Gulf Finance House –2018 and 1Q19 Treasury Share Transactions Cost GFH Shareholders More than USD 37 Million

Satellite View of GFH Statement of Changes in Shareholders' Equity 

Update  12 June below in red.

The sad story of wasted shareholder money continues here.

First, a technical note to ground the analysis that follows.  In line with accounting standards, gains and losses on sales of treasury shares don’t pass through GFH’s income statement so technically they are not “income”.   But since this decline in value is the result of deliberate actions by GFH, it’s hard for AA not to consider this the equivalent of an income statement “loss”.  And I shall use the term “loss” in that sense in this post.  

Now to the analysis.  

In his Shareholders Report in the 2018 audited consolidated financial statements, GFH’s Chairman stated: “Also of note during the year, GFH took active steps to support its share price and market capitalisation, acquiring treasury shares up to 7% of the Group’s total issued shares.”  

Indeed, it did!  

But perhaps the results weren’t so good for GFH’s shareholders.  

In short (1) a lot of money was spent and lost and (2) the impact seems to have been minimal.  

As per AA’s analysis, it appears that the net result of GFH’s buying and selling of its own shares in FY 2018 was a reduction in equity of some USD 27.9 million.   If you’ll look at Statement of Changes in Shareholders’ Equity in GFH’s 1Q19 interim unaudited report, you see that GFH admits to losses of USD 24. 8 million on treasury share transactions in 2018.  

AA believes the roughly USD 3 million difference between AA and GFH relates to the USD 3,058 million 2018 charge to the share premium account which zeroed it out.  It appears that GFH considers that “loss” to be covered by earlier years’ gains.   

You will also note in the 1Q19 report that GFH has continued its treasury share transactions in 1Q19 for an additional USD 9.6 million “loss”.  And three more quarters left this year.  That's a time reference not a monetary one.

So a total of USD 34 million by GFH’s accounting and USD 37 million by AA’s.  

But you might ask AA:  Yes, but what about the impact on the share price? Surely, this was a small price to pay for “supporting GFH’s share price and capitalization”.  

GFH’s closing share price on 2 January 2018 was AED 1.520 and on 31 December 2018 was AED 0.902, according to investing.com.  Looking at share price performance only, that’s a decline of approximately 41%.  The share price at the end of March and May this year was in a similar range to the FYE 2018 price. 

I suppose in defense of GFH one might argue that absent their efforts the price would be even lower.  AA will not.  

The central question is why GFH is spending shareholders’ money to prop up the stock price?   

And perhaps whether regulators think that the method employed is “sound practice”?  

We don’t really know what is motivating GFH’s board and management. 

But what we can do is take a detailed look at their actions and try to guess (note that word) what is going on.  

In the recent past, GFH had minimal treasury share transactions.  It was only in FY 2017 that break was made with past moderate efforts.  FY 2018 saw a real break with the past as this chart demonstrates.  

GFH Financial Group Holding of Treasury Shares
FYE		Number of TS		Total Issued Shares		TS as % TIS
2013		5,283,272		3,161,889,967		0.17%
2014		5,204,536		4,730,665,467		0.11%
2015		24,503,697		2,256,583,403		1.09%
2016		2,211,891		2,256,583,403		0.10%
2017		106,467,804		3,681,450,441		2.89%
2018		255,455,953		3,681,450,441		6.94%

Source:  GFH Annual Reports  

1. Clearly, FY 2017 was a transitional year from the pattern of the previous four years.  
2. FY 2018 saw an “explosion” of Treasury Share transactions.  

Let’s look a bit closer at FY 2018.   

GFH Financial Group Treasury Share Transactions
by Quarter for FY 2018 -Millions of US Dollars
		TS BOP		Buy	Sell	Net = B-S	TS EOP	G/(L)
Q1		$58.4		$5.4	$3.2	$2.2	$60.6	($0.9)
Q2		$60.6		$10.8	$20.6	($9.8)	$50.8	($5.2)
Q3		$50.8		$56.1	$17.9	$38.2	$89.0	$0.0
Q4		$89.0		$88.7	$92.3	($3.6)	$85.4	($21.8)
FY TOTAL				$161.0	$134.0	$27.0		($27.9)

 Source:  GFH 2018 Quarterly Financials, Amounts in Thousands of US Dollars

1. TS= Treasury Shares BOP = Beginning of Period, EOP End of Period.  G/(L) = Gains/Losses.  
2. Buys in 4Q18 were 55% of the FY’s total and 69% of sales.  
3. It appears that these (4Q) sales were undertaken to either fund new purchases or because of imposed limits on the amount of Treasury Shares GFH was allowed to hold either from its regulator (CBB) or the GFH Board itself.  Or perhaps some combination of both.  
4. 78% of FY 2018’s loss on Treasury Share transactions occurred in 4Q.  
5. That suggests, but does not prove, that GFH was frantically trying to stave off a decline in share price for the “all-important” FYE 31 December reporting date.  

Just how frantic that activity was can be seen from the next two charts.  

First, let’s look at 4Q18 transactions in GFH shares on the BSE, KSE, and DFM.

Trading in GFH Financial Group Shares 4Q2018
		Local Currency		USD Equivalent
BSE		BHD 6,379,970		USD 16,906,921
KSE
Oct		KWD 1,013,881.569		USD 3,335,137
Nov		KWD 311,267.257		USD 1,023,905
Dec		KWD 4,119,336.652		USD 13,550,450
DFM		AED 1,363,936,328.99		USD 371,644,776
TOTAL				USD 406,461,188

Sources:  BSE, KSE October, KSE November, KSE December, and DFM.

1. With the DFM, you’ll have to do a bit of manual tinkering to select the time period.  Click on the orange box on the upper left hand side of the Bulletins Page.  Select 2018 and then Q4.  
2. What emphasizes the “frantic” nature of GFH’s efforts is the percentage of their Treasury Share transactions of the above total as detailed in the chart below.

GFH Financial Group Treasury Share Transactions 4Q18
	Amount		% Total 4Q18 Transactions
Buys	$88,662,000		22%
Sales	$92,267,000
Loss on Sales	-$21,780,000
Net Sales	$70,487,000		17%
Total Transactions	$159,149,000		39%

Sources:  Previous Two Charts.

1. Percentages are calculated using the Total Transaction from the previous chart, i.e., USD 406,461,188.  
2. Net sales transactions are estimates of cash proceeds = Cost – Loss = Cash.  
3. Chart is based on the assumption that all of GFH’s Treasury Share transactions took place on a stock exchange.  
4. If the above analysis is correct—and AA invites readers to point out any mistakes—then GFH had an outsized share of transactions.   Does AA dare use the phrase “حوت الخليج“ ?   

What are we to make of all of this? 

Here are some thoughts of what might be going on.  Not proofs, but rather conjectures.  

Some of you out there may have other thoughts.  Please post a comment. Share your views.   Point out AA's mistakes.

If we assume limits on GFH’s holding of Treasury Shares (as a percentage of shares rather than a USD amount), then it would seem likely that GFH’s management would be aware that attempting to continue to prop up the share price in 4Q18 would require selling some of the existing Treasury Shares to make room for new purchases.     

And that selling those shares would lead to losses.  

If one looks at the average Buy/Sell ratio by quarter (adjusted for the cash losses on existing Treasury Shares), it’s 1.7 in Q1, 0.7 in Q2, 3.1 in Q3, and 1.3 in Q4. 

Clearly, the “bang for the buck” in Q4 is rather limited.  Each USD 1 of existing Treasury Shares sold only increases demand by USD 1.3.   Hard to see that having a material effect on the price.  

Perhaps that explains GFH’s whale-sized share of total trades in 4Q.  Trying to use volume to move the price in a favorable direction.

But taking on that volume of transaction caused substantial losses. 

AA is at a loss to understand why GFH did not stop trading in its shares when the losses began to mount.  If this were FX or other trading, a stop loss limit would have been triggered.  

GFH’s shareholders were bleeding substantial cash.  And consequences of continuing in 4Q18 are highly likely responsible for some of the pain in 1Q19. Overall a loss to the tune of USD 37 million for FY 2018 and 1Q19.  

We don’t know what GFH’s reason for continuing Treasury Share transaction but they certainly evidenced determination to proceed David Farragut style at a level that AA interprets as “frantic”.  

All this leads AA to conjecture that there seems more to this behavior than merely propping up the share price because it appears management accepted the large amount of losses incurred.  

What could motivate this behavior?  

As noted above we don’t know. 

But if we want to conjecture, what could be possible motives?  

Was GFH propping up the shares to “help” those investors who financed their share purchases using the shares as collateral?  And were exposed to lenders calling in the loans or asking for more collateral?  If so, who might those shareholders be?  

If Homer can nod, surely AA can.   In early August 2018 as reported by Gulf News, GFH advised the market "that on Thursday that its shareholders Abu Dhabi Financial Company (ADFG) and Integrated Capital (IC) have transferred 102,094,573 and 79,905,427 of GFH’s shares respectively from their NINs to Al Hilal Bank for a financing facility."   Coincidence?

Or perhaps to help investment funds who bought GFH’s shares “high” and would have to report a loss to their investors based on FYE 2018’s much lower price?  Who might those funds be?

Well, according to press accounts, Goldilocks acquired a 4.9% stake in GFH in January 2018.  At that time shares were trading around AED 1.5 per share.   As noted above with the share price at AED 0.902 at year end, Goldilocks would have to have reported a 41% loss on the investment considering only movement in the stock price over the year. 

AA in the Press Again as Usual with Similar Effects, Sadly

Reporting “Rant” Questions 

In previous years, GFH’s Statement of Changes in Consolidated Equity clearly labeled the results of Treasury Sales transactions which resulted in a Loss or a Gain by using those exact words.  That changed with the 2018 FYE report.  The loss amounts appear but there is no descriptor.  

Those who know their IAS/IFRS would understand that there was a loss in 2018.  But AA believes that certainly not all of GFH’s shareholders are accounting experts.  And it’s highly likely that only a handful are.   And how many of the accounting experts are reading GFH's financials?  

2018 was coincidentally a year in which the loss was quite large.  

Questions for GFH:

1. Was this change designed to avoid drawing attention to the loss?  
2. Or a simple oversight?  If this is the case, what caused the change in the existing template?  Or in other words, why change the tried and true? 

Interestingly, the term “loss” to describe 2018 was used in a footnote to the 1Q19 interim financial Statement of Changes to Consolidated Equity.  But in the same note on page 4 in the 1Q19 financials, the 1Q19 "loss" was again not used as it had been in past as part of the main text?   Why is this?  

Questions for external auditors,

1. Did they “miss” this rather important change in 2018 AR?   
2. Or did they approve it?  
3. Additionally, when a bank loses an amount this size (some 20% of net income) is this not a material piece of information that needs to be highlighted?  And not buried in a note?  Which is unclear except to accountants? 
4. Would auditors consider this level of "trading" in a firm's Treasury Shares as constituting "material information" as well? 

More posts to come on GFH’s 2018 results.

Central Bank of Bahrain Compliance Enforcement Reports

In case you missed it, I certainly had until just recently, the CBB is publishing annual “Compliance Enforcement Reports” which provide information on actions taken by the CBB to enforce regulations.  

This is a good source of information on the types of violations that occur as well as trends year to year.  Of interest—AA certainly hopes—is the section that names violators and provides a generic description of the violation.  But this is only for some violations.  You’ll see some of the firms that have appeared on this blog as repeat offenders in the CBB’s  reports. 

Reports for 2018, 2017, and 2016 have been posted.  The 2016 report has some data on 2015.  If the past is any guide, reports for this year will be issued in January 2020. 

AA was particularly gratified by two items in the 2018 report both appearing on Page 9.  

First, the CBB levied a fine (which was upheld on appeal) on a BSE listed company that had provided a clarification to an overseas exchange, where it is cross-listed, regarding the content of a news article published in that overseas jurisdiction about the listed company’s operations.  This clarification was disseminated on the overseas exchange’s website without the same on Bahrain Bourse’s website, which was only published by the listed company, a day after, in response to the CBB’s instructions.   

Faithful readers of this blog (that would be AA) will recall a characteristic AA rant about a failure by GFH to provide the same information on its 3Q10 financials on the BSE as it did in the UAE.  

And AA’s appeal to the CBB to change disclosure rules to require the same. 

As outlined in the CBB’s  2018 report, this requirement exists as per Section OFS-5.1.19 of Rulebook Volume 6 Capital Markets.  It appears to have been imposed in January 2014, though it may have existed elsewhere in another rulebook.  

Here’s chapter and verse of OFS-5.1.19.  

For Bahraini issuers who made an offer or listed their securities outside Bahrain, and for overseas issuers who made an offer or listed their securities in Bahrain, all information of importance to shareholders made public about the issuer in other markets must be made public in Bahrain, whether or not disclosure of such information would otherwise be required by the CBB.    

Note that this requirement includes the "making of an offer" and not just listing on the BSE.

Second, the CBB sanctioned an unnamed individual investor for market manipulation during 2018. 

Mystery US Navy Ship Spotted in Yokohama Harbour

Special to Suqalmal BlogSpot

The internet has been abuzz with speculation about the identity of a mystery ship recently spotted in Yokohama Harbour.

Without looking under the tarp, AA can now report that he has confirmed that the ship in question is definitely not the USS Cadet Bone Spurs nor the USS Richard Hersey.

Dana Gas: FYE 2018 and 1Q2019 Financial Performance - A Brighter Picture But Not by Much

A 5 Watt Bulb is Brighter than 2 Watts

Last December I made a bold prediction based on DG’s 3Q18 financials that the company would have a break-even year or at best case perhaps earn a 4.5% ROAE.  

DG’s 2018 financials  (but not its glossy annual report) have been released. 

Let’s take a look and see how prescient AA’s prediction was.  

Net income for 2018 is what might charitably be described as “disappointing”, a net loss of USD 186 million driven by impairment provisions of USD 250 million.  USD 187 million for the write-off of the Zora field and USD 59 million for certain Egyptian assets (or perhaps uncertain Egyptian assets).  

Pretty far off from AA’s less than less than "prescient" prediction a scant five months ago.  

In the MD&A section of the report DG’s Directors emphasize that the 2018 impairment provisions were “non-cash items” and that “On a like for like basis, excluding one off impairments, profit from core operations increased to USD 64 million (AED 234 million) as compared with USD 5 million (AED 18 million) in 2017".  

On that basis, DG earned an ROAE of some 2.35% using total shareholders’ equity as reported on the balance sheet.  If we adjust 2018 equity for the non-cash impairment that year (add it back) then ROAE is 2.27%. 

In the Directors’ “best” case, a dismal return.  

Certainly well below the risk-adjusted return DG should be earning given its business concentration in risky markets.  Equally well below the return it should be earning ignoring risk.  

However, the picture in 1Q19 is brighter, but only marginally in an absolute sense.  

Net income of USD 35 million, largely driven by a USD 10 million reduction in interest expense.   If this pattern continues, projected ROAE for 2019 is some 5.3% much better than 2018.  

But still subpar for the risk.  No longer pitch dark.  But a 5 watt bulb is cold comfort.  

There was other good news.  

Continued reasonably good collection of receivables from Kurdistan.  

A less favorable 70% collection rate in Egypt, including some receipts in Egyptian pounds.  A less than happy approximate USD 9 million increase in Egyptian receivables.  Both factors –accepting funny money (Egyptian) and increasing receivables --something to keep an eye on.  

DG also reported that it and Pearl had prevailed in their arbitration (LCIA) with MOL over the KRIG settlement. 

So is DG out of the woods?  

Not quite yet.  

While better than 2018, the projected ROAE is still not at a level that a company with this risk pattern should be earning.  

One quarter does not a turnaround make.   

More importantly the factor driving the turnaround is financial not operational.  The current interest charge is based on a non-market rate.  Once the company has to borrow at market rates again, this financing advantage will disappear.  And financing will be important if DG is to materially grow its business.  

With an approximate 5% ROAE, there will also be little opportunity to use financial leverage to increase shareholders returns materially.  And, if lenders demand more than the ROAE, leverage will actually diminish ROAE.

There's a real negative on the operational side: the write-off of Zora.  It was DG's one revenue stream from a creditworthy country. Admittedly small, but perhaps with a potential to grow.

There's also another cloud on the horizon.  

DG is looking at a roughly USD 400 million principal payment on the sukuk in October 2020 some 17 months from now.  

With USD 442 million in cash as of 1Q19, an almost certain USD 95.5 million dividend this year and one next year which is likely to be approved and paid prior to repayment date, there’s little margin for error. 

The sukuk lenders/investors did not or could not impose any real control on DG's payment of dividends.  They agreed that DG could pay dividends equal to 5.5% of paid-in- equity on the condition that after such payment, DG would have cash of at least USD 100 million.  And they did this knowing the repayment due in October next year was going to be a multiple of USD 100 million.  Roughly 4 times.

If DG is able to honor the repayment obligation in full, and that’s not certain, it could be left with little cash for its business.  

In such a case it’s hard to imagine investors and lenders rushing to support DG, but then they (lenders and investors) routinely demonstrate little common sense in their underwriting. 

So the future while brighter (5 watts instead of 2 watts) isn't bright enough to lift DG from the dog investment category.

Dana Gas 3Q 2018 Earnings: "Woof, Woof"

Earlier this year, I took a look at DG’s 1Q18 earnings and made some predictions for the full year.  A best case 4.5% ROE or worst case a break-even year.  As you’ll note, the best case falls well short of what would be an adequate return given the risk profile of DG.  

So how does AA’s prescient prediction look with a full three quarters of data?  

Frankly, not so good.                  

DG reported USD 41 million in net income for the first nine months of the year.  Pro-forming this for the full year, would result in roughly USD 55 million for the full year or an ROE of 1.9%.  

But to get a sense of the return from ongoing operations, we need to exclude two special items.  Those are USD 8 mm in 2Q18 sukuk restructuring expenses and a 1Q18 reversal of 13 million in previously accrued expenses.  If we exclude both amounts—a net of negative USD 5 million--, DG earned some USD 36 million over the first nine months of the year.  Pro-forming this over 12 months results in projected full year net income of USD 48 million or an ROE of 1.7%.  

Inadequate when one considers what would be a normal ROE for a stock investment.  

Dismal indeed when considers the higher ROE that that a risky stock like DG should deliver. 

To boot DG’s ROE remains well below its current roughly 4% cost of borrowing which is artificially depressed from the appropriate risk adjusted cost by the restructuring.  

Of course, there could be a miracle in 4Q18. 

The hoped for settlement with NIOC could materialize.  The US Government could graciously facilitate Iran's payment of the settlement proceeds to DG and, perhaps, as well give DG a license exempting its transactions from newly re-imposed US sanctions on Iran.  

At this point, it appears that the best value creation opportunity DG has is to repay its debt in full.  That will result in a net "benefit" of some 2.1% per annum to shareholders.  Dividends are another option - as it might be expected that shareholders could find other investments to return more than 1.9% a year.

To end on a rare (for AA) positive note,   all things are relative.   

DG may be a “mutt” investment, but AA suspects that investors in Gulf One Investment Bank Bahrain might find it quite attractive. 

Gulf1 has not reported a profit since FY 2013 and appears poised to continue that "run" in FY 2018.  Over the period FY 2014 through FY 2017 Gulf1 “lost” (that doesn’t mean “misplaced”) some 57% of its total equity:  from USD 133 million at FYE2013 to USD 57 million at FYE 2017.  

It’s hard to say how FY 2018 will turn out, though the loss this year for nine months is larger than for the comparable period last year.  But as is well known providing an opinion on fiscal year audited financials generally concentrates the minds of auditors more sharply than the  signing off on interim unaudited financials.  In 2017, the bulk of G1's USD 27 million loss was booked in 4Q.

On another somewhat positive note:  Gulf1 is equity funded so there are no lenders with significant exposure and thus in significant danger.

Brexit: Bishops Pray for Politicians' Integrity Amid Brexit Turmoil

"Father" Ethan Rushes to Join Prayers

According to The Guardian, Church of England bishops have said they are praying for “courage, integrity and clarity for our politicians” after a week of turmoil over Brexit.

According to the Bible, "With God all things are possible".

However, as you'll note, while the Bible speaks about "possibility", it is silent on "probability".  No doubt to cover situations like this.

How to Mitigate Against PE GP “Sharp Practice”

Fait ou fiction?

Ahmed Badreldin, Former Head of MENA for The Abraaj Group, has written an interesting article on the above topic for Private Equity International.  

He emphasizes enhanced controls over the GP by LPs and proper due diligence.  

A lot of good common sense suggestions. 

Some quotes that particularly resonated with AA:  

1. “A key element of diligence is maintaining skepticism until the very end.”  
2. “Furthermore, funds shouldn’t have large positive cash balances and alarms should go off if there are drawdown requests from funds that already have large cash balances.“ 

What I found particularly interesting was his focus on a three specific examples of GP “sharp practices”.   

Do you wonder if he witnessed these “sharp practices” first-hand during his career at one of his previous employers? Or is he just applying his theoretical knowledge to identify key risks?  

AA has his own opinion, but what’s yours? 

In his own words:

“A recent case involved a fund that had externalized fund administration, but where drawdowns were made despite the fund having large cash balances.  Monies ultimately went to a bidco SPV where the bank accounts and the SPV were controlled by the GP without external oversight by independent directors or fund administration (despite the actual fund having fully externalized its fund administration).”

“Funds should not have large cash balances for multiple quarters, especially given the risk of fund bank account balances with “quarter end window dressing”, where the cash balances of the fund can be temporarily shored up from external funding sources, which can be difficult to detect, resulting in reported cash in the GP reports not actually existing for the reporting period.”  

He also focused in on valuation of portfolio companies.  Suggesting that these be audited by independent third parties with perhaps the inclusion “simple” metrics such as EV/EBITDA versus comparables as a way of providing a check on the GP's valuation.  

AA would note that selection of “comparables” can allow the GP a great deal of discretion to achieve a desired result.  And there is always the possibility of manipulation.  

Bahrain International Bank valued its investment in Burger King franchises it owned in the Carolinas using a multiple based on an unconsummated offer to buy the Burger King company. Note that is comparing the value of a franchise (part of the chain) to the main company (ex the franchised outlets).  

That’s not to say the DCF produces a more accurate result.  Small changes to assumptions (discount rate, growth rate) can result in big changes to valuation.  

As he notes, valuation is an art not a science.  When the intended result is known, the artist can employ all of his talents to achieve that result.  Or just enough.  One hopes though that the arts employed are not the "black" arts.