Boxed into a corner

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THERE aren't many things that will attract a crowd in Perth on a wet Wednesday morning. But when members of the CWU postal union arrived last week with a 7ft postcard waving a petition against the privatisation of the Royal Mail, not even the rain could dampen the heated tempers.

Hundreds of people braced the high winds and rain to lend their support to the campaign, which is seeking to derail business secretary Lord Mandelson's plans to offload a stake of as much as 49 per cent to a private sector competitor.

As one of the few remaining state-owned enterprises, the Royal Mail still incites sparks of indignation in even the most placid onlookers when it comes to debates about its future.

Now those sparks are threatening to become a political inferno engulfing Gordon Brown's Government, which has already suffered an embarrassing defeat at the hands of Joanna Lumley and the Gurkhas, and is haemorrhaging support ahead of the European elections on 4 June.

When Mandelson introduced the Postal Services Bill to the House of Lords in February, he was warned it would lead to the most serious uprising this Labour Government has ever seen. That warning appears to be coming good as more than 140 Labour MPs have signed an Early Day Motion voicing their opposition to the part-privatisation. The Bill is due to receive its first reading in the House of Commons next month, and the air at Westminster is thick with dissent as the rebels plot how to get the legislation thrown out.

But last week the political unrest spilled over into the private sector as companies which were previously linked with the potential purchase of a stake began to distance themselves. Policymakers had been hoping for a bidding war to drive up the price. But one of the main contenders tipped for the race, Deutsche Post, last week categorically ruled itself out.

"There is no interest in new adventures just because we have got the cash," Deutsche Post chief executive Frank Appel said on Wednesday. "Our international foreign domestic business is not very successful. Cross-border is successful, and in foreign domestic we are much more cautious than we were before."

City analysts also warned that another potential bidder, the private equity group CVC, would find it difficult to raise the necessary finance in the current climate. Reports leaked from sources close to the group suggested bid talks involving CVC were becoming increasingly protracted.

As Brown's political strategists work overtime on a plan to dodge what could ultimately prove the fatal blow to his leadership, the pressing question now occupying minds is: will the private sector still make a bid for Royal Mail? Even if the Bill survives the political warfare at Westminster over the next few months, will the Government still be able to attract a buyer?

When the Government's part-privatisation plans first emerged last autumn, Dutch operator TNT Post was the first to make its interest known. It is understood to be in advanced talks with the Department for Business, Enterprise and Regulatory Reform (BERR) and UBS, the investment bank appointed to find a buyer. It has been the clear front-runner since Christmas.

But with the first quarter reporting season now in full swing, there is growing doubt over whether TNT will be in a position to proceed with the purchase.

Postal operators across Europe are feeling the pinch, and TNT last week declared a 44 per cent fall in operating profit in the first three months of its financial year. It also predicted the poor conditions were likely to persist through the rest of the year, and the group plans to axe 11,000 jobs in the Netherlands.

With industrial action on the cards following a pay dispute with Dutch unions, analysts say there is pessimism in the market about TNT's ability to take on the Royal Mail. One analyst said: "TNT has a lot on its plate financially and industrially and there's not that much cash around in the markets at the moment."

Rumours are leaking from the negotiating table that there are disagreements over how much the Royal Mail, and therefore a stake, is worth.

Even if TNT and the BERR do reach an agreement over price, the postal regulator Postcomm and legal experts have also warned there could be reprisals from the Office of Fair Trading (OFT) and the Competition Commission if the sale proceeds.

In a letter to one of the leading rebel Labour MPs, John Grogan, last week, Postcomm chief executive Tim Brown said TNT was one of the chief competitors to the Royal Mail in the pre-sorted bulk mail market. "Were TNT to be chosen as preferred bidder then this could have the potential to raise competition concerns," he said.

Duncan Gillespie, a competition partner with the international law firm DLA Piper, argues that it is highly likely the OFT would get involved, with some potentially far-reaching consequences for TNT.

He says: "If the OFT thought it was anti-competitive then they could refer it to the Competition Commission. They could force TNT to divest shares through a fire sale as happened to BSkyB (when it acquired a 17.5 per cent stake in ITV]. I think it would certainly be something the Competition Commission would want to look at."

Gillespie warns a competition inquiry could also take up to six months, leaving TNT on financial tenterhooks even if the purchase was eventually approved. However, few believe the deal will even reach that stage.

With 148 Labour backbenchers having already shown their colours, the Government is likely to rely on Conservative support in the House of Commons. Sources at Westminster say the Tories are planning to use the Bill to further highlight Brown's political weakness if he survives the European elections early next month.

Shadow business secretary Kenneth Clarke is understood to be negotiating an amendment to the bill, which is likely to be so disagreeable to Labour backbenchers and other opponents that the legislation will be voted down. "It may be something that would increase the stake of privatisation over 49 per cent," said one source.

Economists meanwhile point out that the long political process means that even if the Government does succeed, the sale couldn't come at a worse time for the markets. Mandelson is hanging the "for sale" sign on the Royal Mail when valuations are still depressed and there is little hope of securing a reasonable price.

The left-leaning think tank Compass estimates that the Treasury has already lost millions by delaying the Postal Services Bill until this year. Compass chief executive Neal Lawson said: "Because this is the bottom of the market the Treasury would get around £1 billion, little more than half what it would have made if it had sold just a year ago."

One analyst said: "You have got to ask if it's a good time to be flogging off part of the state jewels for a cut price."

The CWU is pressing the Government to publish financial models showing how much the Royal Mail would need in order to turn the service around. It argues that the economic case for private sector involvement is not clear, particularly since the Government has now agreed to absorb Royal Mail's £7bn pensions deficit.

Sian Jones, spokeswoman for the CWU, said: "It's quite incredible really. There's still a lack of clarity around the costs of privatisation and the price. None of these figures have been made public."

The Business and Enterprise Select Committee, chaired by Peter Luff, also accused the Royal Mail and Government of being "very coy" about the sums required.

One argument all sides do agree on, however, is the need for change at the Royal Mail. As Richard Hooper, the former deputy chairman of Ofcom, pointed out in his independent review of the organisation last year, the Royal Mail is the least profitable postal service in Western Europe. In the financial year 2007-08, the Royal Mail's letters business racked up a £3 million loss. Although its most recent third quarter figures showed a return to profit for all parts of the business for the first time in 20 years, analysts say fundamental problems persist as the Royal Mail struggles to come to terms with falling mail volumes and more and more Britons switching to email and text. As the Business and Enterprise committee concluded in its own report earlier this year: "A profit of some £320m on group revenue which can be expected to be over £9bn is hardly impressive."

The Hooper review laid the path towards privatisation when it concluded that if the Royal Mail did not attract a cash injection from the private sector, it would be forced to go cap in hand to the government for a bail-out. Hooper warned it would then have to be restructured under European rules which would ultimately be a "poor outcome" for the taxpayer, employees and customers.

But given Royal Mail's most recent financial results, opponents disagree that Royal Mail cannot modernise without private sector help. The CWU argues that once the albatross of the pensions deficit is removed, and with a change in management, modernisation can be achieved through internal cost cutting and the adoption of new sorting technology. The Government has already extended a £1.2bn loan for new machinery, which the CWU argues has not yet been spent.

The union accepts that the modernisation process will involve some job cuts, but it insists this will be far preferable to transferring the Royal Mail to private sector hands. Jones of the CWU said: "There is still money available for machinery and modernisation. Only a fraction of that Government loan has been spent so far."

In its report earlier this year, the Business and Enterprise Select Committee also raised questions about the need for a private sector cash injection. It said: "It may be possible for Royal Mail to generate much higher levels of profit to fund its investment requirement and, if so, we have difficulty in seeing why a private sector partnership is essential as a means of injecting capital."

The SNP similarly fears that the involvement of the private sector in the Royal Mail would pose particular problems for Scotland. For many customers and businesses in the Highlands and Islands, the service is a lifeline yet there are fears that a company which is accountable to its shareholders may deem services to remote, less heavily populated areas cost inefficient.

So far, however, the Government has shown little sign of conceding to the rebels. Pressure is mounting on Nick Brown, the Government's chief whip and Brown's long-term ally, to rally backbench support before the Bill reaches the Commons.

But as one analyst pointed out: "The Government will have to produce a much more convincing financial argument before it wins back any friends."