Speech

Royal Mail – Ensuring long term success

This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

Government intends to give Royal Mail access to the capital and commercial disciplines that it will need to have a sustainable future.

The Rt Hon Sir Michael  Fallon MP

This financial year will be significant in Royal Mail’s history. It has been in public ownership since 1635 as a government department, a public corporation and, as it is now, a publicly owned company.

As I informed Parliament last week, the government, in this financial year, intends to give Royal Mail access to the capital and commercial disciplines that it will need to have a sustainable future in a rapidly changing postal market. We will give it commercial freedom by selling shares in the company.

A thriving Royal Mail allows government to achieve the overarching objective of its postal market reforms – securing the universal postal service. The 6 days-a-week service, at uniform, affordable prices that delivers throughout the UK. A service that is vital to both consumers and businesses and the UK economy.

This evening I will explain how we have reached this point. I will cover:

  • the recent history that showed we needed action
  • what action government has taken so far
  • what is happening in the postal market in the UK and internationally
  • why Parliament decided that a share sale and an employee share scheme are necessary for the long term success of Royal Mail and the universal service
  • where we are on the options and preparations for the sale
  • I will dispel some myths about the impact of the sale

Recent history (Hooper)

The origins of the government’s reforms go back to the middle of the last decade, when mail volumes began to fall in spite of a growing economy. Previously, the two had been closely linked. The overriding reason for this was the increased use of electronic communications to replace letters. Businesses were using other means to reach their customers - the internet and email were cheaper and more immediate.

These developments prompted the Labour Government in 2007 to commission a review of the postal sector - led by Richard Hooper - to look at how the universal service could be maintained.

Richard Hooper’s interim report in May 2008 confirmed that the postal market faced an uncertain future; that there was a substantial threat to Royal Mail’s financial stability; and that the universal service was also under threat. There was a broad consensus that Richard’s analysis demanded action. As he put in it that report – “the status quo was not tenable”.

The full report was published in December 2008 – aptly titled ‘Modernise or Decline’. The three main recommendations were:

  • responsibility for postal regulation should transfer to Ofcom as postal services were part of the wider communications sector now having to compete with electronic communications
  • government should tackle Royal Mail’s historic pension deficit as it placed an enormous financial burden on the company and made it balance sheet insolvent
  • Royal Mail should enter into a strategic partnership with one or more private sector companies to give it commercial confidence, access to capital and corporate experience

The Labour government accepted these recommendations in full and introduced a Bill in Parliament in 2009 to implement them. This permitted a sale of a minority of Royal Mail shares as well as regulatory changes and allowed government to take on Royal Mail’s historic pension deficit.

This Bill passed through the Lords but was dropped in July 2009 because – and I quote Lord Mandelson - market conditions “made it impossible to conclude the process to identify a partner for the Royal Mail on terms that we can be confident would secure value for the taxpayer”.

And that is where the matter rested until the government picked up the baton in 2010. We asked Richard Hooper to update his report. He confirmed that the challenges he identified 2 years earlier remained. There continued to be a need for action to remove the threat to the universal service. He again recommended the need for regulatory change and for government to relieve Royal Mail of its historic pension deficit.

Given changes to the management at Royal Mail, he concluded that Royal Mail no longer needed access to corporate experience through a partnership but reiterated strongly that Royal Mail should have access to private sector capital.

He believed that private sector capital would:

  • ensure that Royal Mail had the cash available when needed to fund accelerated modernisation
  • inject private sector disciplines into the business
  • reduce the risk of political interference in commercial decisions
  • encourage Royal Mail to develop a more customer-focussed commercial strategy and diversification for the digital age

This government acted swiftly. We introduced a Bill in December 2010 to enable implementation of the Hooper recommendations. The Postal Services Act received Royal Assent in June 2011.

What we have done so far

We have not left our powers unused on the statute book.

In October 2011, Ofcom was empowered as the postal regulator with a clear primary duty to ensure the provision of the universal postal service. We underpinned this duty by requiring Ofcom to perform its duty with due regard to the financial sustainability of the universal postal service – and that includes the need for any universal service provider to receive a reasonable commercial rate of return for the provision of the service.

In March 2012, Ofcom set the regulatory regime for the next seven years. This regime gave Royal Mail more competitive freedom. It removed price controls from 1st class stamps while placing a price cap of 55 pence on 2nd class mail. Royal Mail’s unregulated prices will also need to be competitive as it continues to face pressure from other postal operators, especially in the parcels market, and from electronic communications.

The new regulatory regime puts in place the key regulatory regime elements for the next seven years. This stability allows Royal Mail to plan properly, to set prices to reflect its costs and to grow.

Also in March 2012, the government relieved Royal Mail of its historic pension deficit. This required State aid approval and some £37.5 billion of liabilities have now been passed to a new statutory pension scheme. This preserves the benefits for retired employees and the accrued pension rights of current and former employees.

There have been accusations that we had an ulterior motive for taking around £28 billion worth of assets from the pension fund. We have been completely open and transparent about this. We have not made a profit on the deal as we are committed to meeting the costs of the transferred liabilities. The recently published Royal Mail Statutory Pension Scheme estimates show that the cost of the statutory scheme will be around £1.3 billion in 2013 to 2014 alone.

The action that we have taken on regulation and pensions – coupled with Royal Mail’s modernisation programme - has already produced results. Royal Mail is recovering strongly and delivering positive free cash flow in 2011 to 2012 and at the half year for 2012 to 2013. Its core UK letters and parcels business returned a profit of £99 million in the first 6 months of this financial year compared to a £41 million loss a year earlier. Overall, the company made profits of £144 million in the first 6 months of this financial year.

We have also separated Royal Mail and the Post Office. They are distinct businesses and should operate independently. The Post Office has been equipped with an independent Board so that it has the freedom to develop and implement strategies to grow its revenues and to transform its network. Government has provided £1.34 billion for this transformation and the Post Office must maintain 11,500 branches. There will be no closure programme by this government. We want the network to be successful, and to do that it must also modernise and become more efficient. We remain committed to seeing real progress towards the mutualisation of Post Office Ltd by the end of this Parliament.

Future sale

The final phase of our reforms is the sale of Royal Mail shares. This will be the route that will enable future access to private capital.

This is the way to put Royal Mail’s future onto a long-term sustainable basis. Indeed, if you look at Europe you see that leading postal operators – who provide universal postal services in their respective countries - have moved into the private sector. And they have been successful.

For example:

  • Austria Post and Deutsche Post have delivered consistently high mail profitability since their flotations; their profit margins were 22% and 8% in 2011 to 2012 respectively
  • Deutsche Post is perceived as being at the vanguard of digital transition with innovative packets, e-retail and hybrid mail products
  • Bpost (in Belgium) has, since securing private capital in 2006, returned to profitability and has a profit margin of 15.2 %
  • PostNL (in the Netherlands) has delivered sustained high profitability since its privatisation and is now dealing with some of the most difficult postal market conditions in Europe through restructuring
  • Furthermore, levels of service have remained consistently high – for example in 2012, the percentage of letters delivered next day in Germany and Austria was 95% compared to a 93% regulatory target in the UK

Other Member States are considering ownership change – in Spain, Portugal and Scandinavia.

I mention these developments to emphasise that the government’s intention to sell Royal Mail shares is not unique.

Our decision will not be based on ideology. It will be a practical, logical and commercial decision. And very few people now question whether the likes of BT, BP or Rolls Royce should have remained state owned.

The European postal market is now fully liberalised.

It is a commercial market and one that I believe is best served by fully commercial companies with the freedom to operate on a fully commercial basis. This will mean that postal services will be run efficiently and effectively. And that will benefit all postal users and ensure that universal postal services can be maintained.

Access to capital

Royal Mail is one of the largest companies in the UK – employing over 150,000 people with a turnover of £9 billion. A company of this size and importance to the UK economy should be able to access flexible capital.

Royal Mail will need future access to private sector capital so that it can continue to:

  • modernise and become more efficient and competitive
  • innovate and invest and seize opportunities presented by new markets – like the rapid growth of online shopping

It makes no sense for Royal Mail to have to compete for scarce public capital against other services such as schools and hospitals.

Unless Royal Mail has the capability in the future to access equity markets, every £1 that it borrows, is another £1 on the national debt. That means growing the national debt. No responsible party could propose that in the current environment or for that matter in any environment when Royal Mail – run on a fully commercial basis – has the capacity to be cash generative, profitable and perfectly able to raise the capital it needs from the private sector.

Other reasons for a sale

As Richard Hooper said, private capital will bring with it commercial disciplines. It will ensure that the onus is on providing:

  • services that are efficient
  • services that are customer focused
  • services that meet the needs of businesses and social users

This will in turn deliver enhanced profits and cash flows to fund future growth.

A sale of shares will also reduce the possibility of a future government’s interference in the operations of the company.

We want to give the Board the same freedom that other major UK companies have.

Now the time has come for government to step back from Royal Mail and allow its management to focus wholeheartedly on growing the business and planning for the future. This government will give Royal Mail the real commercial freedom that it has needed for a long time.

Decision on a sale

The Postal Services Act 2011 lifted the restrictions on the sale of Royal Mail shares. As we made clear during the passage of the Bill, we did not want to be tied down at that point to a specific type of sale or an artificial deadline. In this way, government could ensure the best value for money for the tax payer.

Since then we have continued to consider carefully the options for a sale. There are variations on themes but the broad options are an Initial Public Offering (IPO) or a private sale. Both of these options remain on the table.

In my update to Parliament last week, I said that we have received positive feedback from investors to date. This is no surprise.

Royal Mail is the UK’s leading parcels business - successfully leveraging its network to meet the needs of a fast growing e-fulfilment sector with Parcelforce complementing this with a highly successful express business.

There is a growth story here. According to the April 2013 Interactive Media in Retail Group Capgemini e-Sales Index, on-line sales increased 16% over a 12 month period. The IMRG estimates that the e-fulfilment market is £76 billion in the UK and cross border sales in Europe are set to reach €36 billion in 2013. In 2011, 64% of consumers receive one of more parcels each month and this trend is continuing. All of this points to a tremendous opportunity for Royal Mail.

Royal Mail’s new strategy is now fully aligned to customer needs, with product innovation only now possible following the removal of the previous regulatory straitjacket.

Royal Mail has grown its revenues, profits and cash and it has a highly successful European parcels business in GLS.

I also said in my update that the government was attracted to an IPO. In the coming months, we will explore this further. There has already been press coverage about government and Royal Mail appointing advisers to take forward a sale. We will soon be issuing a tender for the procurement of a syndicate of banks that, if this is the sale route chosen, will execute a sale of shares. We expect to make initial appointments by the end of May. Royal Mail will also be exploring access to external capital with the debt markets.

I can state categorically that we have no intention of selling off Royal Mail cheaply. We have not publicly speculated on Royal Mail’s value. We will sell shares in Royal Mail at a fair commercial price that represents value for money for the tax payer.

When a decision is made on the type and timing of a sale I will report this to Parliament. Both options for a sale remain on the table.

Employee shares

I would now like to turn to something that is unique in the Royal Mail transaction.

In the Postal Service Act, Parliament decided that employees of Royal Mail should share in its success. The Act requires that at least 10% of Royal Mail shares should be made available to an employee share scheme - this is the largest statutory commitment of any major privatisation.

We are designing a share scheme which will give postmen and women throughout the country a chance to own shares in Royal Mail. I have regular meetings with the CWU and I have been encouraging them to engage with us on the structure and terms of the employee share scheme.

I strongly believe that employees should share in the company’s future success and dividends. I urge the CWU to put ideology aside and take up that invitation so that their members do not lose out. As the recent Nuttall Review on employer ownership shows, employee-owned or part-owned businesses have greater economic strength, a happier workforce, and higher profitability.

We want to make sure that the scheme is as attractive as possible and are considering options for the employee share scheme but no decisions have been made as to the shape of the scheme which will, of course, depend on the kind of overall sale process that we undertake.

Royal Mail employees spend their working lives making the post run on time, delivering to far flung parts of the country from Lands End to John O’Groats, and they are absolutely central to the future success of the company.

People should be in no doubt, whether the shares are discounted, or free, it is a hugely significant commitment from the government to Royal Mail’s workers and I am determined to do the right deal for them.

The number of employees who will potentially benefit from a scheme will be the largest for 25 years.

It is our intention to have such a scheme in place at the time that we conduct a sale of Royal Mail shares.

Myths

Before I close I would like to dispel some myths that are circulating about the sale of Royal Mail shares.

A change of ownership in Royal Mail will not mean that Royal Mail can stop delivering to rural areas. Royal Mail will remain the UK’s designated universal postal service provider and must continue to provide a six days a week service throughout the UK.

Ownership change will not mean that Royal Mail will no longer provide free services for the blind. Royal Mail has to provide these services which are enshrined in the Postal Services Act as one of the minimum requirements of the universal service – these requirements can only be changed by a vote in Parliament.

It has also been said that free services for the armed forces would be stopped. These free services are available to service men and women who are undertaking operations such as those in Afghanistan. The Ministry of Defence fully reimburses Royal Mail for the provision of these services. It has nothing to do with ownership.

And change in ownership will not lead to VAT being added to stamp prices. First and second class stamps are exempt from VAT as part of the one-price-goes-anywhere universal service. Stamp prices for the universal postal service will still be regulated by Ofcom, which has a duty to ensure that they remain affordable.

Those peddling these myths are seeking to play on the fears of people and communities. There is not a scrap of truth in them. I accept that some people and organisations will oppose a sale but trying to win support through this type of untruthful scaremongering is nothing short of scandalous with the intention of depriving Royal Mail employees of the chance of a stake in the business.

Conclusion

As I said earlier, this is an historic year for Royal Mail. We will take forward a sale of shares. Alongside the sale, we will put in place arrangements for an employee share scheme which Parliament decided in 2011 should be at least 10% of the company - it would be wrong to deny employees a stake in the company any longer.

The action that we have taken so far and the steps we will take to give Royal Mail access to private sector capital will ensure that Royal Mail has a sustainable and viable long term future. And most importantly, these actions will ensure that we can all continue to have access to a high quality universal postal service.

Press release: Royal Mail sale commercial not ideology – Fallon

Published 29 April 2013