OLAM

Olam, Temasek and a huge pile of debt

andyxianwong.wordpress.com/2014/03/23/olam-temasek-a-huge-pile-of-debt/

Temasek’s offer to buy out Olam in a S$2.53 billion deal comes as the commodity trader continues to pile on debt. While Olam’s politically well-connected management and shareholders may appreciate the sovereign wealth fund’s backing, this is a deal which ticks all the wrong boxes for Singapore.

Olam’s management have been fending off critics of their financials and accounting for years. While Carson Block’s very public decision to short the stock in 2012 was widely reported, less well-known is the fact that top Asian equity house CLSA incurred the commodity trader’s wrath the year before over a research note that raised some of the same concerns. And while the public response from Olam has always been defiant, privately management have admitted defeat – tearing up a flagship six-year plan to generate US$1 billion in profits by 2016 and slashing the debt fuelled growth that Block saw as unsustainable.



Expensive failure

It is quite spectacular how badly Olam has failed to deliver on its financial goals. It was in 2010 that Olam launched their strategic plan – on the face of it a relatively simple one – to borrow money, grow the business, grow profits and then pay back the money. Yet while the money was borrowed, the profits never materialised. The plan set out a specific goal to reach US$1 billion in annual profits by 2016, but Olam has come nowhere near achieving that number. Olam’s investor presentations translated the goal to a $1.25 billion Singapore dollar equivalent – yet after reaching a high of S$373 million in FY2011, profits fell to S$356 million and S$349 million in the following years. So while profits are now about a quarter of what the plan projected, debt levels have increased dramatically – 35% in just the last two years, reaching a total of S$8.85 billion in 2013. An obvious question now looms for Olam – if the revenues needed to generate a billion dollars of profit never materialise, and it seems obvious that they will not, how is the debt going to be repaid?

This is where Temasek entered the picture last week, with that S$2.53 billion dollar offer to take full ownership of the company.

Good for Olam, bad for Singapore

Despite Temasek’s bullish support, all those years of borrowing have left Olam’s financials in bad shape. Reuter’s last week described the commodity trader’s balance sheet as “weak“. Michael Dee, a former senior manager at Temasek said the deal “makes no sense” – citing Olam’s negative cash flow and likely further increases in debt. So while it may be a positive for Olam’s embattled management, the deal is a negative for Temasek, and by extension Singapore. Moody’s – a rating agency – explicitly called the deal a “credit negative” for Temasek, due to the impact on portfolio liquidity and dividend yield. And since Temasek’s investment returns are widely believed to be used to pay off the CPF board’s government bonds, a negative for Temasek’s credit rating also means a negative for CPF holding Singaporeans, making the deal all the more troubling.

Now, Olam is small compared to Temasek’s total assests, so there should be no fear that this deal itself will have a material impact on the government’s ability to pay back the CPF board, but there is a question here around how and why Temasek is allowed to absorb the huge debts of a company in which it originally only took a 13.8% stake. We know that the Singapore government cites financial prudence in refusing to borrow money for spending, but borrowing billions to fund spending is exactly what Olam has been doing for years. Does allowing Temasek to take on this debt make sense? How many Olams could Temasek buy, how many billions of dollars of debt could Temasek take on, before the government would struggle to repay the CPF board? With the government’s opaque approach to financial reporting, is it even possible to know?

Well connected

So why not just cut Olam loose? Temasek bought only 13.8% of Olam in 2009 for S$438 million – money down the drain perhaps – but you can’t win on all your deals, Ho Ching certainly knows that. Why throw further billions at a company and a management team that has so obviously failed to deliver? The problem might be that Olam’s management team are politically too well-connected to crash and burn without the government of Singapore being left with some awkward explaining to do.

You see, if Olam fails due to management’s inability to deliver on strategic plans, the Ministry of Trade and Industry’s decision to appoint Olam CEO Sunny G. Verghese as head of IE Singapore for over five years (he just stepped down on 31 December 2013) may look unwise. That is the same IE Singapore that embarrassingly had to restate NODX for September and October last year due to an error in counting exports – an error that seems particularly hard to explain given the oversight of a man who has made his career in imports and exports. And what of Michael Lim – Olam’s lead independent director since 2010 and Chairman of the Singapore Accountancy Commission? Carson Block slammed Olam for supposed accounting irregularities, and with Lim responsible for audit, compliance and governance at the boardroom level in Olam – whether or not any irregularities actually existed – an Olam failure in the midst of such accusations could be awkward for DPM Tharman who presumably appointed Lim to lead the newly instituted SAC.

I’ve written before on the “closed circle” of power in Singapore. Without independent oversight and a transparent framework to guide Temasek’s investments, it is hard to tell whether the purchase of Olam is a purely economic investment decision or a politically motivated face-saving exercise. If Temasek followed the vastly superior Norwegian sovereign fund model such questions could never occur since a full takeover of a failing company would not be possible. But without such transparency, we are just left wondering as to the true reasoning.

Finally, it has been widely commented that news of the buy-out was leaked, and there is a strong suspicion that people close to or on the deal team appear to have traded very profitably on material non-public information, bidding the price of Olam shares up to surprising levels in recent weeks while the SGX looked on. Such a state of affairs just reinforces the perception that institutional governance is weak, and that Singapore lacks proper independent bodies to hold the powerful to account. Without good governance, secret agreements and the right connections rather than pure economics and meritocracy become the easiest way for a well-connected minority to make money in Singapore, often at the expense of everyone else, who suffer a “credit negative” instead. Is this the crony capitalism of Singapore Inc in microcosm?