What are GFH’s Motives for Acquiring KHCB Shares?

لولا اختلاف النظر، لبارت السلع  

 Summary of key points in this post.

• 45% premium over market on 13.64% of shares from Shuaa and Goldilocks.

• Tender offer proposed for remaining 30.95% of shares

• Favorable Impact on GFH’s Consolidated Shareholders’ Equity

Background

On 6 June GFH announced it had increased its shareholding in KHCB from 55.41% to 69.05% as part of the “Group’s strategy to increase its ownership in KHCB.”

On 7 June GFH provided further details as follows:

With reference to GFH Financial Group’s announcement dated 6th June 2021 pertaining to the subject matter, GFH would like to announce that the increase of ownership in Khaleeji Commercial bank was pursuant to a sale and purchase agreement between GFH along with Shuaa Capital and Goldilocks Investment Company, to acquire their stake of 121,726,795 shares for a total of BD 8,764,329.240 equating to BD 0.072 per share.

On 8 June GFH announced that pursuant to Central Bank of Bahrain requirements regarding takeover and mergers, it had approached KHCB’s Board to make a proposed voluntary takeover offer for the remainder of KHCB’s shares.

Deal Analysis

According to the trading data from the Bahrain Bourse, during the period 4 January through 3 June 2021, the average price of a KHCB share was BD 0.050 (rounded to 3 decimal places). Typically the share trades at roughly 50% of book value.

The BD0.0720 acquisition price represents a 45% premium to the average trading price.

Since the GFH acquisition, the price has increased to just below BD 0.070 perhaps in anticipation of GFH offering the same BD 0.0720 price to remaining shareholders.

Apparently, KHCB is quite a valuable asset.

Though one might not have thought so from the fact that

• KHCB required an additional BD 60 million in capital to meet CBB requirements

• GFH had to buy the entire AT1 instrument

Or maybe you read Fitch Ratings comment on KHCB in their reaffirmation of GFH’s B credit rating. (That rating is below investment grade, if you didn’t know)

Following a balance sheet clean-up exercise in recent years KHCB's asset quality has been improving but is still weak and lags higher-rated peers'.

In any case I hope you are confident that the fact that Shuaa and Goldilocks are related parties had no effect on the 45% premium.

That being said, the size of the premium is perhaps perplexing. 

Neither Shuaa nor Goldilocks were inclined to participate in the AT1. That would seem to evidence a lack of faith in KHCB's future.

One might think of them as perhaps motivated sellers of KHCB. 

It is perhaps also difficult to imagine that there were other serious bidders interested in acquiring a minority stake in company where a single shareholder had control.

But then the ways of the market are mysterious and magical. Especially in the land of flying carpets.

Despite the premium, if you look at this earlier post on Goldilocks, you will see that Goldilocks acquired its stake in KHCB from Shuaa for BD0.096 a share. You will also note that KHCB didn’t pay any dividends since Goldilocks’ purchase.

So on this transaction Goldi has a roughly 25% loss from original cost.

No wonder Shuaa doesn’t publish data on Goldilocks’ performance, contrary to previous years.

In the post referenced above I also wondered if Shuaa had held on to its then 3.88% stake.

It certainly appears so because GFH says it bought shares from both Shuaa and Goldilocks and Goldilocks shareholding was 9.76% according to KHCB’s announcement.

Motives for the Transaction

So what is motivating GFH’s acquisition of KHCB?

Only GFH knows for sure but we can explore some possible rationales. 

I've selected two for discussion:

• Overlooked gem
• Increase in GFH equity beyond the purchase price

Other possible reasons for the transaction could be “civic duty”, etc. And more than one motive may be operative.

As you read, you can decide for yourself which, if either, is the more compelling one.

Overlooked Gem

The market has fundamentally undervalued KHCB.

The canny folks at GFH are about to get KHCB “on the cheap”.

Thereby reaping rich rewards long into the future.

Accounting Magic

The key drivers of the appeal of this motive are two “facts”:

• KHCB’s book value per share exceeds the acquisition price

• GFH uses the book value—not the market or fair value—of KHCB’s assets and liabilities (and thus by the process of subtraction also KHCB’s equity) to prepare its consolidated financials.

As of 1Q 2021 KHCB’ s Book Value was roughly BD 0.160

By acquiring the shares GFH stands to benefit from the difference between book value (BD 0.16) and the purchase price (BD 0.072) and the happy application of rules for consolidated financial statements.

121,726,795 shares at BD 0.088 equals roughly BD 10.7 million or US$ 28.4 million.

Compare that to the BD 8.8 million purchase price. 

A not inconsiderable gain on purchase.

You might well ask:

“How can that be? The P/B ratio is well below one. This can’t make economic sense.”

As I’ve posted here before, accounting does not always reflect economic reality.

Here’s how it would work in detail.

Recall that in its consolidated financials GFH records 100% of KHCB’s assets and liabilities in its (GFH”s) balance sheet using the values appearing in KHCB’s balance sheet. Their book values.

Therefore, net assets (equity) are also reflected in GFH’s financials at book values.

As the final step GFH allocates those net assets between shareholders in the Group and Non Controlling Interests (NCI) in the Consolidated Statement of Changes in Shareholders’ Equity based on their respective ownership/voting rights.

With the acquisition of an additional 13.64% in KHCB shares, GFH’s share of the net assets (total assets minus total liabilities) in KHCB will increase.

This increase in equity attributable to shareholders of GFH will be accompanied by a corresponding decline in equity attributable to NCI in GFH's financials.

If its tender offer for the remaining shares is accepted and completed, an additional increase in Group shareholders’ equity will occur.

Depending on the percent take up on the take over offer, the component in NCI related to KHCB may disappear from GFH’s financials.

But there is indeed more!

You will recall (and if you don’t here’s the link to that post) that in connection with its 2020 purchase of KHCB’s AT1, GFH was required to reduce its consolidated equity attributable to shareholders of the Group by US$ 59.9 million in its FY 2020 financials.

The US$ 59.9 million reflects the excess (positive difference) between (a) GFH’s “contribution”--the amount of the AT1-- and (b) GFH’s share of KHCB’s net assets based on its percentage shareholding in KHCB.

Now that GFH owns 69.05% of KHCB, it is entitled to “recover” some of that amount.

Similarly, it will also have to absorb some of the US$ 14.3 million share of issuance costs levied against the NCI in 2020. Perhaps as much as US$ 4.4 million.

We should see the impact of the 13.64% KHCB share acquisition most likely in GFH’s 2Q2021 financials.

Keep your eye on GFH’s financials to see if my prediction comes true and how the related entries are handled.

Are they disclosed separately as in 2020?

Booked directly to equity?

Or perhaps to income?

She Just Can't Get Any Respect

At Least She Got a Seat in Istanbul
Not Even a Mention in the FT

 

Robert Armstrong had an absolutely brilliant article in Saturday’s FT: Rumpled Boris, Macron's mistake and other G7 sartorial missteps.

But one very glaring flaw.

He failed to mention one of the nine leaders at the summit.

At least President Erdogan had a seat for Ms. Von Leyden, albeit not in the front row.

But a seat nonetheless.

Ransomware Prioritize Prevention Then Pursue Prosecution – Part 2

When You're This Far Gone
It's No Wonder You Don't Hear the Wake-Up Call
And a "Sobering Fact" Is Likely to Have No Effect

In Part 1, I outlined (yet again) the above point: hardening the target should be the priority.

In this post, I will hit that downed horse several more times. 

Hopefully demonstrating that with respect to prevention there is quite a bit of low hanging fruit.

Please note that only the first point below directly relates to Mr. Younger’s opinion piece in the FT.  

Russia

Mr. Younger had and perhaps still has access to secret information that makes him better placed than me to make an assessment about the links between ransomware hackers and the Russian Federation.

And as well to draw the conclusion that securing the cooperation of the RF will be a key element in stopping attacks.

His comment may be read to imply that the Russian Government

• is more capable of controlling crime originating inside its borders than other countries are within theirs (that, I’d note, would be a remarkable achievement), or

• that there are bonds between the hackers and certain organs of RF state security or

• perhaps both

In any case, if the hackers were expelled and are motivated by profit, wouldn’t they simply pack up and go elsewhere?

Or in a demonstration of the intense competition in the “free market”, wouldn’t other countries’ enterprising hackers step up to fill the void?

From time to time, countries are “ranked” for the amount of “malevolent” internet traffic they originate.  

Perhaps, these reports may identify potential candidates?  

I didn't include all the countries named. 

You can look at the reports cited below for additional country names.  

One point to keep in mind. 

It’s unclear if these reports are based solely in IP addresses or if there are other metrics.

Like VPNs proxy servers can make one appear to be in a country when one is not. Proxy server chains can create even more difficulty in locating a person or entity.

Matthew 7:7  Just one day after I posted this, Auntie answered.  Still a great deal even at GBP 159 a year!  https://www.bbc.com/news/technology-57504007

According to this report in 4Q2012, the PRC was responsible for 41% of “global attack traffic” on the internet, the US second with 10%, and the RF in fourth place with 4.3%.

According to another report, in 2016 China led the pack with 27.2% of cyber attacks (this is a subset of malicious traffic) the US with 17.12%, Turkey 10.24%, Brazil with 8.6%, and Russia with 5.14%.

According to this report for May 2019, “China, Russia and Ukraine appear to be active in a wide variety of hack attempts, including root kits, ransomware, brute force attacks and a wide variety of malware.”

State Intelligence Operations versus For Profit Criminal Hacking

It’s important to keep this distinction in mind when looking for solutions.

While finance is my provenance, I’d venture to guess that eliminating spying is even harder than eliminating organized crime.

According to what I read in the media, even allies spy on one another.

I’d also venture that countries are not going to allow the extradition of their intelligence operatives to a foreign country. 

What about criminals?

The definition of “criminal” can be tricky—to use a shared finance and legal term --particularly when it comes to matters of state security.

Unauthorized access to state secrets, secret internet or communications systems and physical sites is a crime.

In such a case one might revise the statement about “terrorists” and “freedom fighters” to: 

One country’s cyber spy is another country’s cyber criminal.

So what is to be done?

Prevention may offer a higher prospect of reducing risk than after the fact prosecution. Though prosecution should not be abandoned.

The Sophisticated “Hacker”

There seems to be a general perception that hackers are an incredibly brilliant lot.

Think of an evil twin from a soap opera.

A “rogue” Bill Gates, Linus Torvalds, or Larry Page.

That’s not always the case.

Much of the hacking takes place by the equivalent of opening an unlocked door or open window.

Those tools are fairly simple to program.

And for the lazy available for purchase on the web, or so I am told.

Here is a CISA alert from 6 May of this year.

More sophisticated hacking software is often developed from undisclosed flaws in existing software or systems that the hacker has purchased from someone else clever enough to discover them.

Here’s an article these “flaws” or zero day exploits.

Here’s another on how these sort of exploits were used to hack IOS in February 2020.

And there are other ways.

According to security experts the WannaCry ransomware attack was made possible by using information from some NSA software that Shadow Brokers illegally acquired and then put up for sale.

The Somnolent/Negligent Target

Here’s where we get to the really uncomfortable part – taking responsibility.

Lot of attacks are successful because targets left their doors unlocked and windows open.

WannaCry was facilitated because many users hadn’t upgraded from Windows XP.

As is common practice, after a certain amount of time, software vendors stop “supporting” old software. That includes providing security patches for known vulnerabilities.

You’ll see that same failure mentioned regarding some of the 2018 ransomware attacks in the USA.

Another is failure to install patches and updates that are provided by the vendor. 

That is, perhaps even more egregious. One doesn’t have to plunk down money for a new bit of software, but merely install a “patch” from the vendor.

Pulse Secure VPN appears to be our poster child here.

First, an article from AP about breaches this year.

Here is a CISA alert from 15 April 2020 which is an update from 10 January 2020. 

Take a look at the timeline outlined in this report.

You’ll notice the vendor made its first wake-up call in January 2019. That was followed by several “sobering facts” from a variety of sources.

Both of these incidents may be a salutary caution to those whose mobile phones no longer receive software updates or security patches. Or those who have ignored a message to update their phones.

I’ll upgrade this comment later to “a wake-up call” or “sobering fact" later.

As you will notice from the FT article cited above, WannaCry was described as a “wake-up call”.

That the somnolent didn't and don’t answer.

Perhaps the solution is a louder ring tone? Voice mail?

Not bloody likely! (See picture at the head of this post).

Stricter government requirements and robust penalties for failure to adhere to them are likely to get more attention and responses.