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| Not F. Scott Fitzgerald |
Well, AA always thought he had a
first rate intelligence, but after reading GFH’s Note 20 to its FYE 2018
audited annual report, AA is having trouble dealing with two fundamentally
opposed ideas in his mind at the same time.
In that Note, GFH
discloses that it has become the majority shareholder in Gulf Holdings KSC
(Closed) after it purchased 31.39% of GFH in June 2018 for consideration of USD
6.691 million dollars.
Prior to that GFH held 19.79% to which it ascribed no
value, apparently having written down its much earlier purchase--probably
originally made in November 2005 when GH was established--to zero.
Fair
enough. No problem with that.
The cognitive dissonance occurred
when AA noticed a value of USD 6.691 million was being ascribed to the total of
GFH’s 51.18% holding in GH. That appears to have been based on the 30
June 2018 financials of GH which showed "Total Net Identifiable
Assets" (hereinafter "TNIA") of some USD 13.1 million.
What a remarkable coincidence, 51.58% of TNIA just equals the purchase price
for 31.39% of GH.
That was followed by a puzzling accounting on the
next page, where GFH's previously owned 19.79% shareholding was shown with a
zero value (presumably its book value) with the 31.39% shown at USD 6.691
million with the 51.18% shareholding valued at USD 6.691 million.
A chart which had
in essence two equations valuing the stock of GH. The first: 19.79%
x # shares of GH = USD 0. The second: 31.39% x # shares of GH = USD
6.691 million.
AA struggled to hold
both these opposing ideas (equations) in his mind as simultaneously true.
There doesn't seem anything about the first group of shares that impairs their
rights. In fact GFH through BSB Ventures voted those shares at GH's
delayed FY 2016 AGM and EGM just three months prior to the acquisition of the
second batch of shares.
If USD 6.691
million is the value of 51.18% of GH’s shares, then that means the
purchase price for 31.39% of shares is USD 4.1 million. Thus, GFH has
paid roughly USD 2.6 million more than it should have.
If USD 6.691
million is the value of 31.39% of GH's shares, then GH's firm value is USD 21.3
million. Or some USD 8.2 million more than the TNIA identified in the
balance sheet. Or in percentage terms roughly 163% of TNIA.
That is a very
wide range of firm value -- USD 13.1 million to USD 21.3 million.
No doubt some out there are thinking, “But
AA this was the purchase of a controlling stake and so GFH would have to pay a
"control" premium.”
Indeed.
But on the other hand, did the seller have any other potential buyers? If GFH were to walk away from GH, GH's prospects would be
even bleaker than they appeared at the FY 2016 AGM and EGM last March. And the seller might lose all its investment. In such a case GFH
might be able to pick up GH's choice assets in later fire sale. So GFH had some
leverage. And apparently did not agree to acquire the Villamar Sukuk from
AlRajhi until October, some four months after the acquisition.
Also,
there could be hidden value within GH. Judging from its draft FYE
2017 financials and the June 2018 presented, very well hidden.
There
is a third potential reason. That GFH was more focused on completing the
acquisition than the price of the acquisition.
If you’ve read AA’s posts on GH’s financial condition as of
FYE 2017, it was in a very sorry state. Posts here and here. The auditor refused to render an opinion as
he had refused for FY 2016. He also remarked that he was unable to determine if
GH was keeping proper books of account. A rather damning indictment on
its face.
Was GH’s financial situation clearer a scant three
months after that date?
Clear enough to justify GFH plunking down some
USD 132 million to become majority owner and agree to acquire the Villamar
Sukuk?
I say three months because GH held its FY 2016 AGM and EGM on 1
March 2018 (no doubt delayed for very good reasons) when its woes were many and
manifest.
That doesn’t seem highly likely to AA.
As noted in FYE
2018 financials:
“Given the
size, geographic dispersion and inherent complexity involved in the
acquisition, the Group, as on date of issue of this consolidated financial
statements, has not concluded (emphasis AA) on the determination of fair value of
tangible and intangible assets acquired, liabilities assumed and residual
goodwill arising from the acquisition.“ And further in that paragraph “the
estimates of fair values for tangible and intangible assets acquired and
liabilities assumed is subject to significant judgement and shall be
determined (emphasis AA) by management … “
So what did we learn from this quote and
the above?
First, that GFH bought GH apparently without having
a clear idea of value. It didn’t know in June 2018 when it bought the
company if it was overpaying or not. However, it did pay 163% over June 2018
TNIA In its words it didn’t know the fair value of assets or liabilities
assumed. Almost seven and one-third months later—11 February 2019 the date of
the issue of GFH's audited FY 2018 financials—it still didn’t.
Second,
that any valuation that will be made is an estimate which is subject to
significant judgement. To be fair generally the only certain items on the
balance sheet are liabilities for borrowed money. Everything else is
subject to certain risks of varying degrees. Cash in US dollars or Euros
with a AAA rated bank is more certain usually than accounts receivable for
investment banking services.
In commenting on valuation of such
assets, GFH has disclosed for some time most recently in Note 5 (iii)
Impairment of Investment Properties to its FY 2018 audited financials
that:
“Given the dislocation in the local property market and
infrequent property transactions, it is reasonably possible, based on existing
knowledge, that the current assessment of impairment could require a material
adjustment to the carrying amount of these assets within the next financial
year due to significant changes in assumptions underlying such
assessments.”
Thus, any
valuation on GH would probably be subject to the same caveat. It could
change the next year. Side Comment: Prospective investors in GFH
projects may want to reflect on the inherent uncertainty disclosed by GFH
regarding valuation of real estate projects prior to making commitments.
To summarize having bought GH in June 2018 as of 11 February 2019, GFH had not
made a determination of the value of GH. And it has pointed out that any
such value it does assign is subject to assumptions which might change within
one year.
Given the uncertainty of the value of GH expressed in these
two quotes, AA wonders how GFH determined whether GH was a good investment to
say nothing of what to pay for it. As per GFH’s own words, there might be
“negative” good will.
Also if GFH did not know GH’s value, was it a
wise idea to agree to acquire Villamar Sukuk from AlRajhi for some USD 125.2
million in October 2018? Or should this have been postponed until GFH had
made such a determination?
GFH spent
a total of some USD 132 million on GH-- more than GFH’s 2018 net income. Or for
another comparative GFH could fund a lot of trading in Treasury Shares with an
amount like that and then cancel the shares bought.
Let’s compare the
June 2018 GH financials presented in GFH’s Note 20 to those as of 31 December
2017 for more insights in GH and potential value. As a reminder, GH’s FY 2017 financials are drawn from the “shareholder package” for the FY 2017 AGM and
EGM.
Gulf Holdings Unaudited Financial Statements
|
USD Millions
|
ASSETS
|
30 June 2018
|
31 Dec
2017
|
|
DIFF
|
Investment Property
|
$40.4
|
$48.1
|
|
($7.7)
|
Development Property
|
$387.3
|
$433.8
|
|
($46.5)
|
Cash and Banks
|
$1.5
|
$1.7
|
|
($0.1)
|
Other Receivables and
Assets (A/R)
|
$26.3
|
$6.0
|
|
$20.3
|
|
|
|
|
|
TOTAL ASSETS
|
$455.5
|
$489.5
|
|
($33.9)
|
|
|
|
|
|
LIABILITIES
|
30 June 2018
|
31 Dec
2017
|
|
DIFF
|
Sukuk
|
$202.8
|
$202.5
|
|
$0.3
|
Advances from
Customers
|
$168.9
|
$134.5
|
|
$34.3
|
Related Party
|
$0.0
|
$9.9
|
|
($9.9)
|
Other Liabilities
|
$70.8
|
$69.3
|
|
$1.6
|
|
|
|
|
|
TOTAL LIABILITIES
|
$442.4
|
$416.2
|
|
$26.2
|
|
|
|
|
|
NET IDENTIFABLE
ASSETS
|
$13.1
|
$73.3
|
|
($60.2)
|
What a difference six months
apparently makes.
So how do we perform an analysis of the changes
in its financials without notes and more information? AA thinks the
"key" is the decline in equity. An eye-popping USD 60.2 million
equivalent.
What could cause this? A spin off of assets into a new firm, return of
capital to shareholders, dividends, realized or unrealized losses.
The first three are unlikely.
Why?
No sign of these in either GFH's or
GBCorp's FY 2018 financials. GBCorp in particular is in need of good
earnings news and so would be expected to highlight any positive development no
matter how small.
GH has negative retained earnings and no cash, so
cash dividends are unlikely. Spinoff or return of capital are unlikely
too because as you'll notice GH is still carrying the full USD 203 million
sukuk as of June 2018. Spinning out good assets in such a condition could
subject GH to fraudulent conveyance claims.
AA thinks it most likely that the decline in Development Property
assets is due to write-offs or impairment charges on these assets. You’ll
recall E and Y were unable to value GH’s land parcel in Morocco as of FYE 2017.
It's less likely that these are sales of these assets at a loss.
If the increase in Other Receivables and
Assets (henceforth "A/R") reflects uncollected sales portions from
the Development Property assets and there has been no material increase in
cash, that would imply a loss of USD 26.5 million. If we include the Investment
Property decline a loss of USD 35 million. Not enough to explain the
decline in equity.
It’s more likely the USD 20 million increase in A/R is
the unpaid portion of the USD 34 million increase in Customer Advances than
sales proceeds on Development Property. We'll discuss the
"missing" USD 10 to 14 million from Customer Advances a bit later
which AA assumes was collected and spent.
The
equity decline could be due to provisions for contingencies, legal
claims, etc. If the decline in equity were due to these sort of
provisions, we would expect to see an increase in Other Liabilities. We do
not.
So it's most likely that the equity decline is due to
impairment provisions on Development Property and as well perhaps on Investment
Property. These would be reflected in a contra account to Development Properties netted directly against
Development Properties on the balance sheet and thus
"invisible".
Now to the other side of the balance
sheet.
Total liabilities
increased some USD 26 million largely due to a jump of USD 34 million in
Customer Advances.
AA is
puzzled. Are customers rushing to place money with GH? And have placed
USD 34 million in six months? Perhaps, Villamar sales?
USD 9.9 million in Related
Parties (mostly due to GFH) is not shown. Was GFH repaid? That seems most
likely as GFH is using the balance sheet it presented as value of the firm for
both GFH and the other shareholders. Not just what the consolidation
effect on GFH would be. In a consolidated scenario inter company transactions
would be eliminated. So, if this is the case, it’s likely the amount was
repaid.
AA guesses that GH received some of the funds from the
increase in Advances from Customers. Probably something like USD 10
million to USD 14 million and used those funds to repay GFH and for other
worthy purposes. That would fit with the USD 20 million increase in A/R
(Other Receivables and Assets).
Where did the other cash collected
go? Well, construction at Villamar is chugging along and some of the
previously recorded prepayments to contractors and consultants that were
carried in A/R probably have been expensed. As well, the increase in
construction would require some additional new payments. But AA now is
the very thin ice of sheer conjecture.
Total equity is down some
USD 60 million. As argued above, since the major movement on the asset
side is in Development Properties that suggests impairment charges or losses on
sale of these properties.
Changes of these magnitudes in GH’s
financials in six months must be based on a fairly thorough investigation of
GH's books and valuation of assets.
As part of the purchase
transaction, GFH would have to agree with the 30 June financials. One would
expect that there was more substantial work and thought given to this
transaction than to the basis for US tax policy which was reportedly sketched
out on a cocktail napkin after a few glasses in the local pub. AA wonders
if the Presidential Medal of Freedom mooted for the inventor of this economic
"truth" will be bestowed at the same stool?
Now as of 1 March
2018, GH was in a right proper mess financially. Thus, there is good reason to
suspect that these changes were worked out in the roughly 3 months to the
purchase.
Why?
If changes of this magnitude were known at that point,
wouldn’t the auditor have known and commented about them? The auditor was
not shy in compiling a laundry list of reasons why he couldn’t render an
opinion. And certainly the board would not have withheld this
information from the auditors. Would it?
If the
changes were made within the 3 month period between March and GFH’s acquisition,
why weren't they finalized to the point that GFH could determine the fair value
of assets both tangible and intangible?
In its FYE 2018 annual report GFH asserts that GH’s “size, geographic
dispersion, and inherent complexity” made them unable to make a determination
of the value of the firm some 7.5 months post acquisition.
Yet, even if we
believe the comment above and AA sure hopes you do, some very
significant determinations were made. As of June GH's shareholders'
equity was 4% of its original value down from 24% only a scant three months
earlier (FYE 2017).
AA encountered another conflict of opposing ideas from GFH's explanation about
the difficulties in assessing GH's assets. GH's major three projects are
in Bahrain (two) and Morocco. Does this mean GFH is not that familiar with these markets? And apparently sadly lacks knowledge of and contact with
local experts who might assist in this task? Or that analyzing major (sizeable)
real estate projects is an area where GFH is admitting a lack of skill? Apparently, as well, is GFH disclosing that it did not obtain
any special insight into GH from its significant role in GH's board or management over more than a decade?
Here is yet another instance of AA struggling to hold two opposing
ideas in his mind at the same time. The one above. A second one in
which GFH is an expert in real estate across diverse geography from Morocco to
India with stops in between. A master of the mega project. A
structurer par excellence of complex deals.
More suspicious minds than AA’s might wonder if the fact that
becoming majority owner of GH and “settling the sukuk” was the likely but not the only ticket to GFH recognizing
USD 77.8 million in revenues in Fiscal 2018, an amount which the
preponderant component of GFH’s FY 2018 net income. And that
"matters" were rushed in order to accomplish the transactions during
FY 2018 to generate this income.
Other observers may feel that this
reflects another yet masterstroke by GFH management in the area of
"intrinsic" value identification and exploitation. Similar
to its trading in treasury shares and then cancelling them.
If you
know your financial history of Bahrain, you know that Bahraini investors are
highly suspicious of Kuwaitis who many Bahraini investors believe over
provision companies in order to buy their Bahraini shareholders out on the
cheap. It would appear that this case doesn't apply because the selling
shareholder is a Kuwaiti firm with Bahrainis conducting the buy out.
In
any case AA has his own view but will stay silent so as to not prejudice your
conclusion.
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