Forum Archive Index - May 2004

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Compare the return of the business with the shareholders funds put 
into it and the 'Return on Equity' is as good an efficiency measure as 
any single measure there is.     However, like any 'single statistic', ROE 
can be subject to manipulation.   Any return can look good, provided 
the equity value of the business is low enough.     Start with any price 
of power, then artificially reduce the value of your power station to 
match and ROE will look good.    That may sound cynical, but there is 
some evidence that the old 'Electricorp'  (the monopoly owner of New 
Zealand's power system before it was broken up) did exactly that!

How did Electricorp get away with it?   Many of New Zealand's power 
stations were built in the 1950s-1970s.   The 'mid 1970s to mid 1980s' 
was a decade of high inflation.  That meant that the majority of  power 
assets, on the books at historical cost, were way undervalued.  Back 
then there was no compelling reason to revalue assets 'to market'.   
The one exception to this was the Clyde dam (commissioned 1992).  
There were unforeseen geological issues with Clyde, which meant it 
had to be massively written down in value to become economically 
viable.     I recently visited the Christchurch library to consult some old 
Electricorp annual reports from the early 1990s.   I couldn't see any 
evidence there about how much the Clyde dam had to be revalued 
downwards. The nearest guess I could get was a contemporary article 
in 'the Independent' that claimed the cost of the Clyde Dam was 
$1.7billion.   That figure was more than the total of all assets on the 
Contact Energy balance sheet when floated!     Even then the 'return 
on equity' at the time Contact was floated for the whole company was 
around 7.1% - not high in overall terms.

The trade off between asset value and return is the reason there were 
large revaluations in Contact Energy's assets in 1999 and 2002.     

SNOOPY

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