Friday, April 19, 2013

On giveaways

CBC reports some of the numbers surrounding the Wall government's planned giveaway of the majority of Saskatchewan's Information Service Corporation. But let's take a closer look at exactly what Wall intends to do - and what the province is losing in the process.

Let's make the generous assumption that a share sale will result in the higher valuation mooted by Don McMorris. Conveniently, that would mean that a 60% share of ISC would cost $120 million - establishing a nice, round $200 million valuation for ISC as a whole.

At the moment, the roughly $20 million in annual profits would mean that Saskatchewan's citizens are getting a 10% return on our ownership of ISC. Which, needless to say, represents an absolutely stellar return on capital compared to any evaluation of borrowing costs or normal rates of profit - something to be preserved, not to be discarded at the first opportunity.

Now, McMorris is trying to claim that corporate taxes (yes, the very same ones slashed by the Sask Party) will make up the difference. So let's do the math on that claim - assuming no tax avoidance at all by the new purchaser, and even giving the Sask Party the benefit of current corporate tax rates which they plan to lower.

If the province sells 60% of the shares in ISC, then its returns will be $8 million in direct profits (40% of the current $20 million), plus $1.44 million in corporate taxes (12% corporate tax rate * $12 million in corporate profits), for a total of $9.44 million per year.

So the baseline scenario after a sale will involve losing $10.56 million every year in exchange for a one-time injection of $120 million. Or in other words, a deliberate choice to borrow the $120 million at an effective interest rate of 8.8% - rather than through, say, the sale of Saskatchewan Savings Bonds at rates as low as 1%.

But what about the promise that ISC might grow outside the province and boost the corporate tax returns? Well, it's only the Saskatchewan Party's own ill-advised direction that's preventing a publicly-owned ISC from exploring that strategy in the first place - meaning that a simple and reasonable change in policy would allow for exactly the same process with all returns being enjoyed by the public.

In any event, though, ISC would have to increase in profitability by a factor of 8 to make up the gap between direct public profits, and trying to recoup the same money through corporate taxes after a share sale. And that certainly doesn't seem like a realistic prospect anytime in the near future - particularly if it's looking at having to spend money developing services outside Saskatchewan.

And all of the above assumes the best-case scenario - that ISC remains in the hands of shareholders who seek to build on its operations rather than extracting its current value. But there's another possibility as well: a takeover by vulture capitalists who dilute the value of the province's shares by borrowing against the anticipated value of the company.

Under that scenario, the $120 million in share sales could be matched by an equal $120 million in debt taken on by ISC, reducing the effective value of the corporation to $80 million and the province's holding to $32 million. And if the takeover managed to put the corporation into a tough financial position, then the province would be on the hook to figure out a way to keep ISC's systems functional - as its work involves important public services which can't simply be abandoned in the event of corporate failure.

Meanwhile, the $120 million in value currently held by the province would be skimmed off the top for the benefit of the few operators who manage to wriggle their way into the middle of the deal (then escape before any of the fallout becomes apparent).

Sadly, that result would be far too consistent with Brad Wall's idea as to how an economy should operate. But there's no realistic scenario where an outside takeover could possibly create better returns than the stable, 10% return on capital we currently enjoy as a province. And we should be nothing but skeptical of the Sask Party's glibertarian claims that we'll all be better off if we find ways to siphon that return into the hands of the corporate sector.

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