Olam's moment of truth

FOR nearly a decade now, affable and chatty CEO Sunny Verghese has been one of Singapore's better-known corporate chieftains. Since its listing eight years ago, agricultural supply-chain manager Olam has emerged as something of a local champion. It was battling far bigger, better-capitalised global players and winning. It was the little company that could. Verghese himself has won almost all the top management accolades in town. Yet, in less than three weeks, the company he so painstakingly built and helped co-found in Nigeria two decades ago has gone from a corporate high flyer to one that is clearly struggling to steady itself in increasingly stormy seas. Blame it all on Muddy Waters.

One of the world's largest traders in edible nuts and rice, Olam has been under siege since short-seller Carson Block, who shot to fame last year after bringing down several Chinese reverse-takeover firms in North America, turned his eyes on the Singapore-based company. Olam faces a high risk of failure, Block, who runs independent research outfit Muddy Waters, tells The Edge Singapore in an interview (see Page 20). Muddy Waters has taken issue with Olam's high gearing, aggressive capital expenditure and acquisitions of what it says are "low-quality, badly managed assets". It is also questioning Olam's accounting practices, poor internal controls over financial reporting, risk-management capabilities and complex "black box" business model.

For his part, Verghese couldn't disagree more. Olam, he says, is financially sound, has plenty of cash and is continuing to reduce its already-manageable gearing. On Dec 3, he announced that Olam is raising US$1.25 billion (S$1.53 billion) through a bond-cum-warrant rights issue that will strengthen its already-close ties with Temasek Holdings, its second-largest shareholder. He has also shown a willingness to "recalibrate" and slow down Olam's pace of acquisitions and even hinted at revising some of the firm's long-term goals, such as its target to have a profit after tax of S$1.3 billion by 2016, which he now says is "not an end in itself".

To tide things over, Olam is offering US$750 million in bonds and as much as S$500 million in warrants in an issue fully underwritten by Temasek, which has agreed to buy any rights not taken up by other investors. For each 1,000 Olam shares, existing shareholders get the right to subscribe for 313 bonds priced at 95 US cents and with a 6.75% coupon. The bonds will be stapled with 162 free warrants to subscribe for Olam shares at S$1.575 within the next three to five years. That's an effective yield on its bonds of 8%, with a free warrant. If the rights are renounced by all investors, Temasek, the main underwriter, will end up with warrants that in 2015 will help raise its stake in Olam from 16% to around 30%, or higher than the combined diluted stake of the founding Kewalram Chanrai family and CEO Verghese.

Block calls the unusually structured offering "a sovereign bailout" of Olam to prevent "systemic failure". The offering is a clear vindication of his thesis that Olam is in danger of failing. Block claims the company may have been just days from tipping over before its "rescue". His theory: Olam's banks went to Temasek and said they were ready to turn off the credit taps unless Temasek was willing to provide a backstop. By offering to underwrite the rights issue, which will refinance some of Olam's short-term debts, Temasek may have helped the firm buy more time, he says. "Fundamentally, it doesn't change anything. Olam's gearing is still high, its business model is still faulty and it is still draining cash."

Capital-raising exercise not working

Instead of helping reassure investors about the firm's access to liquidity, the audacious capital-raising was looking like a flop at the end of the week. On Dec 6, Olam's stock plunged another 4.3% following a 6.9% fall on Dec 5 to S$1.45 — its lowest close since March 2009. The plunge erased all of the small gains seen on Dec 4 in the immediate aftermath of the Temasek-backed US$1.25 billion bond-cum-warrant rights issue. The stock is down nearly 18% since Block first revealed his short position on Olam on Nov 19 and nearly 10% since Temasek stepped in to help prop up the beleaguered firm by agreeing to partake in a new US$750 million bond issue as well as agreeing to underwrite them.

"Clearly, the market is reacting negatively to the capital-raising," says Vincent Fernando, an analyst at brokerage Religare Capital. Credibility may have something to do it. "Management's earlier stance that it could easily survive 12 to 18 months even in a credit-market seizure may now sound hollow, and minority-shareholder confidence may be eroded," notes James Koh, an analyst at Maybank Kim Eng Securities, in a recent report.

Indeed, if Olam was hoping the latest bond issue would eventually allow it to raise new financing at lower rates, there was more shock. Its existing bonds weren't doing any better. In recent days, yields on some of its bonds have hovered around 12%, implying a high and unsustainable cost of borrowing.

Several analysts who have spoken to The Edge Singapore in recent days say Verghese may have made a fatal mistake of underestimating the damage that Block and other short-sellers who have since joined the party could inflict on Olam's stock as well as its franchise. "They should have taken Muddy Waters a little more seriously and focused on the issues raised instead of being so dismissive," says one. Others say Olam's CEO may have boxed himself into a corner by openly dismissing any need to raise new equity or debt immediately, then turning around and raising new debt anyway. Soon after Muddy Waters' allegations, Verghese told The Edge Singapore that Olam was committed to not raising any equity until 2015 and that it probably didn't need to go back to the bond markets for another six months or so.

Moreover, immediately rejecting the idea of seeking a rating for its bonds just because Muddy Waters had scored a political point by offering to pay for it was another crucial misstep. Since its closest peer Noble Group's bonds are rated, investors have a right to wonder why Olam has been dragging its feet, notes another analyst. The right response for Olam should have been that, since the concerns had been raised, it would do anything to allay those concerns and shore up investor confidence, whether it concerned capital-raising, bond-rating or asset sale. It should have come up with a clear statement that it was doing all it could to rein in capital expenditure and improve performance at some of its acquired assets.

"We think Muddy Waters' call for insolvency is a stretch," says Conrad Werner, an analyst at Macquarie Securities. He, however, concedes that the short-seller's accusations did raise legitimate questions about the performance of some of Olam's new upstream and midstream assets. "We must accept that Olam's transformation projects are taking longer than we expected to come through," he says in a report on Dec 6. Werner recently cut his recommendation on the stock to "neutral" from "outperform" and slashed his 12-month price target to S$1.60 on new earnings estimates that are 20% to 25% below consensus because he is now convinced the firm's "re-setting process could take time".

He believes a quarterly rather than the current annual reporting of Olam's earnings before interest, taxes, depreciation and amortisation (Ebitda), clearly stating the profitability of its legacy and new businesses, might also help assuage concerns that the new projects are on track.

At some point, Olam's stock is likely to get a temporary pop due to a squeeze on short-sellers. Such a rebound could come as soon as February, when Olam is likely to convene an EGM to vote on the rights issue, although Verghese says the firm's lawyers are checking whether it really needs to get shareholders' approval to proceed with the capital-raising. To attend the EGM, shareholders who have lent the scrips to short-sellers will need to recall the shares. Once the offering is approved, there might be another short squeeze around book closure date, when the scrips are recalled again to subscribe to the bonds and get hold of the attached warrants.

Just don't expect Olam's stock to go back above S$2, where it was hovering until as recently as mid-September. Religare's Fernando, who has a "sell" recommendation on the stock, believes Olam shares could languish or even trend lower until there is more clarity on when it might turn cash-flow-positive. "The stock is unlikely to be re-rated until Olam can clear up all the uncertainties around its financials," he says. He believes this is unlikely to happen in the near future.

No end to crisis in near future

For now, the almost-daily tit-for-tat between Olam and Muddy Waters seems to have subsided. Each side is waiting for the other to make the next move. For its part, Olam is due to issue yet another report over the next few days to address Muddy Waters' concerns. Muddy Waters is playing by ear and has no new salvo planned, although Block says he will respond to any new statements by Olam. The way he sees it, the ball is firmly in Olam's court because it is the company's job to address the concerns of its increasingly nervous shareholders and bondholders.

Don't expect the Olam crisis to be resolved anytime soon. With its current guidance that it will remain cash-flow-negative until at least 2015, it will be fairly tough for the company to fully dispel investors' concerns. Moreover, there is now a timeline for events such as the EGM early next year, a set of quarterly results in February and the completion of a capital-raising exercise by early March. Fernando says the crisis will drag on unless Olam makes substantial changes to its current guidance on business expansion. Other analysts believe the tide for Olam might turn once it refocuses on extracting better performance from its new assets and is seen to cut back on its acquisition spree.

What's next? Beware of the contagion effect. If Olam's shares languish around current levels for a while, analysts believe pressure will mount on similar companies such as Noble and Wilmar International as investors start questioning their business models as well, forcing them to shore up their defences and do more to mollify their nervous shareholders. "I think the issues raised concerning Olam will eventually have a negative effect on other similar companies, and their financials will be under the microscope," says Religare's Fernando. "Investors might be questioning different items in their financials much more than they used to. It is not about right or wrong, but just the nature of the business, and the market might not want to pay too high multiples for their earnings."

In some ways, the Muddy Waters report was a wake-up call for Olam, which is still living in the pre-global financial crisis era, when credit was freely available and consultants and analysts focused on metrics such as return on investment even if it was at the expense of higher leverage. After the financial crisis, when deleveraging is in vogue, investors are less willing to give highly geared companies such as Olam more leeway. "People are certainly more worried about leverage since the crisis," says Fernando. "Now, when concerns are raised about leverage, they focus on it more than they did previously."

If the unflappable Verghese is worried, he is clearly not showing it yet. After the briefing to the media and analysts on the capital-raising on Dec 3, he said he was looking forward to putting out just one more response to allay investors' concerns and then he would go back to focusing on the more mundane matters of running the sprawling company. But Olam's plummeting stock price and the widening yields on its bonds are a reflection of increasingly nervous investors, who have for eight years placed full faith in his ability to navigate in treacherous waters. Verghese knows Olam would need everything he and his team can muster if it is to make it to safety.

This story first appeared in The Edge Singapore weekly edition of Dec 10-16, 2012.

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