GFH 2018 Earnings – A Closer Look At Debt Settlement Gains – AA is Stumped

After Today's Post, I've Removed this Sign from my Desk

By some accounts (pun intended) GFH had a good 2018.  USD 115 million in net profit, of which USD 114.1 million was for shareholders of GFH.  This compares to USD 103.2 million for FY 2017, of which USD 104.2 million was for GFH’s shareholders.  That year Non-Controlling Interests’ share in profit was a negative USD 1 million.  In 2018 it was just under USD 1 million.  

GFH’s 2018 revenue includes USD 113.1 million from “settlement” of liabilities. This single item is 99% of net profit.  It’s also not what one would commonly consider recurring income.  Hence it merits a closer look. 

To start a glance at the Consolidated Statement of Cashflows show this was a non-cash item.  That is, GFH did not receive any cash from the settlement in 2018.  

Now that’s not uncommon.  Under accrual accounting revenues are booked when earned.  Collection may and often does follow in future accounting periods.   

Note 22 to FYE 2018 Annual Financial Statements discloses that USD 35.3 million of this amount represents the reversal a previously accrued provision (itself a non-cash item) for settlement of liabilities of AHC.   So a non-cash reversal of a non-cash charge.  No cash to GFH in 2018 or in the future.  

Let’s let GFH describe the second larger amount of USD 77.8 million in its own words. 

“During the year, the Group agreed to settle sukuk liability with a financial institution of US$ 203 million at a lower amount, resulting in a gain of US$ 77.8 million (net of associated costs). The settlement was in the form of cash and other non-cash assets.” 

Interestingly, GFH’s October 2018 press release on this issue uses a different formulation: “agreed to acquire circa US$200 million of Villamar Sukuk Company Limited, Sharia Compliant Sukuk Certificates from Al Rajhi Bank”.  

You’re probably wondering why AA is quibbling over the language and parsing press releases.  Well, the manner in which the sukuk was settled has an impact on the net income accruing to GFH.  

Typically, an obligor on an instrument (that would be GH Kuwait in this case) can recognize a gain when it settles a liability for less than its face value. 

But, GFH only owns 51.18% of GH.  So, if GH repaid the Villamar Sukuk (probably with the proceeds of a new loan to GH by GFH as GH is cash poor), on an economic basis, GFH can only claim 51.18% of the USD 77.8 million or USD 39.8 million of this income.  The other USD 38 million belongs to the other shareholders of GH. 

However, if this is the case, under accounting principles for consolidations, GFH is entitled to show the entire amount USD 77.8 million in revenue.  Once again we see a divergence between accounting and reality.  Remember a consolidated statement is a construct which purports to show how the economic reality of a group.  It does not show reality in terms of legal ownership of assets and revenues. 

But under those same principles for consolidation GFH would then have to reflect the share of that profit on the transaction which is due to other GH shareholders via a deduction of US 38 million in the line “Profit of the Year Due to Non-Controlling Interests” from total net income.  You’ll notice in FY 2018, the deduction for NCIs is just under USD 1 million.  

That would seem to indicate (note that word) that another form of transaction was used.  But, it could be that there were offsetting losses for the NCIs of USD 37 million and so the net would only be USD 1 million.  (USD 38 million in GH profits less USD 37 million in losses on other transactions for NCIs).  

If this is not the case and that seems likely, could GFH structure this transaction in another way to allow it to keep the entire USD 77.8 million for its own account? 

AA is not a CPA or CA.  What follows are some conjectures or more precisely speculations. Note that word well.  

1. Having acquired the sukuk certificates, GFH as the owner of the debt engaged in a restructuring agreement with GH.   
2. Under the restructuring, GH remained liable for the full USD 203 million.  
3. Because GFH acquired this debt (the Sukuk) at a discount its cost for the restructured loan is USD 125.2 million.  To balance its books, it needed another debit on the balance sheet to bring the restructured loan to USD 203 million which was offset by a credit to income.
4. Hence, the possible USD 77.8 million profit, arising in the transaction with AlRajhi and not GH and thus fully GFH's and outside of consolidation as it is a transaction with a third party.  In this case GFH would not need to have been a majority owner of GH to recognize this profit which would be "all" its own.

Recognizing profit assumes that GH repays the loan in full.  If this is the transaction that was used, if GH does not for some reason repay the debt in full, GFH will have to take a write-off in the future.  And the future is far away.  

As AA understands IFRS 9 (remember the caveat above about AA's accounting credentials or lack thereof) when a debt instrument is acquired at a deep discount due to credit reasons then an assessment of Expected Credit Loss (ECL) must be made.  In this case, the ECL then would reduce the immediate profit recognized. 

Clearly, the roughly 38.3% discount on the Villamar Sukuk is due to credit distress not current market rates being above the coupon on the debt. 

It would therefore seem to AA that some sort of ECL should have been considered and perhaps created.  As well, it seems (to AA) that assuming no loss on a debt that has been in default since 2013 with minimal repayments during that period is a heroic one. 

That being said, GFH is intimately familiar with GH having had leadership positions on the Board and management for years.  As well, perhaps, it acquired collateral which would make an ECL superfluous. 

AA is stumped.  

In the absence of a detailed description of the transaction from GFH so far, we don’t know.  

AA welcomes other conjectures and ideally local accountants’ expert opinions.  

AA also recommends that shareholders and analysts pose this question to GFH management.  The ideal venue for that the 2019 AGM and EGM for FY 2018 have passed without this issue being raised in those fora according to published minutes of the AGM/EGM.  

That doesn’t stop shareholders from exercising their corporate governance rights and responsibilities to pose the question now.  Or for those who analyze GFH’s equity or debt instruments to raise it as well.

Gulf Holding KSC (Closed) – Financial and Legal Problems – Part 1

He's Got A Dossier Too.  That's Why He's Smiling.

As the “Part 1” above indicates, I have a lot of material to cover. 

The principal sources for this post are the FY 2017 AGM and FY 2016 AGM packages (available only in Arabic).  If these links don’t work, go to the investors relations page at www.gfholding.com.  

While this dossier makes lamentable reading indeed, the first thing to note is that it reflects the state of the company prior to GFH’s efforts to right the situation at GH sufficiently to minimize risk to itself  of acquiring the Villamar Sukuk and increasing its shareholding above 50% in GH. Clearly, if GFH had not been successful in its efforts, it would be foolhardy to take these steps.  

When discussing matters financial, where better to begin than with a review of financials?  

The FY 2017 AGM package includes a complete 2017 annual report for GH in Arabic.  AA has transcribed the information into the tables below following the format in the Arabic version and provided USD equivalents. 

Note the financials are unaudited because the local member of Ernst and Young (Al Aiban Al Osaimi and Partners) the auditor refused to give an opinion which it also did for the 2016 annual financials.

Gulf Holdings Unaudited Financial Statements
Assets - Amounts in Millions
	KWD			USD
ASSETS	2017	2016		2017	2016
Non-Current Assets
Real Estate	14.5	12.9		$48.1	$42.8
RE Development	131	123		$433.8	$408.3
Other LT Assets	0.0	1.4		$0.0	$4.6
Total LT Assets	145.4	137.5		$481.9	$455.7
Current Assets
Invest Held for Sale	0.0	0.1		$0.0	$0.3
Other Assets	1.8	1.8		$6.0	$6.0
Cash and Banks	0.5	0.0		$1.7	$0.0
Total Current Assets	2.3	1.9		$7.6	$6.3
TOTAL ASSETS	147.7	139.4		$489.5	$462.0

Source:  GH FY 2017 AGM Package.

1. No real liquidity. 
2. Current Assets are less than 2% of total assets. 
3. Almost no cash. 
4. Over 99% of Other Assets are advance payments to contractors and consultants.  No real liquidity there.

Gulf Holdings Unaudited Financial Statements
Liabilities and Equity - Amounts in Millions
LIABILITIES	2017	2016		2017	2016
Non Current Liabilities
Work in Progress	0.2	0.0		$0.7	$0.0
Sukuk (LT Portion)	58.1	62.1		$192.5	$205.8
Customer Advances	27.1	3.1		$89.8	$10.3
Accrued Expenses  Other Payables	4.8	11.6		$15.9	$38.4
Leaving Indemnity	0.0	0.0		$0.0	$0.0
Total NC Liabilities	90.2	76.8		$298.9	$254.5
Current Liabilities
Due to Related Party	3.0	2.8		$9.9	$9.3
Sukuk (Current Portion)	3.0	1.5		$9.9	$5.0
Accounts Payable	12.9	11.2		$42.8	$37.1
Customer Advances	13.5	18.4		$44.7	$61.0
Accrued Expenses Other Payables	3.0	6.5		$9.9	$21.5
Total Current Liabilities	35.4	40.4		$117.3	$133.9
TOTAL LIABILITIES	125.6	117.2		$416.2	$388.4
EQUITY
Paid in Capital	84.7	84.7		$280.7	$280.7
Reserves	6.7	7.1		$22.2	$23.5
Accumulated Losses	-69.3	-69.6		($229.7)	($230.7)
Shareholders’ Equity	22.1	22.2		$73.2	$73.6
TOTAL LIAB & EQUITY	147.7	139.4		$489.5	$462.0

Source:  GH FY 2017 AGM Package

1. As of FYE 2017, GH has “lost” roughly 82% of its paid in capital.  As is common in the GCC, local law requires the company to take action.  Options are: raise capital, capitalize losses by reducing paid in capital, or wind up the firm.  
2. Current Liabilities dwarf Current Assets. 
3. Roughly 92% of the 2017 Due to Related Parties is due to GFH.  
4. The 2008 Villamar Sukuk (original maturity 2013) was restructured 13 December 2016 (effective 22 March 2017 after finalization of documentation) with the following terms: 
5. Extend maturity to 7 May 2022. 
6. Capitalize KD 5.1 million in unpaid interest (1 May 2008 through 13 May 2013) in the principal of the sukuk.  
7. Commence periodic interest payments starting from 30 June 2018.  I didn’t see a direct statement that interest was not due between 13 May 2013 and 30 June 2018.  But there is recovery of interest paid on the sukuk for  KD6.6 million  in FY 2016 (note 16) which suggests this might be the case.  
8. 1% margin plus 6 month Libor but in any event total rate not to exceed 1.5%.  
9. The notes describe two USD 5 million payments to be made as part of the restructuring.  GH made the first but missed the second due 31 December 2017. The Sukuk holders agreed to an extension while further negotiations took place which appear to have involved GFH.  
10. Villamar Sukuk was structured as a musharakah.  There has been debate if it actually was in conformity with Shari’ah because there are no fixed payments in a musharakah.  Investors in the sukuk share in profit and loss.  The first is from a scholar in Jeddah.  The second from two scholars in Malaysia.  Note that at the time VS was issued this was a common structure until Shaykh Muhammad Taqi Usmani issued his famous opinion.  
11. I have not prepared income statements from the material in the AGM package because income is miniscule.  When an income statement opens with a one line “Other Income” and then goes directly to expenses, you don’t need a CPA to figure out revenue streams are limited.  

Creating income statements is left as an exercise for the student. 

As well those interested may use the 2016 AGM package to create FY 2015 annual financials for GH. 

All in all a dismal picture.   

But this was not the end of GH’s woes. 

Post 2 takes a look at the auditors’ refusal to provide an opinion on the financials as well as legal and other problems that the company faced.