Date: April 30 2012
Since the global financial crisis, we have been bombarded by stories of government waste. The home insulation program and the school building program provided a wealth of stories on government mismanagement, most judged worthy of front- page coverage, some involving alleged waste of a million or two dollars. ''Botched broadcast tender costs taxpayers $2.6 million'' (The Age, April 4) is another in this ongoing saga. The implicit inference is that governments are poor managers of money. The subliminal inference is that private enterprise manages money better. But do corporates manage money better?
Just before the global financial crisis Rio Tinto, faced with a takeover threat from BHP-Billiton, bought Alcan for close to $40 billion as a poison pill. The purchase achieved its objective. BHP backed away. But Rio has since written off close to $20 billion of the purchase price, not one or two million dollars, but $20,000 million.
In effect, Rio gifted $20 billion of the highly-prized after-tax income it got from exporting Australian iron ore to those comparatively few North Americans who owned Alcan shares at the time of the takeover. And that may not be the end of the write-down on Rio's Alcan misadventure, which eerily replicated a similar misadventure by BHP in the 1990s.
BHP, stymied in its effort to take over Rio, stymied in its effort to merge its Pilbara iron-ore operations with Rio's, stymied in its attempt to takeover Canada's PotashCorp, finally found success in American shale gas. It hastily spent some $20 billion on Chesapeake Energy and Petrohawk Energy. Less than a year after these purchases, technological advances in extracting gas from shale have served to vastly increase the US's stock of shale gas and, for energy security and other reasons, there is doubt that the American government will not allow shale gas to be exported.
Both of these factors have served to lower the price of shale gas in America by more than 50 per cent since BHP bought and the shale price is not expected to recover much for a decade or more. BHP is facing a write-down of about $9 billion on those two very recent shale gas purchases.
Sims Metal Management recently wrote off close to $500 million of an American purchase it made a few years ago. Leighton has already written off over a billion dollars on the Brisbane airport tunnel and the Victorian desalination plant.
These corporates are the bluest of blue-chip companies in Australia. Most of us would say that these are problems for shareholders in these companies. They are, but as poignantly hinted in the recently released film, Margin Call, there are implications for the community as a whole (though these would not have ranked a moment's concern for the firm's chairman, his dispassion well captured by Jeremy Irons). Rio and BHP will be able to write off their combined gift to North Americans of about $30 billion for Australian tax purposes.
Taking account of the mining tax, this will amount to a loss of about $20 billion in federal tax revenue over a few years. The other corporates will do the same. The Treasurer's task of balancing the budget is difficult enough. This tax leakage makes the Treasurer's task that much more difficult. What is very disturbing is that most Australians will be adversely affected by measures that must now be taken to reel in government spending more than otherwise would have been necessary.
In addition, productivity growth in Australia will be affected adversely. Rio's strength is iron ore. But it has been forced to direct the attention of managerial and other resources from its area of strength to Alcan and in the end, very little of the Alcan purchase will likely give a return comparable to that which Rio can get from its iron ore riches. Productivity must suffer. BHP is similarly placed. It needs to justify the shale gas purchases. Since the return on shale gas will be low into the foreseeable period, BHP is considering extracting pockets of oil in their shale to improve an otherwise meagre return. Money spent doing this would likely be far more productively spent in Australia at BHP's iron ore operations, rather than in the US. But the need to justify management's shale purchase will dictate otherwise.
Both BHP and Rio have a raft of top drawer assets. Shareholders have long accepted low dividends so that management could exploit these assets to the hilt. Poor management decisions have led shareholders to question that stance. Should shareholders force up the dividend payout ratio, the flow of easily obtained, comparatively cheap funds these firms had at their disposal will diminish relative to what it would otherwise have been.
This too will have an impact on investment and productivity. These are halcyon days for Rio and BHP. It could not be much better. Yet their share market performance in recent years has languished not just because of lower commodity prices but also because of poor managerial decisions and concern that, with so much cash flowing into their treasuries each year, more poor decisions may occur.
The majority of Australians who have superannuation necessarily have an interest in the performance of Rio, BHP and the other bluest of blue- chip Australian companies. Their superannuation balances would likely be higher today if these corporates had managed money better.
The performance of our corporates is far more significant to the community than we realise.
How they perform, how wisely they spend money, has a significant impact on tax revenue, on the ability of government to finance spending on health, education, welfare and aged pensions, on national productivity growth and on superannuation balances.
Clive Edwards has an academic background in economics and management. He has a direct or indirect financial interest in the aforementioned companies.
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