BCA's initial public offering: Let the buyer beware

BCA's initial public offering: Let the buyer beware

By Melville S. Brown

The following is the first of two articles on the Indonesian
banking crisis.

JAKARTA (JP): The current flavor of the month in Indonesian
Bank Restructuring Agency's (IBRA) ongoing struggle to resolve
the Indonesian banking crisis is the agency's initial public
offering of some 880 million shares in Bank Central Asia.
However, the purchase of this particular "asset" may well prove
to have a bitter aftertaste for the unwary investor.

At a time when Indonesia's economic recovery lags well behind
its neighbors' and the government-led bank recapitalization
program continues to founder, IBRA is leading an international
marketing effort to entice foreign investors to buy what is being
touted as: "the country's largest retail bank"; "the bank with
the strongest core deposit base and lowest cost of funds in the
country"; "the bank with a clean balance sheet and huge growth
potential in all areas of the loan market"; and "a jewel among
other banks".

The prospectus document issued by the bank and the equity
analysis prepared by the lead underwriter, PT Danareksa, both
attempt to present an optimistic and self-assured argument for
buying shares in what will actually remain a majority state-owned
financial institution.

IBRA offers to sell up to 30 percent of its equity position,
which if successful, would reduce the government's equity
position to approximately 63 percent.

IBRA management is also proactively flaunting the virtues of
the bank as they are under extreme pressure to raise funds to
partially finance the current state budget.

However, prospective investors are hampered by the limited
financial information available with the only widely distributed
analysis of the bank's performance, share valuation calculations,
and future prospects prepared by the transaction underwriters-not
the most unbiased of sources.

A closer and more independent analysis of BCA's financial
condition and recent performance reveals a number of structural
and operational weaknesses that have been either ignored by the
underwriters, completely misinterpreted by the analysts, or given
an overly optimistic spin by IBRA as the seller.

The calculations for determining the opening share price have
been primarily based on the bank's 1999 year-end financial
statements, which have been enhanced through several highly
questionable accounting practices, and an analytical approach
commonly referred to as reverse titration.

A summary of the more egregious flaws in the analysis of the
bank's financial position, its performance ratios and the
rationale for purchasing BCA shares as an investment, would
include the following issues:

* BCA reported a net profit for 1999 of Rp 641 billion, after
a loss in excess of Rp 28 trillion in 1998.

A closer look at the composition of the profit and loss
statement however, reveals that the bank continued to suffer a
significant loss on operations for the year (approx. Rp 4.6
trillion) and that the primary component for the net profit
figure was a reported extraordinary gain on foreign exchange
trading totaling an amazing Rp 5.6 trillion.

* Research into the footnotes of the bank's audited financial
statements for 1999 discloses that this supposed gain on foreign
exchange arose from the transfer of some Rp 49 trillion in
related party loans, originally due to BCA in US$ to IBRA.

In the course of the transfer these loans were converted to
Rupiah debt at an exchange rate in effect at an agreed prior
date. Despite the fact that there were no cash payments produced
through this transfer -- the Salim's still owe the balance of
these loans to IBRA -- BCA has magically booked this foreign
exchange 'gain' into income for 1999.

* Numerous phone calls to IBRA, PT Danareksa, and the bank's
auditors failed to elicit any satisfactory explanation for this
transaction.

Several of the people contacted admitted that they did not
understand the transaction. Others however, thought it was
strange and did not appear to be an acceptable income item under
internationally accepted accounting principles.

Why the government would accept the foreign exchange risk on
an unpaid debt with such a belated currency conversion, when the
rupiah/dollar exchange rate is so volatile, is unclear.

Also there are a number of other cases of dollar denominated
debt transferred from local banks onto IBRA's books without any
conversion to rupiah; the debtor still owes IBRA in dollars.

At best this action appears to be a case of preferential
treatment for a major debtor; at worst it may be another example
of the corrupt practices that have infected the Indonesian
financial sector for years.

How the bank could be the recipient of any foreign exchange
gain (or loss) when no funds have been actually exchanged and the
debt remains unpaid to a new third party, defies elementary
accounting principles and basic logic.

Whatever the real explanation for this unusual entry to
income, this item should be severely discounted when calculating
the value of the BCA franchise and a greater recognition given to
the fact that in reality the bank continued to lose money on its
operations during 1999.

Another dubious accounting entry appears to be the credit for
past income taxes (apparently overpaid due to the huge losses of
1998), which is shown as an addition or income in 1999.

The bank reported a pre-tax profit, after inclusion of its
extraordinary forex gain; of Rp 234 billion. A tax credit of Rp
407 billion brings the year-end net profit up to Rp 641 billion.

It is highly unlikely, given the financial condition of the
Indonesian government, that BCA actually received a tax refund
that could be included into its income basis. Normally any
overpayment of taxes is credited towards future tax liabilities
and as such would be shown as a prepaid expense on the bank's
balance sheet-not included into income.

If proper adjustments to the profit and loss for these
questionable income entries were to be made, Bank Central Asia
would have reported a net loss of the year of approximately Rp
5.35 trillion.

One suspects that the creative accounting mentioned above has
been employed to achieve technical compliance with the listing
requirements of the exchange. Under the rules of the Jakarta
Stock Exchange, BCA would not be able to "go public" if it
reported continued losses for two years in succession.

In any case, the loss figure is a more realistic base from
which to build assumptions for projected financial performance,
book value, and share price valuations for the year 2000 and
beyond as this highly questionable foreign exchange gain was
certainly an "not-to-be-repeated" extraordinary event.

The Prospectus for this share issue is a cumbersome document
which, while apparently meeting the standards set by the Capital
Market Supervisory Agency (Bapepam), provides little in the
manner of the readily accessible financial information and
projected business plans that sophisticated investors require.

There are virtually no detailed explanations as to how
management expects to achieve the optimistic goals set forth in
their very ambitious business plan.

Additionally, despite the late May issue date for this share
offering, both reports base their analysis on year-end 1999
financial data. There are no data for the bank's performance
through the first quarter of 2000, as is the normal requirement
for financial disclosure at this late date. To date this document
is only available in Indonesian, which severely limits its
usefulness outside of the local market.

The Equity Research report prepared by PT Danareksa is an
imaginative piece of fiction, which is clearly based on the
analyst's ability to spin straw into gold.

If the financial ratios and analysis contained in this report
were taken at face value; one would come to the conclusion that
the bankruptcy and forced nationalization of BCA were actually
positive events.

Contrary to the analyst's statements, the "cleaning up" of the
loan portfolio and the 'recapitalization' of the bank were not
internal management-driven actions. The resultant improvement in
selected financial ratios should not be interpreted as indicators
of the bank's newfound financial strength.

Because the analyst has started from the false assumption that
BCA was actually recapitalized with fresh equity, instead of
illiquid government bonds, many of the interpretations of the
financial ratios, the share price calculations and the
projections of future results are fundamentally flawed.

Neither the bank's prospectus nor the Danareksa report
adequately addresses the fact that Indonesian banking sector
continues to be structurally weak -- many would say bankrupt.

The IMF-led recapitalization program is of itself a highly
problematical exercise, which is in dire need of review and
revision.

The writer is an international banker and financial markets
analyst. He has worked in Indonesia for over 10 years as a bank
representative, advisor to Bapepam, financial advisor with IBRA
and an independent consultant to the financial sector.