To deal with its failing state enterprises, Romania – an Eastern European nation with a population of 19 million – vested 90 state owned businesses in a closed ended investment fund, Fondul Proprietatea, in 2005.
Unlike in Sri Lanka, many of Romania’s state-owned enterprises had been expropriated from private owners during the country’s tryst with communism. However, similar to Sri Lanka, many of these businesses were politicized, poorly managed and were loss making.
Fondul Proprietatea, which was 40% owned by the original owners of these assets, 40% by the government and the rest by institutional investors at its incorporation in 2005, was tasked with maximizing shareholder returns.
Five years after its establishment, Franklin Templeton, a California based investment company, won the mandate to manage the closed-ended fund. Fondul Proprietatea was listed on the Bucharest Stock Exchange and in 2015, it was listed on the London Stock Exchange.
Marius Dan is Deputy Chief Executive of Fondul Proprietatea and is part of the Franklin Templeton appointed team that manages the fund on behalf of the Romanian government and its other shareholders. He was interviewed by Echelon’s Shamindra Kulamannage.
When we think of state-owned enterprise reform, here in Sri Lanka, we are considering one of two alternatives. Independent management for better governance and the second alternative is privatization. Does Fondul Proprietatea’s experience in Romania suggest there is a third way?
I firmly believe so, because the structure that was created by Romania in 2005, as a way to compensate individuals whose properties had been confiscated by the communist regime, is certainly a model that can be replicated in Sri Lanka. It is certainly a model that we are discussing with several other countries to implement. What is it exactly?
It is a closed-end fund structure into which the Romanian government injected minority and majority stakes of both privately owned as well as state-owned enterprises, where the government either had 100% ownership or minority ownership. They injected those stakes into Fondul Proprietatea.
Franklin Templeton was hired in 2010, to manage the structure, list it on the stock exchange and create value for shareholders. We certainly believe this is a very interesting and proven model that can work in Sri Lanka, and other countries because it does not force the government to sell assets right away.
In 2009 Romania was impacted by the global financial crisis. If back then the Romanian government had been forced to privatize and sell off assets, especially in the energy sector where we have majority ownership of assets at Fondul Proprietatea, it would have missed out on a significant amount of dividends paid by the state-owned companies in the last 10 years whilst maintaining majority ownership in state-owned enterprises.
Due to the restructuring, the efficiency and profitability of these state-owned companies have increased. The Romanian government has used the dividends from these ventures to fund various projects, ranging from infrastructure and subsidies to reducing the impact and the effects of the current high energy prices.
How did Franklin Templeton get involved in this?
We got involved as a result of an international selection process for a professional asset management firm to manage Fondul Proprietatea. So we participated in the selection process alongside 25-30 other global asset managers and we won the mandate in 2009. We were appointed in September 2010. We listed the fund on the Bucharest Stock Exchange in January 2011, and April 2015, on the London Stock Exchange, as a way to broaden the investor base and attract more institutional investors in Romania.
Interestingly, Fondul Proprietatea represents the largest foreign direct investment in Romania in the last 30 years. We’ve attracted around $1.7 billion in portfolio investments to the fund’s shares.
When Fondul Proprietatea was established in 2005 what were the net asset values of the assets, and how many companies did the government vest in the fund? And what’s happened to these values in the time since its creation, and in the time since Templeton took over management in 2010?
The government considered that the value of the assets injected into the fund was around 4 billion dollars. The Romanian government thought this was large enough of a fund to compensate those who had lost properties during the communist regime. As the government didn’t have the money to compensate these individuals or give them the properties back in kind, the structure was set up, and they received shares in the fund.
The number of companies injected was around 90. A lot of them were small companies. For instance, the fund has always been concentrated at the top, the top 10 companies in the portfolio account were around 85-90% of the net asset value of the fund. We had a lot of small assets, which we merged or sold to create value for the fund’s shareholders.
Fast forward 12 years, and we have around 30 companies left in the portfolio. The fund’s largest asset is the country’s hydropower producer presently representing 70% of the fund’s net asset value.
As a result of our being very involved in all portfolio companies at the board level, interacting with the management of these companies and interacting with the majority shareholders, in a lot of cases that’s the Romanian government, and its various ministries, like the Ministry of Energy, Ministry of Communication, Ministry of Transportation and Ministry of Economy. We’ve been able to streamline the operations of most of the companies in the portfolio to make them more efficient and profitable.
The value of the fund today is around 3.5 billion dollars.
Have you sold portfolio companies?
Yes, we’ve disposed of around 60 companies in the portfolio.
How much did the disposals generate?
So we’ve distributed to shareholders; 20% of the fund is held by Romanian retail investors, and another 40% by the Romanian pension funds, which have grown tremendously over time, and the rest are foreign institutional and retail investors.
We’ve distributed 4.2 billion dollars through cash dividends, stock buybacks, and tender offers.
The value of all the disposals that we’ve made is around 2.2 billion dollars and then another 2 billion dollars are the dividends from all these state-owned companies. When we started managing the fund 10 years ago, the value of the dividends these state-owned companies were paying was close to zero.
The top objective was to streamline these companies and make them profitable and a source of dividends to the state budget rather than a drag on it”
Today, the largest asset in the portfolio pays over 1.5 billion dollars annually in dividends and 20% of that comes to us and 80% goes to the Romanian government.
The streamlining and the greater efficiency of operations for all the state-owned companies is critical for any government because of the potential to generate a lot of dividends.
to the state budget, which can then be used for any purpose like building infrastructure, hospitals, schools, or in an environment like this, to extend subsidies to alleviate the effects of price hikes.
What were the main objectives of the Romanian government when they established Fondul Proprietatea in 2005?
The top objective was to streamline these companies and make them profitable and a source of dividends to the state budget rather than a drag on it. A lot of the time Romanian state-owned companies were mismanaged and loss-making, and the government had to provide additional funding taking resources away from other important projects. This should never be the case. These companies should have a sustainable future, they should be efficient, profitable, and generate dividends for the government. So that’s the top priority.
The second benefit would be the improvement in the quality of the management and the quality of the boards and oversight of all these state-owned companies. This has certainly been the case in Romania. We’ve worked with the government to write the corporate governance code to be applied when management teams and boards are selected for these state-owned companies.
The third objective, which has been partially achieved in Romania, and we are working towards its completion, is the listing of these assets on the stock exchange, because that takes care of transparency. The moment these assets are listed there is full transparency because they have to publicize their financial statements, they have to publish annual reports and they have to be audited. So the taxpayers know everything that’s going on in these state-owned companies, because, at the end of the day, the taxpayer owns all these assets.
Fondul Proprietatea is listed on the Bucharest Stock Exchange and also in London. Did you raise any money through those listings? And how has Fondul’s shareholder structure evolved?
The purpose of listing Fondul Proprietatea was to meet a unique need in Romania. Back then, the government awarded shares to individuals whose assets had been expropriated as part of the compensation process. The listing was a means to get the right market valuation on the fund so that those individuals, who had been waiting for 25-30 years for some kind of compensation from the government, were able to cash in the shares at market value.
Because Fondul Proprietatea was listed some people were selling shares in the grey market at a 90% discount to NAV. That was a very low valuation. The listing was a way to offer them a market valuation for the shares that they own.
So no fresh equity was raised at the time the shares were listed?
No, because the fund wasn’t raising money at that point.
But, the way to look at it is, a listing with a structure like this, would allow the government to cash in or raise a few 100 million dollars.
If this structure was replicated in Sri Lanka, the government would own 100% of this vehicle initially. And through a listing, they can sell 20% or 30% in an initial public offering and use those proceeds to reduce the debt and fund the state budget. As time progresses, if the government decides to further reduce their holding in the fund, it will have a credible valuation of assets to raise money.
Now, the second part of your question is, what does the shareholder structure look like? When we started in 2011, the government had 40% of the shares in the fund and another 40% was owned by Romanian retail investors. About 10% was owned by foreign institutional investors and the rest by local institutional investors.
Today, the shareholder structure looks completely different. The Romanian government owns only around 6% of the fund through the ministry of finance. We have 40% owned by the Romanian pension fund. Effectively, every Romanian contributor owns shares in the Fondul and underlying portfolio through their pension fund. These are privately managed pension funds. Similar to how Fondul is managed by Franklin Templeton, these pension funds are managed by asset management firms. Then we have another 34%, which is owned by foreign institutional investors. We have been very active in promoting Fondul Romania, and the underlying portfolio companies to global institutional investors and we’ve attracted, over time, more than 7 billion dollars in investments from foreign institutional investors. A lot of them once invested in Fondul initially, and then they started investing in other locally listed companies, like the private oil company and telecom companies.
We also found the investors that we’ve attracted into Romania take a lot of interest in other equity assets and IPOs that have taken place in the country. That’s a long-term benefit for the development of the local capital market as a structure such as this can be a way to attract institutional investors into the country.
Once they make money with the fund, it’s a virtuous circle, because they tell their fixed-income colleagues about the reforms happening in the country, which tends to have a positive impact on reducing the debt of the country. If there is excitement about what’s going on in a country, it can lead to accelerated development of the local capital market.
I can tell you as a Romanian when we started marketing Fondul in the US and Europe, I was very surprised about the negative perception of my country, compared to the reality on the ground and what was happening in terms of the reforms and what we were doing in the state-owned companies.
So it was my job, to explain and showcase what we’re doing in Romania. We brought in a lot of investors through capital markets day, to see for themselves, what was happening on the ground. Because, a lot of times if you’re just reading the press, there can be a lot of noise. So we try to have investors visit the country to meet with government officials and the management teams of the state-owned companies to show them the assets and their potential for cash generation. And it worked.
Marius, there is something in capital markets known as the conglomerate discount. That an aggregation of businesses that aren’t complimentary, or don’t have any synergies tend to attract a market discount. Does Fondul attract a discount on its net asset value?
Yes, you’re absolutely right. A lot of times these types of closed-end funds structures tend to trade at a discount. This was very much the case with Fondul. But we were focused on reducing that discount to the net asset value.
When we started, the discount by the market for the fund was around 60%. Fast forward to eight years later, we managed to reduce that discount down to zero. The fund has also had times in which it traded at a premium to its net asset value. So it falls upon the manager of the fund to be focused on reducing this discount to NAV and there are certain tools that you can apply.
We’ve been doing that successfully like, buying back our own shares and organizing tender offers. We’ve done 12 buyback programmes and we are now completing the tenth tender offer for the fund. So there are ways in which you can reduce this discount to NAV.
What our shareholders expect from us is to deliver a higher NAV every year. If there is a discount to NAV, there is an expectation from our investors that we reduce the discount to NAV significantly”
Can you tell us what a tender offer is?
A tender offer is when you buy back in a short period a large amount of stock. For instance, if the fund is trading at a 10% discount to NAV and the fund has excess cash, it can say to the market, that we’re launching a tender offer to repurchase 5% of our shares and we are paying ‘x’ price which can be something close to NAV. It signals to the market that the discount is too high, and it’s an efficient way to reduce this discount to NAV.
It’s a mix of what you’ve mentioned. What our shareholders expect from us is to deliver a higher NAV, every year. If there is a discount to NAV, there is an expectation from our investors that we reduce the discount to NAV significantly. So we have objectives in our mandate to deliver both a discount reduction, keeping it below 15% and have a higher NAV year on year.
In addition to that, we hold ourselves to a very high standard in terms of maximising shareholder returns. That’s why we pay a certain amount of dividends every year. We want to offer our shareholders an attractive yield on the fund and we want to buy back shares because that offers additional returns and it reduces the volatility of the share price. If I look at the last 10 years, we probably have achieved all these objectives because the share price has gone up more than six times and NAV has increased almost three times. We’ve reduced the discount to NAV significantly, and we’ve distributed 4.2 billion dollars in cash, or through buybacks to our shareholders. So those are the key measures of success.
Of course, the last one you mentioned; corporate governance. We hold ourselves to a very high corporate governance standard because that’s what we want and that’s what we expect from these state-owned companies as well. We want these companies to be managed by the best possible people in the country. Moreover, we also want the oversight of these companies through the board to come from the most experienced and independent people as well.
So your objectives are pretty much identical to those of any listed company, which is shareholder wealth maximization?
Absolutely.
Templeton has been managing Fondul Proprietatea for 12 years. I’m sure it hasn’t been all smooth, all the way. If you thought there were one or two big challenges that are top of the mind for you, as an executive overlooking Fondul and its portfolio of 30 different businesses. What would those one or two challenges presently be?
You’re right, despite the numbers that I gave you in terms of how much the share price has increased and how much the NAV has increased, we’ve had a tremendous amount of challenges over time.
There have been times when we’ve had to spend 13-14 hours a day on the phone with shareholders because one of the largest assets entered a bankruptcy procedure. We’ve had very challenging regulations coming from the government, which would have threatened the reduction of the profitability of all the companies in our portfolio across the board. We had to fight to change those regulations and explain to the government the long-term damage that those types of regulations would have, primarily, on the state-owned companies.
Right now, we are in a very good position the primary challenge that we face is that we want to bring some of the assets onto the stock market. We’ve been trying to do so for the last five to six years. Finally, we have the political support to do so.
We are now working on the IPO of the largest asset in the fund, which is 70% of the fund’s NAV, the country’s hydropower generation company. We think this has the potential to become the most valuable company in both the state and private sectors, given the attractiveness of these assets and their profitability. So, now the challenge is making sure that we can achieve that and deliver a very successful IPO to our shareholders and the Romanian government.
The other challenge we’re facing is a lack of predictability on the fiscal side. Because whenever there is pressure, governments tend to come up overnight with additional taxes or regulations. What we are trying to do is make sure there is a proper consultation process with the stakeholders, because even though in the short term it may seem like a good idea, long term it can have very detrimental effects on the country.
Luckily, in Romania now, we have a constructive conversation with the current government. They understand the position of investors in the country, that overnight decisions don’t bring anything good. But at the same time, we understand that there is pressure on the state budget, and we’re trying to find solutions on how to alleviate those effects.
If the one company that accounts for 70% of Fondul’s net asset value is to be listed, it looks like Fondul can potentially sunset at some point. Is that the intention?
If we deliver strong returns with successful IPOs and return the cash to the shareholders, we would have achieved our objective. But even with the IPO, of the largest asset in the portfolio, we will be left with over 1 billion dollars in assets. We certainly believe there is a place in the Romanian capital market for a structure like Fondul for a very long time.
You said at the time Fondul was formed, the assets were estimated to be worth 4 billion dollars. Now, it seems there was an idea about the net asset values of these companies. In Sri Lanka, state-owned companies don’t use IFRS standards for their accounting. So there is no reliable NAV. How was it in Romania when Fondul started?
Romanian companies weren’t using IFRS either, at the time when we started managing the fund. So the way that these companies were valued by the government, when they were injected into Fondul, was they only looked at book value.
At the end of the day, it’s long-term protection for jobs. Because if a company is mismanaged, nobody wins from that”
When we took over the management of the fund, in 2010, the first thing that we did was to commission independent valuation reports for every single company in the portfolio. So these valuation reports were done by one of the big four accounting firms. That allowed us to have a much clearer picture of the valuation of the assets in the fund.
For the unlisted assets, we still use independent valuation reports, which are done by one of the big four companies to calculate the NAV. But the method of valuation has evolved from book value, where we started.
Now for a lot of companies we are looking at peer comparisons, so EBITDA multiples compared to listed peers, or we use DCF models to value an asset like the Bucharest airport.
At the time the fund was formed, were there assets therein that appeared fundamentally unviable, because they had a significant negative net worth, but you still had to accommodate them in the fund? If so these few poor assets can impact the valuation significantly?
Absolutely, some companies were loss-making, although they had good assets they were mismanaged. They had very high debt levels at a real risk of going into bankruptcy and liquidation. We have to be proactive, get deeply involved in these assets, and try to turn them around.
The most prominent example is the company which is now 71% of the fund’s NAV. At one this company was valued at zero, because of high debt and poor management. It’s a huge success story.
Of course, we also have the country’s coal power producer, which could have been a good story, if it was turned around, but it hasn’t been. So it is still valued at zero in our portfolio.
We have both types of examples. In one instance the government was supportive and worked with us to turn around an asset, and we managed to make it the most valuable company in Romania. In another company where there was a lot of resistance we just couldn’t implement what we thought was the right strategy, and that company is valued at zero. Hopefully, it will avoid bankruptcy in the future.
How is the fund manager compensated? Are there fixed and performance-based measures of compensation?
We are compensated based on the market capitalization of the fund. For a long time, we were receiving a base fee of 60 basis points of the value of the market capitalization. There were some discount-related objectives. So if the discount to NAV was below 20%, then the base fee was 65 basis points. If the discount to NAV was below 15%, the fee would go up to 70 basis points over the market cap.
On top of that, we would receive 1% of the value of the buybacks, and dividend distributions that we make. That’s to further strengthen the alignment of interest between the manager and shareholder.
With the latest mandate, which started at the beginning of April 2022, we have a higher distribution fee. We get 2.5% of the value of the distribution. That’s a way for shareholders to incentivize us to bring some of the largest assets to the market and an IPO like Hidroelectrica, the salt mines in the country and other assets. That’s been compensated with a decrease in the base fee.
When you mean distribution fee, it can come through IPOs or it can come through dividends?
Yes, it can be through disposals of assets and distribution of cash also.
Anything to add, in conclusion?
From our perspective, as Franklin Templeton, the fact that we have over a ten-year track record with Fondul Proprietatea puts us in a good position to try to replicate this model in many other countries.
In case of assets that are struggling, or not performing very well, we are not afraid to take on challenges. And we’d like to take on this type of challenge, to get deep into state-owned companies to help turn them around and put them on a sustainable path.
At the end of the day, it’s long-term protection for jobs. Because if a company is mismanaged, nobody wins from that.
And we certainly believe that, if governments look to replicate this type of model, it can have several positive effects on the local economy, including the acceleration of the development of the capital markets, which can be a critical pillar for economic development.