Most companies with big final-salary pension schemes are being forced to dig deep into profits to keep their pension funds properly funded, but few face the catastrophic liability Royal Mail is having to come to terms with.
After taking a 13-year contributions holiday, the company was last year forced to start contributing again with a bang, when some £300m was sunk into the fund. If trustees get their way, this will rise to £440m this year and £550m the year after. Yet even that won't be sufficient to deal with an actuarial deficit which at the last count had grown to £2.5bn. The trustees are demanding that thereafter, Royal Mail contributes at the rate of an astonishing £800m a year into the almost indefinite future.
Where on earth is Royal Mail going to find the money? Where indeed. The company proudly announced a return to profit yesterday for the first half of this year. With big cost cuts still in the pipeline, it is confident of further improvement. Even so, you don't need a calculator to figure out that profits will need to rise almost exponentially from here on in to fund the size of the pension liabilities just admitted to, this at a time when the company is still struggling to meet its targets on quality of service and faces an onslaught of new competition.
The Government has stated firmly that it has no intention of privatising the Post Office, which is just as well, for one look at the black hole in the pension fund shows beyond doubt that it wouldn't be able to even if it had wanted to. Nor does it look as if there is any prospect of a return to dividends for the Government. Even in its peak year of profitability back in 1998/9, Royal Mail made only £608m, and that was when it wasn't contributing anything to the pension fund at all.
Still, no matter, Royal Mail has one of the few final-salary pension schemes that remains open to new members, the reason for which is that the Post Office is still in the public sector. If Royal Mail cannot cover the deficit, then the taxpayer will pick up the tab instead. Members of the collapsed Turner & Newall pension fund can only look on and cry.
Ofcom's "strategic review of telecommunications" is a big but otherwise unimpressive document which fails properly to answer the question of why there is such limited competition in the telecommunications market.
In rejecting the case for a structural separation of British Telecom into its wholesale and retail arms, the telecoms regulator argues that exactly the same effect can be achieved by making sure that BT offers "real equality of access" to its competitors. Furthermore, it should be achieved via this route more quickly, with less disruption, and at smaller cost. Ofcom reckons that this will require big behavioural changes within BT, and warns that if the response is inadequate, then it will refer the company to the Competition Commission.
Yet the real reason competition has been so slow to take off in the UK market is not so much that BT denies competitors equal access to its networks as that it has been and remains impossible to make a decent rate of return out of new investment in fixed-line telephony. Most of those that have tried have ended up losing their shirts. The huge overinvestment of the late 1990s has yet to work its way out of the system. Nothing Ofcom does is going to make it profitable.
The situation remains little better today with "local loop unbundling", which allows competitors to put their own equipment in BT exchanges. Most such competition is being concentrated on exchanges with the greatest potential for broadband subscribers, with the result that there is already in some exchanges too much capacity chasing too small a pool of business.
Waving a magic wand which says "equal access" isn't going to solve this problem. Nor is it going to be at all easy to police. BT is a past master at running rings round the regulator, at juggling the figures so as to better defend market position and margin. Equal access means nothing if it is set at a level which makes it impossible for all retailers to earn a return. It seems to me also inevitable that BT will continue to favour its own retail operation over others in terms of information sharing and priority of investment, however many "behavioural" reforms are introduced.
In other industries, regulation designed to remove the scope for discrimination has tended of its own accord to lead to structural separation. The costs of compliance come to outweigh the benefits of vertical integration. Ofcom reckons this won't be the case with BT, which it accepts should remain an integrated single company. Yet there is no numerical analysis in the document to back up this assertion.
Such is the pace of technological change in telecommunications that most predictions end up as tomorrow's chip paper, but my hunch is that equal access won't work, and that eventually BT will end up separated.
Flush with cash
National grid Transco is another of those companies making more money than it knows what to do with. Already strong, free cash flow is being further bolstered by the company's decision to sell off parts of its local gas distribution network, adding a further £6bn to its coffers. Roger Urwin, the chief executive, makes a good case for being allowed to reinvest at least a part of this money in US expansion. Unlike most British companies that go shopping in the US, he's so far achieved an impressive track record. All the electricity distribution companies he's bought are growing strongly with the opportunity for generating further improvements in return on capital.
Yet in these markets, even Mr Urwin couldn't get away with reinvesting the whole lot, so in short order there is to be a £2bn capital distribution. The dividend is also being jacked up - by 20 per cent this year with the promise of 7 per cent a year growth thereafter. If the free cash flow keeps growing as anticipated, the company will face calls from shareholders for even more cash back.
Capital return is very much the investment mantra of the moment. Across the industrial waterfront, from Vodafone to British Telecom, and from BP to GlaxoSmithKline, companies are choosing to pay back free cash flow to shareholders rather than reinvest it in the business. The hurdle that managements must jump in convincing investors that capital should be left in the business, or be spent pursuing acquisitions, is much higher than it used to be.
National Grid has chosen the capital distribution route. Most companies use buy-backs, which so far this year are running at record levels, in Britain and Europe more generally. The underlying story is that there has been a big recovery in corporate profits from the lows they sunk to three years ago, but so far managements have found little they want to spend their refound wealth on. Despite the shake-out of the last business downturn, and strong economic growth since then, global overcapacity remains rife across a wide range of industries.
All of which helps explain the apparent "wall of cash" which is building up in investment institutions across the world. Bigger dividends and buy-back programmes inevitably mean investors have more money to plough back into stock markets. The "wall of cash" may in turn help explain the strong rally we've seen in the stock markets these past three months. Ironically, then, the money companies are paying back to their shareholders because they cannot find a sensible use for it in their own businesses may be finding its way back into their equity capital, creating a virtuous circle of rising share prices.
The UK market has suffered more than most over the past five years because of structural selling by life assurers and pension funds. What in the past has been one of the biggest sources of support for the London stock market has been removed in an enforced switch out of equities and into bonds. I'm not yet convinced that process has come to an end. Maturing final-salary pension funds are still on the whole net sellers of UK equities. Yet the phenomenon may now be past its high watermark and, if that's the case, then perhaps this time the stock market rally might be sustained.Reuse content