Thursday, October 25, 2007

The SembCorp Marine Saga

Hot on the heels of the Uni-Asia fiasco is yet another scandal which makes Uni-Asia’s case pale in comparison. The company in question this time is SembCorp Marine (Sembmarine or SM) and they had revealed on October 22, 2007 that their finance director, Mr. Wee Sing Guan, had engaged in unauthorized foreign exchange (forex) transactions and caused the company to lose an amount to the tune of about US$248 million. The amount includes US$83 million which was already paid to a bank through Jurong Shipyard Pte Ltd (JSPL), while the remaining amount is still subject to confirmation as the positions are still “open”, meaning that the losses have not been realized yet. SM has said that it will engage a special audit from Ernst and Young and also lawyers from Drew and Napier to see if it can contain the losses and to assess the extent of the damage. The announcement by SM that it had sold 39 million shares in Cosco Corp for S$272.2 million is widely seen as a move to stem the losses, and is regarded as a form of "damage control".

Consider the numbers involved here and it will be readily apparent to the average observer that US$248 million is a huge sum, as their FY 2006 net profit amounted to S$238.4 million (yes, it’s SGD, not USD !). This means that if taken in context, it would mean that the unrealized losses in question already more than wipes out FY 2006’s profit, and leave extra losses to boot. Assuming that SM’s profit for FY 2007 grows 50% (just an assumption), it would amount to S$357.6 million, which is still lower than the S$362.8 million loss (using an exchange of 1 USD: 1.463 SGD) from the illicit forex transactions. Of course, such a shocking revelation from the world’s second largest oil rig builder sent its share price reeling and it closed 86 cents (15.4%) down to S$4.74 on the release of the trading halt. A full S$1.8 billion worth of market capitalization evaporated in a single trading day, and this is testament to the magnitude of the damaging announcement made by the company.

Several issues arise as a result of this stunning news, which have also been discussed on ST and BT as well as online share forums. Still, it pays to revisit these issues to discuss what went wrong, the implications on corporate governance and whether confidence can (ever) be restored to this blue chip company. Firstly, the glaring issue of corporate governance comes into play again, and one would have thought that after the likes of CAO, ACCS (now MDR), Citiraya (now Centillion) and Informatics, the entire corporate world would have been more guarded about possible fraud or unauthorized risk exposures. SM must delve deep into the reasons for this lapse of internal controls, resulting in one of the most damaging losses since the CAO back in 2003. Considering that it is a company which prides itself of risk management (as disclosed in its Annual Report) and which recently won an award for transparency given out by SIAS, this latest piece of news seems all the more ironic. All I can say is that SM’s directors and top management have to get their act together to ensure that loopholes are plugged, and to carry out a thorough investigation into how such transactions could have been entered into without their knowledge or authorization.

Another issue at hand is also the question of how the losses became so massive. According to SM, they do normal hedging against possible adverse currency fluctuations, such as entering into forward contracts to “lock in” a favourable exchange rate (they earn in USD but report their financials in SGD). However, it was pointed out by analysts that a loss of this magnitude could only be perpetuated by risky forex speculation, by making heavy bets in the billions (probably) on the direction of exchange rates. As the greenback has depreciated only about 7% against the Singapore dollar in recent months, this has led to even more speculation of how these losses came about. SM needs to clearly explain itself after the inquiry and give full and honest disclosure on the entire debacle. If not, then it will be a classic case of a “crisis of confidence”, which will be very difficult to recover in future. As Warren Buffett has said: “You take a lifetime to build a good reputation and only five minutes to lose it all.”

A final note to add for this post and something I wish to highlight yet again are the inherent risks in investing in quoted equities. Even a value investor who had purchased SM based on fundamentals and growth prospects could not have seen this coming. It is one of those anomalies which can hit a diligent investor and cause him to lose a substantial amount of capital, akin to an “Act of God” incident which can cause freakish damage. After all, how is one supposed to even fathom the possibility of a blue-chip Temasek-linked company being embroiled in a scandal of this scale ? It all boils down to whether an investor had made adequate provision for losses stemming from “unforeseen events” such as these, and whether he has adequately hedged his own exposure by diversifying his investment types (e.g. in gold, commodities, real estate). By investing in equities, all of us have to take up a proportionate amount of risk and it is this risk which we manage every single day as we entrust our monies in the hands of the Management of the companies which we invest in.

Note: I will post more updates and opinions on the SM saga as events unfold and more information becomes available.


Alen said...


I was shocked on the news also. This kind of incident should not happen on a company so prominent and big, and perceived as well managed.

Obviously there is a lack of internal control, which the magnitude we are unsure. That proves the old saying - diversify.

musicwhiz said...

Hi Alen,

I would see it more as a case of a lapse in internal controls, rather than a lack of it. A big corporation such as Semb Marine may get mired in a lot of red tape and bureaucracy and as such, this could hamper newsflow and hinder the smooth work processes. SM have to really look in the mirror to see what went wrong, and right now transparency and timely disclosure is paramount in restoring confidence. I am keeping close watch on events as they unfold.

Diversify, yes, but also be wary of over-diversifying. I do not put all eggs in one basket either; but have 4 companies for long-term growth and one REIT for steady dividends.

Regards, Musicwhiz

Kit said...

Well written piece bro Muzicwhiz!

musicwhiz said...

Hi there Kit,

Thanks, am glad you dropped by to read it. Appreciate your views if any, in future. Cheers ! :)

Regards, Musicwhiz

level13 said...

After looking through the news these few days, i cannot fully understand why SM wanted to go into trading of forex. If they are not comfortable about the impact of US dollars on their P&L, they could just simply hedge the risk at a little cost.
For example, the customer has agreed to buy the oil rig for USD100 mil. On the day the contract is signed, SM can just approach any large bank to take up a forward contract on the USD at that day's exchange rate, with the option to exercise it when the oil rig is ready for delivery 1 or 2 years down the road.
It works like an insurance. If the exchange rate move against SM, they could exercise the forward contract. if the exchange rate move in SM's favour, they could just walk away and do nothing. Just that simple. I do not work in the finance dept, so i am be wrong. Maybe the management in SM have other plans? But any plan or strategy that made a company lose >UDS200 mil cannot be that special.


musicwhiz said...

Hi level13,

Yes, you are right about the currency risk. They can do a simple hedge like you described and basically cover themselves pretty well.

They can buy into a forward contract at a fixed rate, in order to hedge against the spot rate moving against them when the contract is due for settlement. What you described is correct, from an accounting perspective as well. I am not too sure what SM is up to, and it will take a while for PwC to dissect their books, but it's worth waiting for if it answers issues on corporate governance.

Regards, Musicwhiz