After Olam, IAS41 deferred till 2014

The continuing Muddy Waters saga raises questions on how biological assets should be valued. Despite the challenges, Olam remains confident, with its announcement of rights issue with detachable warrants to raise US$1.25bil

The on-going war of words between Singapore-based Olam International Ltd and US-based short seller Muddy Waters LLC, has raised a number of issues about accounting practices of companies dealing in biological assets.

At the heart of the quarrel could well be current accounting practices. The International Financial Reporting Standards (IFRS) through the International Accounting Standards (IAS) permits the recognition of future economic gains of biological assets via the IAS41 framework. The IAS41 standard is adopted and implemented in Singapore and in a number of developed countries.

The question is whether this new controversy will impact the accounting practices in Malaysia. According to an accountant familiar with Malaysian Accounting Standards Board (MASB), Malaysian companies are now in a “transitional state”, where they are given the option to use the IAS41 standard or use the existing accounting practice.

“In Malaysia, we have converged (our accounting practice) with the IFRS beginning from January this year. We have adopted the IFRS word-for-word in our own Malaysian Financial Reporting Standard (MFRS). With this, we are one in substance with the IFRS framework,” the accountant says.

Nevertheless, the accountant says that local companies have been the choice of implementing IAS41, which spells out accounting treatments of biological assets. Initially, the MASB had intended to implement IAS41 in January 2013. But with the ongoing controversy over Olam, it is learnt that MASB is extending the requirement to follow the IFRS regulations. “We are having problems with IAS41. Thus we have deferred its implementation until 2014,” says the accountant who explained that the IAS41 also affects construction and property companies.

Accounting conundrum

Malaysian companies have yet to implement IAS41. PricewaterhouseCoopers senior executive director Regina Fikkers says there is concern among plantation companies regarding IAS41 when valuing plantation trees.

Plantation trees can bear fruit for around 25 years. In a way, it is similar to manufacturing equipment. In financial statements, manufacturing equipment can be measured at historical cost and depreciated over its useful life. But how does one fairly value biological assets, which can reproduce and increase in quantity such as poultry and crops?

“Plantation companies would like plantation trees to be accounted for in a similar way to equipment. The Malaysian Accounting Standards Board had asked the International Accounting Standards Board (IASB) to consider amending IAS41 before it is adopted in Malaysia.

“The IASB has agreed to start a project to consider how best to do this. They will debate it further late this month,” she says while stating that no Malaysian agricultural companies are using the IAS41.

According to Fikkers, fair value does have its place in accounting. “For example, if you are holding an asset to sell it or for investing, what the asset is worth today is more useful than its historical price. However, to estimate a future price (of a biological asset), assumptions need to be made. The difficult question then arises on when to use fair value and when to use historical cost,” she explains.

Quarrelling over accounting standards

The whole issue on IAS41 came to light recently with the alleged controversy surrounding Olam’s accounting practice.

Olam, the world’s second-biggest rice trader, had been in the spotlight recently as a result of continued attacks from Muddy Waters founder and research director Carson Block. On Nov 27, Muddy Waters published a 133-page report on Olam, claiming that the latter is a “black hole” in terms of capital expenditure (capex).”

Muddy Waters raised concerns regarding Olam’s method of recognising future economic gains of biological assets (agricultural commodities, feed and livestock). “Olam uses potential future income from biological assets as a significant portion of its present net income. This accounting mitigates the profit and loss impact of its poor business performance,” Muddy Waters says in its report.

Muddy Waters is known for its shorting activities of overseas-traded Sino-Forest Corp last year. On June 2, 2011 Muddy Waters released a report on timber trader Sino-Forest, causing its share price to plummet nearly 80%, wiping out US$3 bil (RM9.15 bil) in market value. In the report, Muddy Waters claimed that Sino-Forest “massively exaggerates its assets” and had overstated its timber investments by about US$900 mil. In March, Sino-Forest filed for bankruptcy protection in Canada.

Will the same fate befall Olam? Likely not. “Making allegations against Olam, which is partly owned by Temasek may be a serious matter. You may get away with it elsewhere, but not in Singapore,” says a senior lawyer of a regional firm based in Kuala Lumpur, explaining that Temasek is a professional institution with rigid rules on governance and high levels of integrity. Nigeria-based Kewalram Chanrai Group’s subsidiary, Kewalram Singapore Ltd, is currently the highest shareholder with a 20.23% stake. The Singapore government’s investment arm, Temasek Holdings is second biggest shareholder with a 16.33% stake.

Sunny Verghese, Olam group MD and CEO, was determined to fight the attacks. When Muddy Waters published its Olam report on its website on Nov 27, Olam immediately responded by filing a 45-page response on the Singapore Stock Exchange the very next day. According to Olam, Muddy Waters had published false and misleading allegations. Verghese says Block’s research is motivated to create panic and thus profit from taking a short position on the stock exchange.

“We refute the report’s allegations which are false and misleading. Our rebuttal to the 133-page report demonstrates the lack of substance in the claims. Our message to Carson Block and Muddy Waters is therefore clear – this time the mud won’t stick.

“We believe that the report’s assertions are motivated to distract and create panic amongst our continuing shareholders, bondholders and creditors, to enable Carson Block and his associates to benefit from their short positions in Olam’s securities – a strategy of shouting fire in a crowded room,” says Olam, promising to vigorously defend its reputation and claim damages from Muddy Waters.

A Standard Chartered research report says that Olam’s 45-page report is “balanced and fair”.

“We view the original 45-page response as clear, balanced and fair. The arguments presented were in keeping with our original understanding, interpretation and reaction to the main points raised by Muddy Waters’ 133-page report,” says Standard Chartered.

Olam had also initiated legal action on Nov 21 in the High Court of Singapore against both Muddy Waters and Carson Block for statements made about the company.

Undeterred by the ongoing controversy, on Monday, Olam announced its proposal to raise US$750 mil via a five-year rights issue with a 6.75% coupon rate, which includes detachable warrants for US$500 mil shares in the company as a sweetener. The warrants have five-year tenure with a strike price of US$1.291, which is exercisable after three years.

To allay fears on its stock, Verghese points out that Temasek has agreed to take up all of its bonds which are not subscribed by existing shareholders. This, says Verghese, will remove any “lingering uncertainty” about the company’s balance sheet. “We received an unprecedented commitment from our long-term strategic shareholder, Temasek which signals serious confidence in Olam’s (financial) ability,” he says.

If Temasek buys all the bonds, it may emerge as Olam’s biggest shareholder with a 28% stake.

“Given recent events, while this is expensive capital relative to its history, this level of support from Temasek is valuable in calming all its stakeholders including key counterparties, bondholders and bankers,” says a Citibank research report.

Olam’s share price closed atS$1.58 on Dec 3, with Citibank projecting a target price of S$2.75 in the next 12 months, forecasting a dividend yield of 2.5%.

The counter registered top volume trades the whole of this week. On Wednesday, it dropped nine cents to close at S$1.52.

Despite the announcement of support from Temasek via the bond issue, Muddy Waters remained defiant on its assessment of Olam saying that the rights issue will only delay the likelihood of the commodity trader’s collapse.


This article first appeared in Focus Malaysia; 8 - 14 December 2012 issue; published by HCK Media Sdn Bhd