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Published December 06, 2012 in BT

10-point plan of tough love for Olam

It needs to restore credibility and take definitive actions for a healthy future

By michael dee (Ex Senior MD of Temasek Holdings)

Muddy Waters is not the issue here, it is Olam's strategic and financial decisions that have brought this situation to a head.
[SINGAPORE]

OLAM'S announcement of a major financing package this week has been characterised as ranging from a "government bailout" to a "vote of confidence". Either way, it is time for Olam to get serious about creating long term sustainability. Having missed the point earlier this year from the Feb 21 CLSA report, the emergence of a significant short position, a 30 per cent decline in Olam's share price since and the resignation of Olam's 20-year CFO in June, Olam's management and board remain in denial. The short-seller research firm Muddy Waters produced an extensive 133 page report which Olam dismissed as out of hand and responded to with a lawsuit which dilutes management bandwidth, wastes shareholders' money and does not address the root causes of Olam's problems. In short, Muddy Waters is not the issue here, it is Olam's strategic and financial decisions that have brought this situation to a head.

The latest Temasek-backed transaction raises significant issues, as it is extremely expensive debt and equity capital, capital that Olam spent a week telling the market it didn't need. The package of US$750 million of five-year debt and so-called "free" warrants are hardly free as they have tremendous value. Black-Scholes models have valued these warrants to be worth an estimated US$127 million. Since Olam's proposed US$750 million of debt is priced at 95 per cent of par, the proceeds, before fees, are actually US$712.5 million including the warrants. By backing out an estimated warrant value of US$127 million, the true bond value is actually only US$585 million, equal to 78 per cent of the original bond value. Thus, the true yield on the bond is not the 8 per cent that Olam would like investors to believe, but rather a whopping 13 per cent. Given the generous nature of these terms and Temasek's commitment to fully take up the rights issue, one has to wonder why Olam is paying US$15 million in underwriting fees to the banks who are taking no risk. If you back out those fees, the cost of this debt is an even more eye-popping 13.7 per cent.

In other words, Olam is offering existing investors a bond yielding an estimated 13 per cent and at-the-money warrants which can only be exercised in years 4 and 5. No wonder Temasek wants to underwrite the entire deal - this is the sale of the century, just in time for Christmas. But before shareholders get too excited about shiny packages under the tree, they should consider that this is just a left-pocket, right-pocket deal. The shareholders are paying for this lavish set of terms. The real losers are the bondholders, not to forget the investors who only a few months ago bought the US$275 million perpetual preferred shares issued at 100 per cent that are now quoted at 82 per cent. Their already over-leveraged securities just got more risky and they get no benefit from this package. And of course any investors unable to take up their rights will see them go to Temasek, who has no shortage of capital.

Muddy Waters' boss Carson Block did not magically create these concerns. He merely capitalised on a well-researched bet. This process is explained with wit and insight in

The Big Short by the author Michael Lewis and is a healthy aspect of capitalism. Now the market is left to sort out what is true and what the end game is.

Since this has not been done yet, I hereby submit to Olam's shareholders a 10-point plan of "tough love" to restore credibility and take definitive actions to reposition a great company for a healthy future:

1) End the war of words. Anyone reading Muddy Waters' 133 page report will see a credible work of research. The market has not been impressed with Olam's attempts to discredit Muddy Waters with ad hominem attacks and lawsuits. What's needed now are strong actions, not words.

2) Raise equity, not more debt. Olam made a strategic error in saying equity was not needed until 2015. It needs equity now. Its net gearing of 248 per cent is well in excess of industry norms and the US$750 million new debt makes matters worse and adds USD/SGD foreign exchange risk to boot. Olam should cancel the egregiously expensive debt issue and execute a meaningful equity rights offering giving the KC Group, Temasek and management the opportunity to take up rights that are unsubscribed, if any. This will underpin Olam's equity capital while demonstrating the commitment of its largest shareholders and management. Selling 13 per cent debt with at-the-money warrants is a sign of desperation.

3) Immediately stop the capital expenditure programme. This is essential as the supply of cheap debt is over. Olam's board must stop the acquisitions, conserve cash and prove the value of the acquisitions to date.

4) Focus on generating positive cash flow as soon as possible. Rule No 1 of battlefield triage is to stop the bleeding. Negative cash flow while executing a capex and acquisition programme with ever increasing leverage is untenable.

5) Sell secured receivables. Olam has said that its secured receivables are as good as cash. It should demonstrate that by selling a meaningful amount, raising cash, paying down short term debt, creating liquidity and convincing the market of these receivables' cash-like properties.

6) Draw down a portion of both committed and uncommitted bank lines. Olam is currently closed out of the fixed income capital markets and the availability of its undrawn, fully committed and uncommitted facilities remains in question. In light of Olam's significant upcoming 2013 debt maturities, showing the availability of committed and uncommitted facilities would boost market confidence.

7) Get the debt rated. Olam has raised billions from the Singapore debt markets with no independent rating of creditworthiness. An independent assessment of Olam's credit is required for investors, many of whom are individuals. The argument that others in the industry do not have a rating is untenable and specious. Olam's net gearing of 248 per cent far exceeds Noble's at 107 per cent and Wilmar's at 88 per cent. The MAS and SGX, whose silence have been deafening, should also publicly back this initiative.

8) Do not buy back stock. A stock repurchase programme burns valuable cash, increases leverage and will not impact Olam's share price. In fact, it would likely only further worsen the precipitous declines in its bond and preferreds prices.

9) Declare if management shares are on margin or pledged. While in the past, it could perhaps be argued that this is a personal matter, with so many questions hanging over the company, management needs to treat its shareholders as partners and declare if any shares are encumbered and could be force-liquidated at a given price point and if so, what that is.

Olam should also disclose the timeline of the events leading up to the announcement of the Temasek underwriting as the storyline has been shifting. Olam claimed this was its idea over the weekend and had the bankers take it to Temasek. Yet Olam also said last Friday that the CEO and two board members bought significant shares in the company. Did the idea emerge after those purchases were made and if so, when and how? There is no need to have questions about possible conflicts of interest when a simple timeline can put the issue to rest.

10) Don't rely too much on Temasek in future. Too often the market believes that when Temasek is invested for over 15 per cent, they will underwrite problems that occur and banks, investors, management, and boards can then get sloppy and lazy. As a professional investor, Temasek will do what is in its commercial interest and those who bet on additional bailouts may one day have a rude awakening, as has happened in the past. The US$750 million debt and warrants package is one sweet deal for Temasek and is not being done for charitable reasons.

Olam, as a trading business, has failed to grasp the realities of the post-financial crisis era. Today balance sheets, accounts and financing must be beyond reproach. Olam has not achieved this, but has continued to travel a dangerous path in recent years fuelled by readily available credit. It has a fiduciary responsibility to its equity and debt investors to respond with a credible and thoughtful plan of action to preserve and enhance value.

Olam has paid an extremely dear price to Temasek to buy some time. How it proceeds from here will be the existential question.

Michael Dee, an investment banker for over 30 years, was Morgan Stanley's regional CEO in Singapore and a Senior Managing Director of Temasek Holdings from August 2008 to April 2010. He has no position in any Olam securities.
More salts are being added .
Just curious, why previously no analysts pointed out what MW had just highlighted in their reports ? Funny !
I would disagree with some of Michael Dee's points. There is a time to, for eg say, declare whether mgt shares are margin or not, or to get the bonds rated. Just like there is a time to have austerity; during a Eurozone crisis or during AFC is not the right time.

Anyone in fact to question Olam accounting, baring fraud, should effectively question Singapore GAAP. I think bio asset reval is ridiculous, but that is not Olam's issue. We have to be objective.
Got hammered everyday , attackers acting in concert. Olam run out of secret weapons ?
............... and Olam's share price is being hammered further today. At noon it was down a further ~ 5% at S$ 1.44 in very heavy volume. Mr. Market appears unconvinced as the implications of Monday evening's announcement soaks in.

Bidders for the S$ 7.0% Perpetuals were apparently being accepted at the ~ S$ 80 level this morning (that is a 8.8% yield in my book).

Vested (in Olam's Perpetuals)
(06-12-2012, 11:46 AM)valueinvestor Wrote: [ -> ]Got hammered everyday , attackers acting in concert. Olam run out of secret weapons ?
Why is Olam trying so hard to prove that they are fine when they have temasek backing?
They should just ignore MW... Retaliate only when u know you can kill your enemy once and for all.
(06-12-2012, 11:36 AM)specuvestor Wrote: [ -> ]Anyone in fact to question Olam accounting, baring fraud, should effectively question Singapore GAAP. I think bio asset reval is ridiculous, but that is not Olam's issue. We have to be objective.

The company doesn't have to report fair value if they cannot determine the value reliably.

FRS41 Wrote:10. An enterprise should recognise a biological asset or agricultural produce when, and only when:

(a) the enterprise controls the asset as a result of past events;

(b) it is probable that future economic benefits associated with the asset will flow to the enterprise; and

(c ) the fair value or cost of the asset can be measured reliably.

Look at Del Monte. Their pineapple plantation life is ~3 years and they cannot measure the value reliably.

And look at Olam 25 year almond orchard.

Olam Annual Report 2012 Page 142 Wrote:The valuations are based on following significant assumptions:
(i) The average life of trees for plantations has been taken up to 15 to 25 years;
(ii) Rates considered for discounting future cash flows range between 12% and 13% per annum;
(iii) Annual rate of inflation ranging from 0% to 4% per annum;
(iv) Location, soil type and infrastructure for determining estimated yield; and
(v) Market price of the biological assets dependent on the prevailing market price of the products after harvest.
Feel just a matter of time, these high leverage or insolvency negative news will become stale. Olam should just say these are critics ,given time the management of Olam will prove them wrong.
Short sellers don't seems to care who Temasek is ?Smile

(Not vested at all, but enjoy the show )
(06-12-2012, 12:18 PM)cif5000 Wrote: [ -> ]
(06-12-2012, 11:36 AM)specuvestor Wrote: [ -> ]Anyone in fact to question Olam accounting, baring fraud, should effectively question Singapore GAAP. I think bio asset reval is ridiculous, but that is not Olam's issue. We have to be objective.

The company doesn't have to report fair value if they cannot determine the value reliably.

FRS41 Wrote:10. An enterprise should recognise a biological asset or agricultural produce when, and only when:

(a) the enterprise controls the asset as a result of past events;

(b) it is probable that future economic benefits associated with the asset will flow to the enterprise; and

(c ) the fair value or cost of the asset can be measured reliably.

The question of "reliably" is not a matter of fact, it's a matter of opinion. This standard of bio reval was specifically allowed a few years ago which should not be enacted in the first place. If we question opinions allowed in the rules of the game then we also have to question opinions from impairment allowances to credit charges in banks.

The question should be whether Olam did any improper accounting like Enron (which MW claimed and I doubt people understood the underlying problem with Enron except MW using it as a headline catching phrase) or Worldcom, which is actually closer to Olam's issue; or whether they are the only listed party doing bio asset reval?

My point is they stuck to the rules of the game. The accounting profession should be instead questioned for allowing it. Olam problem is they played this game too enthusiastically using inflated equity for debt/equity calculation. End of the day over leverage kills, from personal finance to financial crisis. THAT is the root of Olam's problem. It is not their business model of moving goods around the globe, or using leveraged WC to conduct the business. The risk considerations are of course different sector to sector or business to business, but any safe business can be very risky if leverage is not managed properly. And in Olam's case, they remain over leveraged even when their ROIC collapsed post 2008

I agree that they should simply say mgt will prove MW wrong over time. Especially if they have Temasek support. Time is the enemy of the mediocre, and also the short sellers.
(06-12-2012, 07:40 AM)Musicwhiz Wrote: [ -> ]The Straits Times
www.straitstimes.com
Published on Dec 06, 2012
News Analysis
What's the deal behind Olam's rights issue?

Capital-raising exercise looks like a good deal, but raises more questions

By aaron low

AT FIRST glance, Olam International's capital-raising exercise is a pretty sweet deal for investors.

The rights issue is a complex structured deal that allows investors the right to subscribe to a bond offering that has warrants attached.

For every 1,000 shares an investor holds, he can subscribe to 313 bonds, which come with 162 warrants. The total outlay will be $363.

The five-year bond itself will pay an interest of 6.75 per cent. But because it is being priced at 95 per cent to its face value of US$1 (S$1.21), its effective interest rate is actually about 8 per cent.

The warrants can be converted into Olam shares at the conversion price of $1.575 but only after a period of three years. The value of these warrants, which can be traded over the exchange, are a bit trickier to estimate. They become valuable only if Olam shares trade above $1.575.

One question; If we purchase Olam share at this level, 1.44/1.445 and do not want to take up the bonds and warrants, do we get diluted in value ofour holding ?