Shutting down or merging?

With PH in Government, there has been a flurry of news on shutting down or merging Government agencies.

This brings to mind the merger of Sime Darby, Guthrie and Golden Hope into Synergy Drive. The name was obviously chosen to tie in with Sime Darby’s initials, signalling the dominant entity in the merger. The merger failed. Demerger followed. But that merger exercise was perhaps not done with the right objectives from the beginning. There were no clear benefits to be gained from the merger.

So how do the Government entities now prepare for a merger? Unlike commercial entities, the objective of their merger is towards meeting the Government’s objectives which are likely to have socio-economic factors or cost efficiency purposes.

How to align the objectives of the merged entity, the identity, the funding structure, the organisation structure? Constitution of the board? Retrenchment? It will be a survival of the fittest. Knowledge is king as everyone manoeuvres and jostles to be on top.

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The yield curve is flattening!

The yield curve is flattening! Inverting soon. Recession coming!

The yield curve is one of the most trusted leading indicators of an economic slowdown. Lately, much has been made of the US yield curve flattening. The yield curve is a plotting of Government bonds (or treasury bills)’s interest rates of various maturies. A normal yield curve is upward sloping. Investors need higher premium to compensate for longer term uncertainties and because of the expectation that the economy will expand in the future. The reverse is hence true when the longer term rates are lower than the shorter term ones (i.e. expectation of recession), causing the yield curve to invert.

There are analysts considering pressing the panic button while there are others who are saying Hold your horses. The Malaysian yield curve is still upward sloping. But the far reaching US economy has an impact on the world economy, including Malaysia’s.

As the new Malaysian Government works to rein in the national debt, it has no choice but to scale back or cancel big ticket projects. Overall consumption will decrease. Hence some form of contraction to the economy is inevitable. How much is the question now.

The Turkish lira crashed

The Turkish lira crashed, falling by almost 50% against the USD over the last 12 months. Good news for Malaysians going for holiday in Turkey. Bad news for Malaysian companies like MAHB and IHH which have big investments in Turkey.

All eyes are watching what Turkey’s President and the Central Bank do next. The Turkish problem has similarities with the Malaysian 1997 recession and currency crisis. The Malaysian economy had just come off a period of high growth. Like Turkish companies too, many Malaysian companies had borrowed in foreign currencies though revenue was in Ringgit. These Malaysian companies had wanted to take advantage of the low interest rate from borrowing overseas e.g. issuing Samurai bonds. Instead, they got hit big time by the Ringgit’s depreciation.

Malaysia resisted going to the IMF for help, slapped on capital controls. Malaysia managed to get out of the recession and currency meltdown in one piece (though the Ringgit never managed to recover back to the pre-recession levels). What will Turkey choose to do next?

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New Government

There is a new Government and their priority is the economy. If they want to do and sound better than the previous government, all the elected MPs (including the opposition MPs) should undergo a foundation course in finance. Otherwise, they will lose credibility.

Remember the ex-minister who propounded that an increase in taxes on goods and services will result in lower prices? Just read in the news that the MP for Subang recommended to the Government to undertake an MBO of toll concessionaires. 1st, does he know what MBO is? It stands for Management Buy-Out, meaning the company’s Management buys over the company. Perhaps he meant “Nationalisation”? Secondly, the biggest toll concessionaire is the UEM Group, a wholly-owned subsidiary of Khazanah which in turn is owned by the Government of Malaysia.

PLUS, the most important highway is owned 49% by EPF and 51% by UEM. If both make money and there are no leakages, the profit goes back to Malaysians. That’s fine. The issue is the other tolls and new highways where the construction costs may be highly inflated. In order to reduce the incidence of reading things which make one go huh? Symphony would like to offer all politicians a finance course at discounted rates.


Malaysia’s debt

Malaysia has a debt of over RM1 trillion. Where do they come from? Included in the figures are RM199 billion of Government guarantees (GGs) and RM201 billion in committed payments for Public Private Partnership (PPP) projects.

Entities like Danainfra (for MRT), Govco, Malaysia Rail-link and 1MDB issued bonds / sukuk or borrowed to finance their projects or investments. But because they were not credit-worthy on a standalone basis, the Government guaranteed their debts. Guarantees are contingent liabilities, ie. they become a real debt contingent upon the borrower being unable to pay. They do not appear in the balance sheet itself except as a note. So they were not counted as a Government debt. But in this case, as the entities have confirmed that they are unable to pay, the contingency has become a reality. The debt becomes the Government’s.

PPPs were initiated by the Government to fund projects like hospitals, university campuses (e.g. UiTM), buildings (JKR training centre in Melaka) and schools off their balance sheet. PPP contracts were awarded to the private sector to finance, build and maintain. In return, the Government pays them an availability charge and a maintenance charge every year. These are fixed obligations over the concession period.

Malaysia’s Debt (2)

Malaysia’s debt position may not be as bad as the RM1 trillion number.

PPP was initiated to enable the Government to fund projects off balance sheet. Instead of the Government borrowing upfront to finance projects, it gets the private sector to do so. In return, the Government pays the concessionaire an availability charge and a maintenance charge.

The maintenance charge for maintaining the facilities should be considered as a yearly operating cost because if KPIs are not met, the maintenance fee will be adjusted accordingly. It is also subject to negotiation every 5 years (for some concessions).

The availability charge, a fixed obligation over the concession period is to pay the concessionaire for his investment and financing, very much like a finance lease. The financing element includes the principal and interest cost of the “loan”. Hence, the availability charge should not be totaled up but should be present valued to arrive at the debt figure. This will bring the debt figure down. Notwithstanding that, these obligations should be classified as debt.

Qualifier: we have assumed that the PPP obligations were totaled up and not present valued in the RM1 trillion calculation.

Impact of a Change in Government

What is the impact of a change in Government on companies, especially those with Government contracts or Concession Agreements?

The incoming Government must continue to honor the terms of the Agreements unless both parties agree to renegotiate. What can the Government do if the other party refuses to renegotiate lopsided terms? They can go through in detail and identify areas of non-compliance by the Company, e.g. the case of Syabas with regards to increasing in water tariff when the Selangor Government changed hands.

The other avenue available to the Government is to examine the conduct of the Company during the bidding and award of the Contract / Agreement. Under the Integrity Pact adopted by the Malaysian Government, Companies have to give declarations on non-corrupt practices. If they or their agents are found to have been involved in corrupt practices, one of the consequences is the termination of the Agreement.


1MDB Financial Engineering Demystified (2)

Our simplified explanation of how parties could have profited from 1MDB deals. This is meant as an example or illustration only.

2. Acquisition of IPPs
1MDB acquired the equity in 3 IPPs for RM12.07 billion. Roughly 3 years later, these were sold to CGN, a Chinese company for RM9.83 billion. Did 1MDB overpay for the IPPs?

The equity valuation of an IPP is based on the cash flow it can give its shareholders after paying off other claimants to its cash, namely operations, capital expenditure and lenders. Unlike other businesses, an IPP’s cash flow is easy to forecast due to the Power Purchase Agreement (PPA) terms. Hence, equity valuation can be done easily. So how much cash could the shareholders get?

2 of the IPPs were nearing the end of their Concession. Without the PPA extension, their value would be very low. Even if extended, the new tariff would be much lower as the IPPs’ debts had been paid off and they were in a relatively weak bargaining position. Based on the value, it seems that a lot of cash was assumed to be generated for shareholders.

Lastly, valuation using DCF is very dependent on the discount rate used. This is the easiest place to play with valuations. Was the discount rate used fair?

1MDB financial engineering demystified

1MDB financial engineering demystified. This is our simplified explanation of how parties could have profited from 1MDB deals. This is meant as an example or illustration only.

1. Parties making money by “playing” with the yield of bonds. The RM5 billion IMTN Malaysian Government guaranteed bonds

With the guarantee, the yield (or cost of borrowing) should be similar to other Malaysian Government papers, right? Not for 1MDB. At 6.68% p.a., the decision-makers committed 1MDB to a high-interest rate when they could have borrowed cheaply.

The bonds are first sold to the 1st subscriber (buyer) of the bonds at 6.68%. The 1st (called primary) subscriber then sells the bonds to other investors (secondary investors) at a yield similar to other Government guaranteed papers, say 5%. Remember, the credit is the same, ie. The government of Malaysia.

To adjust for the difference in yield (6.68% vs 5%), the price of the bonds go up. So say, the bonds were issued at RM87.92 to the 1st subscriber, the secondary investor now pays RM110 (for example) to the 1st subscriber, for an UPFRONT profit of RM22.08. Or over RM1 billion total profit!

In the meantime, 1MDB is stuck with paying 6.68% p.a. interest (an extra RM84 mil p.a. using the 5% example) for the next 30 years.

Utusan has fallen into the ignominious PN17 category

Utusan has fallen into the ignominious PN17 category. And all over a paltry sum of RM1.2 million which they could not pay their banks. It now has 12 months to come up with a regularisation plan (how it can become solvent again) to avoid delisting.

Utusan has been on a loss-making streak for awhile, chalking up RM71 million in accumulated losses. This UMNO-associated company was focused on its controlling shareholder’s agenda, losing readership and court cases along the way. It had been relying on the Government’s assistance which all came to an abrupt end on 9th May this year.

This then begs the question, didn’t the directors and management of Utusan also have a fiduciary duty to Utusan’s other shareholders who presumably bought Utusan’s shares in the hopes of getting a return? Should the focus have been more on profitability? If not, it shouldn’t have been listed in the first place.

It will be tough road ahead for Utusan based on preliminary indications. If its shareholders and business operations cannot even cough up RM1.2 million to avoid PN17, the future does not look good. Retrenchment is a high possibility.