Olam International

The reason for a pure right issue from Michael Dee does not sound right.

1. the cost of equity is not necessarily cheaper than 13% claimed by him.

2. If Olam has a legitimate business, it can choose to tune its business and release working capital to repay its debt. After all, most of its debt comes from its working capital needs. (more than 4 billion in inventory. If it scales down its business volume, the inventory will go down, so will the receivables/payables/loans). If Olam chooses to use its equity to replenish its working capital, its business can't earn enough to cover the cost of capital, which essentially is destroying shareholder value. It is very likely to be a failed right issue.

(06-12-2012, 05:26 PM)wee Wrote: Can some kind souls help me understand when Michael Dee talks about true cost of 13%, whose 'cost' is this? Cost incurred by Olam, and paid to shareholders? Hmm...

If (and this is a big 'if') everyone subscribes (i.e. no dilution) whatever "cost" incurred by Olam would be paid to shareholders, well, except for the bankers' fees. If shareholders choose to sell the warrants, he will get paid for the dilution, or if the warrants expire worthless, no one exercises, there is no dilution. Again, what 'cost' is there, and whose cost? Isn't this a left pocket / right pocket situation (which Dee mentioned, and I thought it contradicts his own argument of high costs).

ya it's quite funny cos it's not a share placement (if it is a share placement, the shareholder should ask for as high a price for placement since the dilution will happen regardless)

on the one hand, the yield to maturity for the whole package for a shareholder is pretty nice (>13% if u can sell the rights and hold to maturity assuming no bankruptcy and ability to pay coupons)

on the other hand, if the company can only raise capital at an effective rate of >13% (if i remember correctly, Olam claims Temasek approached them with the deal - if they don;t need to capital badly couldn't they have gotten a better deal?), then the cost to the shareholder will be an inability to generate returns in excess of costs, resulting in a tanking of share price. so make 13% but lose >13% in share price?

but then this is really just a poker game in reality - at this stage establishing stability and confidence and preventing a run on the bank is more important to Olam than valuation and what not.

I think the best thing that Olam can do now is to sell its asset to reduce its debt and improves its cashflow instead of coming out with all these complicated mechanism. I never understand why they do not want to sell its asset. It's either they know that their asset are not worth the value that they booked or they really think that if keep for long term, it would improve their cashflow. At this point of time, if they are able to sell their asset at fair value or slightly at a premium, Muddy Water would have backed out and its share price would start going up. It's really like what some analysts mentioned, a stop-gap measure.

It is currently fashionable to bash Olam.

But one should step back and look dispassionately at what the company's management has said and done in response to Muddy Waters' accusations. Even if it feels like a case of "ma hou pao" perhaps we can still learn something from this saga when investing in future.

1. NEED FOR CAPITAL

28 Nov 2012
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Anantharaman Shekhar, an executive director at Olam, said the company has enough capital for the next 12 to 18 months even if it is unable to raise money from the capital markets.

29 Nov 2012
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The Wall Street Journal reports that in an interview with Olam CEO Mr Sunny Verghese:

"In addition, the firm has S$4.3 billion in credit lines to draw upon, he said."

3 Dec 2012
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Olam announces a US$750m rights issue of bonds and warrants.

First, Mr Shekhar. Offhand I can think of 2 simple explanations for the inconsistency:

a. On 28 Nov 2012, Mr Shekhar had no idea what the company's financial situation really was; or
b. On 28 Nov 2012, Mr Shekhar knew - but decided to lie.

In other words, is Mr Shekhar incompetent or dishonest? Or is there another plausible explanation?

From the 2011-2012 annual report:

"A. Shekhar leads the Company’s overall Strategy and New Business Development activities as well as the Corporate Finance & Accounts, Banking & Treasury, Audit & Corporate Affairs, Strategic Investments, Investor Relations and Manufacturing and Technical Services functions. He has 25 years’ experience, 20 of which have been with Olam."

Note that Mr Shekhar's responsibilities include Corporate Finance & Accounts. I would imagine this means staying abreast of the company's liquidity needs, especially whether it needs to raise money soon. Or maybe the annual report is wrong and Mr Shekhar has no responsibility for Corporate Finance & Accounts, which would then beg the question of why he would be talking publicly about Olam's financial needs.

Next, Mr Verghese. 3 simple explanations for the inconsistency:

i. On 29 Nov 2012, Mr Verghese had no idea that the undrawn credit lines did not exist;
ii. On 29 Nov 2012, Mr Verghese knew the credit lines were gone, but decided to lie; or
iii. Between 29 Nov 2012 and 3 Dec 2012 (4 days) ALL of the banks pulled their credit lines with Olam

So which of the following is true:

Mr Verghese is incompetent;
Mr Verghese is dishonest;
ALL the banks pulled Olam's undrawn credit lines within 4 days; or
Something else?

I have no "smoking gun" proof, so I will leave things at the question stage.

2. SEQUENCE OF EVENTS

6 Dec 2012
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The Straits Times reported that:

"... on Monday evening, in a hastily assembled press conference, Olam announced the deal to raise more debt.

Mr Verghese said that it was the company's banks that went to Temasek to propose the rights deal. Temasek then approached Olam, he said.

But this sequence was clarified in another statement sent out by Olam on Tuesday, that stated that it was Olam which had instructed one of its banks to go to Temasek to discuss the investment deal."

So again we have an inconsistency - Mr Verghese tells the press that the banks went to Temasek, which then approached Olam. Then, Olam clarifies that it was Olam that told one of its banks to go to Temasek.

Strictly speaking, Mr Verghese was not wrong. He simply left out the fact that it was Olam that initiated the whole process. But Mr Verghese is not a newcomer to the press. He has been the face of Olam since IPO. So it seems odd that the vital fact that Olam started the process was left out.

Again, 2 simple explanations:

a. Mr Verghese was so busy that "who-started-what" slipped his mind i.e. "it was an honest mistake, let's move on"; or
b. Mr Verghese deliberately chose to mislead the press and thus the public at large

So is Mr Verghese forgetful, or deceitful? Or is there another plausible explanation?

3. STRUCTURE OF RIGHTS ISSUE

It seems odd that a large prime number (313) is being used to determine eligibility for the rights issue. A "3 for 10" rights issue would have been equally effective and simple to implement.

While I do not have evidence to support a conspiracy theory, it is obvious that a 313-for-1,000 ratio will confuse, annoy and ultimately discriminate against minority shareholders.

In order to avoid getting odd lots of bonds/warrants, a shareholder would need to own 1 million shares (1,000 lots) of Olam. A small shareholder would either have to increase his holding to 1 million shares, sell out completely, or simply abandon his rights partially or completely, or else he will be stuck with odd lots. A 3-for-10 rights issue would have allowed virtually everyone to participate, except the very small shareholders with less than 10,000 shares.

Instead, a 313-for-1,000 ratio virtually guarantees that many small shareholders will partially or completely abandon their rights, which paves the way for large shareholders (including Temasek) to mop up the bonds and warrants. It is a direct transfer of value from the small shareholders to the large ones. This is patently unfair and the Olam management is to blame. Since Temasek agreed to underwrite the rights, it too must share the blame because it agreed to such an unfair ratio.

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Readers who understand English should be able to see the inconsistency in #1 and the incomplete disclosures in #2. With PSLE-level mathematics they should also be able to see the unfairness in #3.

I do not wish to fight a libel suit so, unlike Muddy Waters, I will not accuse Olam management of anything. I have merely presented facts that nobody can deny, along with some simple questions and points based on these facts.

As usual, YMMV. As pointed out above, there may exist other plausible explanations for the actions of Olam's management. I am not imaginative enough to come up with more, but other forum members are welcome to contribute their (sensible) ideas.

interesting. how would it be different if it were the banks who approached temasek for the right issue?

Thanks d.o.g for your detailed analysis.

Would it be possible that banks were getting jittery and thus forced Olam's management to get a "guarantor" before continuing their credit lines?
In this way, #1, Mr Shekar would not be at fault but rather forced by circumstances to annouce a $750m rights issues of bonds and warrants so as to prove existence of Temasek being the backer.

For #2, perhaps Mr Verghese was nervous to admit to press that banks were the ones who were raising questions about Olam credit lines status. Yet, he could not admit that fact and the confusion arises from there.

For #3 - Thanks for your analysis. Its interesting to note that this odd number rights issue does have a tendency to be advantageous to the larger shareholders.

Anyway, the points above are just my speculations. Pardon me if they seems unlikely.

My assessment is simple: if Olam was lying about the credit line, would the banks stay quiet since this is now such a public affair?

As discussed, problem of Olam is over leverage and hence at mercy of creditor. And over leverage is not a simple debt to equity (check out starhub). Creditors are also at the mercy of confidence. Now it is a prisoners' dilemma: as a banker I wouldn't want to be the first to pull the rug and hence accused of causing a run (unless I'm very sure like what Merrill did to Bear Sterns), but neither do I want to be the last. So I go to the shareholders for guarantee or loan. I doubt the chairman can cough out the "confidence buffer" but the saving grace is Temasek is a major shareholder. The corporate bankers are happy that someone is holding their hands.

My feel is that post the rights issue, baring fraud, this issue will be over in the medium term and Olam has to delever. Otherwise it will haunt them again. I'm sure Temasek will be watching.

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(06-12-2012, 06:33 PM)AlphaQuant Wrote:

(06-12-2012, 05:26 PM)wee Wrote: Can some kind souls help me understand when Michael Dee talks about true cost of 13%, whose 'cost' is this? Cost incurred by Olam, and paid to shareholders? Hmm...

If (and this is a big 'if') everyone subscribes (i.e. no dilution) whatever "cost" incurred by Olam would be paid to shareholders, well, except for the bankers' fees. If shareholders choose to sell the warrants, he will get paid for the dilution, or if the warrants expire worthless, no one exercises, there is no dilution. Again, what 'cost' is there, and whose cost? Isn't this a left pocket / right pocket situation (which Dee mentioned, and I thought it contradicts his own argument of high costs).

ya it's quite funny cos it's not a share placement (if it is a share placement, the shareholder should ask for as high a price for placement since the dilution will happen regardless)

on the one hand, the yield to maturity for the whole package for a shareholder is pretty nice (>13% if u can sell the rights and hold to maturity assuming no bankruptcy and ability to pay coupons)

on the other hand, if the company can only raise capital at an effective rate of >13% (if i remember correctly, Olam claims Temasek approached them with the deal - if they don;t need to capital badly couldn't they have gotten a better deal?), then the cost to the shareholder will be an inability to generate returns in excess of costs, resulting in a tanking of share price. so make 13% but lose >13% in share price?

but then this is really just a poker game in reality - at this stage establishing stability and confidence and preventing a run on the bank is more important to Olam than valuation and what not.

It is quite a difficult question to answer if we go into details. Michael Dee arrive at 13% by adding the YTM of the bond with the black scholes valuation of the warrants. This is deemed as the price that market is willing to pay to fund Olam. But this may be an overstatement since Temasek seems keen to take it all up, which he himself admits as an early Christmas sale of the century. If it is that toxic, probably it wouldn't be a present

HOWEVER from a company's perspective, their cost is the YTM of the bond and the POSSIBILITY of being diluted at around 1.50 strike. If the warrant expires worthless (which i said is a pyrrhic victory for shareholders) the cost is just the 8% YTM. Question therefore is what is the intrinsic value of the firm, since this is a value forum? Price to book? It is obvious that I'm not a believer of CAPM cost of equity model that relies on volatility/ beta and price action statistics.

Management's integrity of a company typically makes and breaks a company. In Olam case, the inconsistency in the actions and speeches of the Olam's management brings doubts to investors.

So, if there lies so much inconsistencies in this tussle with MW, what other information that the management feed to the shareholders that are less than truth?

Regardless of who is the anchor shareholder or how great is the right issue or how impressive is their business empire, personally I would not put a single cent in those companies that I have doubt in their management's integrity.

Although a small part of my CPF probably ends up in Olam.

Management Integrity is number one importance. One who focus in popping up the share price is "Yao Bu De".
There are already so many signals to us and there is no excuse if one get caught if indeed happens.

It doesn't make sense to me that after having given a forceful response to MW's initial attack and all the assurances through various channels that the company has enough cash/capital resources to meet payment obligations coming, and has enough un-drawn bank credit lines to keep operating, Olam would hastily put together over just a weekend a big rights issue of 5-year bonds and free warrants priced at very generous commercial terms which will cost the company and its existing shareholders dearly. While Temasek (now with a 16.34% stake)'s support for the issue as a sub-underwriter for any amount not taken up by other shareholders will ensure success for this fund-raising exercise, I think it is very clear that without Temasek's undertaking to subscribe their entitlement portion and any among not taken up by other shareholders, the entire rights issue may not fly at all, as the 4 underwriting banks are unlikely to add their names to the issue if is is without Temasek's involvement as a sub-underwriter.

It is to be noted that the money from the 5-year 6.75% bond issue will cost Olam as much as 8%p.a. in all-in borrowing cost, bearing in mind the bonds will be issued at a 5% discount to its face-value and there will be 2 layers of underwriting fees paid to the 4 banks and Temasek, plus other issuance related expenses. As without any doubt Tamasek' interest in Olam will increase over time because of this issue, this exercise is dilutive to other shareholders. If most of the new money raised from the bonds and warrants over time is applied to refinance lenders or creditors who choose to exit from Olam, one can even argue that this fund-raising exercise tantamounts to Temasek bailing out some of Olam's lenders.