Global Investment House: The Future is Now and Likely to Remain So

For Some Now May Be the Only Future They Have

As promised in my first post, some thoughts on Global’s future.

As detailed below, Global faces a variety of very real constraints to growth—the primary one being control by its creditors. If it doesn’t or can’t grow, Global’s net income will remain modest, likely be volatile, and its ROE subpar. These obstacles are formidable and AA has a hard time seeing Global finding a way out of this challenge.

First a recap to set the scene.

Recap

In my previous post I identified a structural problem with Global’s revenues and expenses.  The latter (adjusted to exclude impairment and loan loss provisions) average roughly KD 14 million a year – 140% of the revenues from its core Assets Under Management (AUM) business.  Other lines of business (LOBs) then have to generate enough revenue to cover remaining expenses and produce a profit.

That’s a problem because Global’s other LOBs lack the scale to consistently generate enough revenue to do this –either in absolute or ROE terms.

Profitability is cobbled together from these “hobby” businesses plus one off items such as FX translation gains from a depreciating dinar or loan loss provision reversals—items whose persistence is unlikely.  

By way of example, if these latter two items had not been present in 2015, Global’s net income would be 10 percent of the reported KD 6.5 million.  Additionally, the non-AUM fee-generating LOBs (chiefly brokerage and investment banking) are market sensitive and thus add unwelcome volatility to earnings.

Strategic Options

In the face of this structural problem, Global can either: 

1. Accept its current position. 
• Live with the volatility. 
• Or rationalize its expense base to reduce the volatility. Without detailed information it’s not possible to determine if cutting what appear to be “hobby” operations – Bahrain and Oman brokerage, for example—would result in significant cost reductions without disturbing the AUM business.  
2. Seek to materially change its fate by significantly growing revenues as a way of eliminating volatility, increasing ROE, and making itself a more credible partner for clients and a more compelling opportunity for equity investors.

As my framing of options indicates, I think growth is the preferable path. 

Shrinking oneself to greatness is not really a business strategy.  Growth will also facilitate the sale of the creditors’ 70 percent stake which as argued below is the major current constraint on the firm’s development.

One caveat about growth.

FGB/NBAD is unlikely to challenge ICBC 'sor JPMorgan’s position.  Nor will Global rival the likes of Blackrock.  That’s fine.  There’s nothing wrong with being a fish in a small pond.  But even a fish in a small pond needs to grow to keep up with the other fish in the same pond. 

There is a third option: a sale to another institution that can fold Global’s business into its own, cut costs, and reap the benefits of scale. 

Two things would be required.  

1. A sale price that would satisfy the creditors.  This probably would be the main sticking point to this scenario.  This early in the life of the debt settlement there probably would be creditor price resistance to a “bargain” sale.  
2. A transaction that does not disturb the current client relationships, i.e., that maintains the KD 1.1 billion in AUM.  That is perhaps easier to achieve if current legacy management and board representation is retained.

If Global doesn’t increase revenues, net income is likely to be volatile, remain relatively modest, and ROE subpar.  As outlined below, Global faces some very real growth constraints. It’s hard for AA to see a way forward for the firm out of this conundrum.

Constraints on Growth

Current Majority Shareholders (Creditors)

The primary current constraint on growth is the majority shareholder (Global’s creditors) who by virtue of their 70 percent equity stake control the firm.  Their self-interest is directly at odds with a pro-growth strategy.    

In the best of times, bank creditors like other “bond” investors focus on return of capital and not like “equity” investors on growth and increasing return on capital.

A debt restructuring typically intensifies this tendency.  Cash extraction from the debtor becomes even more urgent and is imposed through aggressive repayment schedules and rescheduling covenants that severely constrain spending and business development.   

But Global wasn’t a typical restructuring.  Creditors normally don’t take assets to settle debts because they know that their track record in realizing assets is much worse than in underwriting loans.   

The fact that creditors demanded 70% of the rump firm’s equity and existing shareholders gave it is a very clear sign that a serious shortfall from asset sales was expected. That deficit and the need to maximize recovery have no doubt exacerbated the impulse for cash extraction.   

When equity in the borrower is taken, creditors cash out by selling the firm to investors or collecting dividends.  When a sale at an acceptable price is not possible, then dividends become “favorite”. 

At this time, price expectations of seller and buyer are probably far apart.

Since we are only three years into the settlement, an acceptable price for creditors is probably one that is no less than the value ascribed to the equity when the “expected” loss on the settlement was calculated.  To sell for a lower price would require booking a loss.  Over a longer period, the creditors’ price discipline could wane, if earnings prove volatile and that volatility requires a revaluation of the carrying value of the equity.

Given its current condition, Global is not a particularly exciting investment prospect for new investors.  Legacy shareholders probably haven’t changed their minds from 2012/2013 when they turned down an opportunity to infuse new cash.      

If creditors won’t let Global spend “precious cash” to build the business, what other ways could they help grow revenues?

Creditors could shift AUM from their own firms to Global.  They could solicit new AUM for Global.  But if they did, they would share the resulting profit with other creditors and the 30 percent “legacy” shareholders in the firm.  Little economic sense in that, particularly because relatively large amounts would be required and creditors have already taken a “hit” on the debt settlement, no doubt exhausting whatever minute amounts of generosity they may once have had.    

Global’s strategy confirms this analysis. It’s clear that the firm is being managed not for ROE or growth, but for cash extraction.   That involves retaining the “cash cow” KD 1.1 billion in AUM, keeping a firm control on costs, and following a conservative risk acceptance policy. 

“Souk legend” (the Gulf equivalent of urban legend) is that GIH’s KD 1.1 billion in AUM-the main driver of current revenue—is largely (almost all?) comprised of KIA funds that Ms. Maha played a key role in obtaining.  The creditors are smart enough to recognize that they need legacy management to keep current customers in place and perhaps incrementally add to AUM. This probably explains her continued presence in the board and in executive management as well as the retention of other “key” legacy managers.

As regards expenses, a glance at note 16 (2015 annual report) shows no evidence of significant investment in new assets, including computer equipment which would involve relatively small amounts.   Assets are almost fully depreciated.  While accounting useful life is not the same as economically useful life, this does suggest some replacement is likely needed.  That it has not occurred at any measurable level is revealing. Directors’ fees are also being kept at modest levels.  Usually, in the old boy (and in this case one girl) world of boards, cost control is not an urgent imperative.  The amounts are not just that large.  Clearly expense control is a key business focus.

In terms of risk aversion, the overconcentration in cash and cash equivalents is a very clear sign of heightened risk control and husbanding cash for dividends.  With 50% of assets in low ROA banks and cash despite there being no material debt obligations, it is clear the firm is being managed for cash not ROE.

Other Actors – Private Clients

Could other parties step up to deliver needed growth?

Retail investors aren’t going to provide the revenue required.  Too many small ticket transactions and portfolios would be required to change Global’s fortunes.  Many new retail customers would increase operational costs offsetting some of the revenue gain.

Large institutions and HNWIs could drive material change at GIH.   But what is their incentive to shift their portfolios? Global doesn’t appear to have any compelling investment product or products that differentiate it from its competitors and make it a “must have” for such an investor.  Why would such an investor select Global over NBK or another major regional or international firm?  

Global also still carries some remaining baggage from its 2008 difficulties, particularly in the treatment of investors in AlThouraia/Mazaya Saudi and Global MENA Financial Assets. This probably exacerbates non Kuwaiti GCC nationals’ general concerns about Kuwaiti business practices as well as the appetite of those Kuwaitis who invested in these funds.

But there’s another constraint. Assuming there are private institutional and HNW investors (and these are likely to be Kuwaiti rather than other GCC investors) willing to do business with Global, where would the funds come from?

As discussed in my post about the NBAD/FGB merger, the GCC is a minor financial market when measured in terms of assets and earnings and is highly likely to remain so for a variety of reasons (demographics, the nature and size of local economies, etc.). 

With GCC asset managers this is even more the case.  Major world firms have AUM in the trillions (Blackrock at $4.6 trillion) and net income is measured in billions (Blackrock north of $3 billion) or hundreds of millions. 

Currently, Global is mid-tier behind NBK Capital and KAMCO each of who have at least 3.5 times Global’s AUM.  A significant shift in Global’s fortunes would require a major shift away from these other firms.  Something that doesn’t seem highly probable to AA.  “Losing” 10% of your clients is a rare occurrence.  “Losing” 30% or more even less probable.     

Other Actors-Official Institutions

What would motivate a government-related entity to place investments with Global when 70% of the profit on the relationship will go into the hands of creditors, who include foreign banks?  And very likely include some investors who have acquired their positions at a discount.  Few like to feed vultures.

Another constraint is that non-Kuwaiti official institutions are unlikely to shift business to Global.  They have their own national firms to support and sad to say many in the GCC have a dim view of Kuwaiti business practices.

All in all a rather bleak strategic cul-de-sac.

Al Mazaya Kuwait - The Villa Project Dubai

When Global floated the subsequently "ill-fated" AlThourayia Project Management Company to invest in Mazaya Saudi Arabia, it noted on page 25 in the Private Placement Memorandum that one of the attractive features of that transaction was the involvement of Mazaya Holding (in which Global has presciently acquired a stake earlier, though Global's stake in Mazaya was not mentioned directly in the PPM):

Mazaya Saudi will be positioned to leverage on Mazaya Holding’s competitive market edge, an absolute advantage against competition. As a new entity, Mazaya Saudi will enter the real estate market backed by Mazaya Holding’s respective expertise. The Company will gain from Mazaya Holding’s breadth of practice,  which has materialized through the 18 projects Mazaya Holding has on hand. Such projects range from megascale residential communities, to high rise mixed-use towers, to BOT projects. Mazaya Saudi will benefit from the know-how of Mazaya Holding, and will seek to develop similar scale projects, which shall be backed by Mazaya Holding’s vigorous methodology.

One of the projects touted as evidencing Al Mazaya's absolute advantage (and if you know the Economics definition between comparative and absolute advantage, you'll know just how remarkable a claim that is) was The Villa Project in Dubai, which involved the construction of 500 villas scheduled for completion in mid 2009. (PPM Page 28).

Gulf News recently ran an update on the project's progress.

The villas were to have a garage and vary in size starting from four bedrooms. "The whole attraction for the project was that you could customise the villas with swimming pools and the landscaping would be included in the fee. We were promised courtyards, water features, a school, mosques, shops and a medical centre, but there is none of that," said the businessman.

According to him, the original location for the development was supposed to be near Global Village, but it was moved by seven kilometres to the current location.

"The big thing at the moment is that [Al] Mazaya are expecting us to pay the Dh25,500 cost of connecting the sewage and Dewa [Dubai Electricity and Water Authority] lines even though its not our responsibility, that's the job of the developer. The frustrating thing is that my neighbour who has Dubai Properties as the developer doesn't have to pay."

The businessman had bought his villa in 2005. "It does say in the contract that they have leeway of a year on completion, but even with that it's two years behind schedule and most of us are still paying rent when we should have moved in," he said.

Other issues concern the poor workmanship and finishing, no boundary demarcation, landscaping or community facilities.

These are some rather serious charges.  But AlMazaya is not shy about taking responsibility for its actions as this quote from the CEO of Al Mazaya Dubai evidences:

"The problems with ‘The Villa' have been due to circumstances beyond our control," he said.

It seems even an  absolute advantage cannot overcome the actions of others.  Unclear if the global financial crisis (lower case "g" on global) is the culprit here.

And a tip of AA's massive tarbouche to Laocowboy2 for calling this article to my attention.

The Curious Case of Al Thouraia Project Management Company WLL

This company has come up more than once in earlier posts on Global Investment House ("GIH"). 

Today it's time to take a closer look. 

Documents related to the Offering of AlThouraia can be found here. If that doesn't work, go to GIH's website.  Click on the Investor Relations tab. And then Global News. And then scroll down to 2 June 2008.

On 2 June 2008, with great fanfare GIH announced this KD180 million (US$630 million or SAR 2.5 billion) private placement.

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. Mazaya Saudi will operate as a real estate development company in the Kingdom of Saudi Arabia in order to capitalize on the opportunities available in the Saudi Arabian real estate sector, which is known to be a vibrant, growing and a lucrative market.  Mazaya Saudi will have a paid-up capital of SR2.5bn.  Mazaya Saudi shall conduct its business in accordance with Islamic Shari'a.

The Al Thouraia Summary outlined the attractiveness of the deal:

1. The market opportunity in Saudi. 
2. Strategic partners from Kuwait (Al Mazaya Holding) and Saudi (Abdullatif Alissa Group and Abdulaziz AlAjlan) plus some unnamed other strategic investors. As noted in GIH's press release above, to include Global itself. 
3. Excellent promised financial results: An IRR of 20.1% with solid cashflow -- an average dividend payout ratio of 60%. All achieved with moderate use of debt. Leverage ratio (no more than 35% at its peak). 
4. As well as the prospects of a liquidity enhancing listing on the Saudi Stock Exchange.
   

As is common, the "teaser" was accompanied by a Private Placement Memorandum . That link will take you to the copy posted on GIH's website. Surprising for a deal this size, this document is rather disappointing. Certainly, this is not as polished or professional as efforts by say Arcapita or Investcorp – two firms that I would expect GIH considers its peers. Perhaps, this is an earlier version which was revised later. Perhaps, this fundamentally reflects on the relative state of Kuwaiti regulations vis-à-vis some other GCC states?

As I read it, some items caught my eye. And some did not – that is, while I was expecting them, they didn't appear. 

The language and content of the Disclaimer need work and tightening. No doubt for some a technical quibble. But how one deals with the details is often a good indication of how one deals with the big picture.  The sort of thing a professional looks at to gauge the professionalism of his or her competitor.

The Term Sheet is rather short and incomplete. It should discuss all significant aspects of the deal, thus, providing the investor with a summary snapshot of the transaction in a single place. Besides the financial aspects, the identity of major parties, relationships/contracts among them, expenses and fees, length of the Offer including various steps, e.g., Offer Period, Allocations, Issuance.  And so forth

The Saudi Real Estate Market section does not discuss major items such as:

1. Laws and Regulations affecting a landlord's right and ability to increase rentals, including requirements, timing, procedures.
2. Commercial Issues:  The types of leases commonly used in the Kingdom, e.g., short or long term, escalation and early termination/cancellation clauses, whether operations and maintenance are separate from rental and what controls exist on increases in those critical cash outflows, etc.  The prevalence of rebates, decorating/finishing allowances to tenants, etc in the market.
3. Legal  Issues including mechanisms for challenges to rental and fee increases.  The ability, procedures and timing to evict of clients in breach, etc. 
4. Status of Mazaya Saudi.  There is a disconnect between the press release  ("has been incorporated") and the PPM ("being established").  A small point admittedly.  One simply explained no doubt.  But one wonders why the two weren't conformed.
5. Mazaya Holding Kuwait:  On Page 25 we learn that Mazaya Saudi will be "positioned to leverage on Mazaya Holding (Kuwait's) competitive market advantage". One that provides as we are told an "absolute advantage against competition". Certainly an enviable position to be in for this Kuwaiti Company not only in its home market but in what is for it the relatively new market of Saudi Arabia.  On Pages 26 -28, we get more details on the remarkable Mazaya Holdings. Formed in January 2004, it has 18 projects – of which it has completed a grand total of 4.  Of the 4, there is the 22 storey Global Tower, 32 villas in the Al Maha Project, the Al Roya Tower and 6 buildings in Dubai Healthcare City.  With these major accomplishments under its belt, it already enjoys an absolute advantage. Imagine its market position today. I'm guessing The Donald may be its latest apprentice. He's going to have to hustle to make the cut!  Or "You're Fired!"
6. Strategic Shareholders:  We also get a partial glimpse into the proposed shareholding structure. There's a list of three entities and the promise of other strategic investors. Perhaps for competitive or business confidential reasons the target holdings of each are not disclosed, though one might expect a prospective shareholder to wonder just what level of financial commitment these entities were going to make to the venture. 
7. Management:  There's no mention of the proposed members of the Board and CEO, their CVs and  perhaps more importantly what rights the investor has in choosing them. Recall that the investor is a unit holder in Al Thouraia and Al Thouraia is the shareholder in Saudi Mazaya. Al Thouraia as an entity will vote for the Board at Saudi Mazaya.  And that is precisely where the assets and cash generation take place.  As an aside, I'd guess (note that word) that this structure is used to "get around" Saudi Capital Markets Authority regulations on floating shares in Saudi companies. The share flotation is outside the Kingdom and therefore outside the CMA's regulations. 
8. Investor/Shareholder Rights: The usual enumeration of rights is missing. Such things as voting for the board and management, pre-emptive rights, requirements for the mandatory provision of periodic information (financials and otherwise) by the company as well as rights to demand information.  
9. Use of Proceeds: No separate page. No real discussion. From Page 7 we see there is a 1% placement fee and 4% marketing fee – both non refundable. Unclear if this means that GIH earns 4% even if it doesn't place the Units? 

Risk Factors are Jenny Craig slim. 

At one level to the point of being obscure. I'm really not sure but it seems that what is being said regarding Regulatory Risk is that the investor only has to fear regulations that are "vague and incomplete in nature". Would that mean that a clear imposition of tax or a definitive cancellation of a permit would therefore be benign? 

On the other hand there are some very clear and very true statements here, such as "Future Performance is Difficult to Predict". 

Mostly though  there's a lot that I would have expected to see but didn't.  And to be fair it's not only in GIH's PPM but in many many others issued not just in the GCC:

1. A clear statement that this is a speculative investment.  If you build it, they may not come.  This is after all spec real estate.  New developments. 
2. Contractor performance issues:  If you hire them they may not build on time or to specification. 
3. Availability and sufficiency of utilities and other public services. If you build it, you might not have electricity, water, sewage. And maybe no or  inadequate roads into the area. 
4. Re-letting rental risk. If they move out, you may get less rent from the new tenant.
5. A wider definition of competition – more than price:  quality, location, amenities, etc. 
6. Increases in operating and maintenance costs above rental increases. 
7. Structural Issues: an SPV in Kuwait stands between the investor and the income generating property in Saudi. Repatriation of funds. Potential tax issues. FX risks. 
8. Potential Conflicts of Interest:  I was surprised that this wasn't discussed since Mr. Omar El-Quqa, EVP at GIH, was also a member of the Board at Mazaya Holding. As we learn in this press release from July 2007, GIH then sold some 48 million shares in MH, but remained the second largest shareholder with 5.5%. Perhaps, between July 2007 and June 2008, there were further changes in shareholding. I didn't see anything on GIH's website, nor in its first three quarterly reports for 2008. But I may have missed something. Depending on the various stakes the proposed Strategic Partners might hold, it would seem that good form would require some contemplation of potential conflicts of interest.In any case, I suppose we can conclude that GIH saw no conflicts of interest nor any potential for them and so rest comfortably. At the end of 2008, GIH reported in Note 19 (a) that it owned 21% of Mazaya. Note this year end shareholding is well after the private placement. And it may have been a Victor Kiam moment. "I liked the razor so much I bought the company". Having done the deal and seen more evidence of MH's absolute advantage, it may have seemed like a good deal to reacquire some shares.  In which case perfectly innocent.
9. Material Contracts:  Summary of contracts with Mazaya Holding and any other parties.  All fees they are entitled to. On Page 35 we see they get an annual fee of 0.75% of paid up capital. KD1.35 million a year seems a rather small incentive for MH to apply its "absolute advantage" for Mazaya Saudi instead of for its own projects where it gets to keep the lion's share of the profits.
   

As we know GIH's placement effort was successful, though I couldn't find a press release on GIH's website. In fact there seems to have been almost total radio silence on the topic going forward. No mention in its 2008 annual of its great success in raising KD180 million. No press release. But then I may have not looked hard enough. The only GIH driven publicity I could find was a Bloomberg press item referring to advertisements that GIH placed in the Kuwaiti press in November 2009. Those trumpeted the fact that the Appeals Court had ruled it was not guilty in a civil case brought by a Japanese real estate firm regarding this transaction. There were, to be fair, the mandatory disclosures in GIH's financial reports.

Subsequent to the Offer, Al Thouraia placed roughly KD83 million with GIH in an "Islamic" transaction. A KD43 million deposit was also placed with a Kuwaiti bank. It's unclear to me why the funds were not immediately transferred to Saudi Mazaya. The 2 June 2008 press release was clear. "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". And we're told on Page 24 that among its other activities, Mazaya Saudi would engage in Portfolio Management to "amplify shareholder value". No mention that Al Thouraia would do more than invest in Mazaya Saudi.  So shouldn't investments, if any, be in Mazaya Saudi's name?  The need for the funds in Saudi would seem to be manifestly urgent. The PPM (Page 24) discloses that Saudi Mazaya intended to begin work on three projects the first year. What better preparation for that than to get the funds in Saudi so they would be ready to be employed?

Perhaps, out of caution in a deteriorating market, the Board at Al-Thouraia decided it would be wise to keep the money in Kuwait where it would be safer. Perhaps just about the same time that the Board at Global MENA Financial Assets decided to park a significant portion of its assets and liquidity at GIH. Two rather strong market endorsements of the financial stability and security of GIH. A possible example of the market phenomenon known as "a flight to quality". And as I've noted before both entities were well positioned to well understand the financial condition of GIH.

Anyways let's follow the story using GIH's 2009 financials. 

1. Note 24 Page 57: It seems that a KD43.3 million AlThouraia deposit with a local bank was offset by that bank against a loan made by that bank to 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, if GIH only owned about 83.36% of AlThouraia, what is the basis for stiffing the minority shareholders on the offset? There are all sorts of theoretical possibilities. And without picking one, let me just list some of them. Was the problem at the outset, when the deposit was placed? Perhaps, Kuwait doesn't have an ironclad "trust" law covering such deposits? And GIH placed the deposit with the bank "in trust for Al Thouraia" only to be rudely surprised later? Perhaps, there was an innocent clerical error about the name of the bank account holder when it was set up? Perhaps, the funds were mistakenly described as collateral? I'd appreciate a post from anyone out there with any insight on this. 
2. Note 25 Page 57: GIH acquired Al Thouraia through an asset swap – a non cash transaction. The assets exchanged are described on Page 58. It would be interesting to know if Al Thouraia's Articles of Association provided for Al Thouraia conducting the sort of activity that this asset swap implies. Or if Al Thouraia's shareholders either approved this step and/or amended the Articles. In any case through this transaction, GIH acquired control.  In so doing it 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 did not necessarily obtain control over that cash. And it's likely that the KD83 million in debt remained a legal obligation of GIH.  In addition to these benefits, GIH's shareholding also implied the right to disconnect the feeding tube.
   

As we learn in Note 5 to the Company's 1Q10 financials, on 14 March 2010, GIH liquidated Al Thouraia recognizing a KD0.824 million accounting profit, while experiencing a KD18.725 million cash outflow. What explains this rather perplexing move by a Company desperately in need of cash to pay hungry creditors? The liquidation extinguished GIH obligations in the amount of KD125.6 million. The rationale for KD18 million tradeoff is suddenly a lot clearer. 

It also closes the book on Al Thouraia. A story which GIH no doubt wishes to forget as well hopes that its clients and the market will as well.

As indicated by the title, a curious case indeed.  And one subject to many interpretations.

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?

Global Investment House Kuwait - Seized Deposits

As per GIH's financials, two deposits totaling KD115 million (US$402.6 million) have been attached or otherwise seized by third parties and are now the subject of legal actions. 

KD71.75 million of this amount relates to an investment that GIH had intended to make in National Bank of Umm AlQawain ("NBQ") for KD183.6 million (US$642.5 million) to purchase a 20% stake.  The two parties signed an MOU in July 2008.  GIH placed the equivalent of KD 71.75 million (US$249.9 million)  with NBQ.  (I suspect the amount placed was US $ or AED as the amount fluctuates from one quarterly report to another.  It would not if the amount were denominated in KD). 

Subsequently, GIH obtained commitments for a US$410 million loan to fund the remaining amount of the purchase price.  In November 2008, it decided not to proceed, canceled the loan and asked for its deposit back.  

NBQ refused alleging breach of contract.  See NBQ's 2008 Annual Report Note #13. (You will have to page through this as it is interactive).

Reportedly, a court in the Emirates gave the first round to NBQ.  No doubt there will be several more rounds.  The two parties' legal arguments are summarized in this article.

The second amount, KD43.2 million (US$148 million), is a deposit placed with a Kuwaiti bank by a subsidiary of GIH (AlThouraia) which that bank offset against obligations owed to it by GIH.  

The total KD 115 million represents roughly 0.1% of GIH's total cash of KD89.6 billion.  From that standpoint it's not a highly significant amount.  

From an equity standpoint, if GIH were to lose the court case against the Kuwaiti bank, the result should be no impact on equity as it would merely be a substitution of liabilities - the liability of GIH towards the bank replaced with one towards AlThouraia.  At some point GIH would have to make its subsidiary whole by transferring funds or other value.

With respect to the NBQ case, it's difficult to make a statement.

It is hard to understand the basis for this lawsuit.  In other words hard to fathom how a properly worded MOU could create a contractual obligation.  But then again AA didn't understand the structure of the convertible bond agreed to by Shuaa Capital and Dubai Banking Group.  Since the NBQ/GIH deal is also structured as a convertible, it may be that some cutting edge financial innovation in the Gulf has produced  a breakthrough in convertible deal structuring.  Or then again maybe just a breakdown. 

In any case, it's hard to imagine the UAE court confiscating GIH's deposit in toto.   

However, even if it did, the damage should be containable.