Monday, October 15, 2018

[Column] Think Strategically: ‘Zugzwang’

By on January 23, 2018

Market Weekly Summary Close

IPO Calendar–Trade Date Estimate: Week of Jan. 22

Government Shutdown: Ends with Zugzwang

The Saxon term “Zugzwang” means “compulsion to move,” a situation found in chess and other games where one player is placed in a disadvantage because they are obligated to make a move when ideally they would prefer not to move. Any player is said to be “in zugzwang” when any possible move worsens their position.

When Congress and the Senate cannot agree on a continuing budget resolution, in this case as happened Friday, Jan. 20, at midnight, the government was shut down.

During a government shutdown, all nonessential federal discretionary programs close. In the conventional budget process, Congress appropriates funds by Sept. 30 for the following fiscal year. When that fails to happen, Congress implements a continuing funding resolution, as it did several times last year, with the final one that year on Dec. 21, 2017.

In an attempt to avoid a shutdown, the House passed legislation to extend fiscal 2018 government funding until Feb. 16. The Senate needed 60 votes, and could not convince at least 12 Democrats for the extension. Thus, the government was shut down beginning last Friday until late Monday night. Democrats wanted the bill to protect immigrants eligible for DACA (Deferred Action for Childhood Arrivals). Senate Democrats stated they were accepting a deal with Senate Majority Leader Mitch McConnell for an immigration vote, clearing the way for passage of a bill to reopen the federal government. 

McConnell, early Monday, promised to take up an immigration bill that would protect an estimated 800,000 “Dreamers” from deportation, under an open amendment process, if Democrats would agree to end the government shutdown. 

Senate Minority Leader Charles Schumer (D-N.Y.) had said that pledge was enough for his caucus to accept a three-week government funding bill.

The Senate, on the afternoon of Jan. 22, voted to break the filibuster and move forward on a vote to pass the government funding bill (with funding to expire Feb. 8) and reopen the government. The concession Democrats received in agreeing to break the filibuster was a Republican commitment to have a vote on various immigration bills after Feb. 8 if a bipartisan resolution is not final by then.

This action mean Congress faces a new deadline Feb. 8 to pass another round of government funding and various immigration issues.  The extension of the period averts today’s crisis, but may just merely move it to next month. 

Schumer said McConnell has committed that if negotiators fail to reach an immigration deal before the stopgap spending measure expires Feb. 8, “the Senate will immediately proceed to consideration of legislation” to protect “Dreamers.”

Senate Democrats were “in Zugzwang” by not being able to deflect President Trump’s message blaming these lawmakers for the government shutdown. Trump claimed Democrats were “far more concerned with Illegal Immigrants than they are with our great Military or Safety at our dangerous Southern Border.”

Thus, today, the government was able to finally reopen normally until the the next deadline.

Puerto Rico Update: Prepa to be privatized

During a televised message, Gov. Ricardo Rosselló announced he decided to privatize the embattled Puerto Rico Electric Power Authority (Prepa). The utility currently still has 45% of its customers without electric power and was severely damaged by Hurricane Maria, leaving millions of Puerto Ricans in the dark for months.

For years, the private sector has consistently requested privatization of the bankrupt utility. In addition, initial approval rating results from several media outlets show more than 80% of all polled approve the sale of the utility. Prepa was brought to its knees with Maria’s aftermath, even though its breakup value is still quite high. The governor mentioned this process could take 18 months to complete, which starts by enacting legislation to establish a legal framework for the privatization–before the government entertains any proposals.

The governor made a daring and aggressive Zugzwang with this announcement. He is positioned as a change and transformation agent, and made the distinction between a public-private partnership by stating this was an asset sale. In our view, this was a solid strategic move, one that will allow the island to move forward to a more resilient system of power generation.

Prepa, which is under Promesa’s Title III bankruptcy-like process and owes $9 billion in bonds, has for decades continued to operate by ignoring the world’s alternative energy trends.

Prepa’s story is also the story of Puerto Rico’s rise and decline. Prepa, created in 1941, was fueled by Operation Bootstrap, which helped the island in the 1960s and ’70s grow into a global center for pharmaceuticals and multinationals, which canvassed the island to take advantage of federal tax benefits.

Prepa ignored most global power generation trends and continues to burn oil to fuel its power generation, which is similar to Saudi Arabia, one of a handful of other countries that consume crude oil directly for power generation. However, Puerto Rico does not have its own oil production.

Another factor that weakens Prepa was the phase-out of Section 936 of the Internal Revenue Code, which started a decline in revenues, exacerbated by political intrusion, constant management changes, corruption, inefficiency, outsized union benefits, among other troubles. Another matter to consider is the fact that municipalities and government agencies do not pay for their electricity.

Most central government administrations, when faced with increased oil prices, spent tens of millions of dollars evaluating solar and natural gas projects to decrease Prepa’s dependence on oil, but somehow nothing worthwhile happens, and today less than 3% of Puerto Rico’s energy generation comes from renewables.

The governor’s statement captures it well: “What we know today as the Puerto Rico Electric Power Authority does not work and cannot continue to operate like this,” Rosselló said. “Honestly, with that PREPA, we cannot face the risks of living in an area of high vulnerability to catastrophic events, such as the two recent hurricanes.

We know for a fact that at least seven groups have offered diverse manners to privatize Prepa.

FOMB hearing: Government’s liquidity position

This past Friday, Jan. 19, the Financial Oversight & Management Board (FOMB) held a hearing regarding recently published stories on government bank accounts.

The FOMB invited and heard testimony from nine current and former government officials, including the Puerto Rico Fiscal Agency & Financial Advisory Authority (Fafaa) and Treasury Department. During the hearing, former Treasury Secretary Juan Zaragoza confirmed what many had feared–that the Government of Puerto Rico was not wholly aware of its liquidity position and had a limited view of all cash and cash equivalents available.

Zaragoza further mentioned that when they were transferring the government’s accounts from the Government Development Bank to the commercial banking sector, he assumed the total number of accounts would be 30, and said he was shocked when more than 800 accounts were opened. Other members of the fiscal team noted that the system was fractured and lacked visibility to make solid financial decisions.

After the hearing, the FOMB “confirmed it expects to soon appoint an independent forensic analysis team to compile a comprehensive inventory of all government bank accounts, cash equivalents, and investments along with their respective account balances.”

In this day and age, it is nearly unbelievable to learn that with so much technology available, our government does not have a unified system to monitor its finances on a daily basis and lacks the visibility to understand its funds by using the best basic cash management practices.

Fafaa Executive Director Gerardo Portela stated his agency had commenced an inventory of all bank accounts and began publishing since Oct. 31, 2017, a weekly cash flow report.

Below is a slide from Fafaa’s presentation during the FOMB hearing.

Final Word–WEF: Measuring improvement

The World Economic Forum (WEF) convenes Jan. 23-26 in Davos, Switzerland, under the theme “Creating a Shared Future in a Fractured World.”

WEF’s effort will explore and make sense of the complex forces driving transformational change across economies, industries and global issues. We are watching developments at WEF, especially all that applies to transformations and how to measure success. Our government and focused private-sector organizations need to regulate their activities and results, which are important to successfully achieve their goals.

One of the best tools Puerto Rico had at its disposal was the World Economic Forum competitiveness rankings, a benchmark we lost a couple of years ago.

Puerto Rico needs a Measurement Improvement Program to allow our residents to understand what progress looks like and to evaluate our leaders’ work.

Our economy has the significant unexploited potential to simultaneously increase economic growth, improve living conditions and per capita income.

Defining and executing structural economic reforms are an effort to strengthen the institutions and increase economic indicators that play a crucial role in obtaining improved living conditions and implementing growth in our economy. The reforms must happen while we adopt a broader metric for national economic success that corresponds better to Puerto Rico’s bottom-line measure of economic progress: broad-based living standards.

A new growth model is needed that places people and living conditions at the center of our economic policy, and is the key to transform our growth from an aspiration into action.

As Oracle CEO Mark V. Hurd has said, “Without execution, ‘vision’ is just another word for hallucination.”

–Francisco Rodríguez-Castro is president & CEO of Birling Capital. He has served in government, multinational and public corporations for more than 25 years, and has advised multiple entities in a diverse array of market segments. He has also participated in multiple mergers and acquisitions as well as structuring transactions that combined surpass $10 billion.

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