#over leveraged

New Post has been published on http://www.therakyatpost.com/letters-from-the-rakyat/2014/11/13/1mdb-leveraged/

1MDB over leveraged?

The release of 1Malaysia Development Bhd’s (1MDB) financial results for the full year up to March 2014 was met with public scrutiny.

Based on the report, 1MDB made a loss of approximately RM665 million. This is in contrast to a recorded profit of RM778 million in the previous year. The numbers while disappointing at first glance do not take into consideration the cost of acquisition and the value of 1MDB assets. 1MDB’s performance over the year isn’t as bleak as headlines and public statements suggest.

When examining a company’s losses, one must look at what those losses are made up of. In 1MDB’s case, the declared losses were made up of higher costs and expenses, incurred as a result of the acquisition of assets. The assets were purchased to expand the company asset base and create a long term revenue stream.

While the high acquisition costs and investment strategy of 1MDB has drawn flak from certain quarters over the last few years, the strategy utilised by 1MDB is to invest in the near term with the aim of building a long-term sustainable future is sound.

The value of 1MDB’s asset base increased from RM44.6 billion to RM51.4 billion over a one-year period. The report also stated that revenue has increased from RM2.6 billion to RM4.3 billion amounting to an increase of over 60%. This is a strong indication of the quality of the assets acquired as evidenced by their ability acquired to generate revenue.

1MDB is arguably one of the largest independent power producers Malaysia and has also expanded to an additional four markets internationally. The company also entered the real estate sector with developments such as the Tun Razak Exchange and Bandar Malaysia.

The company is now positioning itself to raise funds through an initial public offering transitioning 1MDB into a leading regional player in the energy sector.

All of this has comes at a cost. It takes money to make money.

Debt Markets — A Global Norm

Other than a small initial investment of US$1 million (RM3.3 million) by the government when 1MDB was formed and a single line of credit guaranteed by the government, 1MDB is self funded through the use of the debt markets. This would explain why the company’s debts have increased alongside it’s asset base up from RM36.2 billion last year to RM41.9 billion at present,

It is the norm for major projects to be funded through the debt markets, either in part or in full.

The Putrajaya administrative and the KL International Airport (KLIA), both of which are former prime minister Tun Dr Mahathir Mohamad’s pet projects, are no exception.

Then, the powers that be also “borrowed’ to fund infrastructure.

The reliance on borrowings to build Malaysia’s federal government administrative centre is well documented below.

Malaysia Rating Corporation Berhad (MARC) has affirmed its AAAID and AAAIS ratings on Putrajaya Holdings Sdn Bhd’s (PJH) Islamic debt issuances at RM8.2 billion as follows:

(i) RM3 billion Sukuk Musharakah Programme (due 2032);

(ii) RM1.5 billion Sukuk Musharakah Medium Term Notes (MTN) Programme (due 2033);

(iii) RM1.5 billion Murabahah Notes Issuance Facility (MUNIF) (due 2015); and

(iv) RM2.2 billion Murabahah Medium Term Notes (MMTN) Programme (due 2021).

(see http://www.marc.com.my/ratbase/pub.press.detail.php?aid=4606)

Have we forgotten how the construction of the KLIA was funded?

The full cost of the airport’s construction was RM8.5 billion (http://www.akademi.audit.gov.my/index.php/en/2012-10-04-09-09-34/akta-audit-1957/klia)

RM4.06 billion was from Bai’ Bithaman Ajil Notes Issuance Facility (2003/2015) (“KLIA Notes Facility”) post restructuring from conventional loans. (http://www.ram.com.my/Staging/pressReleaseView.aspx?ID=9ccb9af9-0945-4f7b-800a-58736316c261)

RM1.5 billion came from low interest development loans from Japan. (http://www.epu.gov.my/en/jica /http://www.jica.go.jp/english/our_work/evaluation/oda_loan/post/2001/pdf/e_project_39_all.pdf)

Similar to 1MDB there was the issuance of conventional loans and restructuring of debts.

Normal to raise sukuk

The Malaysian International Islamic Financial Centre, in its paper “Sukuk: Growing Relevance in Infrastructure Development”, said “raising funds through sukuk has become an integral part of Islamic finance and a pivotal pillar of overall Islamic finance’s continuous growth.”

In the year 2012, Saudi Arabia ranked second with issuances worth US$6.08 billion or 21.9% of all sukuk issuances in the same year. Other notable countries that have issued infrastructure sukuk include Indonesia, Pakistan, Brunei and Kuwait.

Of course, Saudi Arabia, Brunei and Kuwait are oil rich. Interestingly, they also borrow because it is standard international practice to seek external financing for large scale infrastructure projects.the construction of the KLIA was funded in a similar fashion

1MDB assets increase

Public scrutiny of 1MDB has led to suggestions that the company is over-leveraged. However, debt must be observed in the context of the company’s ability to generate income in the long term from asset acquisitions as well as ability to service it’s debts.

High levels of debt are expected in the energy sector due to the high entry level that is involved. This is why power contracts are negotiated on long term basis spanning decades as this allows power providers to recuperate their initial high entry costs over time. Taking this into consideration the long term revenue generation that 1MDB the level of borrowings comes across as sustainable.

Based on 1MDB’s published results, the company assets has increased from RM8.4 billion to RM9.5 billion from a year earlier. It is apparent that the speed at which 1MDB is growing the value of its assets exceeds that at which it is taking on debt. What this effectively means if 1MDB were to close it’s doors tomorrow, it’s asset value would be enough to pay off all debts with a surplus close to RM10 billion.

It is often easy to forget just how painful change can be, especially when it has to be done in full view of critical public scrutiny. It is easy to see the mistakes with 20/20 hindsight and overlook the tremendous challenges that guided solutions proposed earlier. What many fail to realise is that without 1MDB, Malaysian power assets could have easily fallen into foreign hands. While some may see this to be a preferable situation, what happens if and when something goes wrong?

Basically, Malaysians — like many emerging economies around the world — are slowly learning that freedom to express open criticism isn’t always the best way to handle matters that need deep thought and taking calculated risks.