Would You Buy Shares In Royal Mail?

Published in Investing on 27 September 2010

It may not float, but the Royal Mail looks set for the private sector in some shape or form.

After a review of the Royal Mail by Richard Hooper, the former Ofcom deputy chairman, it looks like the government is committed to transferring the Royal Mail to private ownership in one form or another.

It might be sold to a private company, or it might be offloaded in a public offering to a mix of institutional and private investors, or something else -- the plans really are at a very early stage now, though part of it will involve a significant chunk of the shares going to Royal Mail staff.

Naturally, the unions are aghast at the idea, with Billy Hayes, general secretary of the Communication Workers Union, predicting higher postal prices and job losses -- and he may well be right about that. But he also said he fears "the government may also be plotting to seize the pension assets." What, Billy, you mean they might steal the £8bn deficit?

What about the pension fund?

Would-be Sids could be forgiven for seeing that pension fund deficit, which is likely to rise, as the poison in a not very shiny chalice. If included as part of the privatisation deal, it would surely send most investors running for the hills. After all, long-suffering investors in BT (LSE: BT-A) have had their massive deficit acting as a drag on the company for years, and it is not without good reason that people so often refer to BT as a pension fund manager running a telecoms business on the side.

But it looks like that is not going to happen with the Post Office -- the government is at least smart enough to realise that we're not all going to pile in to buy a share of a pension fund manager that happens to deliver letters, and has said it will take over the pension fund liabilities itself.

The network of Post Offices, which is a separate entity, is to be retained in state ownership, though whether that assuages any fears about further closures remains to be seen -- they've been closing them aplenty so far.

Investment prospect?

Anyway, what might the Royal Mail look like as an investment prospect? Well, up front, general business trends aren't exactly rosy.

Email has pretty much been the coffin of hand-written letters. As more of us quill-wielding oldies pop off to be replaced by kids who wouldn't recognise a pen if you poked them in the eye with one, the nails are slowly being hammered down.

In 2005, the Royal Mail was shifting 84 million postal items a day, including letters and parcels, and just 5 years later that is down to 71m. Over the next five years, the Royal Mail itself is predicting a further 20% fall, with some pundits suggesting the drop might be up to twice that.

The Royal Mail's own financial statements don't make for happy reading either. The 2009-2010 year saw overall group revenue a shade short £6.5bn, down from just over £6.6bn the year before, leading to an overall operating loss of £98m, which at least is down from an operating loss of £175m the year before. 

What is perhaps more worrying is that operating costs account for 98.7% of revenues, even before any exceptional items, so we're looking at an operating margin of just 1.3%. The overall pre-tax loss for the year came in at £262m.

Regulation

Part of the problem is that the Royal Mail is operating in a highly regulated environment, with nearly 90% if its business being subject to price controls, and it is obliged by its Universal Service Obligation to carry letters to every address in the UK for a flat low price. The competition, of course, has no such obligation, and can offer only those services it wants at profitable prices.

On top of this, the EU wants mail services to be opened to full competition by 2012, and the Royal Mail is clearly in no position to face that -- even if it is privatised successfully and gets some new red-hot managers at the helm, it has no real hope of being turned into a slick profit machine in just two years.

Valuation?

Can we put any kind of valuation on a floated Royal Mail? Well, it's pretty hard to value a loss-making company that currently has no strategy in place for turning to profit.

A profitable low-margin company might manage a Price to Sales ratio (PSR) of , say, 0.5 to 1 -- a supermarket like Tesco (LSE: TSCO), which has pretty thin operating margins of around 5%, has a PSR of about 0.6.

So if the Royal Mail was priced on a PSR of, say, 0.5, it might be worth around £3.2bn. But given its almost non-existent operating margin, I think it might be generous to reduce that by only half to £1.6bn. And once we add other factors, like the lack of any sign of profit on the horizon, the strictly regulated environment that the Royal Mail has been operating in, and its lack of experience of free market price-setting and competition, I think we would have to knock another big chunk off that valuation.

So, in all, I think a fair valuation of the Royal Mail has to be less than £1bn, though how much less I wouldn't even try to guess -- it is entirely possible that it's worth nothing.

Would I buy shares? It wouldn't be investing, it would be charity -- Sid can have it.

More from Alan Oscroft:

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Comments

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BarrenFluffit 27 Sep 2010 , 1:07pm

Its a curious business. Lots of substantial city centre property assets for functions that could be done in cheaper locations. Also very labour intensive but not particularly well paid once hours are taken into account. But conversely that network places them in a good position for the delivery of retail goods and advertising.

LastChip 27 Sep 2010 , 5:42pm

I agree with this article 100%; 'nough said!

shinygoldcar 28 Sep 2010 , 11:27am

I'd find it hard to believe that a company (with its limited liability) is worth nothing, unless it is already bust.

If the company ever paid out a dividend or two before it went bust, then surely it is worth those dividends (adjusted for inflation/opportunity cost) at least?

Or risking being called a vulture, what is its book value? What would it fetch if it was liquidated? Surely "property, plant and equipment" would be quite significant! And all those vehicles...

TMFBoing 28 Sep 2010 , 3:38pm

I'd find it hard to believe that a company (with its limited liability) is worth nothing, unless it is already bust

Well, as a business, it's technically insolvent - what would you pay to buy a loss-making business if you couldn't see how it could turn to profit?

Or risking being called a vulture, what is its book value?

That is the other way of looking at it, of course - as an asset-stripping exercise. But any such valuation would not be realisable, at least not in the short to medium term, as the government would not sell it on such terms.

Best,
Alan

Dozey1 28 Sep 2010 , 6:15pm

You occasionally read of dead-beat companies being sold for £1 just to get rid of them, In the case of the Post Office my feelings are that would be a tad expensive.

Doze

shinygoldcar 28 Sep 2010 , 6:45pm

Ok Alan, good points.

AlysonThomson 29 Sep 2010 , 12:36pm

I don't think so. Union activity is too strong among the workers.

snikmij 30 Sep 2010 , 8:56pm

If the workforce were allowed a portion of shares that may help.

It can be interesting, no matter how unionised, if the post office employees are invested in the company then they, hopefully, would not 'rock the boat' but work with the management.

Remember the coal industry when bonuses were introduced to the work force, Arthur Scargill ranted on about more deaths in the industry, the workers ignored his drivel and went for the money.

In other words make it a good enough carrot to make them want it to work.

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