David Webb advises independent shareholders of Aeon Credit Service (co) Ltd (ACSA, 0900.hk) to vote against a proposal to lend money to its parent company.
Strong words by David Webb:
"Loans to controlling shareholders are always a bad idea. The controlling shareholder, through its power to control the composition of the board, can in practice decide whether to repay the loan or seek rollover. If a controlling shareholder gets into financial difficulties, it is more likely to repay its bankers than it is to repay a company it controls. Its bankers may even have a security pledge over the listed company's shares.
If a company has surplus capital beyond its foreseeable requirements, then the golden rule is that this should be returned to all shareholders by way of a dividend, not to one shareholder by way of a soft loan. Loans to controlling shareholders are an abuse of company funds.
ACSA is in the business of consumer credit, on which it normally makes a decent spread. In the year to 20-Feb-2012, it had interest income of $1,010m and interest expenses of just $118m, on outstanding loans of $4775m. That's an average interest rate of about 21% on the loans, ignoring the near-zero rate on time deposits. But for a loan to its parent, it proposes to charge only 0.75% above its unspecified "Cost of Funds", which is probably only about 2% p.a.. ACSA says that "the Company" (presumably, its directors) "considers it desirous to grant the Loan Facility to ACH to generate a reasonable return for the Group". Desirous for ACH, perhaps, but not for minority shareholders, given the risks involved.
Setting aside the issue of whether lending money to a controlling shareholder is a bad idea, the terms are lousy. ACH does not even offer any security, and the interest rate is not reasonable compared to the rate on consumer loans. If ACH wishes to borrow money, then it should go directly to the banks and pay market rates.
Another concern for ACSA shareholders is what this says about the parent's strategy in greater China. ACH wants to use the money to invest in its own "PRC Business" outside of ACSA, defined as micro-finance, leasing and consumer finance. That puts it into competition with ACSA, and reduces the potential for ACSA to expand beyond its mature HK business. ACH also has wholly-owned subsidiaries in Taiwan doing credit cards and hire purchase. If AEON wishes to regain investors' confidence after this proposal is either withdrawn or defeated, then it should announce a consolidation of all its greater China business into ACSA and sign a non-compete undertaking, removing the conflicts of interest."
In Malaysia, Panasonic Manufacturing (Malaysia) Bhd (previously known as Matsushita Electric Company (M) Bhd) is engaging in a similar practice. From its latest quarterly report:
In its latest year report the company was keen to brag about its track record of having delivered good returns to its shareholders. It has all rights to do so, investors who would have invested in the shares of the company at its IPO in the 70's would have done very well indeed. But that doesn't mean that placing funds with related companies is a good practice, in the contrary.
I love capitalism, despite its short comings I don't know of any system that is better. It performs best if left alone, with a decent amount of corporate governance. Japanese companies have their own sense of corporate governance, by global standards it is very disappointing for such a developed and rich country. After the share market bubble in the 80's burst, the performance of the NIKKEI index has been bad. Japanese companies should welcome good, internationally accepted, corporate governance practices, it is long overdue.