Royal Mail is now in the black. The business made an operating profit of £403 million over the 12 months to March 2013, up from £152 million a year earlier.
• It is true that the organisation's core business of delivering letters is dwindling at an ever-faster pace - letter deliveries fell 8% last year alone - but it can at least charge more for this service these days, with a liberal relaxation of limits on first-class stamp price hikes having contributed substantially to last year's profits. Moreover, the problems in the letters business are substantially offset by rising parcels business, as internet shopping continues to boom.
• Also, the government has done its best to offer Royal Mail a fair wind by taking the organisation's pension scheme - £8 billion deficit included - off its hands.
• Then there are the potential benefits of privatisation for those who buy the ideological arguments that private sector management will deliver the efficiencies and market-leading practices supposedly not possible under public sector ownership.
• It's not as if the management team will change following the privatisation. Chief executive Moya Greene, recruited from Canada Post three years ago, will stay on after the sale. She's highly rated, but wasn't put off taking the job by Royal Mail's state ownership.

Factors against investing:

• Against the favourable factors, however, are a number of substantial headwinds. Most importantly, Royal Mail faces fierce competition for those increasing parcels volumes. Dangerous rivals include ultra-efficient international giants such as Germany's Deutsche Post, the owner of DHL, and America's FedEx, both of which have substantial operations in the UK. At the other end of the scale, fleet-of-foot logistics businesses such as Yodel are also snapping at Royal Mail's heels.
• None of its competitors are saddled with the statutory responsibility of Royal Mail to continue providing a universal delivery service to every address in the UK six days a week. And none of them are dealing with workforces that are as heavily unionised as at Royal Mail.
• Indeed, Royal Mail is struggling with high fixed labour costs having agreed a restrictive deal with the unions on future staffing (not that this appeased the CWU, which is nonetheless threatening industrial action over the privatisation process).
• Nor is it clear that private ownership always delivers on the potential that supporters of privatisation cite so enthusiastically. While several former state-owned businesses have flourished in the private sector - from BP (BP.) to the power and water companies (leaving aside arguments about customer detriment) - others have not been so successful. Railtrack, for example, went bust.

In a nutshell:

In the end, it's almost certainly fair to say Royal Mail is not going to be a stock to set investors' pulses racing. Still, it may have a broad appeal that is similar to the attractions of the utility sector - a steady income stream partly guaranteed by the state (Royal Mail's distribution deal with the Post Office does not expire until 2022) should finance reasonable dividends and underpin the share price.