A Gem of an Investment: Damas

One of this blog's select group of readers raised a question about Damas and provided a link to an article in The National newspaper from Abu Dhabi.  I promised to put a few thoughts together in a post and belatedly am making good on that promise.

First, a bit of background to set the stage.

1. In Summer 2008 Damas offered 270.6 million shares of which 233.9 million were new shares.  36.7 were sold by Amwal al Khaleej Commerical Investment Company (Saudi Arabia)  as per the Final Offering Circular ("FOC").  As per page 72 of the FOC, the three Abdulla Brothers (Tawfique, Tamjid and Tawhid) would own more than 51% of the Company after the Offer.
   
2. Fees and expenses on the transaction were reported as US$10.4 as  (page 19 FOC).
3. In July 2008, Damas listed on the DIFX, now NasdaqDubai.
4. In December 2008, the Company changed its fiscal year from 31 December to 31 March with the following justification:  "The Board of Directors of the Company vide their resolution dated 22 December, 2008 has changed its Financial Year End from 31 December, 2008 to 31 March, 2009 due to the following reasons.
   i) Since the market conditions were very much volatile, the first part of 2009 would give the Company, some time to see how expansions could be made effectively in the later part of the calendar year.
   ii) All the Auditors were extremely busy at the end of the calendar year and feel pressurised to deliver and that it would be a better option to choose a lean period for audit reviews and for consolidation of more than 75 Group companies."    
5. On 12 October 2009, Damas announced the resignation of Mr. Tawhid as Managing Director and CEO "due to his disclosure to the Board of what is understood to be unauthorized transactions conducted by him.  The full extent of these transactions has not been ascertained at this time but the Company’s initial estimate is that these transactions could amount to approximately USD 165 million."
6.  On 15 October 2009,  the Board of Damas announced "the appointment of PricewaterhouseCoopers (PWC) as an independent auditor to examine the unauthorized transactions conducted by the former CEO and Managing Director Tawhid Abdulla."
7. On 4 November 2009,  the Company announced a Settlement Agreement with the three Abdulla Brothers to repay US$165 million over the following 18 months in three installments of US$55million due within each of the three six-month periods comprising that longer period.  Certain real estate was pledged as were 350 million shares of Damas to be taken in the event that the Settlement Agreement was not honored.

Now to more recent details.

On 16 December 2009, Damas published its September 2009 interim financials.

The following five notes particularly caught my eye:

(1) Note 6:  Provision Against Consignment and Receivables Exposure

"Included in unimpaired receivables (note 9) are debts amounting to AED 53 million (31 March 2009: AED 47 million) due from particular consignment debtors and AED 32 million (31 March 2009: AED 54 million) due from certain high net worth customers who are familiar and acquainted with certain Directors."  AA:  It would be interesting to know who these "high net worth" customers are who apparently forgot their credit cards or chequebooks at the time of  purchase.

(2) Note 11 Related Party Transactions

"The Executive Directors have provided personal guarantees amounting to AED 150 million (31 March 2009: AED 150 million) in respect of risks associated with unfixed gold lying with certain parties, dues from particular consignment debtors and certain high net worth and important customers (note 6)."  AA: I wonder if these "important customers" are among those who haven't settled their purchase payments yet.

(3) Note 12 Directors' Current Account

"The above balances relate to Mr.Tawfique Abdulla, Mr. Tamjid Abdulla and Mr. Tawhid Abdulla. Against the balance above there are loans due to these directors amounting to a total of AED 150 million which are subordinated to bank facilities.

Subsequent to the period end, the management has entered in to a Settlement Agreement with the concerned directors wherein they have undertaken to repay an amount of US$55 million within 6 months; an aggregate of US$110 million within 12 months; and an aggregate of US$165 million within 18 months; and, should there be any balance in excess of the US$165 million as a result of any findings arising from an ongoing independent investigation or otherwise, any such excess amounts in cash and/or unencumbered assets within 24 months. All payments are to be made in cash and/or unencumbered assets.

As part of the Settlement Agreement, the concerned directors have produced a list of assets that are potentially available for liquidation to be converted by them into cash and/or to be contributed to the Group as unencumbered assets to meet their obligations under the Settlement Agreement. Such assets consist principally of real estate investments in the Middle East and North Africa (including a number of residential and commercial buildings and units in the United Arab Emirates) and an investment in a shopping mall in Turkey.

As part of the Settlement Agreement, the concerned directors have pledged 350 million of their shares in the Company that would be transferred in whole or in part back to the Company in the event the terms of the Settlement Agreement are breached. These shares had a market value of AED 275 million as at 25 November 2009.

As at the date of authorisation of this financial statement, the process of independent valuation of the assets available for liquidation is still under process. An independent investigation is also ongoing into transactions undertaken by the former CEO and Managing Director of the Company. This investigation is being overseen by a subcommittee of the Board.

Subsequent to the period end due to increase in the price of gold and additional transactions the amount due from the directors was AED 635 million as at 25 November 2009 (net of loans due to directors amounting to AED 150 million)."  AA: There are several more interesting details in this note in the comparative table of outstandings and their movements, including the use of a company deposit to secure a related party's loan.  Presumably, one of the unauthorized transactions.  Or at least one hopes so.

(4) Note 13:

"* A subsidiary of the Company had provided a loan amounting to AED 294 million (USD 80 million) to Dubai Ventures Group Limited (“Dubai Ventures”) at a rate of interest of 6% p.a. which was due to be repaid in August 2009. On 18 August 2009 an investment agreement was signed with Dubai Ventures, wherein Dubai Ventures confirmed that all monies previously provided to it under the loan facility were held by it as money provided for investment purposes and would be transferred into a investment account over which Dubai Ventures would have discretionary management powers. Subsequently when the Group requested information as to the nature and value of the investments held in the investment management account they were informed that the account held shares in Damas International Limited with a value of only AED 73.5 million and that no other assets were available to the Company. Although discretion had been given to Dubai Ventures in respect of investment choice, the Board of Directors of Damas International Limited had not authorised Dubai Ventures to invest in shares of the Company. The Board intends to dispute Dubai Ventures actions in this regard and will seek to recover the full amount due under the original loan facility agreement.  For reasons of prudence a provision has been made amounting to AED 312 million against the total loan amount including accrued interest."

(5) Note 17 Going Concern

"The increasing spot price for gold has resulted in a decline in sales and an increase in margin calls from financial institutions from whom the Group obtains gold loans. These factors combined with the amounts withdrawn by a director (note 12) have resulted in a significant decline in the liquidity of the Company. It has also resulted in the Group defaulting on certain of their facilities subsequent to the period end and a number of financial institutions reassessing their facilities with the Group.

Discussions are currently ongoing with banks regarding renewal/restructuring of facilities and securing sustained funding to carry on its operations. As part of this process the Group has signed an agreement with certain institutions that may result in certain diamond inventory being sold at a loss in future as an additional cost of finance. Additional funding is required to ensure that the Company can continue its operations and meet its financial obligations as they fall due.

Whilst the results of the negotiations with the banks cannot be determined at this time, the Board of Directors has elected to prepare these financial statements on a going concern basis as they are optimistic that agreement will ultimately be reached with the banks."

Now to some commentary.

How did this happen?  

It appears from the timing that the conversion of the loan to Dubai Ventures happened during the tenure of the previous Managing Director/CEO.  Earlier I had raised a question as to what a jewelry company was doing making a commercial loan to another entity and whether this was ultra vires.  A glance at Damas' Articles of Association show that the answer to the latter question is a resounding no. 

Basically Article 1.4 (b) allows the company to anything that's not illegal.  As well, Article 15.3 would seem to permit the delegation of authority to engage in such transactions to the MD/CEO by the Board.

Of course, there is still the valid question of why this company got into the loan business, when it appears to have been in financial distress from unfavorable developments in its core business.  This loan was disclosed in Damas' 2008 fiscal financials issued in July 2009.  So the Board  cannot disavow knowledge, though its knowledge may have been post facto after the loan was granted.   It would be interesting to know the Board discussion that took place on this issue.

As indicated in Note 13, when the loan was not repaid, presumably because Dubai Ventures could not, it was converted to an investment account.  Not an untypical strategy to prevent the recognition of an impairment or a loss.  The AED64,000 question here is whether the MD/CEO undertook this decision on his own or the Board was involved.

What is also intriguing is whether Dubai Ventures inability to pay is evidence of a wider pattern of cash shortages or other financial distress within Dubai Inc.

What about the Settlement Agreement?

As is probably obvious from previous posts, AA has a particular fancy for settling obligations in cash.   As per Note 12 it seems that settlement can be made in "cash and/or unencumbered assets".   Since Damas is not a real estate investor (or at least AA hopes they're not), it would seem that settlement should be in cash.  Any real estate should be sold and the proceeds given to the company with the Abdulla Brothers bearing the conversion risk, not the Company.   

Also I'd note that Article 2.15 of the Company's Articles states:  "The Company may not take a lien over any of the shares."  Presumably legal work has been undertaken by clever counsel to make the pledge by the three Abdulla Brothers legally effective.

Bottom Line

When investing in a family company make sure you've got adequate control  at the Board over the family members' management of the company and signature authorities (enhanced requirements for Board approval is one technique), robust corporate governance actually implemented, and of course detailed disclosure of company affairs.