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.