Keppel Limited

[GreedandFear]

Interesting quote from Credit Suisse analyst regarding Kris Energy :

"Keppel (UNDERPERFORM) has a 40% stake in KrisEnergy, which has a carrying value of S$490 mn on its balance sheet as of December 2015, above the market value of about S$71 mn".

Assuming that this is correct, then I am amazed, following the whole Noble saga, that auditors and regulators continue to allow companies to NOT mark to market large equity stakes in listed companies where there is a clear market. As far as I can see, the share price of Kris Energy was 17 cents on December 31st, 2015 (when, according to Credit Suisse, the carrying value was S$490) versus 11 cents today (where, according to Credit Suisse, the market value of the stake is S$71). If that is correct, then it appears that the value was significantly overstated even as of December 31st, 2015....

Don't forget that fair value marketing was blamed during GFC2008 for exacerbating the loss in confidence of the financial firms, when most of these firms intended to hold these "temporarily impaired" assets to maturity. There were also conspiracy theories that short sellers of the company indirectly attacked it by working to de-value the assets held on the company's books. A little while earlier, the S&L crisis was blamed for using historical cost to hide the losses.

End of the day, the rules were set (well meaningfully) but (abused) according to the flavor of the day by Man.

Hi Weijian.

I agree that the rules were probably constructed with the best of intentions but I am a firm believer in mark to market. Not marking to market is a luxury that you only have if you have so much liquidity that you are never forced to sell.....otherwise, the tendency is to pretend that an asset it worth more than it is, until lack of liquidity forces you to sell it, at which point the excuse usually is that this is "at a fire sale price that is not representative of the intrinsic value of the asset..."....but that is the way of the market. In the case of Keppel, even if you accept that it is an asset intended to be held for the long term, you would have at least expected an impairment charge given low oil prices.....

[donmihaihai]

End of the day, the rules were set (well meaningfully) but (abused) according to the flavor of the day by Man.

 IMO fair value is one of low point in accounting. Abused by co. And auditor knowingly or unknowingly.

Wrong direction. I would say. Place too much in hand of management to play around and liabilities on auditor if they got it wrong. How can auditor get it correct with their limited industry knowledge?

Disclosure is the best thing to happen in accounting.

[GreedandFear]

End of the day, the rules were set (well meaningfully) but (abused) according to the flavor of the day by Man.

 IMO fair value is one of low point in accounting. Abused by co. And auditor knowingly or unknowingly.

Wrong direction. I would say. Place too much in hand of management to play around and liabilities on auditor if they got it wrong. How can auditor get it correct with their limited industry knowledge?

Disclosure is the best thing to happen in accounting.

I agree that, above all, disclosure is key. However, I feel that mark to market should be used when a price is clearly observable as is the case with a share price. What we don't want is the generation of accounting profits by present valuing contracts as these contracts also contains performance risk which could lead to a default under the contract and hence cause the evaporation of the profits that have previously been recognized upfront. Also, in such situations management may have too much discretion as to valuation methodology. Where mark to market becomes nonsensical is in the case of banks that are obliged to mark to market their own debt.

[specuvestor]

In that case do you think their debt, at least the tradeable ones, should be marked to market as well?

If a company is unlisted than what do one do? It's actually the uncertainty of cashflow and hence also leverage, that is the killer, not the marked-to-market. IMHO key problem over the past few decades for these financial crisis has always been overleverage cause people assume the uncertain cashflows to fund the leverage are certain.

Like I posted in another thread.... if the Development Bank of Singapore can backstop the O&G funding, the crisis will be stabilized in the medium term unless oil goes below $40.

[CityFarmer]

End of the day, the rules were set (well meaningfully) but (abused) according to the flavor of the day by Man.

 IMO fair value is one of low point in accounting. Abused by co. And auditor knowingly or unknowingly.

Wrong direction. I would say. Place too much in hand of management to play around and liabilities on auditor if they got it wrong. How can auditor get it correct with their limited industry knowledge?

Disclosure is the best thing to happen in accounting.

I agree that, above all, disclosure is key. However, I feel that mark to market should be used when a price is clearly observable as is the case with a share price. What we don't want is the generation of accounting profits by present valuing contracts as these contracts also contains performance risk which could lead to a default under the contract and hence cause the evaporation of the profits that have previously been recognized upfront. Also, in such situations management may have too much discretion as to valuation methodology. Where mark to market becomes nonsensical is in the case of banks that are obliged to mark to market their own debt.

Full disclosure (transparency) is very important. Fair value adjustment, will create un-necessary volatility, but without it, mislead valuation on a company might happen. No best tool, but best user.

Banks don't mark to market their debts? Banks rate their debts, and obligated to allocate allowances for NPLs, which indirectly mark-down the value of their debts. Don't they?

[donmihaihai]

It is getting confusing.

Bank debts and NPL. Assets with allowances or liabilities with? Diff thing diff accounting.

Contract and recognition. Financial contract for trading/hedging or project/construction contract. Diff thing diff accounting.

KrisEnergy. Associate co of keppel i believe. Recognition of investment and subsequent profit. Is a play of fair value and historical cost.

Lastly. Impairment and fair value doesnt always mean the same thing

[GreedandFear]

End of the day, the rules were set (well meaningfully) but (abused) according to the flavor of the day by Man.

 IMO fair value is one of low point in accounting. Abused by co. And auditor knowingly or unknowingly.

Wrong direction. I would say. Place too much in hand of management to play around and liabilities on auditor if they got it wrong. How can auditor get it correct with their limited industry knowledge?

Disclosure is the best thing to happen in accounting.

I agree that, above all, disclosure is key. However, I feel that mark to market should be used when a price is clearly observable as is the case with a share price. What we don't want is the generation of accounting profits by present valuing contracts as these contracts also contains performance risk which could lead to a default under the contract and hence cause the evaporation of the profits that have previously been recognized upfront. Also, in such situations management may have too much discretion as to valuation methodology. Where mark to market becomes nonsensical is in the case of banks that are obliged to mark to market their own debt.

Full disclosure (transparency) is very important. Fair value adjustment, will create un-necessary volatility, but without it, mislead valuation on a company might happen. No best tool, but best user.

Banks don't mark to market their debts? Banks rate their debts, and obligated to allocate allowances for NPLs, which indirectly mark-down the value of their debts. Don't they?

It used to be that banks did not mark to market their own debt (ie the debt that they have issued to fund themselves) but now, at least in Europe and the US, they need to record "gains" or "losses" on their own debt which is very silly. The theory behind this is that a bank could buy back its debt and crystallise that gain or loss but in reality there is little buy back as banks need the funding and tend to keep it to maturity. As a result, the P&L of banks gets distorted by these large MTM swings and most banks will release both accounting new income and adjusted net income ignoring MTM of own debt.

[weijian]

I agree that full disclosure is very important. It is not the ultimate solution though, for example, full disclosure has more costs and also it makes it hard for the lay-man to comprehend. At of the day, many have commented that Accounting is an Art, not a Science. I would like to bring it further by proposing that Accounting is a State of the Mind, not an Art.

In the face of such "(non)sense", (un)common sense needs to prevail. A conservative (and trusted) Mgt whom has skin in the game, has to display the necessary candor to make the necessary mark-ups/downs accordingly. Mgt whom has skin in the game (aka major shareholder and involved in day-to-day operations), can easily mark this to market, this is a real non-cash cost and doesn't affect the normal course of operations. But for a Mgt, whose future remuneration depends on performance, it directly hurts to display the necessary candor. But let's say Mgt is cash rich and is also a major shareholder, or a new CEO has just been installed. I predict that marking down this investment is highly probable now. The former, is having the intention to do a cheap takeover will use the mark down to flush out the weak hands, while the latter is just kitchen sinking everything to build the (low reference) base for this future remuneration when the tide turns.

[GreedandFear]

In that case do you think their debt, at least the tradeable ones, should be marked to market as well?

If a company is unlisted than what do one do? It's actually the uncertainty of cashflow and hence also leverage, that is the killer, not the marked-to-market. IMHO key problem over the past few decades for these financial crisis has always been overleverage cause people assume the uncertain cashflows to fund the leverage are certain.

Like I posted in another thread.... if the Development Bank of Singapore can backstop the O&G funding, the crisis will be stabilized in the medium term unless oil goes below $40.

My view is that  if a company owns bonds, as an investment, and there is a market for these bonds, then I think they should be marked to market.
If a company owns shares in an unlisted company then that company's share price is not readily observable and, my view is that you account for it at cost and add any impairment. My point with Keppel is that the share price of Kris Energy is very observable....there can be no dispute as to what the share price is. The only dispute will be as to whether Keppel wants to sell at that price or can get a buyer to pay that price given the size of the stake that they have.

[Clement]

In that case do you think their debt, at least the tradeable ones, should be marked to market as well?

If a company is unlisted than what do one do? It's actually the uncertainty of cashflow and hence also leverage, that is the killer, not the marked-to-market. IMHO key problem over the past few decades for these financial crisis has always been overleverage cause people assume the uncertain cashflows to fund the leverage are certain.

Like I posted in another thread.... if the Development Bank of Singapore can backstop the O&G funding, the crisis will be stabilized in the medium term unless oil goes below $40.

My view is that  if a company owns bonds, as an investment, and there is a market for these bonds, then I think they should be marked to market.
If a company owns shares in an unlisted company then that company's share price is not readily observable and, my view is that you account for it at cost and add any impairment. My point with Keppel is that the share price of Kris Energy is very observable....there can be no dispute as to what the share price is. The only dispute will be as to whether Keppel wants to sell at that price or can get a buyer to pay that price given the size of the stake that they have.

Keppel Corp accounted for its stake in Kris Energy using associate rules which prescribe the equity method of accounting. It is not required to perform mark to market on the value of associates, but will have to impair the book value of the associate if the recoverable value is lower. You are proposing using an active market value to estimate the recoverable value of associates, which I think is fair enough, but let’s not forget that stock market prices are reflective of transactions for stakes between minority shareholders with no influence on the running of the company.

In 2015, Keppel opted to use a 5 year discounted cashflow + terminal value approach to determine the fair value of the investment and disclosed the assumptions it made. Looking at the assumptions made, the oil price assumption of $55 - $80 for the forecast period seems to be high with most mainstream estimates having been revised downwards. The 10% required rate of return also seems to be too low an estimate of what the market is demanding for offshore exploration and production assets. Keppel will have to re-perform an impairment test before the full year results with revised assumptions and will most likely have to make provisions for impairment.