Waseem Sayegh

In a recent article published in the Wall Street Journal (click here for the article), a Mideast-Deutsche bank executive predicts that Dubai will recover from the global financial crisis quicker than other economies in the Middle East because of its openness. That is great news for Dubai’s economy which is suffering tremendously in this current financial crisis.

Over the past couple of years Sovereign Wealth Funds (SWFs) have received massive media coverage, leading many to mistakenly believe that they are a 21st century invention. This media coverage has focused on several high-profile deals that went sour. The reality of the matter is that the history of SWFs date back to 1953 when Kuwait established the first SWF, Kuwait Investment Office (KIO), to reinvest Kuwait’s petrodollars. Furthermore one of the more high profile deals that went sour happened in 1987 when KIO bought more than 20% of British Petroleum. This deal inflamed the British government and KIO responded by selling more than half of their stake.
As with most things under the sun, SWFs are neither villains nor saviors. These funds are not isolated islands. Rather,  they are complex entities that are forced to play within the international political landscape. SWFs are thrown into the mix of international political tension, string pulling, power play, political perception, pragmatic nationalism, sovereignty and autonomy, the rising price of oil, and huge US foreign account deficits and Asian and Middle-Eastern economy surpluses. This mix results in a multidimensional equation with a slew of stake holders ranging from your average Joe to governments. In other words, everyone on this earth is directly or indirectly affected by SWFs.

For the full report, please click here.

For the accompanying presentation, please click here.

For better or for worse, ordinary citizens expect more from public and high profile figures. Not only do they expect more, but they also forget that these figures are mortals and want them to behave as infallible gods. Once a public or high profile figure steps out of line, the masses shout: Foul! There is a whole industry that thrives on public and high profile figures stepping out of line. You will see it and read it all if you tune into Entertainment Tonight on CTV, or flip through a tabloid such as the National Enquirer at the supermarket’s checkout isle. Luckily these media outlets report on Hollywood Boulevard celebrity mishaps that typically do not affect our way of life, investments, pensions and savings. That said the masses should be more concerned about Wall Street, Bay Street and Downing Street “celebrities” mishaps that make it to the front page of the Financial Times and Wall Street Journal. When political and business leaders step out of line the ramifications of these events are much dire. Our readings, which included cases about Conrad Black, Brian Mulroney and the Sub Prime Fiasco, are all mishaps and disasters that made it to the front page of the Financial Times and Wall Street Journal. This paper will enumerate and discuss the main issues highlighted in our readings and what we should learn from them.

Where is the Line in “Stepping out of Line”?
We previously mentioned the term “stepping out of line” several times. Though, where is the “line” that cannot be crossed? We learn from our readings that the higher you rise in the corporate ladder the more thought you have to give about your actions. From our readings we learn that the pundits are split on whether the actions of Conrad Black and Brian Mulroney are legitimate or illegal. That said the pundits seem to agree that their actions were questionable. “Crossing the line” for a public figure or leader is doing anything that might be considered as questionable judgment. Leaders should not only avoid questionable actions, but they should also distance themselves from anyone who carries out questionable actions.

Ensure that your Dealings are Ethical
Public figures should be expected to be scrutinized at any point in time. For this point, all their dealings should pass the “sunshine test”. The sunshine test can be described as: “if my decision or action would become known to other people, would it cause embarrassment?” If the answer to this question is “yes”, then that decision or action is most probably unethical. Had Brian Mulroney asked himself this question he would have not accepted to receive the cash payments he received.

Your Credibility is Your Biggest Asset
Leaders should not forget that their credibility is their biggest asset. Once your credibility is compromised it is never fully regained. The fact of the matter is that Conrad Black is not only serving a “6 year 6 months (sentence) at a low-security jail in Florida,” but a life-time sentence in the eyes of everyone that once trusted him. The same applies to Brian Mulroney. Peter C. Newman highlights this point when he says: “although he says he (Conrad Black) hopes to re-emerge as an investment dealer, it defies gravity to believe that many people will want to place their money with him.”

Challenge Your Assumptions
The sub-prime fiasco teaches us to challenge the underlying assumptions. The models that were used to value subprime mortgages were built on false assumptions. These assumptions were overly rosy and were based on the early years of the housing boom, where the default rates on all mortgages were unusually low. Investors never stopped and challenged these assumptions. Had investor banks challenged these assumptions they would had either not gotten into the subprime mortgages all together, or had charged a rate comparable to the risk they were taking.

The Age of Rubber Stamping is Over
Do you want business to be more regulated? If your answer is “no,” which is most probably the case, then expect to ask or be asked tough questions. The role of the board member keeps on getting more and more complex. Prior to Enron and Sarbanes-Oxley, a board member’s job was to rubber stamp managements decisions. This is no longer the case. Corporations should embrace a culture that allows board members to be skeptical of management decisions and allow them to ask tough questions. Board members are not responsible for a company’s day to day operations, but should ensure that management does not step out of line, deals ethically, maintains its credibility, and challenges assumptions.

Last week’s “Finance Course with Finance Practitioners” guest lecturer was Tullio Cedraschi, the CEO of CN Investment Division. During the lecture he handed out “Tullio’s 20 Red Flags”. These flags are meant to help investors with their investment decision making. According to Tullio these flags have stood the test of time. Before going into the flags let’s make sure that you’re clear on the following rules:

1-3 red flags: probably no problem
4-5 red flags: watch out
6-20 red flags: sell or do not do the deal

Here are Tullio’s 20 Red Flags:

1. Creative accounting: High reported earnings with large deferred expenses. Accounting too complicated for even the most knowledgeable analyst.
2. Unfocused business strategy: The company enters unrelated businesses on a whim. The oil company entering the real estate business, the real estate company entering the computer business. Nobody can be an expert in all industries.
3. Promise of assured high returns without risk: Risk-free high returns on business are a sure sign of fraud. The business world is very competitive. High returns mean high risk.
4. Speed of deal making: Management is involved in too many deals at once.
5. Share structure with voting and non-voting common stock: A controlling shareholder who can control the company through a small number of voting shares can be tempted to disregard the interest of the non-voting (or low voting) shareholders in his action.
6. Excessive taste for leverage: Too much debt. Because of low interest, attention has been removed from this critical fact: Excessive debt can lead to bankruptcy.
7. Excessive tax avoidance: Tax planning is, of course, very much a part of the modern corporation but when tax evasion becomes the raison d’etre of the corporation, it is possible that shareholders will also fall victims to the schemes used to defraud governments.
8. Lying and excessive hype: The company bends truth about its products and markets, and hypes itsadvertising far beyond the quality and usefulness of its products.
9. Too much litigation: Too many court cases pending against the corporation. Constant hassle with security commissions and stock exchanges.
10. Conflicts of interest: Management or controlling shareholder dealing their assets or buying from the company at non-market values, or leasing personal real estate to the company.
11. Too many insiders on the Board: How can the Board judge management if it is stacked with Vice-Presidents and close personal friends of th CEO?
12. Nepotism: Too many family members of the CEO in the top management.
13. Excessive indulgence by management and Boards: Personal use of corporate jets; business meetings held at only the best resorts.
14. Excessive executive compensation: There is nothing wrong with very high management compensation. Indeed, any company should attempt to attract the very best – and pay to keep them. But consistent, very high compensation, combined with steady deteriorating shareholder value, signals a problem.
15. Lousy investor relations: Refusal to answer legitimate questions from analysts. Painting too rosy an earnings picture followed two weeks later by profit warning. Erratic disclosure of important corporate events. Systematically misleading the financial community about the outlook of the company’s business. Leakage of information to related shareholders.
16. Insider information: Trading by management and board members reflecting abuse of insider information.
17. Disorderly corporate books and meetings: Contracts not properly documented. Board meetings called and canceled. Management late for meetings. Minutes do not reflect decisions taken.
18. Megalomania: CEO has a Napoleonic streak, acts like a dictator, does not tolerate dissent. He sees himself running a Fortune 500 company, when presently his is a small cap company and should remain small.
19. Complicated corporate structures: Corporate legal structure too complicated for an outsider to understand. Large number of intricate and non-transparent offshore holding companies involved with the listed public company.
20. Doubtful history of main promoters: Promoter or CEO was previously invovled in shady deals, associates with suspicious characters. New management appears in town, without anyone knowing where they came from or their previous history.

Today the stock of New Corporation, the parent company of Fox News, went down by 2.59%. Bloggers have jumped the gun to claim that this drop is due to Fox News snubbing Ron Paul. This has been mentioned here and here. Let me break the news to you, MOST stocks are down today. Competitors to Fox News such as Viacom, CBS and Time Warner are down 3.12%, 3.05% and 1.33% respectively. The S&P index, which is a good indicator of the market, is also down 1.44%. Now Ron Paul can only be behind News Corp’s stock going down and the whole market going down only if he’s also behind the $100 oil barrel. I personally cannot stand watching Fox News, but please do not blow things out of proportions.

This report was compiled to provide KPMG with guidelines to handle scenarios that were outlined by Mr. Colin Sharman, UK Senior Partner at KPMG. These scenarios include What KPMG might do if:

1. it were to become obliged to formally separate the accounting function from the consulting function
2. consultants demand more work/life balance

Following the suggested action plan will ensure that KPMG maintains its position as a major enterprise in a swiftly changing global business environment.

Click here to download the report

While Bombardier has strong cash flows, we believe that it has low quality of earnings, because these cash flows diverge significantly from its reported earnings:

• Its inventory valuation and cost of sales involve very large “program estimates”. If these estimates change by even 1%, the resulting difference is about 30M. Furthermore, they appear to be managing their excess over average production cost account (EOPAC) to smooth income.
• They appear to have taken a “big bath” when they restructured in 2003-2004, creating “restructuring reserves” and expensing special items in such a way as to smooth earnings.
• Bombardier has an aggressive revenue recognition policy with its airplanes. While its competitors only recognize revenue when the plane is delivered. Bombardier often recognizes it when the customer gives signoff on “interior fitting”.

While Bombardier is able to meet its short term obligations, it nevertheless has a bad credit rating. Moody’s and Standard and Poor’s have both rated Bombardier as being slightly below investment grade. Part of the reason for this is Bombardier’s very high level of long term debt, as compared to the industry average.

Furthermore, Bombardier has a very low operating profit margin, and seems to be relying on its high asset turnover. Given the steep global competition that Bombardier faces, many analysts are predicting that it will continue to lose market share. After all, its direct competitor, Embraer, is more liquid, much more profitable, and significantly less indebted than Bombardier.

Due to the aforementioned reasons, we recommend that Investa Group sell off its current holdings in Bombardier.

PDF version includes complete report.