Friday 1 November 2013

Making US$1billion, the quick and easy way

The Edge team this week put together the most comprehensive story to-date of Asiasons, Blumont and Lion Gold.  What happened, why and some probable rationale for the spectacular rise and collapse of the stock prices of these three Singapore-listed companies with major Malaysian personalities as directors and shareholders.

The stock prices rose even as the values of their investments were falling.  Further intrigued by a series of stock placements and short-selling of shares.

Then there is Black Elk, a highly problematic oil and gas company operating in the Gulf of Mexico and its owner, Platinum, a US hedge fund.  What have they got to do with the three companies above?

Thursday 31 October 2013

A boost for media freedom

Freedom of speech and freedom of choice are fundamental human rights that should be enjoyed by every man.  In a democratic society, we also expect media independence and press freedom. Freedom of the press means freedom of communication and expression through mediums including various electronic media and published materials. Logically, this includes the right to a permit to print.

Indeed, freedom of the press is also about property rights. These properties are printing presses, auditoriums, billboards, radio equipment, computer networks and so on. “Property rights” is a necessary condition for market economies to work.

Yesterday’s Court of Appeal decision rejecting the government's appeal against the High Court ruling that publishing a newspaper is a right, not a privilege, is commendable.  The consistent decision delivered by both the High Court and Court of Appeal is a move in the right direction.

Intervening in the application for a publishing permit on the basis of limiting competition is a flawed argument.  Monopolistic behaviour will only breed inefficiencies and deprive the public from the freedom of choice, and in this context, the access to more print options. It is also inconsistent with the new Competition Act. 

Media owners should be given the right to compete on a level playing field. Let the newspaper fend for its own survival. It is time to stop protecting status quo and embrace a more inclusive economic and social policy for the sake of the country.

Friday 25 October 2013

Property gets a beating, and operating expenditure is under-budgeted

As I mentioned in last week’s article, I expected the property sector to be hammered. Complaints of rising prices and affordability triggered by more foreign buying and the need to address social inclusion has resulted in very severe measures just announced in the budget.

The removal of DIBS (interest paid by the developer during the construction phrase) has removed a major “warrant” price for new launches. By just paying a small deposit, say 10%, buyers were free from any subsequent payments until completion, some 2 to 4 years away.

While raising the RPGT for everyone has the effect of reducing speculation, the perpetual and higher RPGT on foreign buyers will take a heavy toll on demand too. This is especially so when it is also combined with raising the minimum price for foreign buyers to RM1 million from RM500,000 previously.

There are many properties priced to sell at just above the RM500,000 threshold. These are small units, like the SOHO and small apartments, ranging in size of between 500 and 1,000 sf and priced at around RM700 to RM1,000 psf. This was the fast moving market segment.

We know the prices of new launches are at about a 10% to 20% premium to a comparable property in the secondary market. And new launches sell quickly in comparison too.

The new measures will change the game. The “warrant” premium is substantially gone. As such, we expect in the short-term, transaction volume will fall substantially. Prices will fall too, perhaps by as much as 10% to 20%.

On the overall budget, the Government is expecting its deficit to fall to 3.5% of GDP. I believe the operating expenditure is under-budgeted. Emoluments are expected to rise by just over 3%. We have not seen such a small increment in recent years. Also, subsidies are forecasted to fall by some 20% or over RM7 billion. What subsidies will be cut, besides sugar?

It is most likely that we will see supplementary budgets in the months ahead.

The budget is contractionary overall. This is positive for the long-term. The announced 6% GST from 2015 is also in the right direction, especially since it is accompanied by reduction in personal and corporate tax rates.
The splattering of small handouts, I suppose, is populist to gain the support of the poorer communities and a way to offset rising cost of living.

I expect the stockmarket to be adversely affected but the Ringgit will take the news positively… with some skepticism.

Buying water and selling stationeries

Water problems have long dogged Selangor, with the issue compounded by politics. With the General Election over, there will be less political posturing in Selangor. With that, there will be renewed commitment by both the Federal and State Governments to work towards resolving the issue of treated water in the state.

Between 2011 and 2012, incidence of water shortages in Selangor increased by 79%. Syabas is reportedly running on a reserve margin of just 1% with water consumption growing at 3-4% per year. This will adversely affect future economic activities in the Klang Valley, which accounts for 38% of the country’s GDP.

It is also clear that the governing party in Selangor, which sits as the opposition in the federal parliament, needs to show it is able to run the state effectively, generate new jobs and bring in new investments. A recent public criticism by the leader of the Opposition, of the Chief Minister of Selangor, a senior member of his own political party, is telling.

While the Chief Minister has managed Selangor well in the past term, resolving the water issue is critical for the future of industries and consumers in the state. With this in mind, there may be opportunities for investors in the sector once the restructuring takes place.

Credit Suisse recently issued an excellent report on the Bursa Malaysia-listed companies with exposure to the water sector.  I know the analysts Danny Goh and Rachel Tan well and therefore, the quality of their work. There is no need to reinvent the wheels.

Here is a quick summary table of the financials of three companies in the sector, for those who may not be able to secure a copy:

Company                    Price                P/E (x)                               P/BV (x)
                                    (RM)                2012    2013    2014
Gamuda                      4.89                 20.3     19.8     14.4                2.8
Puncak                        3.25                 5.6       4.9         4.2                 0.8      
KPS                             2.00                16.8      n/a         n/a                 0.9

The Selangor State government has offered RM9.65 billion to buy all the four water concessionaires in February 2013. It was not successful as Puncak Niaga rejected the offer, while the others accepted. To succeed, a better offer will have to be made to Puncak Niaga. Despite the recent rally, Puncak Niaga’s shares are currently still trading on single digit multiples and below book value.  

To be fair, the water restructuring play has made its rounds many times in the past three years, only to peter out as talks ended in a stalemate. However, with the general election over and the danger of dry taps a growing reality, there is palpable sense that a definitive solution will soon be found.

Turning from water to stationery, I feel compelled to return to China Stationery Ltd, which I wrote in this column on 5 Oct 2013. There are troubling facts that are inconsistent and not logical, at least to me.

Below is an extract of the last two years financial information

China Stationery Ltd
Extracts of Financial Statements
                                                               RMB’000                         RMB’000
                                                            31 Dec 2012                 31 Dec 2011
Cash and Bank Balances                   1,889,491                      1,327,077
Borrowings                                               54,400                             49,100
Amount due to a shareholder                        38                              71,746
Revenue                                               1,980,628                     1,774,710
Cost of Sales                                      (1,110,626)                      (979,207)
Gross Profit                                              870,002                        795,503
Gross Margin in %                                      43.9%                             44.8%
Interest Expense                                          8,261                           41,908
Interest Income                                            7,014                             5,200
Interest rate on borrowings                         15.2%                           34.7%
Interest rate on deposits                               0.37%                          0.39%

It raises many questions, such as:

1) What stationeries are sold by China Stationery Ltd that generate an astronomical 44% gross margin? The company makes plastic stationery, plastic tape printer and ink.
2) Why does the company borrow when it has so much cash?
3) In 2012, the company paid back RMB 71.7 million to its shareholder. Is this the controlling shareholder?
4) Why is the total effective cost of borrowing between 15% and 35%?
5) Why was the company paying a hefty 57% interest rate, with RMB 38.9 million interest on a RMB 68.5 million convertible bond in 2011?
6) Why are the bank deposits of some RMB 1.9 billion earning only 0.4% interest when the 1 year deposit rate in China is over 3%?

In our previous report, we also indicated that the major shareholder, Lead Champion, has sold down from 71.85% to 23.43% since the beginning of this year.

China Stationery Ltd is a Bermuda registered company. Its principal place of business is in Fujian Province, China. It is listed in Malaysia. Its independent auditor is in Singapore.

The stock price may look “cheap” now. The cash available per share, accordingly to the financial statements, is four times more than the stock price. But I believe it may get “cheaper” soon. 

This article will be published in The Edge this weekend.

Sunday 20 October 2013

Fixing the budget deficit is critical, and it requires a political consensus

By Tong Kooi Ong and Chan Jian Ming

In every Budget, the government presents its fiscal and economic policies to promote and sustain growth. This year, we suspect the emphasis will be on social inclusion, reducing the cost of living such as housing. To achieve the stated objective of transforming the nation into a high-income society, realistic policies will have to be articulated to enhance labour and capital productivity.

This year, the markets will watch closely how the government intends to reduce its fiscal deficit and what measures will be taken to boost revenue as well as rein in its operating expenditure.

The spending binge in recent years has deteriorated government finances, especially after 2003 and 2007. Before that, there were only three instances when the government's total revenue cannot meet its operating expenditure. This was in 1972, 1986 and 1987.

In terms of interest coverage [(total revenue less operating expenditure and add debt service charges) divided by debt service charges], it has been on a downtrend since 1997 and at a critical level of only one. And this is despite the very low global interest rate environment of recent years. (See chart 1)

Malaysia's total debt now stands at RM737 billion (of which RM485 billion is domestic debt), rising by a compounded growth rate of 13% during the last 43 years. Dividing the debt service charges by the annual total debt will give us the cost of borrowings imputed to the government. As indicated by chart 2, this low cost of funding has been helpful.

But with the reversal of the quantitative easing programme in the US, interest rates may well begin to rise. Further, any downward rating by international credit agencies will have significant consequences on the cost of borrowings, not just to the government but also to the private sector.

What is equally of concern is the percentage of domestic debt held by foreigners. Today, foreigners hold 27% of our total domestic debt. It was virtually non-existent before 2004. If the foreigners decide to cut back on their holdings, the consequences on our exchange rates and interest rates should give nightmares to some people.

Chart 3 indicates that theoretically, the Employees Provident Fund (EPF) could step in should the foreigners withdraw their funds. This would involve a rebalancing of EPF's portfolio, with massive selling of its stakes in Malaysian companies.

The resultant effect on the stock market is unthinkable. Also, the dividend payout by the EPF to its contributors will fall, since the interest rates on government securities are much lower than the long-term returns from the equity markets, both in Malaysia and abroad.

Finally, the share of the government's operating expenditure to total expenditure has exceeded 80%, rising consistently since 2002. The last time it happened was in 1987 and 1988. Basically, we have less money to invest for the future, in areas such as infrastructure, transportation, healthcare and education. (See chart 4)


From 1988 to 1997, the surplus of government revenue to operating expenditure grew every year. It peaked at RM21 billion. (See chart 5)

During this period, operating costs were kept in check, doubling during these 10years, while government revenue tripled. This was a period of rapid economic expansion, coupled with large privatisation exercises. Tax collected from companies alone rose from RM3.1 billion to RM16.7 billion.

The surplus was invested in developing the nation. Total development expenditure tripled to more than RM10.5 billion. The major beneficiaries were transportation (from RM1.065 billion to RM3.578 billion), education (from RM865 million to RM2.521 billion), healthcare (from RM69 million to RM449 million), housing (from RM58 million to RM735 million) and social and community services (from RM197 million to RM1.214 billion). (See chart 6)


For better or worse, 1998 was the year Malaysia entered into a new political economy, where politics influenced economic decisions more than ever.

With a vibrant and strong opposition, the Barisan Nasional government has increasingly succumbed to populist policies. To gain support, the government has been spending more on the civil service and handouts.

While democracy may offer greater freedom and voice to the people, short-term economic consequences are often negative.

This is not to argue against freedom or democracy. To quote Winston Churchill, "Democracy is the worst form of government, except for all the others."

Election spending

From 1970 to 1999, total federal operating expenditure increased from RM2.2 billion to RM45 billion (over a period of 30 years). In the 13 years since, it shot up to RM206 billion.

The biggest single year increase was 2008 when the operating expenditure shot up 29%, followed by 2004 at 21.4%. The total operating expenditure rose 13% last year.

What did we spend on
The single largest component of the operating expenditure is emoluments. If we add pensions and gratuity, it accounts for 36% of the total. From RM18 billion in 1999, it stands at more than RM74 billion now, growing at a compound rate of 11.5%.

In 2008, civil servants' payroll grew 26% in one year. Last year, it increased 20%. What is more frightening is that salary increases are permanent and will snowball in future years. (See chart 7)

Total subsidies account for 21% of the total operating expenditure. It grew from RM1.1 billion in 1999 to RM44.1 billion now, or at a shocking compound growth rate of 33%.

In the 28 years, from 1970 to 1997, total subsidies exceeded RM1 billion only on three occasions - from 1981 to 1983. In contrast, in 2008, subsidies shot up to RM35.2 billion from RM10.5 billion the year before.

The problem with all subsidies is that once given, it is difficult to take away. The government talks of subsidy rationalisation and indeed, it must be done. But the political costs may be huge even if there is a will to implement it.

From 1999 to 2012, supplies and services grew from RM6.1 billion to RM32 billion. In 1986, the amount was only RM2.6 billion. In other words, for the 13 years before 1999, the amount grew 135%. After 1999, for the same 13-year period, the amount exploded by 425%.

Short of a change in mindset, one will have to assume that each year, the budget will simply give a percentage increment over the previous year. And the price the government pays for each of these supplies and services will simply be in reference to past prices paid.


In contrast to the operating expenditure, the government is prudent on development expenditure. The compounded growth rate from 1970 is only 10.4%. This is due in part to the privatisation policy implemented.

Since 1999, total development expenditure grew from RM22.6 billion to RM46.9 billion.

The only area of concern in the development expenditure is that classified as "others". From RM581 million in 2008, it now stands at RM6.4 billion. A total of RM14.8 billion was spent under this category from 2009 to last year.

Representing 13.6% of the total development budget, surely there is a better name than "others" to explain what these items are. In fact, this item alone is as large as the sum spent on agriculture and rural development, healthcare, housing and social and community services.

Forecasting the federal government finances in the future
We did an analysis of the various expenditure items to try to understand what they are and how they came about. The objective is to try to forecast the federal government's revenues and operating expenditures.

We created our own simplified The Edge econometric model, based on conventional methodology.

All forecasts are necessarily wrong. Our goal is to ask the right questions and hopefully, indicate the trends.

The results of our econometric model are as indicated in the table. (See charts 8 + 9)

What our modelling implies:
1.  Without any new major sources of revenue, the fiscal deficit is not sustainable if the status quo is maintained and there is no cut in operating expenditure. This is highlighted in the projected interest coverage chart.
 2.  Even with growing revenue from corporate and individual taxes, operating expenditure will grow at a faster pace. Emoluments are snowballing out of control, especially come another election.
3.  There is no option but to cut subsidy soon. When oil prices go up, the increase in subsidy is greater than the additional revenue the government receives. Even when oil prices fall, the subsidy may not decrease due to rising domestic consumption.
4.  Hoping for higher oil prices to get the economy out of the jam is unwise. The forecast is for lower prices with additional production coming from the US. And unless we address the fuel subsidy, the cost will be higher than the tax revenue derived from higher oil prices.
5.  There are limited options for the government to substantially increase its revenue, except for the Goods and Services Tax (GST). Even at 5% GST - generating RM8 billion in additional revenue - and netting off sales and service tax would yield about RM3 billion. This will improve the fiscal position, but not by much.
6.  Assuming a full-year implementation of a 10% GST rate, it will generate about RM25 billion (depending on items that will be exempted and zero rated). Without addressing total operating expenditure, particularly subsidies, there is no way for individual tax rates to be reduced. In other words, GST will likely be just an additional tax on society.
7.    The incumbent government will not have the financial resources to spend come the next general election, as if they do, the forecasted deficits as per the model may become the reality.

We are aware that we are concentrating our discussion on operating expenditures. The sustainability of deficits is related to the ability to borrow, which is based on your ability to pay back. It is possible for the government to cover the operating shortfall by reducing development expenditure. But this would be cutting back on long-term investments, and this is not sustainable on its own.

To relate this to an average household, you want to make sure you are earning more than your spend, and not dig into your savings. Cutting back on development expenditure is like cutting back on your children's education.


The government's state of finance requires bold and courageous actions to bring down the operating expenditure. It is difficult in a climate where it is highly polarised, whether in politics, race or religion.

The opposition will say no new taxes, no cuts in subsidies and more pay for civil servants. We need to remove the high costs of corruption and wastage. The problem is, such arguments cannot be quantified.

The people are concerned about the state of finance, but they do not want new taxes, since all taxes introduced become permanent. They want assurances that the introduction of GST will be tied to a lower personal income tax rate. And they want to know that the government, too, is tightening its own belt.

We need to cut subsidies quickly, cap the size of the civil service and impose GST, but also announce a gradual reduction in personal income tax rate over time. At the same time, the people must be satisfied that corruption and wastage are seriously addressed, and showing results.

This requires some form of political consensus. A bi-partisan approach would be helpful instead of the partisan political posturing we are seeing.

In the US, the Republicans and Democrats make compromises and come together in times of crisis as we just saw with the debt ceiling issue.

Will Malaysian politicians be equally mature and capable of bi-partisanship?

The Edge's Wish List 
1  A push towards greater social and economic inclusion. To be economically inclusive, we must do away with rent-seeking activities, profiting from granting and securing licences and monopolistic practices. Anti-competitive behaviour should be rigorously prosecuted.

2  Support Malaysian workers and move the economy towards higher income by introducing a wage rebate scheme. Around 82% of all working Malaysians are currently paid below RM4,000 a month. The introduction of GST will have a substantial impact on their cost of living. These workers need wage adjustments to cushion the impact.
    A wage rebate scheme will encourage employers to raise the wages of their employees. The government subsidises half the increased wages for a limited period, say two to three years. The companies will have to become more efficient as their cost of labour will be pushed up permanently.

3  Invest more in public transport and improve connectivity. This will reduce cost of living, pollution and traffic congestion.

4  Set up more vocational training and hospitality schools to improve technical skills and thereby increase the wages of these workers.

5  Encourage seed capital, venture capital, private equity set-ups and financing through tax relief. These will fund new and small entrepreneurs. Such new businesses will create more employment per dollar invested and also generate new ideas and innovations.

6  Make housing more affordable by removing risks so that the industry can be more competitive. These risks include regulatory ones with respect to approvals and timing. Also, allow developers to withdraw their launches if sales targets are not met. This could be disclosed transparently at the time of sales. By so doing, the risk of default, abandoned projects and bankruptcies will be minimised.