Published in Business Times, Dec 28, 2012
 Mak Yuen Teen
In the light of criticism of Olam’s way of doing business, it’s useful to revisit what happened to an Australian company
Fair dinkum: To avoid suffering the same fate as ABC Learning, Olam must use the new funds it has obtained to improve its operations, business model, strategies, capital structure and governance. – PHOTO: STOCK.XCHNG
MUDDY Waters rather unfairly compared Olam with Enron but another case closer to our shores is a more apt comparison: ABC Learning Centres in Australia, which collapsed in late 2008. Olam has so far avoided ABC’s fate, but the uncanny similarities are a reminder that the line between corporate survival and failure can be a fine one.
ABC was co-founded in 1988 as a childcare centre by Edmund (Eddy) Groves and his (now estranged) wife Le Neve Groves in Brisbane, Queensland. Back then, childcare centres in Australia were mostly non-profit organisations supported by government subsidies. In 1996, ABC managed 18 childcare centres and was the major player in a nascent private childcare sector in Australia. In 1997, the Australian government decided to move the subsidy to direct payments to families, which created the potential for growth in the sector.
ABC seized the opportunity and expanded ambitiously by acquiring properties in prime locations and buying out single daycare centres and smaller childcare groups. In 1999, it owned 30 centres. In 2001, ABC listed on the Australian Stock Exchange (ASX), giving it access to capital for further growth. At that time, it had 43 centres and had just started expanding outside of Queensland. Growth became exponential after the listing, with the company nearly doubling its operations each year. By the end of 2005, there were 660 centres in Australia. In 2006, ABC ventured overseas and, two years later, it owned 2,238 centres in Australia, New Zealand, the United States and the United Kingdom.
When ABC listed, its market capitalisation was just A$25 million (S$31.7 million). In March 2006, its market capitalisation reached A$2.5 billion and in 2007, it reported after-tax profit of A$143.1 million and revenues of A$1.7 billion.
Then it all went pear-shaped. ABC was overwhelmed by debt repayments and had to sell 60 per cent of its US subsidiary and its entire UK subsidiary. Its last traded price was A$0.54, well below its peak of A$8.62. It was then delisted from ASX and went into receivership.
The main criticisms of Olam by Muddy Waters were about its business model, accounting, aggressive acquisitions and capital expenditure, leverage and weak operating cash flow. These are very similar to the factors which contributed to ABC’s demise.
When ABC collapsed, potential rescuers found that the operations were run in an opaque way, and that the business model was “hard to decipher” (The Business Times, Nov 7, 2008). Muddy Waters has called Olam’s business model “a black box”.
Accounting issues
ABC’s acquisitions resulted in the recognition of the licences of operating the childcare centres and large amounts of goodwill – both of which are intangible assets – at fair value on its balance sheet. At the beginning of the 2006/7 financial year, there was A$37.4 million in goodwill and A$647.6 million in childcare licences.
Goodwill rose to A$271 million and licences to A$2.4 billion by the end of FY2007/8. However, the impairment charges for these intangibles were only A$2 million for goodwill and A$8.4 million for childcare licences over the two financial years. Intangible assets often become worthless when a company runs into trouble.
According to Philip Ross, head of the school of accounting at the University of Western Sydney: “ABC Learning’s profits increased rapidly through acquisitions, which should have raised questions about the underlying valuation of assets it acquired – especially given that 70 per cent of its assets were intangibles . . . The inherent risk associated with the valuation of the assets was enormous” (Sydney Morning Herald, Jan 2, 2009).
In 2006, an anonymous complaint raised concerns with the Australian Securities and Investment Commission about the valuation of ABC’s childcare licences. The complainant said most of the value created “was based entirely on the future net cash flows of the company, which may or may not be realised” and estimated that between 2001 and 2005, ABC generated A$390 million in gains through revaluation of these licences.
Like ABC, Olam has major items on its balance sheet, such as biological assets, derivatives, goodwill and other intangible assets, which are difficult to value and account for, and questions about their impact on Olam’s financials have been raised by Muddy Waters and other commentators. Many of these assets are the result of Olam’s aggressive acquisitions and its rather complex business model.
ABC’s external auditors, Pitcher Partners, gave ABC unqualified opinions since their appointment in 2003. However, after they resigned in late 2007, new auditors Ernst & Young took a very different view of the profits previously stated in the accounts. The board brought in KPMG as a third party to settle the difference of opinion between the two auditors.
According to the Sydney Morning Herald (Jan 2, 2009): “Put simply, three different audit firms – including two of the biggest names in the business – looked at ABC Learning’s account practices. KPMG could not find fault with two materially divergent opinions provided by different auditors, one of which correctly diagnosed what was ultimately a fatal condition.”
In Olam’s case, external auditors Ernst & Young have given it unqualified opinions since their appointment and have stood by their views. However, as the ABC case indicates, different auditors may have different opinions about the financial statements – and today’s principles-based financial reporting standards largely predicated on fair value accounting provide companies with enough “wiggle room” to “manage” their financials and still receive unqualified auditors’ opinions.
It is important to bear in mind that “unqualified” audit opinions by the major accounting firms have been challenged in the aftermath of a number of corporate scandals and failures of financial institutions during the global financial crisis.
Debt
Between June and December 2007, ABC’s total liabilities remained relatively constant. However, in December 2007, around A$1.1 billion of borrowings was reclassified from current to non-current liabilities, due to refinancing.
ABC’s lenders included several leading banks. On June 13, 2007, ABC finalised a syndicated multi-option bank facility for A$1.48 billion. In the first half of FY2007/8, profit fell 42 per cent due to one-off charges, and covenants for debts amounting to A$1.2 billion were breached. As it headed into trouble, ABC tried to renegotiate a loan agreement with its bankers. A turnaround plan was rejected by the banking syndicate.
Olam’s strong reliance on debt to fund its growth has been criticised. The ABC case shows how quickly support from banks and other lenders can dry up when a company gets into trouble.
Supposedly long-term debt can quickly become repayable in the short term or much more expensive, especially if debt covenants have been breached. Breaches of debt covenants can also have a domino effect.
Operating cash flow
ABC could not generate enough operating cash flow to pay interest, suppliers, salaries and dividends. Olam has an erratic pattern of operating cash flow, which has been generally negative. Although its profits had been increasing steadily over the last few years, there have been many cases of companies which have failed on the back of positive profits and negative operating cash flow.
It emerged that the Groves and some of the other ABC directors had pledged their shares to borrow money. As the share price plummeted, they were forced to sell shares equivalent to 5.6 per cent of the company to satisfy margin calls. This flooded the market with shares and pummelled the share price further.
Muddy Waters has questioned whether Olam’s management have pledged their shares for loans. The ABC case shows that forced sales of pledged shares can have a dramatic impact on the company’s stock price.
In September 2011, the Singapore Exchange (SGX) amended its rules to require “issuers with loan covenants making reference to shareholding interest to obtain an undertaking from the controlling shareholder that he/she/it will notify the issuer of the share pledging arrangements”. This was in response to cases where forced sales of pledged shares by controlling shareholders in some companies have triggered breaches of debt covenants.
Striking resemblance
All corporate collapses have certain broad similarities and differences, and Olam is not a mirror image of ABC. However, the similarities in terms of issues which brought down ABC and the concerns raised by Muddy Waters about Olam are quite remarkable. Even their corporate histories bear a striking resemblance.
The two companies were founded a year apart as relatively small domestic companies, with ABC founded in 1988 in Brisbane, Australia, and Olam in 1989 in Nigeria. Both became listed companies, ABC in 2001 and Olam in 2005, and grew very quickly on the back of opportunities created by booming demand in their respective industries.
Temasek bought a 13.76 per cent stake in Olam in June 2009, becoming its second largest shareholder. This was increased to over 16 per cent and more recently to 18 per cent. In ABC’s case, Temasek bought 55 million shares, or 12 per cent of the company, at A$7.30 per share in May 2007. As the share price fell in early 2008, it also bought more shares, increasing its stake to 14.7 per cent. This made it the second largest shareholder.
Thankfully, Olam has avoided ABC’s fate – for now at least. One big difference in Olam’s case is Temasek’s strong and timely support through the large bond-cum-rights issue. Although it is not without its critics, it has undoubtedly reassured lenders and investors, and given Olam some respite.
Although Temasek also bought more shares in ABC’s case as its share price came under pressure, there was no significant injection of new funds into ABC. In ABC’s case, Temasek’s support turned out to be an expensive lesson for itself.
In the longer term, the final outcome can be very different in Olam’s case. However, this can only happen if it uses the new funds to improve its operations, business model, strategies, capital structure and governance. If it is business as usual for Olam, then it risks ending up the same way as ABC.
The writer is associate professor of accounting at NUS Business School, where he specialises in corporate governance. The information on ABC Learning Centres in this commentary is based substantially on a 2011 case study written by Kwan Yu Hang, Lee Ai Lian and Teo Chee Yong, and supervised by the writer
