GFH 2019 EGM – A Timely Accounting Lesson for Shareholders of All Companies

Not Available, You'll Have to Make Do with AA's Tuition

Note this post concerns the EGM held in March 2019 for FY 2018.

As promised earlier, AA has prepared a translation of the EGM Minutes which are available elsewhere in Arabic only.  

The contents of this meeting are certainly interesting in their own right.  

But AA thinks there’s something more significant here. 

That there is an important lesson for shareholders of all companies to learn.  That is, shareholders need to look at more than just the Balance Sheet and Income Statement.

According to the formal published minutes of the EGM, there does not appear to have been any shareholder comment or discussion, except on two points. And that discussion was in AA's opinion sorely off point.  

So AA will focus on those two and draw the lessons to be learned from the second point – the discussion or lack thereof on the cancellation of Treasury Shares.  

You can use the English or Arabic very brief summaries of the EGM available on the GFH or DFM website for the other points.  

First point:  Mr. Ali Tariif asked why HSBC acting as representative of investors holding 1.68% of GFH’s shares had objected at last year’s EGM to the proposals in Agenda Items #2 and #3 to amend the Memorandum and Articles of Association to comply with changes to Bahrain Company Law and requirements of the Central Bank of Bahrain with any such changes subject to CBB approval (#2) and authorize the Chairman or CEO to delegate authority to another person to implement such changes (#3).  Agenda here.  

AA couldn’t find 2018 EGM or AGM minutes for FY 2017 to see if these would shed any light on the topic.

Mr. al Seddiqi responded that the majority of shareholders present at the EGM voted for the proposals.  

Essentially he did not answer the question directly.  Perhaps, he did not know. In any case these actions were forced on GFH by operation of law and changes were subject to CBB approval.  

Second point:  Regarding the cancellation of 207,547,170 Treasury Shares, Mr. Tariif asked about the mechanism for deleting the shares.  Mr. al Seddiqi responded that GFH’s lawyers would provide him a complete explanation about the mechanism after the meeting in the case the shareholder needed more details. 

That's the end of AA's translation of the EGM Minutes.  

It’s clear to AA from this that shareholders did not understand that GFH had purchased the Treasury Shares using GFH’s cash (ultimately shareholders’ money) and that by cancelling them the money “invested” in Treasury Share would be lost. 

Why is it so clear to AA?  

In the AGM the shareholders evidenced a serious concern about “money points”, e.g., the increase in expenditures, Board remuneration, dividends, etc. So it’s unlikely they would be indifferent to this spending of their money.  Thus, they must not have known. 

Given the amount concerned, they missed the elephant in the room. 

1. That is, a cancellation of Treasury Shares would cost them perhaps between 12x and 20x the USD 3.5 million proposed as 2018 compensation for the Board. 
2. Or that it is an amount equal to 1.4x to 2.3x the USD 30 million cash dividends to be paid in 2019. 
3. The two data points used to compute those ratios are the FYE 2018 USD 0.33 average price per Treasury Share and an estimated 1Q19 USD 0.22 average price. 

Why?  (Tuition bit starts here). 

Because the gain or loss on Treasury Share transactions does not appear in the income statement. 

And because the decline in equity due to purchasing Treasury Shares occurs upon purchase. It occurs gradually over time.  Not all at once. 

Cancellation of Treasury Share involves accounting entries within the equity account alone.  There is a credit to the Treasury Shares sub-account offset by a debit to Retained Earnings.  There is no net resulting change in the amount of shareholder equity. Thus, the loss is “invisible” to shareholders. Cancellation may, therefore, appear as a “costless” transaction.  It is not. 

Earlier in the AGM meeting Mr. al Seddiqi mentioned the purchases of Treasury Shares as one reason why shareholders’ equity declined along with dividends. Clearly, the implications did not register sufficiently with shareholders.  

AA’s observations. 

1. Investors would be well served by knowledge of the information available in the various financial statements provided in an annual report. One doesn’t need to be a CA or CPA to glean information from these. 
2. Paying close attention to what is said in meetings can also be of benefit. 

To address the first point AA will provide some tuition about sources of information in financials that can help shareholders and others track and understand the impact of non income statement events.  

AA sadly is unable to help on the second as Madame Arqala will testify. 

As noted the Income Statement and Balance Sheet do not provide the information that would be useful to shareholders in analyzing the cost of cancelling the Treasury Shares or the profit and loss earned from trading in them. 

However, the Consolidated Statement of Changes in Owners’ Equity (CSCOE)--also known as the Consolidated Statement of Changes in Shareholders’ Equity--and the Consolidated Statement of Cash Flows (CSCF) do contain useful information.  Information that can be used to analyze other non income statement transactions that affect the value of a company not just those involving Treasury Shares. 

In the CSCOE the total value of purchases and sales of Treasury Shares during the reporting period are clearly stated.  Also one can determine the profit or loss on sales of Treasury Shares during the period.  The value (cost of acquisition) of all Treasury Shares held by the company as of the statement date is also clearly stated. 

Information on how many Treasury Shares are held is disclosed in the Equity Note, at least in the FYE report.  One can use that information to compute an average purchase cost of a Treasury Share and then compare it to the market price to see if there are potential losses or gains in the Treasury Shares account and their magnitude.  And, perhaps, whether Treasury Share transactions appear to have been in the shareholders’ interests. 

To start some accounting basics. 

Entries on the liability and equity side of the balance sheet are the mirror opposites of those on the asset side.  This is to maintain the logic of double entry bookkeeping.  Assets = Liabilities + Equity.  

A purchase of a Treasury Share is recorded as a negative (a debit because it decreases equity). 

A sale is a positive number (a credit because it increases equity).  

A loss on a sale must therefore show up as a negative entry because like any loss it decreases Shareholders’ Equity.  

Keep these basic points in mind as we proceed. 

To make this clearer via some examples.

Open your textbooks (GFH’s FY 2018 AR) and turn to GFH’s 2018 CSCOE on page 9.  

During 2018, GFH purchased Treasury Shares in an aggregate amount of USD 160.973 million (shown as a negative). This is the total price paid for Treasury Share purchases during fiscal 2018 and is recorded in the Treasury Shares sub-account in Shareholders’ Equity. 

GFH also sold an aggregate of USD 133.966 million of Treasury Shares (shown here as a positive number).  Similarly recorded in the Treasury Share sub-account.  This amount ascribed to sales is the original purchase cost of the Treasury Shares sold not the cash received for them. It therefore does not reflect profit or loss but merely the equivalent of the cost of goods sold. Keep that point in mind.

The net of these two resulted in the value of Treasury Shares increasing from USD 58.417 million to USD 85.424 million as shown in the opening and closing negative balances of the Treasury Share sub-account. 

How did GFH do on the sales of Treasury Shares in 2018?  Did it sell them at a profit?  Or a loss? 

It had a loss which was recorded as a decline of USD 3.058 in Share Premium and USD 24.818 million in the Statutory Reserve Account (SRA). Note both figures are presented as negatives in the CSCOE because a loss on the sale of Treasury Shares is the same as any other loss it reduces equity.  

Side comment:  AA is puzzled by use of the SRA to reflect the loss on sale of Treasury Shares.  AA also notes that starting in 1Q2019 GFH began reflecting losses on Treasury Share sales directly to Retained Earnings. This is certainly more transparent regarding profit and loss than the previous year’s entries. There’s that word again (شفافية ). Keep it in mind.  I’m sure we’ll hear it again. It often comes up in regard to GFH. 

From this information we see that the total loss in FY 2018 was some USD 27.876 million.  Or in other words, GFH sold Treasury Shares it previously purchased for USD 133.966 million but only received consideration (presumably cash) of USD 106.090 million. 

You will note that this amount appears in the “Total Change Attributable to Shareholders of the Bank” (TCASB) (on the right on the page) on the line for Treasury Share sales. Looking at the amount shown in TCASB and comparing it to the amount shown as "sales" in the Treasury Shares column gives a very quick insight whether there was a profit or a loss.  If the number in TCASB is less than "sales", there has been a loss.  If it's greater, there is a profit..  

Note: The sub-accounts are displayed vertically as columns, e.g. Share Capital, Share Premium, Treasury Shares, etc.  

We can use a similar method to analyze the cost or loss of cancelling the Treasury shares.  There will be a positive number shown (remember this is the cost of the shares)  in the Treasury Shares sub-account and the same amount though a negative number shown in the Retained Earnings sub-account.  No cash received.  No revenue. The loss equals the cost of shares that are being canceled.  This should appear in GFH's 2Q19 interim financial statements. 

But we can estimate the "loss" now.   Calculate an average price per Treasury Share and multiply times the number of shares to be canceled.  See earlier post here.

This technique can be used with other sorts of transactions. 

Take a look back in the CSCOE in GFH’s 2017 AR to examine the issuance of USD 314.530 million in new shares in exchange for GFH assuming ownership of certain infrastructure and portfolio investments.  That amount (USD 314.5 30 million) appears in the Share Capital sub-account. You’ll notice in the Total Change (again attributable to bank shareholders) column for the line “Issuance of Share Capital” that GFH received value of USD 293.106 million which indicates that shares were issued at a discount. More on that in a post to follow. In the interim some preliminary thoughts from an earlier post.

Here’s another way to think of a Treasury Share sale to understand losses and gains. 

Recall that the original cost of the purchase of a Treasury Share is recorded in the Treasury Shares sub-account (within Shareholders Equity).  When the company sells a Treasury Share it must remove the cost of that share from the Treasury Shares sub-account.  Think of this operation as the equivalent of determining the Cost of Goods Sold (COGS).  Cash or consideration received is the Revenue.  If COGS is greater than; Revenue, there is a loss equal to the difference Revenue – COGS.  If Revenue is greater than COGS, there is a profit equal to the difference Revenue – COGS. 

But unlike other gains or losses which flow through the income statement, including the "comprehensive statement of income" which usually follows the traditional income statement in financial reports, the gain or loss on treasury share transactions is  directly deducted from equity in the case of a loss or added to equity in the case of a profit.  

Now open your other textbook (GFH’s 1Q19 interim statement) and look at the CSCOE on page 4 at Treasury Sales, the negative number appearing in the Retained Earnings Column means the GFH had a loss on a sale of Treasury Shares of some USD 9.574 million.  GFH sold USD 40.86 million of Treasury Shares (COGS) but received only USD 31.286 million (USD 40.86 million less USD 9.574 million) in Revenue (Cash). Notice that USD 31.286 appears in the Total Column Attributable to Shareholders of the Bank (appearing on the right side of the page). 

Let’s turn to the Consolidated Statement of Cash Flows.  In the CSCF one gets the net flow for the year – purchases offset by any sales.  The point here is that if one can see the net cash going out of the company (a net purchase) or cash coming into the company (a net sale).  One can compare the amount to the other cash inflows and outflows during the year. One can do this with Treasury Share transactions and other non-income statement items. 

But of course, you’ll want to look at the detail shown in the CSCOE as a net of USD 10 million could be that there were only USD 10 million in purchases.  Or it could be the net of USD 1,010 million in purchases and USD 1,000 million in sales.  

For example, in GFH’s 2018 AR the CSCF shows net purchase of Treasury Shares of USD 54.883 million in the section “Financing Activities”.  Referring to the CSCOE, we see there were USD 160.973 million in purchases and net sales (after loss) USD 106.090 million.  Confirming our earlier analysis that GFH lost USD 27.876 million on the sales. If you were to merely look at the Treasury Shares sub-account and ignore this number, you'd think that net purchases were USD until you remember that the "sales" shown are cost of goods sold not revenues or proceeds of sales. 

Other Uses:  Under accrual accounting, a firm recognizes income when earned (creating an account receivable) and expenses when incurred (creating an account payable). These recognition events often occur prior to the movement of any cash.  So it’s not uncommon for revenue and thus income to be recognized in one period and received in another in the future.

The CSCF will also show which revenues have been received in cash during the reporting period and which expenses have been paid in cash.  One can also look at revenues that have not been collected to determine whether there will be a cashflow in the future. 

Let's start with expenses and then turn to revenues.

For example, a provision for a legal case is a non-cash charge for estimated future cash payments which may or may not occur. 

A reversal of a provision, e.g., the USD 35.3 debt settlement gain on AHC in FY 2018 (a reversal of a previous legal provision), will never result in a cash inflow. 

A loan provision is established to cover the possibility that the borrower will not pay the loan in full.  It is an estimate of the amount of non-payment.  

A depreciation charge is not paid in cash during the reporting and won’t be paid in the future.  It is the expensing of a purchase of a machine or other “hard” asset made in the past.  That cost is expensed according to estimates of the useful life of the “hard” asset. And there may be more than one depreciation method.  Methods that stretch the charges over many years make income higher.  Methods that accelerate depreciation will make income lower. 

To track receipt of revenues one can use the CSCF to if there are any adjustment to net income.  For example in GFH's 2018 AR, we see that USD 113.1 million in "debt settlement income" was not received in cash.  We can also see adjustments for other items, such as depreciation which is added back.  In general when income is recognized, an account receivable is created.  As the money is collected, the receivable will decrease.  Of course, if there is new income recognized, then that decrease may be partially or fully offset depending on the amount collected and the new amounts recognized. 

How does one dig further?   

One should go to the notes to the balance sheet to see if money was collected. 

Looking at GFH’s 2018 AR we see they booked some USD 121 million in revenue in 2017 for Investment Banking Fees.  A look at Note 16 indicates that this was either all or largely received in 2018 – the receivable for IBF is down some USD 100 million from FYE 2017.  If one looks at GFH’s 2017 AR, Note 11 there is a footnote that USD 104.6 million was received in January 2018. 

If there is a decline in receivables, one can’t just assume that cash was received.  One needs to read the Note (usually Other Assets) to see if there was an impairment provision that accounts for the decline.  Or that these receivables were settled for non-cash consideration, e.g., shares or other investments.  

And then one might want to look at just what that non cash consideration is and whether there is any question about the “value” of these non cash assets both in terms of their credit/investment quality or the time it will take to realize them, that is, to receive cash from them.  

Delayed receipt of payment is a discount in present value terms.  A $100 receivable paid today is worth a lot more than $100 paid five years from today as AA expects the hapless shareholders of Dubious Gas know all too well. 

Knowing these additional sources of information and how to use them can help shareholders and others better understand the performance and health of companies.  And help guide them as to questions to pose to management.