[This article was first published on Linkedin on 29 July 2016.]
It was reported on the morning of 28 July 2016 that Swiber Holdings Ltd. filed a petition to wind up and liquidate the company after facing demands from creditors amid a slump in the offshore oil and gas businesses. This comes less than only 3 years after Swiber reported record revenue and profits for 2013, declared a special dividend in March 2014, and recorded profit before tax in each of the last 5 financial years. Here’s 7 things we may learn from Swiber’s corporate failure.
- THE ORDER BOOK: MUCH ADO ABOUT NOTHING?
Companies whose businesses are project-based like to boast about this, because the order book size is supposed to be a measure of revenue that can be recognised over the foreseeable future. Nevertheless, investors and creditors should take this figure with a big pinch of salt. In its latest annual report, Swiber was “pleased to report” that it had an order book of US$1.35 billion as at 29 February 2016 — about 1.6 times its 2015 revenue. So it looked good, except for the risk that orders can always be withdrawn, delayed or contractual terms (such as pricing) renegotiated. On 8 July 2016, Swiber warned (only after an SGX query) that its US$710 million project in West Africa has not been able to progress on schedule “due to weakness in the oil and gas sector since the latter half of 2014”. Swiber added that it has not recognised any revenue related to the project. Now we know that the company’s revenue recognition policy for construction projects is based on percentage-of-completion (see Note 2.10 on page 73 of its 2015 annual report). Having not yet recognised any revenue related to this West Africa project (which was awarded in December 2014), Swiber may be implying that no construction at all had commenced on this important project throughout the course of 2015. If this is correct, why then was there no disclosure of this delay or non-commencement of the West Africa project in its 2015 annual report — until 8 July 2016 that is. In fact, till today, there has been no announcement of even the name of the client who supposedly awarded this big contract. This US$710 million West Africa contract is clearly more than material vis-à-vis the entire order book of US$1.35 billion. Is this why the SGX is saying that it will undertake “thorough investigation” into Swiber? See http://www.businesstimes.com.sg/companies-markets/sgx-to-undertake-thorough-investigation-into-swiber-to-take-action-if-any-breach
2. BLAME IT ON THE RAIN, BUT LET’S NOT BLAME IT ON THE OIL PRICE SLUMP
It is too easy and convenient for an oil and gas-related company to blame all their financial troubles on the oil price slump — hey it’s not my fault, it’s just external market factors and bad luck, how was I supposed to know, right?
Well, not really. Swiber’s management had built up their investments and PPE (property, plant and equipment) from US$574 million at end-2013 to US$973 million at end-2015. This 70% increase in these assets in just 2 years was fuelled by none other than bank borrowings, notes payable and “senior perpetual capital securities” (that paid out 9.75% annual income to the holder, which effectively makes it a form of debt even though it was classified under equity on the balance sheet). The net debt-to-equity ratio (a.k.a. the net gearing ratio) rose from an already challenging 1.1 times at end-2011 to 1.59 times at end-2015. Swiber’s 2015 annual report seems to reassure shareholders by saying that the group is required by its banks to maintain a gearing ratio of not exceeding 2.0 times (see Note 32 on page 119). Therefore, on the surface, it seems that Swiber has been acting in line with the banks’ covenant. But this is scant comfort because 1.59 times per se is still a very risky level for any company in a cyclical industry. The high threshold level of the restrictive covenant makes it ineffective as a benchmark for financial risk control.
Furthermore, what the annual report did not explicitly report was that because of this rising debt burden, the interest coverage ratio (i.e. EBIT/finance expense) of Swiber had fallen from a relatively comfortable 4.1 times at end-2011 to only 1.5 times and then 1.16 times at end-2014 and end-2015 respectively. In layman terms, this means that there has been less and less profits to pay for the rising interest expenses; by end-2015 the company had barely any safety margin to buffer any miscalculation or bad luck in its earnings generation.
One should always be thinking “what can go wrong”, protect one’s downside first and be careful about expanding using debt when everything looks rosy. The right thing to do is usually the counter-intuitive thing.
3. THINK AHEAD HOW YOU’RE GOING TO REPAY THAT LOAN: BECAUSE CASH (FROM OPERATING ACTIVITIES, NOT DIVESTING NOR FINANCING ACTIVITIES) IS KING
A medium-term, multicurrency notes programme (“MTN”) sounds like a useful facility that your bankers will be happy to push to you, and many SGX-listed corporates seemed to have caught on to borrowing via issuing MTNs. But due to the relatively short tenure of a MTN (typically 3 to 5 years), the borrower must be sure it can quickly produce enough cash and some more from its capex and operating activities in order to repay the principal when it matures in 3 or 4 years’ time — this is no mean feat.
In 2013, Swiber issued S$160 million of fixed rate notes due 2017; in 2014, it issued another S$230 million and S$50 million of fixed rate notes due 2016 and 2017 respectively. However, in the 4 years between 2011 and 2014, Swiber had experienced 2 years of negative cash flow from operating activities; its best year was 2014 but with only US$33 million of positive cash flow from operating activities. If Swiber’s management back then was not praying for a sudden surge of future billings and collection to boost operating cash flow by the magnitude of 10-fold (at the least), it might have been counting on asset sales — which is again no mean feat. More likely, Swiber and its bondholders might have been hoping that the banks or the bond market would be kind enough to refinance these S$440 million of MTNs due this year and next at a reasonably low interest rate (this amount does not include another $231 million of bank borrowings due this year), which brings me to my next point.
4. BANKING ON THE BANK: DO YOU REALLY WANT TO HURT ME?
Bob Hope once said that “a bank is a place that will lend you money if you can prove that you don’t need it”, and the comedian’s words still ring true today. But to this quote, I like to add that banks may still lend you money if they had already lent you money, and then realise that you’re too big to fail, i.e. you’re so large and so interconnected that your failure would be disastrous to the greater economic system. We now know that Swiber (and I suspect other local oil and gas engineering SMEs too) is not deemed too big to fail by the banks, and the latter will rather not throw good money after bad when there is no clear recovery prospect in sight. “We do have exposure (to Swiber). (But) it doesn’t worry me. It’s manageable,” said UOB chief executive Wee Ee Cheong.
5. THE IMPORTANCE OF A GOOD CHIEF FINANCIAL OFFICER
When I was an accountancy undergrad some moons ago before attending law school, my dream job was to be a CFO just because it sounded so cool — nowadays I much prefer Cycling For Occupation. A CFO is much more than just a high-class accountant cum compiler for the periodic financial reports cum liaison officer with the corporate secretary — although this seems to be the way some CFOs are treated by their boards. An effective CFO should be able to, inter alia, connect the dots between the CEO’s business plans and unique industry characteristics with an appropriate capital structure, as well as to clearly understand and model the financial and credit risks (associated with the capital structure) brought about from potential market risks (e.g. oil price slump in this case). The end result should be a capital structure that is sustainable and adds value to the shareholders. In other words, an effective CFO has to play the role of an influencer.
Financial management and risk management cannot be about ‘hoping for the best’ with blue-sky assumptions in the financial model amid the bullish tone of the market, the CEO or the board, but instead should involve ‘expecting the worst’ with realistic stress-testing or sensitivity analysis, which brings me to my next point.
6. RISK MANAGEMENT AND INTERNAL CONTROLS
This is a gentle reminder and I quote from both Singapore’s Code of Corporate Governance and the Corporate Governance Report in Swiber’s 2015 annual report:-
“Principle 11: Risk Management and Internal Controls: The board is responsible for the governance of risk. The board should ensure that management maintains a sound system of risk management and internal controls to safeguard shareholders’ interests and the company’s assets, and should determine the nature and extent of the significant risks which the board is willing to take in achieving its strategic objectives. The Board annually reviews the adequacy and effectiveness of the Group’s risk management and internal controls framework, including financial, operational, compliance and information technology controls.”
Enough said. The above should already be self-explanatory.
7. SWIBER IS JUST THE TIP OF THE ICEBERG
Liquidators may wish to pre-book their Porsches or cancel their Christmas holidays, or do both, what with California Fitness last week and Swiber this week engaging their services. There’s more insolvencies to come from the local oil, gas and mineral companies, given that oil services companies had been racking up their borrowings only in the last 2 to 3 years (see chart above from Bloomberg) and these debt will be due next year and 2018 — it’s actually quite irrelevant whether one has any dealings with Swiber or not. It is doubtful that even a oil price rebound to US$100 per barrel (if it even happened) will stimulate sufficient rebound in high-margin works to stave off the ongoing cash crunch. It’s not good EQ to name names, so just watch out for those companies whose latest annual reports show very high levels of debt and/or bank borrowings under “Current Liabilities” vis-à-vis the sum of their cash at bank and cash flow from operating activities. Their boards will either be calling on the shareholders with a rights issue, or they’ll be calling the liquidators.