Dilute conglomerate holdings<\/p>\n
By Hidayat Jati<\/p>\n
JAKARTA (JP): Four years after the financial crisis broke out
\nin 1997, more and more skeletons are coming out of the closets of
\nIndonesia's conglomerates; the last of which concerns the once-
\nmighty Sinar Mas Group. Creditors (including the Indonesian
\ngovernment) and minority shareholders learned that they are
\nincreasingly placed at the receiving end of the group's inter-
\ncompany transactions and complicated structure.<\/p>\n
All the skeletons indicate that many Indonesian conglomerates
\nare hollow, as their financial strengths and management prowess
\nhad been overrated. Indeed, these weaknesses had been masked by
\nthe flow of easy money (thanks to gullible asset managers,
\ncorrupt state bankers and the violations of the legal lending
\nlimit regulation) in the early 1990s.<\/p>\n
The flow of leverage into those conglomerates, in fact, had
\nbeen a major source of growth and a key driver for return on
\nequity, as asset turnover was relatively slow. This was well
\ndemonstrated in a recent study of corporate governance produced
\nby the Asian Development Bank (ADB).<\/p>\n
This, consequently, shows that for the most part the
\nIndonesian corporate sector had been skating on thin ice -- due
\nto the high leverage that came amid the country's nonexistent
\ngovernance, poor legal infrastructure and growing current account
\ndeficit in the late 1990s. Lenders and investors alike chose to
\nignore such fundamental factors for the most part. The ADB study
\nshows, for example, that listed property\/real estate companies --
\na sector that almost all Indonesian conglomerates had exposure to
\n-- between 1994 and 1996 continued to have average annual debt-
\nequity ratio of 163 percent while average annual sales growth
\nover the same period was a negative 15.5 percent. This seems to
\nconfirm that, indeed, easy money tends to be dumb money. For more
\nexamples, just ask those folks that used to run the bonds
\ndepartment of Peregrine Investments in Hong Kong.<\/p>\n
The structural causes of the conglomerates' current mess are
\nthreefold:<\/p>\n
* Complicated ownership structure of the conglomerate, especially
\nregarding cross holdings between banking\/financial companies and
\nnonfinancial, a factor which encourages the companies within the
\nconglomerate to carry out incestuous deals and transactions
\n(violations of bank industry lending rules);<\/p>\n
* Overwhelming domination of the controlling shareholders over
\nlisted companies (usually flagship units of conglomerate groups),
\nleading to inevitable passive roles of minority investors and
\nlittle management accountability. This contributed to high
\nleverage, as bank lending retained majority ownership while
\nproviding engines for growth;<\/p>\n
* Weak regulatory regime due to co-opted, corrupt and inept
\nbureaucracy.<\/p>\n
It is public knowledge that for the most part -- PT Astra
\nInternational Tbk is a notable exception -- Indonesian
\nconglomerates are not structured under one holding company. The
\nlack of a unified structure is a deliberate way to minimize tax
\nobligations and public scrutiny.<\/p>\n
Tycoons like Sjamsul Nursalim, Eka Tjipta Widjaja and Sudono
\nSalim tend to use different \"holding\" companies, usually little
\nknown, to represent their ownership in their flagship
\nsubsidiaries. Some even use proxies to conceal their ownership or
\noffshore-registered companies, especially to break the legal
\nlending limit, to make the entire scheme even more opaque. This
\nhas resulted in a complex web of companies whose common link is
\nthe same majority shareholder.<\/p>\n
To make things even more complicated, practically all
\nIndonesian conglomerates are family owned, a factor which
\ncontributes significantly in hindering governance. Family
\nownership inevitably encourages these conglomerates to adopt a
\nmanagement culture based more on filial piety rather than
\nprofessional accountability.<\/p>\n
After all, how can a manager\/nephew say no to the clan
\npatriarch or to the heir apparent? How can the patriarch say no
\nto the favorite son? How can the chairman-cum-eldest brother deny
\nthe wishes of the maverick younger brother who wants to expand
\ninto real estate and television broadcasting at the same time?<\/p>\n
It is in Indonesia that the concentration of conglomerates'
\nownership is most extreme, especially when compared to other
\nAsian former tigers. A 1999 World Bank study on the subject,
\nwhich is also quoted by ADB's governance study, shows that in
\n1996 about 15 families controlled 61.7 percent of Jakarta's
\nmarket capitalization. This is the highest rate of concentration
\nin all the Asian countries surveyed by the bank. It is surely no
\ncoincidence that Indonesia's corporate sector was also the most
\nleveraged and now the weakest in the region.<\/p>\n
Subsequently, a very dangerous symptom emerged from the
\ncomplex structure of family firms. This is the incestuous
\ntransactions between companies within the same conglomerate. Most
\ntypical are the cases involving the listed entities (usually the
\ncrown jewel of the conglomerates) and the privately held
\nentities.<\/p>\n
All these practices breed moral hazards since it is almost
\ncertain that in most cases, there is no competitive bidding. In
\ncases of inter-company acquisitions (most often involving a
\nprivate asset being acquired by a listed unit), a common
\nphenomenon on the Indonesian capital market, valuations had
\nalways been suspect, while the synergic pretext for the
\nacquisitions, was often, well, just pretext.<\/p>\n
This symptom is dangerous because it reflects a very
\nfundamental flaw in the thinking of the controlling shareholders.
\nOn the one hand, they aim to create a real institution, a going
\nconcern, while, at the other, they want to exploit their crown
\njewel for short-term benefit.<\/p>\n
Such contradictory activities by definition cannot be
\nsustainable, as over time these companies will lose their sense
\nof strategy -- in the Michael Porter sense of the word, as they
\nare never forced to make a trade-off in their investing
\ndecisions. More profoundly, inter-company transactions make the
\nline between personal interests of the owners and what the
\ncompany really needs very hazy.<\/p>\n
In some extreme cases, the line disappears altogether, as
\nevidenced in the example of one Indonesian cement company, owned
\nby a conglomerate, who \"lost\" US$250 million from its coffers. A
\nless controversial example was provided in 1995, when an
\nIndonesian cigarette company, following the personal investment
\ndecision of its chief executive officer-cum-largest shareholder,
\nbegan to accumulate shares of PT Astra International, a largely
\nautomotive company (the cigarette company has sold all its Astra
\nholdings by now).<\/p>\n
To put an academic spin to the issue, it strongly appears that
\na case of institutional failure overcame most of Indonesia's
\nconglomerates. The contradiction mentioned previously reflects
\nthat impersonal rule, a cardinal rule in all modern institutions
\nas formulated by the great sociologist Max Weber, failed to
\nmaterialize among Indonesian conglomerates.<\/p>\n
In the meantime, the most obvious and immediate costs for such
\nincestuous practices, of course, falls on minority shareholders
\nand creditors, especially the unsecured ones. But because of the
\nconglomerates' exposure to the banking industry, and the
\nincestuous bad lending that resulted, Indonesian taxpayers too
\nare paying the price to resurrect the banking and corporate
\nsectors, even though most of them never directly enjoyed the
\nfruits of the abuses.<\/p>\n
The solutions must go to the heart of the problems. It must
\naddress the matter of corporate structure, the lack of
\nshareholder activism and the debt overhang. This is a monumental
\ntask, but some steps can be taken.<\/p>\n
The solution must involve an element of de-personalization of
\nlisted companies. In other words, the government must provide the
\ncarrots to encourage founding shareholders to release more shares
\ninto the market, so that a healthier ownership structure, at
\nleast for listed companies, is attained. This could be done in
\nthe form of zero capital gain tax charged on founders to reduce
\ntheir holdings in listed entities (during an initial public
\noffering or a right issue). In some restructuring cases, a
\ndilution of the founders' ownership has already taken place, such
\nas in the case of PT Bakrie Brothers Tbk.<\/p>\n
True, this is a controversial idea given the current fiscal
\noutlook. But the potential benefits of having extra liquidity in
\nthe stock market (which may result in greater capital inflow,
\nsomething which should help the current account situation) as
\nwell as greater control of the investing public should be
\nconsidered. The potential long-term benefit is likely to override
\nthe short-term fiscal cost.<\/p>\n
The second element of the solution is shareholder activism to
\ncounter the founding shareholders and their management teams.
\nRather than waiting for the government to provide the
\naforementioned carrot, and to reinvent the wheel, Indonesian
\nmarket regulators and investors (pension fund managers, insurance
\ncompanies) should consider a recent proposal suggested by David
\nWebb, a lone but increasingly respected market watchdog in Hong
\nKong. His proposal is smart, realistic, market-friendly and
\napplicable to Indonesia (http:\/\/www.webb-
\nsite.com\/articles\/hams.htm.). This proposal, centered on the
\nformation of an association of independent shareholders (to be
\nfinanced by a small levy on stock transactions) has been endorsed
\nby the Asian Wall Street Journal.<\/p>\n
Third, and most difficult, is debt restructuring\/workout. This
\nexercise, usually quite mundane affairs in developed markets, is
\nhighly political in Indonesia given its persistently weak legal
\nsystem and the Soeharto legacy of unholy alliances between
\ntycoons and political leaders. But without restructuring, which
\nmay or may not involve bankruptcy, the Indonesian corporate
\nsector cannot move on, as it cannot get new capital. (The ADB
\npoints out that unlike Korea and Thailand, foreign banks directly
\nlent to Indonesian companies. The two countries' foreign
\ncreditors first enter the domestic banking sector, a factor
\ncontributed in a speedier restructuring process.)<\/p>\n
This part of the solution clearly requires careful thought.
\nBut it is clear that the chief condition to force deadbeat
\ncompanies to deal with their lenders (read: taxpayers -- who are
\nfinancing the new capital in the form of recapitalization bonds
\ninto the banking system) is a reliable stick, i.e. an impartial
\ncommercial court. The current outlook for this to develop remains
\nmixed at best. Why?<\/p>\n
Because we continue to hear, even today, that families of
\npolitical leaders travel overseas with owners of deadbeat
\ncompanies, who have possibly committed corrupt acts in the past.
\nWe also continue to hear and see how defense attorneys easily
\nflaunt their \"friendship\" with judges.<\/p>\n
In short, it is clear that Indonesia's public institutions too
\nare in a major mess. On this issue, it remains to be seen whether
\nthis saying is true in the Indonesian case: \"The more things
\nchange, the more they look the same.\"<\/p>\n
The writer is a Jakarta-based business researcher.<\/p>", "url": "https:\/\/jawawa.id\/newsitem\/dilute-conglomerate-holdings-1447893297", "image": "" }, "sponsor": "Okusi Associates", "sponsor_url": "https:\/\/okusiassociates.com" }