Privatisation commercial case is weak

[TrueBlueTerrier]

Royal Mail privatisation looks inevitable - but the commercial case is weak

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The caricature that the postal service is a leech on the public purse is out-of-date – Royal Mail is generating cash at a rate of £400m a year and profit margins are now 5%

It's a bit rich for trade minister Michael Fallon to argue that the Royal Mail must be privatised because the business needs to be spared an annual competition for capital with schools and hospitals. The reality is that the government has been lending to Royal Mail on terms that would almost make a New York hedge fund blanch.

Royal Mail's latest annual report gives the details. At the last balance sheet date, the company owed £973m and was paying an average interest rate of 8.8%. But this included a £473m slug of debt akin to a payment-in-kind note, a device commonly found in leveraged buyouts. Interest on that loan was rolling up at 12% – a nice little earner for a government that can still borrow for 10 years at 3%.

Not surprisingly, the Royal Mail said on Thursday that refinancing with banks would lead to "a significant reduction" in its cost of debt. You bet.

Those statistics ought to make the case that a "healthy future" for Royal Mail could easily be secured in the public sector. The caricature that the postal service is a leech on the public purse is out-of-date (if one ignores the state's kind removal of the old pension fund). Royal Mail is generating cash at a rate of £400m a year and profit margins are now 5%, thanks in part to a more sensible regulatory regime that gives greater freedom to increase the price of a first-class stamp.

In operational terms, the business looks more competitive than it has done in years. If more funds to invest in automation are required, there's a strong argument for the government to advance the cash at gentler rates of interest. No schools or hospitals would have to go unbuilt.

Instead, privatisation has acquired an air of inevitability over two decades as both Conservative and Labour administrations have attempted the feat. Politicians' understandable desire to run away from poisonous industrial relations is one reason; envy of a successful privatised Deutsche Post is another. But the irony is that the commercial case for a sale has rarely looked weaker than it does today.

Don't doubt, though, that the government will get its wish. The threat of strike action is unlikely to undermine the float – City investors would only be scared if Labour was threatening re-nationalisation, and it isn't. And the shares, inevitably, will be priced to go. Annual dividend payments will start at £200m, said Royal Mail, which implies a dividend yield of 7% if the equity is priced at £2.75bn. There will be buyers.