Tuesday, February 14, 2017

GFH 2016 Results: Settlement Assets

It Depends ...

This is the third in a series of three posts on GFHFG’s 2016 earnings.
Today’s post looks at GFH’s US$ 464 million out-of-court settlement.

What precisely did GFH get?

Well for one thing, not a dime or even one fils of cash.  

Instead GFH got illiquid hard-to-value assets, primarily real-estate.  

GFH’s 2015 financials state that “The fair values were determined by independent external professional firms using a combination of market and income approaches, as appropriate for each asset”.  Determining fair value of illiquid assets like these is no easy matter (euphemism of the post).  Different assumptions would lead to different “fair values”. 

Time will tell whether GFH gets more or less than the current carrying value.

For details let’s turn to note 19 in GFHFG’s 2016 financials which contains key information.

If you look at the auditor’s opinion, you’ll see that GFH’s auditor used a “matter of emphasis” comment to call attention to this note.  Presumably they felt it was critical information for readers of the financials. So exploration of the note is worthwhile for just that reason alone.  But we’ve got another purpose:  determining what was received and what the impact and implications of that receipt are.

The following table is based on note 19.

Litigation Settlement - USD Millions
Development Property

$118
Investment Property

$192
Unlisted Equity Securities

$9
Investment in Associates

$28
Other

$117



Total

$464

Let’s take a closer look.

Development Properties—US$ 118 million. As per GFH’s financials (page 21), “Development properties are properties held for sale or development and sale in the ordinary course of business. Development properties are measured at the lower of cost and net realisable value.”   As per note 8, the properties are in UAE, Bahrain, and North Africa.   There appears to be no cashflow from these assets until they are sold.  Note that in 2016 GFH sold DP with cost of US$ 43 million and declared a profit of US$ 46 million.  Of which some US$38 million remains uncollected as of 31 Dec 2016 (note 11). 

Investment Properties—US$ 192 million (net of financing).  As per GFH’s financials (page 21), “Investment property comprise land plots and buildings. Investment property is property held to earn rental income or for capital appreciation or both but not for sale in the ordinary course of business, use in the supply of services or for administrative purposes. Investment property is measured initially at cost, including directly attributable expenses. Subsequent to initial recognition, investment property is carried at cost less accumulated depreciation and accumulated impairment allowances (if any). Land is not depreciated.”  I didn’t see a disclosure of the amount of revenue from IP.  Any revenue associated with the IP acquired via the settlement would accrue only from October.

Unlisted Equity Securities—This amount is so small as to not be worthy of attention.

Investment in Associates—The US$ 28 million in value is ascribed to 20% interest in Global Banking Corporation Bahrain and 33.33% of  Ensha Development Company Bahrain.  Another small irrelevant amount, except those who follow the financial sector in Bahrain might question the ascription of value to GBC and wonder what this means for valuation of the larger amounts in the “windfall”.   

GBC’s 2015 audited annual report repeats the going concern qualification in the 2014 report (note 2.1). The auditors state that GBC’s Board decided in May 2014 not to undertake any new business and dramatically reduced staff from 31 to 10, including key management and risk control positions.  As in 2014, 2015 note 6.1 discloses that there is material uncertainty about the full recovery of one of GBC’s investee companies.  GBC reported losses in fiscal 2014, 2015, and for the first nine months of 2016.  

Since GFH does not show separate values for GBC and EDC, it’s not possible to determine the value ascribed to GBC.  AA would not expect GBC to have much, if any, value from continuing operations.  Even though GBC reduced staff to 10 and has no interest expense (GBC is essentially funded by equity and non-interest bearing accruals), it still cannot generate a profit. 

So any value ascribed must be liquidation value.  Taking values in 3Q16 financials for investment properties (real estate assets) and bank deposits at face value, 20% of GBC would roughly equal US$ 14 million, though liquidation values—particularly for real estate-- can often be much less than carrying values.   What would happen to values in liquidation is anyone’s guess.  I couldn’t find anything on Ensha either but both are relatively small amounts in the grand total.

Other Assets—US$117 (net).  This includes three assets related to Al Areen, including the Lost Paradise of Dilmun Water Park, and the British School of Bahrain.  Note 19 provides additional information on the determination of the value.  Some US$55 million of the US$212 million gross value of assets roughly 26% is “goodwill”.   

My impression is that the LOPD is not a major cash generator but would welcome readers’ comments.  There was an article back in 2010 or 2011 in the GDN with expectations for 180,000 patrons for the year.  There doesn’t seem to be any news reports more recent.  Nor could I find any financials or financial data.  Not surprising because it’s not a listed company. 

Looking at the summary financials for all of the US$ 117 million in other assets, it’s a bit troubling to see so little cash and cash equivalents on hand given the US$ 32 million in deferred revenue (payments made by customers for services to be provided).  This money has apparently been spent but the services not provided yet and expenses likely need to be paid, e.g., teachers' salaries. 

Some closing observations.  

The settlement did not include the payment of any cash to GFH.   There’s nothing like cash to settle an obligation.  Clear value is received.  Cash can be easily employed for acquisitions, funding development of one's existing lines of business, etc.

So what explains the absence of cash?

When one take assets in lieu of cash, one takes a residual risk that asset values may go down as well as a chance for upside appreciation.

There are two reasons for taking assets in a settlement. 
  1. The payer doesn’t have sufficient cash and assets are the best the payee can do.  
  2. Or the payee knows the assets are dramatically undervalued presenting an opportunity for an additional gain. 

AA suspects the first is the explanation.  The inclusion of GBC, Ensha, and the equity securities--all minor amounts--indicate that value was short and had to be topped up with some minor assets.  And in the case of GBC a troubled asset whose value is most likely based on a liquidation scenario.     

If the assets were dramatically undervalued, the payers would have sold some of them and thus been able to give less in value to GFH minimizing the decline in their own net worth.

These assets do not appear to generate substantial cash flow or profit, though there is insufficient information in the 2016 financials currently issued.  Perhaps the Pillar 3 disclosures for 2016 which are likely to be included in the “glossy” annual report will shed more light.

In light of this analysis of the “windfall”, what are we to make of GFH’s pronouncements about its performance, the success of its 2014 strategy, and prospects for the future?

When I read GFH executive management comments, I also see assertions that somehow receipt of illiquid hard-to-value assets somehow has dramatically improved GFH’s fortune, positioning GFH to “accelerate” its strategy. 

But how? 

GFH isn’t sitting on a cool half a billion in cash which it could use to fund acquisitions or to expand its lines of business.   The windfall doesn’t seem to generate stable cashflows that might fund such expenditures albeit at a lower level.   Nor are lenders likely to find these assets suitable collateral against which to advance loans in significant amounts.  Realization (sale) of these assets is likely to require time.

In addition GFH’s underlying business hasn’t been transformed as 2016’s results show.  And that’s even if one discounts the full amount of the impairment allowances taken.  To top it off the strategic talk sounds strangely similar to the pre-2014 strategy.

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