University of Groningen. Corporate value creation, governance and privatisation Hailemariam, Stifanos

Transcription

1 University of Groningen Corporate value creation, governance and privatisation Hailemariam, Stifanos IMPORTANT NOTE: You are advised to consult the publisher's version (publisher's PDF) if you wish to cite from it. Please check the document version below. Document Version Publisher's PDF, also known as Version of record Publication date: 2001 Link to publication in University of Groningen/UMCG research database Citation for published version (APA): Hailemariam, S. (2001). Corporate value creation, governance and privatisation: restructuring and managing enterprises in transition Groningen: s.n. Copyright Other than for strictly personal use, it is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s) and/or copyright holder(s), unless the work is under an open content license (like Creative Commons). Take-down policy If you believe that this document breaches copyright please contact us providing details, and we will remove access to the work immediately and investigate your claim. Downloaded from the University of Groningen/UMCG research database (Pure): For technical reasons the number of authors shown on this cover page is limited to 10 maximum. Download date:

2 10.1 Introduction Chapter 10 Textiles Manufacturing Enterprises In the previous chapter, we presented the case studies of footwear and leather manufacturing enterprises. In this chapter, we report the case studies of textile manufacturing enterprises in Eritrea (hereafter referred as TI) in order to explore and explain how the state-owned textile enterprises are restructuring and how their managers are trying to create value. The state-owned textile manufacturing enterprises selected for this study are Asmara Textile Factory, Eritrea Textile Factory and Lalmba Sack Factory. As described in chapter five, we have collected financial data of , management response to questionnaires on restructuring activities and structured interviews with general, financial and administrative, production and marketing managers. The results are presented in this chapter. In this chapter, we will examine the case of Eritrea Textile Factory in depth because it represents the challenges that the textile enterprises in Eritrea are facing. However, this does not mean that the other enterprises studied are left out. We will compare the Eritrea Textile Factory with the other TI enterprises studied by highlighting their similarities and differences. In sections , we present the operations, investments and financing, governance, value creation and problems of Eritrea Textile Factory and we compare it to that of the other TI enterprises studied. In section 10.6, we discuss the industry overview in terms of financial performance and managers responses to restructuring activities questionnaires. Finally, in section 10.7, we conclude the chapter by highlighting the findings of the enterprises studied Operations of Eritrea Textile Factory and the other Textile Manufacturing Enterprises Company operations are studied using income statement data, management responses to operations questionnaires in terms of relevance, management empowerment and criticality and management interviews Operations Performance of Eritrea Textile Factory The operating performance measures of profitability, sales, cost of sales, material costs and productivity of Eritrea Textile Factory and the TI enterprises studied in general are presented in table 10-1.

3 Chapter Table 10-1 Operating Results of Eritrea Textile and the TI Enterprises Studied. [Amounts in 1,000 Nakfa] Eritrea Textile Factory Total of TI Enterprises 1991/ Year 1991/ Annual Annual 92 average 1 92 average 1 Sales 2,440 6,430 6,862 6,334 13,164 54,863 46,844 39,837 Cost of sales 2,238 8,652 8,893 7,168 11,547 58,769 49,138 41,248 Materials ,763 6,915 4,771 5,081 34,157 29,166 23,990 Other costs 3 1,665 2,889 1,978 2,397 6,467 24,613 19,972 17,258 Operating expenses , ,314 3,011 2,737 2,525 Operating profit -81-2,932-3,052-1, ,917-5,031-3,936 # of Employees ,205 3,417 2,534 3,237 Profit margin 6-3% -46% -44% -23% 2% -13% -11% -10% Value added per 7 employee Source: based on annual accounts received on request by the courtesy of the companies Notes.1. Annual average is computed for the years 1991/ Materials show the cost of materials placed in production. It also includes material cost for those still in inventory and thus, materials and other costs may not add up to the cost of sales. 3. Other costs include labour, power, depreciation and other production costs. 4. Operating expenses include sales and administrative expenses. 5. Number of employees is an average number of employees for the year 6. Profit margin is computed by dividing the operating profits by sales. 7. Value added per employee is computed as follows: (sales-cost of sales)/number of employees. The operations of Eritrea Textile Factory have resulted in losses throughout the study period. The worst periods were 1995 and 1997 with operating losses of 2.9 million Nakfa and 3.1 million Nakfa respectively. The profit margins of the company also declined from 3% in 1991/92 to 46% in 1995 and 44% in 1997 due to overproduction and poor pricing policy. The operating losses of the company are explained in terms of sales, costs and productivity. The sales of the company increased from 2.4 million Nakfa in 1991/92 to 6.4 million Nakfa in 1995 and 6.9 million Nakfa in The main market for the company products had been Ethiopia, but after the liberation of Eritrea, according to the general manager of Eritrea Textile Factory, Ethiopian citizens were boycotting Eritrean products for political reasons. Therefore, efforts were made to change the attitude of Ethiopian consumers towards the Eritrean products by exhibiting products in various Ethiopian cities. The company also has been reducing prices to attract customers. The cost of sales of the company increased from 2.2 million Nakfa in 1991/92 to 8.7 million Nakfa in 1995 and 8.9 million Nakfa in The major cost element is materials. The cost of cotton has been increasing rapidly. For instance, it was 3 Nakfa per kg in 1991, but in 1999 it reached 13 Nakfa per kg. The cost of chemicals and dyestuff costs are also becoming expensive because they require hard currencies to import them. Labour cost has been low, however, it is likely to increase because the Government has already given salary increments to civil servants in Eritrea and the living standard is increasing. In order to reduce costs, the company has laid-off redundant workers. According to the general manager: The factory was producing from 30 to 40 different articles irrespective of their saleability before and after liberation of Eritrea. In order to sell

4 Textile Manufacturing Enterprises 191 these unwanted products, the company has been obliging customers to buy those unwanted articles together with what they have requested. To cut short this habit, we have stopped the production of unwanted articles in 1995 and this enabled us to layoff workers. Moreover, yarns were produced using long fibre cotton only but since 1996, the company is producing yarns by mixing long, medium and short fibre cotton. This reduces wastage because the short fibres now used in making yarns would have been thrown as waste. In addition, the management attempted to make workers cost conscious and to reduce absenteeism and tardiness. During interviews, the managers reported that the main obstacles to cost reduction are obsolete and non-flexible machinery and a low salary of employees. The general manager explained that the old machinery is hindering the competitiveness of the company products in national and international markets because it produces large amount of defective products. According to him, three out of four T-shirts produced are defective and sold at a very low price. Due to this, the quality product has to absorb the cost of the defective products and thus, it makes the price of the quality T- shirts high and non-competitive. Moreover, the general manager stated: The company employees are not cost conscious. For instance, if we take a piece of cloth, employees are not concerned whether the article is knitted properly or not; whether it is properly sewed or not; and what its effect will be on final cost analysis of the product. They are mainly concerned with production for the allotted eight hours. They don t ask themselves whether they are producing a quality product or not. To produce quality articles all employees starting from the top management should be quality oriented. The company sells yarns and knitwear articles. A cost study conducted by University of Asmara [1995] (see appendix A10-1) indicated the sales, manufacturing costs, gross profit margin (sales-cost of sales) and contribution margins (sales-variable costs (direct material, direct labour and power)) of Eritrea Textile Factory products. The cost analysis of yarns revealed that in 1994 yarns were the major source of revenue of the company. They covered their manufacturing costs and had a positive contribution margin of 266 thousand Nakfa. However, the analysis for the 1 st half of 1995 evidenced that sales of yarns did not cover their manufacturing costs and thus, resulted in gross losses and that the contribution margin was negative. Analysis of the costs of knitwear articles revealed that in 1994 all knitwear articles were selling below their manufacturing costs; they were not even covering the variable costs incurred to manufacture them. In the 1 st half of 1995 also except 7EL T shirts, all knitwear articles were selling below their manufacturing costs and except 7CB/W, 1C, 8BB, N3 Plush and 7EL while all other knitwear articles were not covering the variable costs. The management is selling these products below cost and thus, they are exacerbating the losses of the company. The production manager said: we sell below cost price to reduce finished goods stock. Selling below cost helps in reducing finished goods stock, but also reduces the capital of the company by accumulating losses. It also encourages customers to wait as far as possible till the company reduces its prices. Shifting production towards items with positive gross profit margin or at least those with positive contribution margins can enhance the operating profits of the company. The value added per employee shows that an employee has added a value of 0.4 thousand Nakfa in 1991/92, but afterwards per employee it decreased by 4.7 thousand

5 Chapter Nakfa in 1995 and by 4.5 thousand Nakfa in The decline in the productivity measure is related mainly to a lack of demand for company products, though the reduction in employment was also small and the managers feel that a further reduction could be done. Moreover, the managers interviewed elaborated that the workers' salary is low and is causing negligence. They feel that if the workers were paid higher they would produce more. The interviewees also suggested that it would have been wise to lay-off the redundant workers and give good pay to the remaining employees Managers Responses to Operational Restructuring Questionnaires Table 10-2 summarises the responses of managers of Eritrea Textile Factory and the TI managers of the enterprises studied in general. Table 10-2 Summary of Managers' Responses to Operational Restructuring Activities Activities Eritrea Textile All TI Enterprises R E CF R E CF Number of respondents Revenue Seek new markets Increase exports Drop product price Increase product price Strengthen marketing Establish sales office Increase advertising Cost Reduce employment Cut wages Increase employment Increase wages Being selective to suppliers More effective use of resources Other Operations Change product quality Change area of activity Change of production mix Improve production efficiency Source: Primary data collected by using questionnaires Legend: The cells on the table refer to the average of the marks given by managers on relevance (R), management team empowerment (E ) and the sum of marks given by managers on criticality of the activities in the future (CF ). For R and E a score of 2.5 to 3 indicates high relevance or influence, a score of 2 to 2.4 means some relevance or influence and a score of less than 2 represents low relevance or influence. For CF, a high sum score shows a high criticality rank of an activity in creating value. Table 10-2 reveals that Eritrea Textile Factory managers are of the opinion that seeking new markets, reducing employment, establishing sales offices, dropping product prices and increasing wages are of high relevance in increasing value. In addition, the managers indicated that in the future seeking new markets is going to be the most critical activity in increasing value. The general manager stated: to improve sales there are many factors that should be considered. The factory should advertise,

6 Textile Manufacturing Enterprises 193 open sales offices in various locations and assign agents in various places. But we don t have a budget for this and thus we cannot plan to promote our products. The responses of the managers of the textiles manufacturing enterprises studied also indicated that seeking new markets was an activity of high relevance and the most critical in creating value. The financial manager of Eritrea Textile Factory stated: the main problem that we are encountering is not widening our market, but how to find a new market where we can sell our products. However, the respondents also cited a lack of exposure, a lack of qualified marketing staff and a lack of budget for sales promotion as constraints in improving sales. Exposure to the outside markets would have enabled company management to identify new markets. Management needs money to strengthen the marketing department by hiring qualified personnel, to send marketing staff on trade fairs for exposure and to promote company products, but the lack of finance is constraining such activities of the management. The managers also revealed that more effective use of resources is of some relevance and is critical in creating value. The production manager of Eritrea Textile Factory elaborated the problem as follows: There is no study conducted to improve effectiveness. For instance, we are using production costs of 1991 in estimating standard product costs (e.g. cotton was 3 Nakfa per kilogram in 1991, but now it is 13 Nakfa per kilogram). However, the company is using cost determined in 1991/92 to estimate unit cost of articles produced at present. In addition, the higher authority should control the lower authority to use production effectively. For example, we have one boiler here and it is supposed to be operated while all machines in a department are working. However, sometimes you see that the boiler is operated when only one machine is working in a department. There is a co-ordination problem. The Eritrea Textile Factory managers feel that a reduction of employment is of high relevance and they feel that they have high influence on this activity. However, they do not think it is critical because they have already laid-off some workers. The government has reduced the number of employees to clear way for privatisation and one of the reasons for the low salary payment is that the Government does not want to leave highly paid workers to the would be owner. In addition, discussion with the managers revealed that the company is facing the following constraints in restructuring its operations: obsolete machinery, non-competitive prices, a low salary of workers, a loss of market share, a lack of exposure, a lack of budget for promotion and high energy costs Comparison of Operations of Eritrea Textile and the other TI Enterprises Like Eritrea Textile Factory, the other textiles manufacturing enterprises studied are facing the following constraints in increasing operating profits: non-competitive prices of company products, a lack of demand for company products and high manufacturing costs. The free market policy of the Government has opened the Eritrean market for foreign imported textiles. The textile factory managers believe that the cotton products of Eritrea are of high quality in comparison to the synthetic textile products

7 Chapter of the Far East countries, but in terms of price, the textile products from Far East countries are cheaper. The general manager of Asmara Textile Factory stated: The Government is following a free market policy and traders are importing many cheap textile articles from the Far East countries. We are not able to compete price wise and thus, we are losing our market shares in Eritrea and Ethiopia. Prior to 1995, the Ministry of Trade and Industry controlled the state-owned enterprises and set selling prices. Government gave autonomy to the enterprise management in 1995 and company managers were responsible for the operating decisions such as determining selling prices of their products and purchasing materials from suppliers of their choice. The managers increased sales volume but the sales prices of many products were below manufacturing costs. The growth rate of cost of goods sold was higher than the growth rate of sales. Most of the company products are selling below cost in the textile factories. A cost study carried out by the University of Asmara [1995] (see appendix A10-2), similar to that of Eritrea Textile Factory discussed on section of this chapter, gave an indication of gross profit contribution and marginal contribution for 1994 to mid 1995 for Asmara Textile Factory. The study shows that over the 18 months in 1994 to mid 1995, no major section consistently made gross profit. The only individual products to be consistently profitable were Khaki Twill, bed sheets (200cm) and the woollen and acrylic blankets. The greatest loss margins were exhibited by the other fabrics and knitwear. The two largest product lines (Abujadid and Jersey knitwear) contributed to 80% of the total gross loss for the 1 st half of 1995 (30% and 50% respectively). The contribution margin analysis of the same period shows that blankets form the only category of products in which revenue exceeds variable cost. Grey yarn, Abujadid, Sutti, French Twill, towels and knitwear all fail to make a contribution. The company sales increased, but since most of the products are selling below manufacturing costs, the larger the number of products sold the larger the loss incurred in operating the company. Product rationalisation by eliminating loss-making products and increasing production of profitable items such as Khaki Twill, towels, bed sheets and blankets in Asmara Textile Factory can improve the operating profits of the company. The main component of the textile industry costs is cotton. The price of cotton has been increasing and though sufficient quality cotton is produced in Eritrea, the Aligheder Cotton Plantation management (the only cotton plantation in Eritrea) is asking textile companies to buy it at world market prices. This made the cotton grown in Eritrea very expensive and the managers had been purchasing lower grade cotton from Ethiopia at a cheaper price to reduce cost. Ethiopian Domestic Distribution Agency (EDDC) had been distributing all goods manufactured by state-owned enterprises during State-owned enterprises had been producing irrespective of its saleability and the marketing and selling activities were the responsibility of EDDC. In 1992, the Government liquidated EDDC and state-owned enterprises were left to market their products. However, there were no qualified marketing officers at enterprise level and there was any experience gained from previous years and this had its impact on the company sales. The marketing manager of Eritrea Textile Factory stated the following: we are not accustomed to promotion. We do not advertise on television, radio or newspaper because there is no such habit. The managers of the state-owned textile enterprises were not able to adjust easily. They have been contacting one or two wholesalers who

8 Textile Manufacturing Enterprises 195 dictate prices to the companies. For instance, the textile factories have been distributing their products to two merchants in Ethiopia on a barter basis. The textile companies sell yarns to the Ethiopian merchants and the Ethiopian merchants buy cotton of equivalent value and send it to Eritrea. The factories have no marketing plan or set of sales targets for their commercial department. There is no attempt to seek out alternative distribution methods or to set up direct marketing arrangements either independently or with the other textile companies. None of the factories have distribution facilities or marketing networks outside the factories. All sell to wholesale traders or direct to retail merchants who come direct to the factories. Introducing their own sales forces and sales offices can help in increasing sales in the local and regional markets. By dealing direct, higher profits can be achieved since the mills prices could be slightly higher than at present but lower than those charged by the intermediaries. Textile production has to cope with contemporary fashion, but according to the managers interviewed the companies are producing the same fabrics they have produced in the 1960 s. The management interviews revealed that the textile factories did not introduce new products or changed the existing production mix. Competition with imported or substituted products also has been fierce and thus, the market share of the textiles manufacturing companies is decreasing. The reason for a sharp decline in sales in 1997 in Lalmba Sack Factory is the loss of two main customers, Massawa Salt Works and Assab Salt Works. They shifted to plastic bag usage. The general manager of the company stated: During , the factory had enough local as well as Ethiopian markets and the factory products were highly demanded. After that, the two main local customers, Massawa Salt Works and Assab Salt Works shifted to plastic bags and our factory s financial condition became worse. We tried to produce plastic lined jute bags, but we were not able to compete pricewise successfully." In addition, Lalmba Sack Factory tried to produce various types and sizes of sacks for cereals, however, meeting specific needs of each customer was difficult and time consuming. The customers also want to come and buy sacks immediately. They do not see that the production process requires time and that it has to be planned. These constraints are creating problems in the operations of Lalmba Sack Factory. There was a free trade agreement between Eritrea and Ethiopia signed in 1993 regarding taxation of traded goods. Goods produced in Eritrea would be taxed in Eritrea only and there would not be any additional tax if they are sold in Ethiopia and the same for goods produced in Ethiopia if they were to be sold in Eritrea. Despite this agreement, according to the responses of the managers interviewed, at the beginning of 1997, the Ethiopian government introduced a border tax to curtail the sales of Eritrean products. For example if a T-shirt is to be exported from Eritrea to Ethiopia, at the border the Ethiopian custom officers levy an excise tax of 10%, a sales tax of 12% and a profit tax of 10% to 40% depending on the level of estimated profit of the businessmen. All these additional taxes increased the price of Eritrean textile products and made them non-competitive in the Ethiopian markets. At present, there is no trade with Ethiopia because of the border conflict and the textile factories lost about 80% of their market. However, the increase in demand for military khaki uniforms by the Ministry of Defence on the other hand brought some opportunity to the textile factories.

9 Chapter The managers interviewed elaborated that the product prices of Eritrean textile products are not competitive in the Ethiopian markets because Eritrea Textile factories are incurring transportation cost to ship goods to Ethiopia and raw material and energy costs are also cheaper in Ethiopia. There are also seven textile factories in Ethiopia producing similar products, which makes price competition fierce. According to the general manager of Eritrea Textile Factory these textile companies in Ethiopia have about 15 million Nakfa worth of finished goods stock and their managers are asking approval of the National Supervisory Board of Ethiopia to cut prices. The Ethiopian textile factories are cutting price every week to sell the accumulated finished goods stock and this is making the products of Eritrean textile factories less competitive price wise in the Ethiopian markets. In November 1997, Eritrea has introduced a new currency Nakfa as a national legal tender in Eritrea. This phenomenon has also its impact on the trade between Eritrea and Ethiopia. Since there are two currencies, Nakfa in Eritrea and Birr in Ethiopia, businessmen need intermediary currency, that is, U.S. Dollar and need to open L/C (letter of credit) in banks for guaranteeing the trade transaction. Eritrea Textile Factory customers in Ethiopia now, will have to compete in an auction market to buy U.S. Dollar and they then have to open a L/C in banks in Ethiopia paying commission charges. All these new procedures are inconveniencing the company customers in Ethiopia. Now, since similar products are available in Ethiopia and since the recent conflict closed the borders, the sales of Eritrean textile products virtually stopped. The general manager of Asmara Textile Factory stated: Even though there is high competition in the textile market, the market is large and the textile companies in Eritrea can export to The Middle East countries and Europe. The managers also said that the European Economic Commission (EEC) member countries allow developing countries such as Eritrea to sell manufactured goods quota free. For instance, the textile industry can export to the EEC member countries freely and customers in Europe get tax exemption for their purchases. This shows that there is a market opportunity, but the managers were not able to access this market. There is a lack of information and an exposure. According to the general manager of Eritrea Textile Factory: We do not have exposure of other markets. We do not know what kind of markets there are in the World and whom we should contact. This lack of exposure has limited our market share. When we recently lost our market share in Ethiopia, we did not know what to do. We are walking in the dark and we do not know where we are heading right now. We do not have know-how and we do not know the market elements. We do not have marketing officers and thus, we have a large constraint in improving the sales of the company. Asmara Textile production and marketing managers stated: There is a weakness of the export support institutions. The banking, customs, maritime and packing services are not effective and are hampering export activities. For instance, the Nakfa is a free-floating currency and thus we need daily exchange rate of Nakfa against the US Dollar to make informed decision on buying and selling. However, the bank does not provide us with the daily exchange rates. The analysis of the operations of the Eritrean Textile Factory and the other textile enterprises studied revealed that the factories are losing money due to a lack of demand for company products and because of high manufacturing costs. Recruiting

10 Textile Manufacturing Enterprises 197 their own sales officers instead of intermediaries, shifting to production of profitable product and decreasing or eliminating production of unprofitable products, blending synthetic products such as polyester with cotton to produce affordable products in Eritrea and Ethiopia may improve the profitability of the companies Investment and Financing of Eritrea Textile Factory and the other Textile Enterprises Studied Eritrea Textile Factory and the other TI enterprises investments and financing are studied using balance sheets data, managers responses to structured questionnaires and interviews Investment and Financing Performance of Eritrea Textile Factory In order to produce quality products and compete in a free market economy, enterprises in transition economies need to restructure investments and finances. Investment in a company can be of a short-term nature such as working capital investments or of a long-term nature such as investments in fixed assets that will help the company for more than a year. Financial strength of an enterprise also determines its future viability. How operations and investments are financed affects firm value. Table 10-3 Investments and Financing Results of Eritrea Textile and the other TI Enterprises Studied [Amounts in 1,000 Nakfa] Eritrea Textile Factory All TI Enterprises Year 1991/ Annual 1991/ average Annual average 1 Investments Total assets 6,525 12,364 12,356 10,047 42,950 56,341 46,912 52,849 Short term assets 2 6,208 12,116 11,937 9,715 40,798 54,375 46,017 51,104 Fixed assets ,152 1, ,746 Return on Assets 4-1% -24% -25% -14% 0.7% -12% -11% -7% Short term % assets 95% 98% 97% 97% 95% 97% 98% 97% Current ratio 5 31% 74% 66% 54% 47% 98% 78% 69% New fixed assets New fixed % sales 0% 0% 0% 1% 0% 0% 0% 1% Financing Short term debts 19,805 16,298 18,205 18,123 86,672 55,655 58,687 74,075 Long term debts ,914 2,807 2,186 State Capital 5,398 5,500 5,500 5,456 32,071 32,173 32,173 32,130 Retained earnings 6-18,677-9,434-11,349-13,532-75,829-38,402-46,757-55,542 Debt to total assets 303% 132% 147% 181% 202% 99% 125% 140% Source: based on annual accounts received on request by the courtesy of the companies Notes.1. Annual average is computed for the years 1991/ Short-term assets include cash, receivables, inventories and other pre-payments. 3. Fixed assets include machinery and equipment, buildings, land and other long-term assets. 4. Return on Assets (ROA) is computed by dividing operating profits to total assets 5. Current ratio is computed by dividing short-term assets to short term debts. 6. Retained earnings represent accumulated earnings (losses) from the past. The data in table 10-3 show that the assets of the company are highly dominated by short-term assets. Short-term assets were 95% or more throughout the study period. This asset structure is highly abnormal taking the nature of textile factories. The

11 Chapter return on assets of the company has been negative throughout 1991/ It decreased from 1% in 1991/92 to 24% in 1995 and 25% in Eritrea Textile Factory has been underperforming the average return on assets of the enterprises studied. The current asset ratio is low. The financial data of the company show acute cash shortage due to the continuos annual operating losses. The bank overdraft balance has reached 11 million Nakfa at the end of The company is investing in current assets only and fixed assets have been neglected. The fixed assets of the company are almost fully depreciated. The plant and machinery account of Eritrea Textile Factory shows 0.4 million Nakfa book value on December 31 st, The company managers stated during the interviews that one of the main constraints that the company is facing in improving firm value is obsolete machinery. The production manager of Eritrea Textile Factory commented that step by step modernisation of the mill starting from the major bottlenecks could enhance company sales. He stated that the introduction of combing machines at the Spinning Department could open a new export market for the company T-shirts. Now they are less attractive to foreign businessmen because they are not manufactured using combed yarns. On average the debt to total assets of Eritrea Textile Factory has been 181%, which is abnormal. The company is also financing its investments using short-term debts only. The factory does not have a single long-term debt. In 1994, the Government wrote-off outstanding debts of all state-owned enterprises which existed prior to May 24, 1991 and this decree helped the Eritrea Textile Factory to write-off 16 million Nakfa. The analysis of the ownership equity of Eritrea Textile Factory shows that the Government as an owner did not invest new capital in the company throughout 1991/ The annual losses of the company have been accumulating and decreasing its capital balances. The interviews with managers indicated that the Government did nothing to revive the textiles industry finances. The Government does not have any plan to subsidise the industry, except providing guarantee for bank overdraft loans, which are growing each year. The managers responses indicated that the main constraints that the industry is facing in enhancing company finances are operating losses, a lack of an investor and a lack of working capital fund for buying raw materials and others. According to the general manager of Eritrea Textile Factory: Losses make companies unattractive to privatisation investors. The textile companies are not attracting investors due to their operating losses and thus, to make them attractive to buyers they must be restructured to enhance their profitability. The analysis of the Eritrean Textile Factory balance sheets revealed that there was no significant addition to the fixed assets. At present the machinery is old and frequent maintenance need is increasing production costs and inefficiency. The new fixed assets to sales ratio was also on average 1% throughout 1991/ This indicated that there was hardly any capital invested back in the factory in the form of machinery, which is one of the major bottlenecks for greater profitability and competitiveness of the factory. The managers interviewed feel that a phase by phase

12 Textile Manufacturing Enterprises 199 modernisation of machinery by starting from the critical areas such as spinning, model cutting and knitting can help in restructuring company assets Managers Responses to Investment and Financial Restructuring Table 10-4 summarises the managers responses to investment and financial restructuring questionnaires. Table 10-4 Summary of Managers' Responses to Investment and Financial Restructuring Activities Activities Eritrea Textile ALL TI Enterprises Factory R E CF R E CF Number of respondents Investment New investment in equipment Upgrading technology Disposing off of fixed assets Control of capital expenditures Reduce collection period of receivables Increase payment period of payables Implement cash control Change in inventory policy Financing Obtain new loans from banks Reschedule old loans Reduce inter-enterprise loans Reduction of subsidy Elimination of subsidies Develop relation with creditors Improve communication with customers and suppliers Issue new financial instruments Seek foreign investors Source: Primary data collected by using a questionnaire Legend: The cells on the table refer to the average of the marks given by managers on relevance (R ), empowerment (E ) and the sum of marks given by managers on criticality of the activities in the future (CF ). For R and E a score of 2.5 to 3 indicates high relevance or influence, a score of 2 to 2.4 means some relevance or influence and a score of less than 2 represents low relevance or influence. For CF, a high sum score shows a high criticality rank of an activity in creating value. The results of the analysis of the investment restructuring activities questionnaire revealed that investing in new machinery and upgrading technology are highly relevant and are critical issues in enhancing firm value. In addition, the interviews with the managers show that the factory has already assessed the machinery needs of the company and are constrained due to a lack of finance to acquire this machinery. There are also sewing machines that can be sold at the market to raise some money, which have been kept idle at the company for over 9 years.

13 Chapter The managers revealed that there was a plan to change the obsolete machinery with new machines in collaboration with the Eritrean Peoples Front for Democracy and Justice (EPFDJ). The company management and the prospective acquirer have made an extensive study regarding the type of machinery and technology needed and where to acquire these machines. There was a proposal of restructuring the machinery in three phases. In addition, there was a plan to transplant the Spinning Department because its present location is far (due to this the company is incurring transportation, loading and unloading costs and also yarns are spoiled due to rain while they are transported during the rainy season). The interviewees also stated that the main constraint in restructuring investments is money (finance). The production manager stated: The privatisation process had started two years ago and the Eritrean Peoples Front for Democracy and Justice (EPFDJ) was interested in acquiring this factory. Due to this, the Ministry of Trade and Industry did not bother much in rehabilitating and restructuring the company as this factory was to be given to EPFDJ. The factory was left in between the two and there was a problem on who would make the capital injection required for reviving the investments of the company. Finally, the would be buyer EPFDJ dropped its offer and the company will be auctioned now to other buyers. Table 10-4 reveals that from the financial restructuring activities seeking foreign investors, improving communications with customers and suppliers and developing relationship with creditors are of high relevance in enhancing firm value, but the managers feel that seeking foreign investors is the most critical in restructuring finances. The managers also stated that the main obstacles to financial restructuring are the annual operating losses. According to the general manager of the Eritrea Textile Factory: Nothing has been done to improve company finances. We only know one way, that is, trying to earn profit to pay off debt. If this does not work, we resort to bank overdrafts. We do not know any other method of finding finance. The lack of financial markets and private banks is restricting the financial restructuring that can be done to improve finances. The Ministry of Trade and Industry determines the financing policy of the state-owned enterprises. The company is not allowed to contact or invite investors to bring in finances. In order to improve the profitability of the company, the National Agency Board has to seek foreign investors in the form of joint ventures, 100% private ownership and/or management contracts. The delay in privatisation is influencing the performance of the textile companies. According to the financial manager: The delay of privatisation is aggravating the financial problem of the company. The use of overdraft is hurting the company. Had there been an ownership change, the new buyer would have injected new finances and would have found new markets outlet s to make the company prosperous. At present, there is no skilled manpower to conduct market research and to improve company finances.

14 Textile Manufacturing Enterprises Comparison of Investment and Financing of Eritrea Textile Factory with the other TI Enterprises Studied Like the managers of Eritrean Textile Factory, the managers of the other textiles manufacturing enterprises studied did not make major investment in long-term assets during due to a lack of finance. The Government as an owner did not provide funds to rehabilitate the factory and the managers were not able to invest from retained earnings because the companies have been running on losses. The textile companies have good metal and electrical workshops and experienced technicians who have been maintaining the old machines. However, unlike the managers of Eritrea Textile Factory, the managers of Asmara Textile Factory and Lalmba Sack Factory have made some investment in order to rehabilitate the machinery. According to the general manager of Asmara Textile Factory, in 1992 the company management purchased about 12 million Nakfa worth of spare-parts to maintain the old machinery using a loan from the Eritrean government. In order to substitute import of raw materials (jute), Lalmba Sack Factory management rehabilitated Akordet Doum Fibre Plant, a separate entity that supplies doum fibre to the company, by paying 12.7 million Nakfa. The investments made in are 2.6 million Nakfa on buildings, 7 million Nakfa on machinery and 0.4 million Nakfa on vehicles and 2.7 million Nakfa on working capital. In order to produce quality yarn, the managers of Asmara Textile Factory emphasised the need for rehabilitation of the Spinning Department of the factory. The managers reported that there is a high demand for Knitwear articles and there is a potential of increasing sales by increasing quality. However, the poor quality of the yarns produced in the Spinning Department are resulting in poor quality products. They responded that improving yarn quality is overriding for efficiency and production throughout processing. The results will then be immediate, enabling quality products to be produced at lower operating costs. They recommended improvement of the Spinning Department machinery to enhance exports of T-shirts. The managers of Asmara Textile Factory during the interview disclosed that Asmara Textile Factory has some 15 residential houses (villas) adjacent to it, originally built for expatriate staff, but now rented to some of the factory s own workers which could be disposed off to raise money. The interviews with managers also revealed that the textiles manufacturing enterprises are not utilising their capacity due to a lack of demand and there is an acute cash shortage in financing working capital investments. The NASPPE has restricted the purchase of raw material stocks to less than three months only and the extension of credit to customers to only one month and even that is only allowed if the debtor is a Government institution. This also made the companies less flexible and less attractive for customers. In order to alleviate interest and debt burden of all state-owned enterprises, the Eritrean government cancelled all obligations to the Government and bank overdrafts that were outstanding prior to the liberation of Eritrea. Due to this, the debt to total assets ratio of the textiles manufacturing enterprises studied decreased to 98% in In addition, the Government has announced that it will absorb the company debts outstanding at the time of privatisation. However, this gives a mixed signal to

15 Chapter state-owned enterprises managers. It evidences that the Government will bailout the companies if they do not succeed and thus, managers may resort to perverse behaviour of borrowing from banks without prudent evaluation of the result. In 1995, the debt to total assets ratio was 99%, but it increased to 125% in 1997 because there was an increase in bank overdraft balances of Asmara Textile Factory and Eritrea Textile Factory and Asmara Textile Factory management also borrowed a new longterm loan in In order to financially discipline state-owned enterprises, the Government did not give direct subsidies to enterprises. This was aimed at making the state-owned enterprises financially self-sufficient. However, the textiles manufacturing enterprises have been operating on losses and thus, resorted to bank borrowing using overdraft facilities guaranteed by the government to finance operating as well as working capital investments. The bank overdraft balance of the textiles manufacturing enterprises studied has increased from 4.7 million Nakfa in 1994 to 26.1 million Nakfa in This indicates that the managers are borrowing from banks to finance operations and investments and the budget constraint is not hardening. It is an indirect subsidy because the Government is guaranteeing the loan and if the company cannot pay it, the government will pay the debt. The textiles manufacturing enterprises have been chronic loss-makers and they accumulated large deficits (a negative retained earnings balance). The Government s cancellation of obligations, which were due prior to liberation of Eritrea, improved the financial structure of textile companies. However, the government as an owner did not contribute any new investment to enhance the financial condition of the enterprises. Due to this, the ownership equity balance of the textiles enterprises studied has decreased from 0.9 million Nakfa in 1994 to negative 14.6 million Nakfa in The companies are surviving due to the continuous bank overdraft support provided by the Government; otherwise, it would have been difficult to run the enterprises as going concerns. The managers are of the opinion that the companies will continue running on losses because they provide employment and they are of national importance. According to the general manager of Asmara Textile Factory: The Government is subsidising us by using bank overdraft in order to solve a social problem. The factory employs about 2,000 workers. If the Government closes this factory, the workers, as well as their families will face problems. Assuming an average family of four, for instance, the closure of Asmara Textile Factory would place about 8,000 persons in problem. The government is concerned about this and thus, we will continue working at loss till the factory is sold. By letting this factory operate at loss the government is solving a social problem. The commercial bank of Eritrea is also government owned and is accepting loan requests from state-owned enterprises without rigorous evaluation of the feasibility of the projects and the probability of collection of the funds. The Government guarantees the loan requests of the state-owned enterprises to avoid social problems. This is resulting in bad debts because the loss making state-owned enterprises such as textiles are not paying back their debts. Unlike Eritrean Textile Factory and Lalmba Sack Factory which were borrowing from a bank only, Asmara Textile Factory accounts indicated that the managers have

16 Textile Manufacturing Enterprises 203 been borrowing from other state-owned enterprises. The associated enterprises account on average had been 12.5 million Nakfa for the years 1991/ This evidences that the company had been supplementing its financial needs through inter enterprise debts. When the government cut subsidies to financially discipline enterprises, Asmara Textile Factory found another source of finance (borrowing from sister plants) to survive. The interviewees also stated that privatisation is becoming an obstacle to investment. As a policy investment is not recommended and even spare-parts purchases are constrained. The National Supervisory Board of Agency will not approve any new fixed asset investment especially if factories had been incurring losses. The privatisation process has affected company investments negatively. According to the financial manager of Eritrea Textile Factory: Since the company is going to be privatised all activities are targeted towards short term survival only. If we take, for instance investment in fixed assets, this will first curtail future choices of technology and machinery of the private buyer and it will also increase the sales price of the factory. If the demand for company products increases, it will need new investment in machinery. Therefore, the old machinery should be changed and technology should be upgraded. Privatisation is affecting the investments in long-term fixed assets negatively. The factory may try to invest in new machinery, but since the debt level of the company is very high the banks may not offer credit to our company. In addition, since we are looking for new markets, borrowing and investing to meet the needs of the new markets is highly risky. Therefore, we are not promoting investments in long term assets. We plan to proceed as it is till privatisation. We are planning only in terms of the short-term. Asmara Textile Factory is a highly integrated large textile factory and the size of the company and its situation is making it unattractive to buyers. According to the general manager of the company: The factory is diverse with many product lines such as fabrics, knitwear articles and blankets and the machines are old. These constraints are making privatisation of the company difficult. The investors, especially local investors, do not dare to buy this factory because of its size and situation. It requires a huge investment to revive this factory after privatisation. Due to this, it is beyond the capacity of local investors. We did not get any interested investor so far even though the factory has been offered fore sale since It seems that privatising this company will take a long time. The analysis of investment and financing data from the balance sheets and the managers responses indicated that most equipment requires complete reconditioning or replacement and that the present machinery is producing narrow fabric widths (90 cm), which are no longer demanded in most markets (where cm is more common now). The enterprise managers feel that much can be done to improve production and product quality by rehabilitating bottlenecks such as the spinning department s machinery in order to upgrade the quality of the yarn produced. The financial condition of the textile companies is deteriorating each year. The managers indicated that seeking foreign investors is highly relevant and critical. During the interviews, the managers of Asmara Textile Factory elaborated on a