P&O is undervalued but not a tempting target

COMMENT

After Forte, P&O? The parallels are obvious. Even after their recent run, P&O shares, like those of Forte before the Granada bid, trade at a substantial discount to underlying assets. Nor are profits at P&O anywhere near their potential; making the assets sweat is apparently what the Carol Galleys of this world expect of company directors these days.

At P&O it is simply not happening. And although P&O is plainly not quite the business dynasty that Forte was, it comes close. Lord Sterling of Plaistow has been at the helm for donkeys years; some accuse him of falling asleep at the wheel.

So is P&O heading the same way as Forte, into the arms of an asset-stripping predator? Post Forte, the idea of the break-up bid is suddenly respectable once more, in the City at least. With its dozen or so unrelated divisions, P&O might seem a classic for the treatment; it is easily possible to get to a break-up value of pounds 7 a share so even after the recent ride - up another 13p yesterday to 542p - there is still plenty to go for.

However, there are a number of reasons why the present wave of speculation is probably wide of the mark. For a start P&O is an awfully large bite for anyone; the likely takeout would be anything up to pounds 4bn. On top of that, the bidder inherits a mountain of debt. Furthermore, the break-up effort required would make P&O distinctly unappealing to any industrial bidder. In the Forte case, the disposal programme faced by Granada is large but containable, in the sense that it could be achieved in just two or three sales. With P&O, there would be division after division to sell, all for the sake of the one or two businesses that the bidder really wants.

This wouldn't rule out a break-up specialist such as KKR, of course, but whether the Americans would have the stomach for an assault of such size on British soil must be open to question. The stock market has always found it hard to value conglomerates, even those like P&O that claim to have some kind of common thread to unite their disparate businesses. P&O is also in some highly unfashionable, downtrodden industries.

Even the most inspired of managements would find it hard to sparkle in cross-Channel ferries, construction and house-building. As it is, P&O is probably as effective as most. Its under-performance is also in part a reflection of the fact that it invests heavily for the future - an old fashioned concept this.

There is a time for making the assets sweat, but also in business, a time when managements must look to the future and invest in it; that at least is what an increasingly worried P&O management has been telling the City. In the past three or four months it has visited more institutional shareholders than in the previous three or four years. The message is that the dividend is safe and that the business will soon be reaping the rewards of heavy spending and caring management. If, in the meantime, bid speculation makes investors realise quite how undervalued the company is, nobody is going to quarrel too much with that.

PFI is just another form of never-never

The cross-party Treasury committee concluded its hearings on the Private Finance Initiative this week. It must now begin the more difficult part - deciding what to make of it all. If MPs have any sense, they will expose the PFI for what it really is - a questionable exercise in off-budget financing.

The scale of PFI expansion the Government is seeking is staggering. According to the Treasury, departments expect to have agreed pounds 14bn worth of PFI contracts within the next three years. In its absence, total public sector capital spending would fall drastically, by almost a tenth in real terms, in the next financial year.

No one is in any doubt about the political reason for this helter-skelter rush into these uncharted waters. The Government couldn't make its sums add up for the budget, so something had to give. In time-honoured fashion, that something was public investment. Enter the deus ex machina, the Private Finance Initiative.

A useful advantage for the Government in its now reckless love affair with the PFI is that it is not the only suitor. Indeed, doughty John Prescott, deputy leader of the Labour Party, takes credit for inventing the idea. Industrialists are more guarded in their support, particularly since right now the PFI is not delivering the contracts expected, but if in the end it results in more work than the public sector would have put up for grabs on its own, then they are happy too.

Sometimes this kind of consensus is a Good Thing: think of the new-found bipartisan accord on keeping inflation under control, together with sustaining the institutional changes, in particular those to the Bank of England, that have added credibility to this objective. As often as not, however, a blanket consensus hides a conspiracy of silence, in which the various parties have very different motives in backing a policy.

So it is with the PFI. Labour backs the scheme because it sees it as a way of escaping the tyranny of the public sector borrowing requirement and so boosting public investment. The Conservatives back the initiative because it allows them to cut public investment - while claiming they haven't. Industry sees the PFI as a back-door entry to nice juicy contracts. Everyone loves the PFI then. But who eventually picks up the bill?

Answer: the taxpayer. Except that under the PFI, the bill is pushed into the future. The public sector no longer contracts to buy assets: instead it enters into agreements to purchase services. Not a penny is paid until those services start to be provided, so under the cash-based public accounts, not a penny is shown in the projections of public expenditure until that happens.

The official rationale for the Private Finance Initiative is that this further extension of market disciplines into the public sector stands or falls on value for money. A PFI scheme must satisfy this criterion if it is to go ahead. Top departmental civil servants in their capacity as accounting officers and the National Audit Office can be relied upon to police the new practice.

Despite these protestations, which include claims of substantial savings and better quality services on early deals, serious doubts remain. Whatever the efficiencies the private sector can deliver, it will always face substantially higher borrowing costs than the Government.

A further worry is that departments are locking themselves into long- term, inflexible contracts for services which may become redundant. The public sector may find itself tied into onerous contracts for services that are no longer needed.

But the biggest concern by far is that the PFI is for the Government just another form of the never-never. MPs must insist that the the capital costs of PFI contracts are included in next year's public expenditure figures. Otherwise, claims of spending control compared with previous years will increasingly lose credibility.