Saturday, 15 November 2014

Cutting accumulated losses through financial engineering (2)

I wrote before about this issue. I received two reactions that confirm my suspicion.

From "Anonymous":

Sadly, it is a global accounting treatment. Just google "accumulated losses write off", you can see lots of same treatment for this situation. Mitsubishi, Yamaha, United Bank of India and etc. I suppose this is a grey area in the accounting standards.

From "Avatar":

I'll be slightly more brief here. What you have illustrated above is a good example, so I'll use that simple one. I'll try to state the issues in a more simplistic manner.

1. A clean slate or forever blacklisted
To put it simply, just like a ex-convict that has been released and is looking for a job, is it fair to forever label him as an ex-convict when the prospective employer searches his records through some database?

Similarly, in this situation ~ the so-called accounting 'innovation' (it's not btw) goes along the same line of thinking. Since the company has made substantial losses, it weighs down on the mind of any future investors, same as the employer with the ex-convict. That's why most companies go down this route to wipe out the past bad track record, so to speak. In this time where first impressions count, I don't blame them.

2. The cat has flown the 'coop' so to speak
The accumulated losses is just a summary or 'report card' of all the bad decisions made by the company, so to speak. It doesn't really matter whether it's netted off against the share premium of share capital, as more importantly, the cash is already gone. You are right though, keeping it there, lets the investor see all the bad decisions that have accumulated throughout the years, but a good investor can always look at the losses throughout a 5 or 10 period anyways.

3. Companies Act 1965 and SC
There are some safeguards before companies are allowed to set off their losses against the share capital and premium, especially if they are listed on the Bursa. It's not a difficult thing, but there are some procedures to be followed, so it's on some whim and fancy. Probably it's pursuant to some restructuring and injection of new share capital and such.

As to your last question, YES! It's a perfectly legitimate technique though there are safeguards in the UK Companies Act to prevent share capital from being reduced in this manner, which was exported to the Commonwealth Countries such as Malaysia and Singapore.

Thanks for the two contributions, appreciated.

I guess we have to be careful and review the whole history of a company before we make a judgement. We actually even need the history of the larger subsidiaries, to be complete.

On a slightly related matter, I am completely puzzled why companies are getting away with publishing only their last few (often three) years of results in an IPO prospectus. A prospectus often contains hundreds and hundreds of pages, a lot of that information is not very useful.

Why not make one simple table with say the last ten years of results containing the most important numbers, like revenue, PBT, PAT and dividends? At most it would cover half a page, and it would likely be the most important information of the whole document. It would also exactly help in the cases described where accumulated losses are written off.

I have seen many instances where the last three years before the IPO showed net profits in a nicely rising pattern, like RM 20M, RM 40M, RM 60M and after the IPO the company hugely disappointed despite the injection of fresh money. Giving the numbers of the last 10 years might have shown a very different pattern than just the last three years.

1 comment:

  1. Dear M.A. Wind,

    Another good question, that will attempt to try to answer. Let me try to set this out again into 3 main points:

    1. It's history! Otherwise known as 'we ain't got no profits'
    If I am not mistaken, there are revenue and profit thresholds set before a Group of Companies are allowed to list on a stock exchange. Largely, since there is a minimum requirement of say, 3~5 years to meet these targets, why bother to provide further detailed historical information when the SC and Bursa Listing Requirements don't require them. A more pertinent reason could also be the one below.

    2. Technical difficulties or shenanigans?
    Certainly, it is not as simple as one may envisage. Prior to a listing, the listed company is merely a shell company that may not exist prior to the IPO project. In many cases, the owner may own a variety of companies and undertake a lot of company restructuring to buy out the minority shareholders, change the shareholding structure of the various companies he owns. Once this is done, the penultimate step is for the investment bankers and auditors to step in, set a valuation price and transfer shares of the various subsidiaries into this umbrella listed company, which will then show the past result of all these subsidiaries.

    In other words, the so-called past historical results of 3~5 years of the listed company as a single entity does not really exist. What exists as historical results on the IPO is merely an aggregation of the results of these various subsidiaries 'as-if' these subsidiaries were acquired by the proposed listed company, say 3~5 years ago, depending on the assumptions made by the auditors. Needless to say, this is not an easy task, and it's relatively meaningless to try to go further into the past.

    Once you add in some possible 'accounting techniques' that may boost the profits for the past 3-5 years of these subsidiaries at the expense of the profits in the 6-10 years earlier, you may start to see why older historical information is not provided.

    3. Load the prospectus with crap, then they'll only look at the summary
    As a general rule, IPO prospectus are thick because it's just there to overload the general investor with crap. By putting all the crap there, all the negative and pertinent information gets buried in the avalanche of crap. So, in the end, hopefully, the user just reads the summary or recommendation section. Well... that's life I guess.

    Keep on asking the good questions!