Dilute conglomerate holdings
By Hidayat Jati
JAKARTA (JP): Four years after the financial crisis broke out in 1997, more and more skeletons are coming out of the closets of Indonesia's conglomerates; the last of which concerns the once- mighty Sinar Mas Group. Creditors (including the Indonesian government) and minority shareholders learned that they are increasingly placed at the receiving end of the group's inter- company transactions and complicated structure.
All the skeletons indicate that many Indonesian conglomerates are hollow, as their financial strengths and management prowess had been overrated. Indeed, these weaknesses had been masked by the flow of easy money (thanks to gullible asset managers, corrupt state bankers and the violations of the legal lending limit regulation) in the early 1990s.
The flow of leverage into those conglomerates, in fact, had been a major source of growth and a key driver for return on equity, as asset turnover was relatively slow. This was well demonstrated in a recent study of corporate governance produced by the Asian Development Bank (ADB).
This, consequently, shows that for the most part the Indonesian corporate sector had been skating on thin ice -- due to the high leverage that came amid the country's nonexistent governance, poor legal infrastructure and growing current account deficit in the late 1990s. Lenders and investors alike chose to ignore such fundamental factors for the most part. The ADB study shows, for example, that listed property/real estate companies -- a sector that almost all Indonesian conglomerates had exposure to -- between 1994 and 1996 continued to have average annual debt- equity ratio of 163 percent while average annual sales growth over the same period was a negative 15.5 percent. This seems to confirm that, indeed, easy money tends to be dumb money. For more examples, just ask those folks that used to run the bonds department of Peregrine Investments in Hong Kong.
The structural causes of the conglomerates' current mess are threefold:
* Complicated ownership structure of the conglomerate, especially regarding cross holdings between banking/financial companies and nonfinancial, a factor which encourages the companies within the conglomerate to carry out incestuous deals and transactions (violations of bank industry lending rules);
* Overwhelming domination of the controlling shareholders over listed companies (usually flagship units of conglomerate groups), leading to inevitable passive roles of minority investors and little management accountability. This contributed to high leverage, as bank lending retained majority ownership while providing engines for growth;
* Weak regulatory regime due to co-opted, corrupt and inept bureaucracy.
It is public knowledge that for the most part -- PT Astra International Tbk is a notable exception -- Indonesian conglomerates are not structured under one holding company. The lack of a unified structure is a deliberate way to minimize tax obligations and public scrutiny.
Tycoons like Sjamsul Nursalim, Eka Tjipta Widjaja and Sudono Salim tend to use different "holding" companies, usually little known, to represent their ownership in their flagship subsidiaries. Some even use proxies to conceal their ownership or offshore-registered companies, especially to break the legal lending limit, to make the entire scheme even more opaque. This has resulted in a complex web of companies whose common link is the same majority shareholder.
To make things even more complicated, practically all Indonesian conglomerates are family owned, a factor which contributes significantly in hindering governance. Family ownership inevitably encourages these conglomerates to adopt a management culture based more on filial piety rather than professional accountability.
After all, how can a manager/nephew say no to the clan patriarch or to the heir apparent? How can the patriarch say no to the favorite son? How can the chairman-cum-eldest brother deny the wishes of the maverick younger brother who wants to expand into real estate and television broadcasting at the same time?
It is in Indonesia that the concentration of conglomerates' ownership is most extreme, especially when compared to other Asian former tigers. A 1999 World Bank study on the subject, which is also quoted by ADB's governance study, shows that in 1996 about 15 families controlled 61.7 percent of Jakarta's market capitalization. This is the highest rate of concentration in all the Asian countries surveyed by the bank. It is surely no coincidence that Indonesia's corporate sector was also the most leveraged and now the weakest in the region.
Subsequently, a very dangerous symptom emerged from the complex structure of family firms. This is the incestuous transactions between companies within the same conglomerate. Most typical are the cases involving the listed entities (usually the crown jewel of the conglomerates) and the privately held entities.
All these practices breed moral hazards since it is almost certain that in most cases, there is no competitive bidding. In cases of inter-company acquisitions (most often involving a private asset being acquired by a listed unit), a common phenomenon on the Indonesian capital market, valuations had always been suspect, while the synergic pretext for the acquisitions, was often, well, just pretext.
This symptom is dangerous because it reflects a very fundamental flaw in the thinking of the controlling shareholders. On the one hand, they aim to create a real institution, a going concern, while, at the other, they want to exploit their crown jewel for short-term benefit.
Such contradictory activities by definition cannot be sustainable, as over time these companies will lose their sense of strategy -- in the Michael Porter sense of the word, as they are never forced to make a trade-off in their investing decisions. More profoundly, inter-company transactions make the line between personal interests of the owners and what the company really needs very hazy.
In some extreme cases, the line disappears altogether, as evidenced in the example of one Indonesian cement company, owned by a conglomerate, who "lost" US$250 million from its coffers. A less controversial example was provided in 1995, when an Indonesian cigarette company, following the personal investment decision of its chief executive officer-cum-largest shareholder, began to accumulate shares of PT Astra International, a largely automotive company (the cigarette company has sold all its Astra holdings by now).
To put an academic spin to the issue, it strongly appears that a case of institutional failure overcame most of Indonesia's conglomerates. The contradiction mentioned previously reflects that impersonal rule, a cardinal rule in all modern institutions as formulated by the great sociologist Max Weber, failed to materialize among Indonesian conglomerates.
In the meantime, the most obvious and immediate costs for such incestuous practices, of course, falls on minority shareholders and creditors, especially the unsecured ones. But because of the conglomerates' exposure to the banking industry, and the incestuous bad lending that resulted, Indonesian taxpayers too are paying the price to resurrect the banking and corporate sectors, even though most of them never directly enjoyed the fruits of the abuses.
The solutions must go to the heart of the problems. It must address the matter of corporate structure, the lack of shareholder activism and the debt overhang. This is a monumental task, but some steps can be taken.
The solution must involve an element of de-personalization of listed companies. In other words, the government must provide the carrots to encourage founding shareholders to release more shares into the market, so that a healthier ownership structure, at least for listed companies, is attained. This could be done in the form of zero capital gain tax charged on founders to reduce their holdings in listed entities (during an initial public offering or a right issue). In some restructuring cases, a dilution of the founders' ownership has already taken place, such as in the case of PT Bakrie Brothers Tbk.
True, this is a controversial idea given the current fiscal outlook. But the potential benefits of having extra liquidity in the stock market (which may result in greater capital inflow, something which should help the current account situation) as well as greater control of the investing public should be considered. The potential long-term benefit is likely to override the short-term fiscal cost.
The second element of the solution is shareholder activism to counter the founding shareholders and their management teams. Rather than waiting for the government to provide the aforementioned carrot, and to reinvent the wheel, Indonesian market regulators and investors (pension fund managers, insurance companies) should consider a recent proposal suggested by David Webb, a lone but increasingly respected market watchdog in Hong Kong. His proposal is smart, realistic, market-friendly and applicable to Indonesia (http://www.webb- site.com/articles/hams.htm.). This proposal, centered on the formation of an association of independent shareholders (to be financed by a small levy on stock transactions) has been endorsed by the Asian Wall Street Journal.
Third, and most difficult, is debt restructuring/workout. This exercise, usually quite mundane affairs in developed markets, is highly political in Indonesia given its persistently weak legal system and the Soeharto legacy of unholy alliances between tycoons and political leaders. But without restructuring, which may or may not involve bankruptcy, the Indonesian corporate sector cannot move on, as it cannot get new capital. (The ADB points out that unlike Korea and Thailand, foreign banks directly lent to Indonesian companies. The two countries' foreign creditors first enter the domestic banking sector, a factor contributed in a speedier restructuring process.)
This part of the solution clearly requires careful thought. But it is clear that the chief condition to force deadbeat companies to deal with their lenders (read: taxpayers -- who are financing the new capital in the form of recapitalization bonds into the banking system) is a reliable stick, i.e. an impartial commercial court. The current outlook for this to develop remains mixed at best. Why?
Because we continue to hear, even today, that families of political leaders travel overseas with owners of deadbeat companies, who have possibly committed corrupt acts in the past. We also continue to hear and see how defense attorneys easily flaunt their "friendship" with judges.
In short, it is clear that Indonesia's public institutions too are in a major mess. On this issue, it remains to be seen whether this saying is true in the Indonesian case: "The more things change, the more they look the same."
The writer is a Jakarta-based business researcher.