Outlook: Rick Haythornthwaite faces a long road ahead

Credit rating blues; Another fine mess
Click to follow
The Independent Online

Rick Haythornthwaite, the new chief executive at Invensys, has stirred the pot and come up with a reasonably credible if unremarkable strategy for this bombed out old dinosaur of the engineering sector. So how come the stock market, which marked the shares down nearly 12 per cent yesterday, reacted so negatively?

One reason is the group's estimate of the value of the businesses it has earmarked for disposal, the industrial components and systems interests. At just £1.5bn, this amounts to only 65 per cent of annual sales for these businesses, which even in today's depressed market conditions amounts to a very poor price indeed. Extrapolating that valuation across to what remains of Invensys after the disposals makes for some worrying reading. Even allowing for the paid down debt, the company would not be worth nearly as much on the stock market as it is today.

Invensys has a history of overpromising and underdelivering, so it is hardly surprising that Mr Haythornthwaite should want to err on the side of caution in estimating how much these businesses might fetch, but even so, investors are right to be nervous. Since Mr Haythornthwaite's appointment was announced, the shares have doubled, which is an awful lot of hope to put in the transforming powers of just one man.

After all the disappointments of the past, Mr Haythornthwaite is naturally keen to talk up the complexity and difficulty of the task he faces. There was a lot of that going on yesterday. The merger of Siebe and BTR that brought Invensys into being was depicted as an ill-conceived and poorly executed mess, and that's just the operational side of the business. The accounting exaggerations are presumably still being worked out of the system.

Even so, Mr Haythornthwaite reckons he can avoid both a rights issue and a breach of banking covenants. As to whether Invensys can survive and prosper again in the long term depends largely on inspired operational management and a revival in the global economy. In his previous incarnation, Mr Haythornthwaite did a great job in dressing Blue Circle up for sale. As things stand, there would be few if any takers for Invensys. Mr Haythornthwaite has a long road ahead of him.

Credit rating blues

Credit rating agencies are modern day Captain Mainwarings; in a world where creditworthiness is more and more governed by the markets, and not the banks, they have taken over the role of the bank manager in helping determine how creditworthy a company or country is, and as a consequence how much they should be required to pay for their borrowings. Not all business and public debt is traded, of course, and banks still lend directly, both to small businesses and larger enterprises, but increasingly even on this lending the banks use the agencies to assess risk and the consequent capital requirements.

On the whole, this is a sound development. The big banks never were much good at banking, witness the disastrous boom to bust of past banking cycles. The markets are better judges of creditworthiness than bank managers, who have often seemed as clueless as Captain Mainwaring himself. However, it is not entirely certain that the same can be said about the rating agencies. There are only three of them of any significance internationally – Moody's, Standard & Poor's and Fitch Ratings – and as such, very substantial power has become concentrated in very few hands, to the growing concern of the governments and companies that have to use them.

Enron has highlighted once again the curiosity of their position. All three get most of their income from the organisations they are required to rate, which in any other business would be seen as an extreme conflict of interest. To make matters worse, all three have been attempting to link fees directly to the benefit their rating produces. In simple terms, that means the agency gets more the better the rating, since the better the rating, the lower the cost of servicing the debt.

Enron's tradable debt was admittedly rated as risky, but no more so than many perfectly solvent organisations. What's more, when the balloon went up, the rating agencies were dissuaded by the investment bankers from downgrading the debt because of the further damage this would do to confidence. The credit rating agencies are reasonably accused of reacting to events, rather than leading them, which rather begs the question of what on earth is the point of them in the first place.

Most finance directors forced to pay good money for a poor rating, would thoroughly agree. The quality of the rating makes a big difference to the cost of debt servicing, and a bit like Third World countries, many companies believe they are unfairly penalised. The obvious solution is that there should be more agencies, producing a more diverse range of ratings and research, but the system conspires against it.

In most cases, international capital markets require one rating from one of the two biggest players – Moody's and Standard and Poor's – and a separate rating from one of the remaining two. Barriers to entry are high, and on the rare occasions when smaller players do establish a market niche, they tend to get swiftly hoovered up by the big three. Credit rating is a cartel of three, and as such it must be inherently unsatisfactory.

With introduction of the euro having given the whole thing fresh impetus, the tradable debt market continues to grow exponentially. The agencies insist that the markets themselves provide all the discipline they require, since they are found out when they repeatedly fail. Many a finance director and finance minister would disagree.

Another fine mess

Stephen Byers can presumably claim simply to have been unlucky over the part privatisation of National Air Traffic Services (Nats). The Civil Aviation Authority warned him the business plan was vulnerable to a catastrophic event, such as an airport disaster or a deep recession, but nobody could have anticipated 11 September. Britain's beleaguered Transport Secretary can be held responsible for many things, but not that.

All the same, the fact that Nats has been forced to go cap in hand to the Government for extra money so soon after being privatised speaks volumes about the flawed nature both of this particular sell-off and large parts of the wider public private partnership initiative. In the case of Railtrack, Mr Byers was happy to appoint administrators, leaving shareholders high and dry. In this case, he seems equally happy to bail the company out.

The difference, Mr Byers would no doubt argue, is that Nats is in trouble through no fault of its own, while at Railtrack there was indisputable evidence of management incompetence. But it is also because Railtrack was a Tory privatisation and Nats was a New Labour one. And the problem with this Government's half-way house approach to privatisation is that it wants the best of both worlds. It wants private sector management and money, but it also wants to maintain direct control so that ministers can interfere and meddle. As Mr Byers is discovering to his cost, the effect is to leave the Government both as the lender of last resort and ultimately responsible when things go wrong.