Written by KPMG and Bocconi University February 2018

Study on State asset management in the EU

Pillar 4 (Case studies) - The full privatisation of Royal

Mail

Contract: ECFIN/187/2016/740792

2

EUROPEAN COMMISSION

Directorate-General for Economic and Financial Affairs Directorate Fiscal policy and policy mix and Directorate Investment, growth and structural reforms

European Commission B-1049 Brussels

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Privatisation - Royal Mail

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The full privatisation of Royal Mail

This note discusses the privatisation of Royal Mail plc (“Royal Mail”), currently a public

limited company sited in London which is the holding company of the Royal Mail Group

Limited. Royal Mail’s full privatisation took place in three stages (October 2013, June

2015 and October 2015), leading to the privatisation of the whole company for an

overall value of 3.3 Bn GBP (around 4 Bn EUR). In October 2013, following a package

of reforms implemented by the British government, the Department for Business,

Innovation & Skills sold 60 per cent of the government’s shares in Royal Mail to

private investors for 330 pence each (around 4.2 EUR)1. Following these events, the

company joined a peer group of listed postal operators active at national level across

Europe, which had been privatised in the previous years (e.g. full privatisation of

PostNL in the Netherlands in 2006, partial privatisation of 69.5% of Post DHL in

Germany since 2000, partial privatisation of the 47.2% of Österreichische Post in

Austria since 2006, partial privatisation of BPOST in Belgium since 2006 with the state

still owning a 50% stake + 1 share).

1. INTRODUCTION

The case of the privatisation of Royal Mail has been chosen in order to provide an

example of public-owned company operating within a historic monopolistic sector

(postal sector) privatised through Initial Public Offering (IPO)2.

Indeed, Royal Mail plc is the universal postal service provider in the United Kingdom.

Currently three broad business areas operate under the Royal Mail Group: Royal Mail

for letters and parcels, in the UK and internationally, Parcelforce Worldwide for

express parcels in the UK and internationally; and General Logistics Systems (GLS),

providing other logistics services, primarily in Europe. In recent years Royal Mail

Group has adopted a three-pronged strategy focusing on parcels, letters and

customers3. In particular, Royal Mail’s strategic drivers can be summarized as

following:

maintain a pre-eminent position regarding parcels;

mitigate the impact of digital innovation which has led to the substitution of

letters with e-mails;

meet changing customer demands by offering improved access to products and

services.

The market positioning of Royal Mail has started to change, also because of the digital

revolution: indeed, as the use of e-mail and the internet has grown, the overall postal

sector in Europe has experienced a structural decline in the number of letters being

1 Throughout this case study, values related to the privatisation of Royal Mail (e.g. deal values, price per share) and to Royal Mail annual reports (see sections 4 and 5) are reported in local currency (i.e. GBP). This methodological choice has been made in order to avoid issues possibily related to an “exchange rate effect”, which can affect trends and values reported. As for deal-related values, the value in euros is also reported. In fact, in these cases, we have used the average exchange rate registered in the year of the operation

(from October 2013 to June 2015) - 1 GBP: 1.2877 EUR (source: information provider) [Accessed 15th January 2018]. 2 The Initial Public Offering (IPO) is a process implying that an unlisted (private) company sells new or existing securities offering them to the public for the first time. After an IPO, the issuing company can be identified as a publically listed company on a given stock exchange. 3 For more details on Royal Mail current strategy, please see: https://www.royalmailgroup.com/about-us/our-strategy [Accessed 11th January 2018].

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sent4, registering a drop in related revenues. However, over the same period, the

parcel market has grown fast thanks to a parallel increase in online shopping, which,

in turn, has led to a rise in the number of shipped boxes and to an increase in the

volume of the related income.

2. CONTEXT AND IMPLEMENTATION

Historically, one of the key objectives of the UK government in relation to postal

services had been to safeguard the universal post service in the country, as an

important component of the social and economic framework. Royal Mail was

considered as the only company capable of providing postal related services to

consumers and businesses at “public good” conditions. Therefore, in order to improve

the company’s efficiencies in light of market changes, in 2007 Royal Mail started a

long-term transformation programme.

In 2008, Richard Hooper’s reviews5 recommended a package of reforms in order to

modernise Royal Mail and to make it more suitable to meet the demand for universal

postal service. In more detail, the Hooper reviews (the first in 2008, and the second in

20106) stated that Royal Mail was less efficient than many comparable postal

companies around Europe. At the time, there were concerns over the financial

sustainability of the universal postal service. According to Hooper’s reviews, the

inefficiency was also partly due to the relative lack of a modernisation strategy in the

UK, compared to other European countries. According to Hooper, to improve the

quality of services provided by Royal Mail to its customers, the introduction of investor

scrutiny, with the associated greater commercial awareness, external capital and

expertise, represented a fundamental step towards a quick and effective

modernisation.

Hooper’s recommendations can be summarized as following:

transfering the responsibility for Royal Mail’s past pension liabilities to the

central government;

reforming the regulatory regime in which Royal Mail operated and introducing it

into the broader context of the communications market;

injecting some private capital to Royal Mail, and potentially creating a

partnership with one or more private sector companies.

These recommendations were taken on board through the Postal Services Act 2008-

2009, which did not proceed to Second Reading because of the difficulties in

identifying a potential private sector partner. However, UK policy makers perceived a

need for fundamental change in the sector, resulting in the UK government’s decision

to proceed with the full privatisation of Royal Mail. The Postal Services Act of 20117,

4Ofcom Communications Market Report 2012 – August 2013 - http://stakeholders.ofcom.org.uk/binaries/research/cmr/cmr13/2013_UK_CMR.pdf [Accessed 11th January 2018]. 5 Hopper, R., and Hutton, S. (2008). Modernise or decline: policies to maintain the universal postal service in the United Kingdom. Available at:

http://webarchive.nationalarchives.gov.uk/20090609005129/http://www.berr.gov.uk/files/file49389.pdf [Accessed 11th January 2018]. 6 Hopper, R. (2010). Saving the Royal Mail’s universal postal service in the digital age. September 2010. Available at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/31808/10-1143-saving-royal-mail-universal-postal-service.pdf [Accessed 11th January 2018]. 7 Postal Services Acts 2011. Available at: https://www.legislation.gov.uk/ukpga/2011/5/contents [Accessed 09th January 2018].

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came into force between 2011 and 2012 and brought a new postal regulatory

framework, also inspired by the provisions included in the Directive 2008/6/EC8.

Therefore, from 2012, Royal Mail and the postal sector in the UK was subject to a

number of reforms and changes:

Ofcom was appointed as the body responsible for postal services with a primary

duty to ensure the financial sustainability of the universal postal service, and

additional duties in relation to ensuring service levels and efficiency were

mainatined;

legal separation of the Post Office business, becoming a publicly-owned

company, with the intention for it to become a mutual structure by 2015, from

the Royal Mail Group;

elimination of existing restrictions on the ownership of Royal Mail, with the

intention to open up Royal Mail’s ownership to private investors by April 2014,

allowing the government to privatise up to 90% of Royal Mail, with the

condition of the maintenance of at least 10% of shares to be held by its own

employees;

the relief of Royal Mail’s historic pension deficit by the Government (April 2012)

through the transfer of pension benefits to a new government pension scheme.

This measure was recommended by Hooper in order to make Royal Mail more

attractive to private investors. On 1st April 2012, the government transferred

Royal Mail’s and Post Office’s pension liabilities (around 40 Bn GBP) from Royal

Mail Pension Scheme to a new scheme (“the Royal Mail Statutory Pension

Scheme”) directly administered by the government9. Simultaneously, around

28 Bn GBP of pension assets were transferred from Royal Mail to the

government;

introduction by Ofcom of new regulations on postal services such as:

o the removal of price control on stamps10, in line with Ofcom’s duty to

ensure the financial sustainability of the universal postal service. This

scheme led to an increase of first class stamp prices in April 2012

(second class stamp price was capped at 55 pence for 7 years);

o the introduction of requirements in terms of efficiency for Royal Mail

(with a main focus on cost control) and of affordability of the service

provided (with particular interest on vulnerable customers);

o provisions on quality of services11.

8 Directive 2008/6/EC of the European Parliament and of the Council of 20 February 2008 amending Directive 97/67/EC. For more details, please see: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32008L0006&from=EN [Accessed 11th January 2018]. 9 For more details, please see http://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN04940 [Accessed 11th January 2018]. 10 For more details, please see

http://researchbriefings.files.parliament.uk/documents/SN06296/SN06296.pdf [Accessed 11th January 2018]. 11 Since 19th December 2012, the EN 13850:2012 standard specifies a EU unique method for measuring the end-to-end transit time of domestic and cross border Single Piece Priority Mail (SPPM) operated by universal postal operators. This standard method must have been applied (by 2013) by all EU Member States for theirself and to report to EU government with regard to the quality of services provided by postal companies in each European country.

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Privatisation - Royal Mail

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As mentioned above, the legal framework for the sale of shares of Royal Mail can be

traced backed to the Postal Services Act 2011, which lifted restrictions on Royal Mail’s

ownership, thereby permitting the UK government to sell its shares in the company. In

particular, the privatisation of Royal Mail was driven by the intention make the

universal postal service sustainable. The key objectives of the privatisation were:

introducing external shareholder scrutiny to the governance of Royal Mail,

incentivising greater innovation, efficiency and accountability;

making the company and the postal sector as a whole more efficient, and

improving the quality of the services provided;

spreading shares, so to move from the monopoly to a widespread ownership.

The government published its objectives for the sales of Royal Mail’s shares in April

2013. They were to deliver a sale of shares within the Parliament, to create an

employee share scheme in order to encourage the ownership of part of the company

by its employees, and to find a reasonable financial outcome for the taxpayer.

In general, the main objective of the sale was to allocate the shares to investors

optimizing the price and establishing a long-term shareholder base for Royal Mail. In

order to ensure the success of the operation, the government conducted an extensive

marketing campaign for attracting private investors starting in 2011 and succeeded in

selecting 17 “priority investors” willing to place non-binding offers at 250 pence per

share (around 3.3 EUR). After the privatisation, the ultimate responsibility for

maintaining the sustainability of the universal postal service in the UK sat with Ofcom,

while Royal Mail had the duty of guaranteeing the ongoing delivery of the universal

postal service, helped by the injection of additional private capital.

3. ANALYSIS OF THE DEALS

On 15th October 2013, Royal Mail’s shares were formally listed on the London Stock

Exchange (LSE). The privatisation was carried out through an IPO process that led

Royal Mail to become a quoted company traded on the LSE, and completed after two

more rounds (June 2015 and October 2015). Its market capitalisation at entry was of

around 3.3 Bn GBP (around 4 Bn EUR).

The privatisation started in July 2013, when the government announced that Royal

Mail was to be floated on the London Stock Exchange, also confirming that its staff

would be entitled to free shares. It stated that the decision was “consistent with

developments elsewhere in Europe where privatised operators in Austria, Germany

and Belgium produce profit margins far higher than the Royal Mail but have continued

to provide high-quality and expanding services”.12

On 12th September 2013, a six-week plan for the sale of at least 50% of the company

was released. At that time, the Communication Workers Union (CWU), claiming that

up to 96% of Royal Mail employees opposed the sell-off, balloted its members about a

nationwide strike action to protest against the privatisation. Despite the ensuing

strike, conditional trading in shares began on 11 October 2013, preparing the full

listing on the LSE for the 15th October 2013.

Following the IPO, 52.2% of the postal provider’s ownership was held by private

investors, while 10% of shares were given to employees for free. Because of the high

12 Jennifer Rankin (10 July 2013). "Royal Mail privatisation will not affect postal delivery – Vince Cable". The Guardian [Accessed 11th January 2018].

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Privatisation - Royal Mail

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demand for Royal Mail’s shares, the government decided to add a further 7.8% (on 8th

November 2013) reaching up to 60% of shares sold to private investors. This meant

that the government retained a 30% stake only, having raised 1.98 Bn GBP (around

2.6 Bn EUR) from the sale of 60% of its stake to private investors.

Following the first stage of the privatisation, the Royal Mail share price rose (with a

peak of +87% six months after the IPO). The majority of shares were acquired by

large private investors, such as pension funds and hedge funds. On the first day of

conditional trading, Royal Mail’s shares closed at 455 pence (around 5.9 EUR), plus 38

per cent in respect to the sale price; in the following six months they traded in the

range of 455 pence to 615 pence (between 5.9 EUR and 7.6 EUR).

In June 2015, following the outcome of the first stage of privatisation, the government

announced the sale of the remaining 30% stake. Following this announcement, two

more privatisation rounds were implemented. During the second stage (June 2015) a

15% stake was sold to private investors for 750 Mn GBP (around 9.6 Mn EUR) and a

further 1% passed to Royal Mail's employees. During the third, and final, stage

(October 2015) an additional 13% stake was sold to private investors for 591 Mn GBP

(around 7.6 Mn EUR) and the remaining 1% was given to employees.

The proceeds of the full privatisation of Royal Mail are summarized in Table 1.

Table 1 Proceeds of the sale of Royal Mail

Source: KPMG elaborations on Department for Business, Innovation and Skills Royal Mail Share Offer. NB. The total shares sold to private investors is shown as 88%, with the remaining 12% of shares being given to Royal Mail’s employees for free.

4. IMPACT ASSESSMENT

In the following section, the impacts of the privatisation (and the measures adopted

by the UK government in order to enable it to happen) on the target company

performance, on public finance and other impacts are analysed, using publicly

available data. The measures that we have analysed include the transfer of

responsibility for Royal Mail’s past pension liabilities to the central government, and

the reform of the regulatory regime in which Royal Mail operated, also removing price

controls and the IPO process.

In relation to both the first and the second element, these steps were implemented, at

least in part, to facilitate the privatisation of Royal Mail. In particular it has been

suggested that, due to the historical poor financial performance of the Royal Mail

Group, the privatisation might have been unattractive to private investors without

such an intervention to improve Royal Mail’s financial and solvency position.

Please note that the impact assessment is mainly based on the comparison between

trends and performances registered by both the company and the country before and

after the measures introduced took place (i.e. regulatory reform, IPO, and transfer of

past pension obligations). Therefore, no counterfactual assessment has been carried

out, being beyond the scope of this case study, as well as very challenging with

respect to the “do-nothing” scenario.

Shares sold to private

investors

(% of shares)

Amount raised

(GBP Mn)

First sale (October-November 2013) 60% 1,980.0

Second sale (June 2015) 15% 750.0

Third sale (October 2015) 13% 591.1

Total 88% 3,321.1

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4.1. Impacts on the target company

As far as the impact of privatisation on Royal Mail, it can be observed that the

privatisation seemed to have a positive effect on both the financial and the operating

performance of the company and the group. The sale process as a whole has

significantly improved its profitability and solvency profile, as it will be explored in the

following sub-sections.

Despite Royal Mail (as a private company) currently seems not to get any royalties or

incentives from the government in order to continue to provide the universal postal

service, and there is little suggestion that Royal Mail would want to reduce the scope

of the universal service obligation (USO), both Royal Mail and the Ofcom has

concluded that Royal Mail currently gets more from delivering the UPS than from

stepping away from it.13

Market positioning

Royal Mail was the monopoly provider in the postal industry in the UK for more than

three hundred years and has only very recently been privatised. Up until 2006, Royal

Mail held a monopoly, to sell postal services on an end-to-end delivery basis under the

USO. The USO was liberalised in 2006 and it has been open to access competition

since.

Royal Mail Group’s reference market is mainly the UK where, as a result of opening of

the market to new entrants, Royal Mail delivered around 39% of letters on an end-to-

end basis in 2016/714. The remaining 61% of letters were collected by other postal

operators which access Royal Mail’s delivery network on regulated terms. However,

Royal Mail still collects around 96% of revenues from the letters market, via end to

end revenues and access revenues15.

In contrast to letters, the parcels sector is highly fragmented, with Royal Mail Group

as the largest operator (31.5% of UK domestic parcel revenue market share in

2014)16. Because of its role as provider of the universal postal service in the UK, it is

illustrative to review the group’s operating revenues in comparison with other national

universal postal service providers at EU28 level.

Looking at the operating revenues registered by Royal Mail versus its national

comparators’ (i.e. very large EU companies carrying out postal activities under USO),

Figure 1 shows that the operating revenues of Royal Mail increased from 2010 to 2015

(independently from the changes in its ownership), while it has decreased between

2015 and 2016. In the meanwhile, the other peers had experienced very different

trends mainly depending on different strategies adopted by them. Infact, in the last

decade, the developments in the postal market across the EU28 forced universal

postal service companies to diversify their activity portfolio (e.g. Poste Italiane S.p.A

in Italy, La Poste in France have started to provide some financial products). Since it is

impossible to find out a common trend among the analysed peers and Royal Mail’s

trend in term of operating revenues has remained coherent during the pre and post

13For more information on the debate please see: https://www.ofcom.org.uk/__data/assets/pdf_file/0033/97863/Review-of-the-Regulation-of-Royal-Mail.pdf [Accessed 30th January 2018] 14

See Figure 1.1 of https://www.ofcom.org.uk/__data/assets/pdf_file/0019/108082/postal-annual-

monitoring-report-2016-2017.pdf. 15 See Figure 1.2 of https://www.ofcom.org.uk/__data/assets/pdf_file/0019/108082/postal-annual-monitoring-report-2016-2017.pdf. 16

Date taken from “Triangle Management Services/Royal Mail Group Fulfilment Market Measure, 2013”.

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privatisation period, it is very difficult to assess the impact of its privatisation on

operating revenues of Royal Mail.

Figure 1 Trend of the operating revenues (base year 2010) of the Top5 EU28 postal

operators, 2010 - 2016

Source: KPMG elaborations on Amadeus data. (a) The trend in the operating revenues of Royal Mail compared to other EU28 peers has been calculated

considering the top 5 EU28 companies according the operating revenues among the peer group NACE Rev. 2: 5210 VL (i.e. “Postal Activities under universal services obligation (very large companies)”). The graph shows the evolution in the operating revenues for each peer from base year 2010 on.

Profitability

Despite the fact that EU20 and the UK postal services market have witnessed a decline

in the operating revenues during the entire reference period, the operating revenues

of Royal Mail have increased.

The changes in the regulatory framework

has had an impact on revenues. In more

detail, on March 2012, Ofcom introduced

a new regulatory framework designed to

ensure the sustainability of the provision

of the universal postal service. It gave

Royal Mail commercial flexibility, for

example by removing nearly all direct

price controls on stamps. From 2012-13

direct price controls only applied to about

5 per cent of Royal Mail’s revenues,

compared to around 60% previously. As shown in Figure 2, Royal Mail increased the

price of first and second class stamps by 30% and 39% in 2012-2013, respectively.

Furthermore, as shown in Figure 3 below, Royal Mail was able to return to profitability

as a consequence of the increased freedom over stamp prices.

The reported net income in the year of the first stage of the privatisation (i.e. 2014) is

heavily influenced by several extraordinary items. First, the accounting impact of the

Pensions Reform, increasing the accounting pension surplus significantly, and resulting

in a one-time non-cash credit of 1,350 Mn GBP. In addition, there were specific items

with regard to transaction-related costs of 28 Mn GBP (10 Mn GBP in 2013) and the

charge associated with the Employee Free Shares Offer of 94 Mn GBP.

The Employee Free Shares Offer charge represents the charge to the income

statement relating to the issuing of Free Shares, which is calculated from the start of

the period when employees become eligible for the shares and it is based on the mid-

market closing price on the day of admission to the London Stock Exchange. The

charge for 2014-15 was expected to be around 170 Mn GBP.

Figure 2 Stamp prices, 2009 - 2017

Source: KMPG elaborations on Royal Mail data.

39 4146

60 62 63 64 65

30 3236

5053 54 55 56

0

10

20

30

40

50

60

70

80

03/10 -03/11

03/12 -03/13

03/09 -03/10

03/11 -03/12

03/14 -03/15

03/13 -03/14

03/15 -03/16

03/16 -03/17

First class

Second class

First IPO stage

Second, Third IPO

stages

GBP

70

75

80

85

90

95

100

105

110

115

120

125

130

135

2010 2011 2012 2013 2014 2015 2016

ROYAL MAIL PLC

DEUTSCHE POST AG

POSTE ITALIANE - SOCIETA’ PER AZIONI

LA POSTE

DIE SCHWEIZERISCHE POST AG

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Privatisation - Royal Mail

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Business-related costs of 15 Mn GBP were noticeably lower compared to the 67 Mn

GBP in 2013. They include 15 Mn GBP historical employment costs, a 7 Mn GBP

release (28 Mn GBP charge in 2013) of the industrial diseases claims provision and 5

Mn GBP of POL separation costs (20 Mn GBP in 2013) associated to facilities

management. However, the value for 2013 also included 20 Mn GBP of asset

impairments (mainly property).

Royal Mail returned to profitability before being privatised, and since then, has

maintained earnings at a stable level.

In addition, also as a consequence of the increase in Royal Mail’s revenues driven by

the charge in stamp prices, the Return on Assets (ROA) of the company became

positive. The profitability has remained positive in the period after the IPO although

the ROA decreased.

Figure 3 Profitability profile of Royal Mail, 2010 – 2017

Source: KPMG elaborations on Royal Mail annual reports and information provider database. n.a. = not applicable (a) In order to avoid issues exchange rate effects, which can affect trends and values reported, values are

reported in local currency (i.e. GBP). (b) The ROA has been calculated as the ratio between the Adjusted Earnings before taxes and the total

assets of Royal Mail.

Efficiency

The cost structure of Royal Mail Group is made up of a high proportion of fixed costs.

Due to this fact, a small change in Royal Mail’s revenues can have a large impact on

profit because of the high proportion of fixed costs. Royal Mail employs a large

workforce totalling 167,000, of which 150,000 provide mail and parcel collection and

delivery services throughout the UK. Royal Mail has made substantial progress in

automating the letters business.

As a consequence, the increase of revenues by 5.9% in the financial year 2013 (which

allowed Royal Mail Group to report a profit), compared to the mild increase in the

operating cost (+2.5%) resulted in a big increase in the EBITDA as well as in the

EBITDA Margin.

In relation to the cost structure of the company, Royal Mail has made several attempts

to reduce its operating costs. Looking at the operating costs as a percentage of the

operating revenues as a measure of efficiency, the privatisation has had no significant

impact on this measure of efficiency. Specifically, labour costs have been stable (if not

slightly growing) in the period after the privatisation, while distribution and

conveyance costs, as percentage of operating costs, have increased. It should be

noted that labour costs are heavily dependant on the relative bargaining position of

10,000

8,800

9,600

8,400

0

9,200

03/11 -03/12

03/13 -03/14

03/14 -03/15

03/16 -03/17

9,357

03/10 -03/11

8,5478,415

03/15 -03/16

9,328

03/09 -03/10

9,279

8,764

03/12 -03/13

9,776

9,251+3%

+2%

IPO

CAGR'10 – '13

CAGR'15 – '17

Mn GBP

Operating revenues

-320

-552

-104

600

1,280

328248 273

-1,000

-500

0

500

1,000

1,500

03/10 -03/11

03/09 -03/10

03/13 -03/14

03/11 -03/12

03/14 -03/15

03/12 -03/13

03/15 -03/16

03/16 -03/17

n.a.-9%

IPO

CAGR'10 – '13

CAGR'15 – '17

Mn GBP

Net income

-20.0

-268.0

-70.0

517.0552.0

491.0427.0

478.0

-400

-200

0

200

400

600

03/14 -03/15

03/09 -03/10

03/16 -03/17

03/10 -03/11

03/13 -03/14

03/11 -03/12

03/12 -03/13

03/15 -03/16

n.a.

-1%

IPO

CAGR'10 – '13

CAGR'15 – '17Mn GBP

Adjusted Earnings before taxes

-0.3

-7.4

-1.8

11.210.1

6.85.6 5.7

-10

-5

0

5

10

15

03/12 -03/13

03/15 -03/16

03/09 -03/10

03/14 -03/15

03/10 -03/11

03/16 -03/17

03/11 -03/12

03/13 -03/14

n.a. -8%

IPO

CAGR'10 – '13

CAGR'15 – '17

%

ROA adjusted

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the CWU, the main union that most postal delivery workers belong to. It had been

hoped by the UK government that a privatised Royal Mail, with greater investor

scrutiny, might be better able to stand up to the CWU in wage negotiations, although

this does not appear to be the case in practice.

Figure 4 Efficiency profile of Royal Mail, 2010 – 2017

Source: KPMG elaborations on Royal Mail annual reports and information provider database. n.a. = not applicable

Solvency

The Royal Mail pension scheme had historically been a defined benefit scheme that

pays employees a certain pre-determined portion of their final salary every year for

the rest of their lives. However, this approach, which was common in the UK at the

time amongst state-owned entities, had become too expensive to run, due to

increasing longevity expectations and historically low interest rates, both of which

increased the estimated cost of pension obligations.

As a consequence, in 2010 Royal Mail suggested a pension deficit repair plan that

would pay back the deficit over 38 years and in 2011 had to pay 300 Mn GBP in deficit

repair payments, despite the company’s trading loss. In order to improve the solvency

situation of Royal Mail and to make the company more attractive for private investors,

the government decided to assume responsibility for Royal Mail’s historical pension

deficit on April 2012, by transferring around 28 Bn GBP of assets and approximately

£40bn of estimated liabilities to a new government pension scheme.

This operation, together with the impact of the entrance of private investors in the

equity of Royal Mail, has led to a drop in the Debt to Equity Ratio (D/E)17 and to a

parallel rise in the Solvency Ratio18. It should be noted that, up to privatisation, Royal

Mail was effectively a government agency, and any losses and solvency issues were

underwritten by the UK government.

Figure 5 Solvency profile of Royal Mail, 2010 – 2017

17 Debt-to-Equity ratio: Non current Liabilities/ Shareholders’ funds. 18 Solvency Ratio: Equity/Total Assets.

6.4 6.2 6.4

9.38.8

7.7

6.56.9

0

2

4

6

8

10

03/14 -03/15

03/13 -03/14

03/09 -03/10

03/10 -03/11

03/12 -03/13

03/11 -03/12

03/15 -03/16

03/16 -03/17

+14%-5%

IPO

CAGR'10 – '13 CAGR

'15 – '17

%

EBITDA Margin

105.1 106.2

95.7 92.1 92.2 92.1 92.0 92.7

0

20

40

60

80

100

120

03/11 -03/12

03/14 -03/15

03/13 -03/14

03/09 -03/10

03/10 -03/11

03/16 -03/17

03/12 -03/13

03/15 -03/16

-4%0%

CAGR'10 – '13 CAGR

'15 – '17%

Operating cost as % of operatingrevenues

IPO

67.2 67.9

56.1 54.750.9 51.3

56.2 54.8

0

10

20

30

40

50

60

70

03/09 -03/10

03/12 -03/13

03/10 -03/11

03/11 -03/12

03/13 -03/14

03/14 -03/15

03/15 -03/16

03/16 -03/17

-7%

+3%

IPO

CAGR'10 – '13 CAGR

'15 – '17%

Cost of employees as % of operating revenues

18.519.2

20.019.1 19.2 18.9 18.8

21.5

0

4

8

12

16

20

24

03/16 -03/17

03/11 -03/12

03/09 -03/10

03/10 -03/11

03/12 -03/13

03/13 -03/14

03/14 -03/15

03/15 -03/16

+1% +7%

IPO

CAGR'10 – '13

CAGR'15 – '17%

Distribution and conveyancecosts as % of operating revenues

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

12

Source: KPMG elaborations on Royal Mail annual reports and information provider database. n.a. = not applicable (a) In order to avoid issues possibily related to an “exchange rate effect”, which can affect trends and values

reported, values are reported in local currency (i.e. GBP). (b) The Equity of Royal Mail is negative over the first three financial years. Therefore, the calculation of the

Debt to ratio and the Solvency ratio asset based is not applicable for these years.

4.2. Impacts on public finance

One of the conclusions of the Hooper report was that the financial sustainability of the

universal postal service was in doubt if Royal Mail had continued as a nationalised

company, with price regulation based on an RPI-X formula. Such a situation would

have continued to deliver financial losses, underwritten by the UK government, and

therefore at the whim of a change of political direction.

In this final section, we tentatively address one of the most important issue in state

asset management, i.e. the impact of the privatisation of the target company on the

country’s public finances. The proceeds generated in “cash” from the privatisation of

Royal Mail amounted to 3,321 Mn GBP, of which 1,980 Mn GBP was via the IPO in

2013 and 1,341 Mn GBP was in the following rounds. The government, through its

decision to give a 12% stake of Royal Mail to its employees (worth about 400 Mn

GBP), reduced the potential earnings due to the operation but it also made it easier to

persuade Royal Mail’s highly-unionised workforce that the privatisation process would

be of benefit to them.

Dividends

The impacts of the privatisation can also be analysed in term of the lack of dividends

the British government would have received if it had not sold Royal Mail. In fact, the

company paid dividends to the exchequer only in the two years before the full

privatisation (i.e. 2014 and 2015). These amounted to 103 Mn GBP and were

significantly lower than the “lost” on future dividends from the profits of the company

(i.e. 690 Mn GBP in the 2013-2017 time period) that would be paid to the government

in the case of no-privatisation, as shown in Figure 6 below.

“Dividends not received due to privatisation” in the figure below refers to the

dividends paid by Royal Mail to its shareholders that, due to the different privatisation

rounds, were not paid to the state. It is worth noting that the amount of potential

dividends to be paid to shareholders by the company is in any case connected to the

company’s performance. Due to this reason, we do not know what the dividends paid

by Royal Mail would be in the absence of privatisation.

12,174

7,602

6,352

3,211 3,075 3,183 3,133 3,336

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

03/15 -03/16

03/14 -03/15

03/09 -03/10

03/10 -03/11

03/11 -03/12

03/13 -03/14

03/12 -03/13

03/16 -03/17

-36%

+2%

IPO

CAGR'10 – '13

CAGR'15 – '17

Mn GBP

Total debt

-6,281

-3,994

-2,455

1,4052,401

3,9964,467

4,998

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

03/16 -03/17

03/09 -03/10

03/11 -03/12

03/15 -03/16

03/10 -03/11

03/14 -03/15

03/13 -03/14

03/12 -03/13

+12%CAGR'10 – '13

CAGR'15 – '17

Mn GBP

Equity

n.a.

IPO

2.3

1.3

0.80.7 0.7

0.0

0.5

1.0

1.5

2.0

2.5

03/14 -03/15

03/09 -03/10

03/12 -03/13

03/10 -03/11

03/11 -03/12

03/13 -03/14

03/16 -03/17

03/15 -03/16

-9%

CAGR'15 – '17

Debt to equity ratio

IPO

30.4

43.8

55.758.8 60.0

0

20

40

60

80

03/09 -03/10

03/10 -03/11

03/14 -03/15

03/11 -03/12

03/16 -03/17

03/15 -03/16

03/13 -03/14

03/12 -03/13

+4%

CAGR'15 – '17

Solvency ratio asset based

IPO

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

13

Figure 6 Dividends received by the British government after the privatisation, 2010 -

2017

Source: KPMG elaborations on Royal Mail annual reports and information provider database. (a) In order to avoid issues possibily related to an “exchange rate effect”, which can affect trends and values

reported, values are reported in local currency (i.e. GBP). (b) Please note that, for the sake of completeness, year from 2010 to 2013 are reported in the chart,

although Royal Mails did not distribute dividends in those years.

Pension transfer

A major impact linked to the privatisation was in relation to the British government’s

taking over of Royal Mail’s historical pension assets and liabilities, the transfer of

which to HM Treasury was made to allow Royal Mail greater access to private capital.

In order to improve the solvency situation of Royal Mail and to make the company

more attractive for private investors, the government decided to assume ownership of

Royal Mail’s pension deficit (an estimated 37.4 Bn GBP of liabilities and 28.8 Bn GBP of

assets, representing an estimated deficit of 8.6 Bn GBP) in April 2012, with a

consequent increase in unfunded government pension liabilities. Proceeds from the

privatisation (3,321 Mn GBP) were considerably lower than the estimated value

associated with the pension deficit transferred to the government.

Government debt

While in public ownership, Royal Mail had borrowed money from the government on

commercial terms to cover cash shortfalls and to modernise its operations. In June

2013, the company had nearly 1 Bn GBP in outstanding government debt, at an

average interest rate of 8.8 per cent, far higher than commercial rates of interest. In

September 2013, Royal Mail signed an agreement for 1.4 Bn GBP of new bank debt

and borrowing facilities which were available upon listing in October. Royal Mail used

existing cash and its new debt to repay government borrowing19.

Others

It is also necessary to consider that the privatisation has reduced taxpayers’ risk in

supporting the universal postal service. Private capital has created an equity buffer to

protect taxpayers; in addition, Ofcom could intervene in case of potential threat of the

universal service or in case the company fails to meet service standards.

4.3. Other impacts

The privatisation of Royal Mail, a company providing services to UK citizens (i.e.

consumers), has also had an impact on customers and employees involved in the

corporate and ownership transformation. First of all a privatisation or a nationalisation

of a company providing a universal service (such as the postal one) generally might

have the effect of increasing or lowering the price of the services/products provided to

19 Department for Business, Innovation & Skills (2014). The Privatisation of Royal Mail. Available at: https://www.nao.org.uk/wp-content/uploads/2014/04/The-privatisation-of-royal-mail.pdf [Accessed 11th January 2018].

40

63

93

147

221229

0

20

40

60

80

100

120

140

160

180

200

220

240

2012 201520132011 2014 20162010 2017

Dividends received Dividends not received due to privatisation

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

14

citizens as well as, potentially, modified the quality of those services/products. In

addition, a privatisation or nationalisation might also have an impact on the number of

employees of the target company.

Customer–oriented indicators

Royal Mail has obligations to ensure that it complies with minimum standards of

universal postal services across the UK, as laid out in the Postal Services Act 2011. For

this reason, the quality of service continues to be high, with the company meeting its

regulatory target of 93% of first class retail products delivered by the next working

day, even after the privatisation took place. As the key performance indicators on the

quality of service included in Table 2 shows, the IPO has not had a significant impact

on the quality of service provided by Royal Mail.

Table 2 Key performance indicators on the quality of service provided by Royal Mail,

2012 – 2017

Source: KPMG elaborations on Royal Mail annual reports. (a) The “mean business customer satisfaction” indicator has been calculated by Royal Mail from the results

of the customer satisfaction survey completed by business customers. (b) It is an independent, audited measure of quality of service for “first class retail products” delivered by

the next working day. (c) It is an independent, audited measure of quality of service for “second class retail products” delivered

within three days of posting. (1) The above-mentioned EN 13850:2012 standard must be applied not later than 2013, so measures about

the quality of Royal Mail service are available from the financial years 03/2011-03/2012.

As for the prices for services provided to customers, they rose significantly during the

period 2012 – 2013 (pre-privatisation), remaing quite stable in the post privatisation

period (from 2014 on). In detail, in the period before the privatisation, the price of

stamps has gone up as part of the commercial freedoms afforded to Royal Mail, but

not to unaffordable levels.

Workforce

Royal Mail Group’s number of employees has shown a fluctuating trend since 2010,

with no relevant variations post privatisation. Indeed, prior to the privatisation the

number of employees dropped (- 8.1% between 2012 and 2013), rising again the

following year (+3% between 2013 and 2014); and then dropping once again post

privatisation (-3.8%). Overall, since 2014, employment has been reasonably stable;

we cannot therefore conclude that the privatisation of Royal Mail had a significant

effect on employment or retention policy.

Figure 7 Evolution in the number of employees of Royal Mail, 2010 – 2017

Source: KPMG elaborations on Royal Mail annual reports.

Data in % 03/11 - 03/12 03/12 - 03/13 03/13 - 03/14 03/14 - 03/15 03/15 - 03/16 03/16 - 03/17

Mean business customer satisfaction(a)

70 74 75 76 76 78

First Class Retail Quality of Service(b)

92.7 92.5 93.3 93.1 92.6 93.2

Second Class Retail Quality of Service(c)

98.7 98.7 98.9 98.9 98.5 98.9

185,602 180,384 176,242162,000 166,813 160,518 161,396 161,136

03/09 -03/10

03/10 -03/11

03/12 -03/13

03/11 -03/12

03/16 -03/17

03/13 -03/14

03/14 -03/15

03/15 -03/16

-4.4%

+0.2%

IPO

CAGR'10 – '13

CAGR'15 – '17

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

15

Table 3 provides a synthesis of the major impacts identified above. The results are

presented by means of a RAGS (i.e. Red; Amber; Green; Silver) classification. In

detail: “Red” stands for a negative impact, “Amber” for no clear patterns for the

impacts, “Green” stands for a positive impact/s and “Silver” stands for no data

available for the analysis. As already mentioned, this analysis is only based on the

comparison between trends and performances registered by both the company and

the country before and after the operation (IPO, regulatory reform and transfer of

pension branch) took place. In fact, it is difficult (as well as beyond the scope of this

case study) to track back impacts created by the counterfactual event of no

privatisation of Royal Mail for comparing them to the real event (full privatisation).

Table 3 Summary table of potential impacts

Summary of potential impacts

Impacts on the target company

Market positioning

Scoring

A

Royal Mail Group’s market share in the

domestic market has remained high

independently from the privatisation: in the

letter market it still collects 96% of revenues

and in the parcels sectors it collects around

31% of UK domestic revenues. Therefore it

is very difficult to assess the impact of

privatisation on Royal Mail positioning.

Profitability

Scoring

G

The changes in the regulatory framework

(since 2011), which led to the privatisation,

had a strong impact on Royal Mail’s

profitability. It allowed the company to

report profits for the first time in 2013.

These earnings have been roughly stable and

positive also over the three-year period after

the IPO.

Efficiency

Scoring

A

The cost structure is made up of a high

proportion of fixed costs; we cannot

therefore conclude that the privatisation of

Royal Mail has had a significant effect on the

efficiency of the company.

Solvency

Scoring

G

The operations undertaken by the

government and Royal Mail itself in order to

make the company more attractive for

private investors allowed Royal Mail to

improve its solvency situation.

Impacts on public finance

Fiscal impacts Scoring

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

16

Summary of potential impacts

A

In the face of immediate proceeds from the

transaction, the government has to face the

lack of dividends from the company and the

payment of interests on the pension debt

contracted to improve the solvency situation

of Royal Mail.

The government’s measures implied a higher

debt for the government itself; nevertheless,

they also reduced the taxpayers’ risk of

supporting the UK universal postal service.

Private capital has created an equity buffer

to protect the taxpayers.

Other impacts

Impacts on

customers/clients

Scoring

A

Given the legal obligation of Royal Mail as

USO provider in the UK, the quality of the

services provided to its customers has

remained stable after the privatisation.

Similarly, also the prices of products sold

(i.e. stamps) did not seem to have been

affected by the privatisation. Infact the price

of stamps has gone up as part of the

commercial freedoms afforded to Royal Mail,

but not to unaffordable levels.

Impacts on Royal

Mail’s workforce

Scoring

A

Overall, since 2004 Royal Mail’s workforce

has been pretty stable; the power of the

CWU Union gave employees 12% of the

shares of Royal Mail and low levels of

redundancies. we cannot therefore conclude

that the privatisation of Royal Mail has had a

significant effect on employment or retention

policy.

Source: KPMG elaborations

5. CONCLUSIONS AND LESSONS LEARNT

This case study represents an example of a publicly-owned company operating in a

historically monopolistic sector (the postal sector) privatised through an Initial Public

Offering (IPO). The main selected conclusions and lessons learnt could be summarised

as follows:

the pre-privatisation work carried out by the government in order to make the

privatisation viable had relevant, positive impacts on the sustainability of the

target company (i.e. significant improvements in terms of profitability and

solvency, also thanks to other measures adopted by the UK government before

R

Legend

= Negative impact GA = No clear pattern = Positive impact S = No data available

Study on State asset management in the EU – Pillar 4

Privatisation - Royal Mail

17

privatisation). Royal Mail is now a profitable, sustainable business with much

improved cash flow;

the decision of giving part of Royal Mail’s shareholding to its own employees

(overall, 12% of the total amount of disposable shares, worth about £400 Mn)

has implied an indirect cost for the government, because of the subsequent

loss of potential earnings from private investors. Neverthless, it potentially

increased employees’ loyalty to the company, as well as trust to the

government;

the government’s interventions had public finance costs, mainly related to the

government decision to assume public ownership of Royal Mail’s pension deficit.

On the other hand, the intervention has improved the economic situation of

Royal Mail and speeded up the privatisation process and also reduced

taxpayers’ risk from supporting universal postal services;

going for a privatisation process through an IPO structured in different steps

allowed the government to have greater flexibility in its strategy. Indeed, by

having differents slots of shares to be placed in the London Stock Exchange “as

necessary”, the state could decide to place a small amount of shares at a lower

price for sounding the market, and then eventually decide to change its own

strategy by increasing the price per share for the next rounds or to postpone

them;

following the privatisation, Royal Mail’s share price rose (with a peak of +87%

six month after the IPO). In the five months following the privatisation, it

traded in the range of 455 pence to 615 pence (between 5.9 EUR and 7.9

EUR). The value of Royal Mail has remained relatively high since then: as of

end January 2018 it had a market cap of 4.7 Bn GBP (around 5.3 Bn EUR) and

the share has a current value (maximum) of 470 pence (5.4 EUR)20.

20 Exchange rate 1 GBP: 1.13 EUR [22nd January 2018].