Leasing

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Leasing is a popular form of financing. There are 2 types of leases, operating and finance lease.

For clarification, the lessee is the user of the asset while the lessor is the financier of the asset.

In operating lease, the lessor owns the asset and is responsible for its maintenance and insurance. The contract may be cancelled and the asset goes back to the lessor. The lessee recognises the lease payments in its P&L. That’s all the effect on the company’s financial statements. Typical assets leased are photocopying machines, computers and automobiles (not to be confused with HP for cars).

In a finance lease, the lessee owns the asset and is responsible for its maintenance and insurance. This is akin to the company borrowing money from a bank to buy the asset. The asset appears in the lessee’s balance sheet and is depreciated. The lease payments are discounted at the lessee’s borrowing cost and appear as a liability in the lessee’s balance sheet. Assets leased include buildings and aircraft.

Hence, a company will choose finance lease if it wants to report a bigger balance sheet. If it doesn’t want to have a high gearing (debt), it will choose operating lease.

Collateral

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When you borrow money, a bank will very likely ask you, “What collateral (security) can you give?”

What is collateral? That’s an asset pledged by a borrower to protect the lender’s interest. If the borrower defaults ie. do not pay back the loan, the lender can sell the asset to recover the money lent. Types of assets used as collateral include landed property, securities (shares), receivables, fixed deposits and plant, and machinery.

For an individual who is applying for a housing loan, the house to be financed will be the collateral for the mortgage. If the individual defaults, the bank will sell the house. If there is a shortfall between the sales proceed and the loan outstanding, the lender will claim the shortfall from the borrower. This happens when the house value is below the loan value. This is called negative equity, which hit many homeowners in the USA during the subprime crisis.

Share investing – dividends

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An investor gets 2 forms of return from share investing – dividends and capital appreciation when the share price rises. We take a look at dividends here.

If you are a retiree, what kind of shares should you buy? As a retiree, you need a dependable passive source of income because you no longer have a salary. You also cannot take on high risks because unlike a young investor, you do not have a long horizon to recover any loss.

Shares with a steady dividend payout suit that investment profile. These are typically blue chip stocks which are market leaders in matured industries. Some companies like TM have stated their dividend policy of how much they will pay out as dividends from yearly profits. They can do that because they do not need to invest aggressively or unexpectedly. Young companies on the other hand need most of their cash to be reinvested.

Look also at the dividend yield of the company. This is dividend divided by the current share price. This ratio changes as the share price changes. A 5% dividend yield means the dividend paid is 5% of the current share price. So assuming the company’s situation does not vary in the future, you can expect a return of 5% from buying the share.

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.

Learn more about M&A with Symphony.

 

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?

NB: If you are interested to be a trainer on ad hoc basis, please contact firdaus at firdaus@symphonydigest.com

 

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.

#sdfinance

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.