FG’s plan to recapitalise DisCos has corporate governance concerns

With shortfalls in the electricity market at over N1 trillion, the need to rescue the electricity sector has never been more acute. The challenge however is that the distribution companies (DisCos), who collect on behalf of everyone else in the value chain, are inefficient.

This is why the Federal Government has been considering options to recapitalise the DisCos, who are veering dangerously close to bankruptcy. The challenge is ‘no option appears without pitfalls.’

For the past two months, the Federal Government has been considering raising its stakes in the DisCos to 60 percent from the current 40 percent to which it hopes to offer to interested investors, since it cannot own a majority shares in the DisCos after privatisation.

But that plan was scuttled after government was unsuccessful in appointing two non-executive directors on the board of the DisCos, who could push the plan. The DisCos argued that the move was illegal as the volume of shares held on behalf of government by the Bureau of Public Enterprise (BPE) and the Ministry of Finance (MOFI) do not empower it to appoint new directors without recourse to shareholders.

The shareholders agreement also said that the number of directors in the Disco shall be no more than seven; the investors will nominate six directors, while BPE and MOFI shall nominate one.

The DisCos may tolerate incompetent engineers, owe everyone else in the value chain, but they don’t economise on their lawyers.

The government soon shelved the plans. However, the Power Sector Recovery Programme (PSRP) recommends recapitalisation of the DisCos as a measure to put the power sector on the path of financial viability.

It suggested using the Central Bank of Nigeria to facilitate renegotiation of the shareholder loans outstanding and redenomination of the loans from dollars to naira in line with the DisCos revenue profile.

Another option is the potential dilution of both the Federal Government’s and privately held stakes, which will help bring some stability to DisCos balance sheet. The government has not initiated a discussion on diluting its own shares.

Meanwhile, the troubled balance sheet of the DisCos may stall either option. Abuja Electric, Port Harcourt DisCo and Enugu DisCos are struggling to keep a healthy balance sheet. Yola DisCo has been relinquished to the government by the core investors.

BusinessDay’s examination of the financial statements of seven DisCos in February indicates reported losses of over N196.23 billion to end the 2016 financial year.

Analysts have urged government to dilute the shares of the core investors in the DisCos using the funding clause in their performance agreement as a way of resolving the current shortfalls in the electricity market.

“The Federal Government should rely on the funding clause in the Shareholders Agreement, which allows the BPE as a 40 percent shareholder in the DisCos to inject capital into the DisCos in the event that there is a requirement for further funding, which the core investor is unable to provide. The clause allows the BPE to dilute Core Investors equity in the DisCo by such funding,” Wesley Omonfoman, CEO of New Hampshire Capital Investments Limited, an energy-consulting firm, told BusinessDay last year.

“The dilution mechanism leverages on the huge liabilities of the DisCos to the Nigerian Bulk Electricity Trader and the Market Operator. In simple terms, the mechanism for dilution is for the BPE, acting for the Federal Government, to guarantee the DisCos obligations to NBET (under the vesting contracts) and the CBN (under the N213bn NEMSF and the N701bn power sector payment assurance guarantee).

“Where DisCos fail to meet their payment obligations to NBET and the CBN, NBET should call the BPE guarantee. Then the BPE should then converts the called portion of the guarantee to shareholders funding for DisCos and dilute the core investors.”

However for this move to succeed, the Federal Government has to buy out the DisCo debt as equity, ensure that electricity tariff are market-based, and help DisCos get returns on their investments on these assets. The action would also need to be in line with the Put/Call agreement government signed with the DisCos.

Worse still, investors are not exactly beating a path to the doorsteps of the DisCos. Wolemi Esan, energy and infrastructure lawyer and partner at the law firm of Olaniwun Ajayi, said “If the proposal is about voluntary divestment, the first challenge is that it assumes that the core investors are permitted to sell down as they desire, while in reality, under the terms of the privatization, the core-investors can only sell substantial parts of their shares with the prior consent of the Bureau of Public Enterprise (BPE).

“Even if the BPE grants the core investors a dispensation to dispose of a significant part of their stake, the divestment proposal further assumes that there is a universe of investors that are eager to invest in the distribution companies. This is not consistent with what we see in the market. First, one must bear in mind that conditions prevailing during the 2012 privatization process when the investors stayed away have actually worsened.

“It is therefore unclear why we seem to think that the investors would be willing to invest under worse operating conditions. The investor apathy to the Nigerian power sector is typified by the NIPP assets, which the government has been trying to sell for the last two years without success. Preferred bidders were announced about 2 years ago, but the transactions have not closed as yet,” said Esan.

This is why the current plan by the government is even more curious. The Ministry of Power Works and Housing last week issued advertorial for the purchase some low voltage substation equipment for the DisCos. The Ministry will pay for them as the DisCos cannot afford them and use it as part of their equity to ask the DisCos to match the same amount.

“They have advertise for supply of various substation equipment for power distribution network, FG will bring it as part of its capital in each of the DisCos and say I am bringing in this equipment valued at lets say $50m per DisCo. Since you have 60% of the company, bring 60 percent cost of the same value, in corporate law is calling of additional of shareholder fund, if they can’t meet it, they will dilute their shares,” Nwani explained.

The concern however, is that, the DisCos will challenge this move in court based on the fact that it runs counter to corporate governance rules.

“This is unconventional, it is usually the board members of the companies who push this kind of idea, you cannot impose it on them, it will be against the corporate governance and if challenged in court, it might be thrown away,” he said.

While the DisCos inefficiency is no longer news, the role of the regulator in this instance is to enforce market rules and run a market based electricity sector. But these are not the arguments most governments will entertain in an election year, not the least one where you need to look really hard for concrete achievements.