Tuesday, May 18, 2010

Global Investment House –Commentary on 2009 Financials & Rescheduling



Earlier yesterday when I saw that GIH had posted summary 1Q10 financials, I decided to do a quick comment while waiting for the full report. 

That reminded me that I had not taken a close look at their audited 2009 annual report. So as a way of preparing to comment on 1Q10 I did. 

Now instead of commenting on 1Q10, I've decided it's preferable to first make some comments about 2009 FYE as a way of providing a basis for later comments. And, as you quickly see, spouting off on a topic or two along the way.

Cash and Banks  - Less Than Appears

Note 12 Page 48: At year end, Cash and Banks was a robust KD101.2 million. A closer look at Note 12 discloses that KD55.1 million was cash at subsidiaries. That is, this cash is in separate legal entities (at least KD28 million at Al Thouraia) and not necessarily at the disposal of GIH. 

AlThouraia -A Strange Saga

Note 24 Page 57: It seems that a KD43.3 million deposit that AlThouraia Properties placed with a local bank was offset by that bank against a loan made by that bank to the Parent, GIH. It's unclear to me what the legal basis for this offset is. Did AlThouraia guarantee the loan made by the bank to GIH? If not, how does the bank cross legal entity lines? 

Particularly, when GIH only owns about 83.36% of AlThouraia, what is the basis for stiffing the minority shareholders on the offset? By the way GIH "recognized" the offset in its financials.   No skin off its nose as they say.

Note 25 Page 57: This discusses the acquisition of Al Thouraia through an asset swap – non cash. The assets are described on Page 58. In effect through this transaction, GIH acquired control of this company, added KD28 million or so to its cash balance, and removed KD83 million in borrowings (from Al Thouraia) from its balance sheet on consolidation. Note GIH does not necessarily have control over the new cash. And it's likely that the KD83 million in debt remains a legal obligation of GIH so that impacts GIH's (the Parent's) cash position contrary to the impression from the consolidated numbers.  It's not only down KD28 million but another KD83 million.  This transaction may also be a very convenient way of dealing with a troublesome issue as discussed below - Saudi Mazaya.

Page 58 reveals that Al Thouraia Project Management Company was established in 2008. Having raised a large amount of capital for no doubt worthy investments, it decided to place most of it with a single financial institution – which technically was not a bank but a entity with an investment firm license. Now why would Al Thouraia's highly responsible board do something like that?   Of course, some out there asked similar impertinent questions about the placements by Global MENA Financial Assets with GIH.

Well, it knew the credit of GIH intimately as this press release shows. And as we learn there: 
"Global announced the launch of Al-Thouraia Project Management Company's capital increase to KD180 million.  Al-Thouraia shall be utilized as a Special Purpose Vehicle (SPV) to invest its whole capital in Mazaya Saudi for Commercial Investment Company "Mazaya Saudi", which has been incorporated in the Kingdom of Saudi Arabia, and will be managed by Mazaya Holding Company "Mazaya". Global Acts as Lead Manager Al-Thouraia Project Management Company." 
If you've been reading the readers' comments to this blog (where you will often find more informed comment than in the main articles), you have seen The Rageful Cynic's link to a post on the saga of Saudi Mazaya.

Debt Rescheduling - "The Most Short-Sighted Unrealistic Deal of 2009"

Note 29 Page 61-62 details the debt rescheduling.  To put my comments in context, note that this US$1.7 billion equivalent deal is secured by US$1.4 billion in principal investments and US$0.3 billion in real estate.  All conveniently hived off into separate companies so that that the lenders should have an easier time of taking ownership.  They merely have to take the equity in the holding companies.  No need to re-register a plethora of individual assets in their own name.

This transaction, as GIH constantly reminds us, won the "Most Innovative Deal" by Euromoney for the Islamic tranche. And you can read more praise on pages 20 and 21 of GIH's 2009 annual report.  Earlier GIH also issued a brochure full of self praise.

After looking through the terms of the deal, I'd like to belatedly award the entire transaction "The Most Short Sighted Unrealistic Deal of 2009". 

A charitable soul would be likely to give GIH's management the benefit of the doubt – that they were coerced into signing this deal.   In evaluating this it would be useful to know just how hard they fought these terms, if at all.

I'm at a loss to find even a single kind word to say about financial institutions that would impose such a deal on a borrower. Banks are not to be faulted for trying to get back the amounts they loaned. But the terms of a rescheduling should be designed to minimize the damage to the borrower.  Milk the cow don't kill it.  

This deal, as you'll see from the details below, does not do this but sets a thoroughly unrealistic repayment schedule and then couples it with interest rate step ups and other onerous clauses. 

Repayment Schedule:
  1. Year 1: 10% 
  2. Year 2: 20%. 
  3. Year 3: 70%. 15% in the first six months, 20% in the next six months and 35% at year end. 
Did anyone in their right mind think this was achievable without causing great damage?  That markets would recover that fast?  Did anyone notice that GIH has almost KD41 million in bonds maturing during Year 3 on top of this debt service? Even if markets have recovered a sale of that size - a literal fire sale - is likely to burn a lot of value up.

Interest Rate
  1. Year 1: 1.5% plus Libor, EIBOR or Central Bank of Kuwait discount rate). 
  2. Year 2: An additional 1% on the margin, taking it to 2.5%. 
  3. Year 3: An additional 1 % on the margin, resulting in 3.5%. 
The interest rate step-up is designed to put pressure on GIH to meet the unrealistic repayment schedule. It's hard to see the rational rationale for this.  If the term were longer, say 7 to 10 years, this might make sense (though with the step ups a little more spread out).  But with the short tenor, it doesn't make a lot of sense. How many whips do you need to apply to the horse?   And, if GIH can't sell its assets, another 1% is not going to suddenly cause them to do so.

Fees: 
  1. A 1% flat fee on the amount of the rescheduling.
  2. Plus 0.25% of the amount rescheduled starting on 15 December 2008 to the date of signing. Both amounts to be capitalized. 
  3. Then 24 months after signing another 1% flat fee on the amounts outstanding. Also to be capitalized.   A third whip?  Same comment as above.  If GIH is in a tough spot, an extra 1% on the debt isn't going to move them one way or the other.
Covenants:  

GIH commits to maintain: 
  1. Asset value to debt outstanding of .75x. 
  2. From 30 June 2010 a minimum Capital Adequacy Ratio of 5% increasing to 7% from 1 July 2011 through final repayment 9 December 2012. 
  3. If GIH fails to repay 40% of the original facility amount by the second anniversary, the banks have the right to convert the shortfall into GIH shares. 
  4. Finally, the proceeds of any new equity raised must be used to prepay the rescheduled debt. Funny I must have missed that point in previous discussions about GIH's approval of its Rights Offering. Did anyone (including GIH's wise creditors) think that potential shareholders are going to be excited about buying new equity in a firm that can't pay dividends and where the proceeds of the offering will not be used to build the business but to pay back apparently rather greedy lenders? Might it not have been a better idea to let GIH raise capital without requiring that it be used for debt prepayments? On the theory that additional capital would build the business capacity which would strengthen the banks' position.  And of course once the cash was in the till, it could be used for cash shortfalls on debt repayments?  Looks like a case of "wise" bankers shooting themselves in the foot.  One wouldn't use the expression "shoot themselves in the head" here as it's pretty clear there would be more damage caused by a bullet in the foot than one in the head to this wise collection of lenders.
No wonder the lenders were besides themselves with effusive praise for GIH and its management. It seems that GIH gave them everything they asked for. Or perhaps just about everything.  Whether this is all achievable or makes the best sense for the banks is debatable.

The only thing I can think of that would justify such terms would be a profound lack of faith in management - probably based on an adverse assessment of fundamental ethics.  That clearly can't be the case here.  Can it?

6 comments:

The Rageful Cynic said...

I think you hit the nail on the head with your last paragraph. Global will probably default on its debt again at some point in Year 3 which is, I think, why the restructuring schedule is so short, to get as much out as they can.

there's no way Global is gonna be able to sell all of those crap assets, especially in this market.

You didn't comment on the newly created Global Macro Fund, which will probably be upwards of KD 400 mn in size by the end of the year
(so, basically, don't be fooled by a sudden leap in AUM, which no doubt Global will pat itself on the back for)....

Abu 'Arqala said...

TRC

I'll be posting a bit later today I hope on GIH's 1Q10 financials. It's hard to see how they will generate enough cash from operations to pay the light bills - particularly because of their cost structure - which appears largely unchanged from 1Q09.

As to the addition to assets, seems perfectly within character.

If one can sign a poorly crafted debt restructuring and claim triumph, then how hard can it be to claim responsibility for the increase in AUM?

In fact it might just demonstrate yet again the nature of GIH's "proven business model". And the wisdom of its leadership.

Anonymous said...

thought-provoking points to say the least but i can't help but feel this theme is by now hackneyed and tackled from the angle that the company can do no good.

for arguments sake, lets look at the other side of the coin and consider how the company can look forward and come out of this better than most of its peers that have also fallen by the wayside. something akin to a SWOT analysis would be apt.

far from being an exhaustive list, here are some thoughts:

- Global has some good infrastructure (offices, staff, an organization, client base) that would take any new competitor a while to replicate.
- While there are many clients that have been hurt there are also those that are willing to give them a second chance (no scientific, measured data here. just an anecdotal opinion that i'd like to see argued)
- Market equity (and other?) regional funds with a decent portion being the index-tracker type in a market where these are still small but growing. One just has to look at Barclays' BGI unit to see how much value this generated when it was sold off on a relative basis (the unit's AUM was, in itself, huge)
- Transactional brokerage (retail i believe) across a number of markets that can be further enhanced. this is an area where most regional institutions and even the global ones have simply not done enough and at a time when more - not less - people are interested in directly investing their savings and even after the crisis (my opinion based on observation).

so is there an opportunity? how do you take advantage?

Abu 'Arqala said...

Anonymous

Part 1

As to your central question, the steps GIH needs to take:

(1) The first priority is paying off the debt. A second default will more likely than not be fatal. Perhaps, not immediately but if GIH gets into this situation, it will be in a tailspin to a slow lingering death.

Paying the debt is also critical from a client relationship perspective. In order to do new business with the firm, clients have to feel comfortable that GIH will be there in the future. With the stupid deal imposed by the banks on the company, serious clients have to have serious questions on that.

(2) Another key priority is restoring market reputation. As I see it, GIH has two hills to climb on this score.

One of these just has to do with overcoming the damage caused by being in a restructuring. That's why there's all this hype at GIH about how transparent, honest, co-operative and successful they were in their debt restructuring.

The second of these has to deal with perceptions of integrity and business ethics.

It's a difficult thing to lose money in a deal that doesn't turn out as expected. An investment that doesn't work out. When that happens clients are unhappy, and it can be hard to restore their confidence -- though it can be done as evidenced by one long standing investment bank in Bahrain.

BUT when clients lose on investments and there is the perception that they were taken advantage of, then the task is even harder. It's hard to see how clients could form a good impression of GIH's conduct with respect to Al Thouraia (aka AlThuraya), Global MENA Financial Assets for example.

The usual solution to this is a change in the management including the Board. New faces = new ethics.

Abu 'Arqala said...

Part 2

Assuming that GIH addresses the legacy issues mentioned in Part 1, how does it build a new viable business?

GIH has charted a course. Asset management, brokerage, and investment banking services. And will at least in the near to medium term avoid principal investments. The latter means a leaner firm - a smaller balance sheet, and the need for less debt.

I'll post on this a bit later when I comment on 1Q10 financials.

A quick summary.

The current cost structure is out of proportion with likely revenue streams over the next 3 or so years. So they face the conundrum - do they cut expenses to match projected revenue levels? Or can they generate the revenues necessary?

On that latter score the fundamental nature of their "core" businesses is different from principal or proprietary investments - the profit margin is smaller. Their core activities are largely transactional - which means that volume is the key. How to drive volumes? That's not only a question of market share (how much GIH can get), but also how big the market is.

If GIH continues to have losses (even if it can pay its debt), that is going to be a very big stone on its shoulders - a stone that goes back to the first point in Part 1. Client and market confidence. And there's a feedback loop to getting new business.

A magic bullet (note not "the magic bullet") would be a massive capital infusion - which would remove uncertainty on Point #1 Part #1. And give GIH the breathing space to absorb losses while it tried to build up new businesses.

And that's why I'd argue that my analysis is not "they can't do anything right" - but rather here's the situation they are in. It's not pretty but it's the fact.

Anonymous said...

I think Global is not really doing anything to improve their situation. It seems as though they are waiting to file bankruptcy and this debt restructuring is just an excuse to cipher money out of the orgnization.
In the end the people at the bottom of the food chain will suffer.