We hear frequent complaints from state-owned enterprises (SOEs) that they are struggling to meet their debt obligations and need to be recapitalised. Yet they are simply not generating enough return on invested capital (ROIC) to justify allocating more capital to them.
Take Transnet, whose return on invested capital was 1% in 2024, even lower than the miserable ROIC of 1.5% it posted in 2023. The cost of debt on long-term SA government debt is 11%. This is the bare minimum cost of capital Transnet should meet.
When the difference between its return on capital and its opportunity cost is considered Transnet is destroying more than R30bn in economic profit every year. That is a terrible, unaffordable waste.
There are two key value drivers that feed into ROIC: operating margin and asset turns. To improve the operating margin Transnet needs to increase revenue and bring down operating expenses. To meet an 11% cost of capital it must generate R47bn in annual operating profit on its invested capital.
Its profit from operations was R4.3bn in 2024 (operating profit is before interest expenses). Assets need to be run more efficiently or sold to private parties that can do so.
The large SOEs, Eskom and Transnet, among others including the Post Office and trading divisions of most municipalities, have not remotely met the requirement for an investable credit rating. They have not been able to contain their costs well enough to cover their interest bills, let alone their true opportunity cost of capital.
Nor have they properly maintained their plant and equipment. Fundamentally they have failed because the bottom line — an adequate return on invested capital — has had little influence on their behaviour. Without many eye-watering billions of maintenance capex their ability to continue to supply the essential services that are indispensable for economic growth is severely compromised.
The government now recognises that the only practical way to secure the supply of essential services is to attract large investments of private capital, of which there is no shortage provided the terms are acceptable.
It would only be a private company, with a bottom line that requires a risk-adjusted return on capital, that could realistically hope to control costs and preserve and improve the capital stock, to reliably supply essential services in future.
Any imaginary, mythically reformed SOE — capable of containing costs and operating efficiently but without the right private incentives — is not a viable option. We’ve been down this track too many times.
The agreed terms for private sector engagement would have to recognise the true market value of the plant taken over by the new operator of a network, or part of it. Given years of neglect, existing assets might have little value to any new operator. The potential market value could be exchanged for equity held by the government in the new privately controlled suppliers.
The private operator would have to commit the extra capital required to guarantee a flow of essential services over the long run. Such extra capex would have to be recognised in the tariffs for what could be valuable access to the networks.
Complicated calculations or regulations of appropriate charges do not have to be a barrier to private entry. Any private company that won a tender to enter a network with a degree of monopoly power would be conscious of the effect of the prices it could charge on demand, sensitive to degrees of capacity utilisation and so its bottom line.
It would be considerate of its growth prospects. Becoming a reliable supplier at a competitive price with market-related returns would be a valuable outcome for all stakeholders.
The purpose of any private-public partnership or initiative is simple — to secure the future supply of essential services for SA users, without which incomes and output will stagnate or decline. This all-important objective, viewed realistically, must be top of officials’ minds when they engage in any negotiation with potential private partners.
• Kantor is head of the research institute at Investec Wealth & Investment, but writes in his personal capacity. Holland, a former senior adviser at Credit Suisse, is cofounder of Fractal Value Advisors.
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