P. Gunasegaram
KiniBiz
TigerTalk | DECEMBER 29, 2014

Tiger is appalled at the misinformation that 1Malaysia Development Bhd (1MDB) chairman Lodin Wok Kamaruddin has dished out, claiming he is answering questions posed by the press. Its just a masquerade – as Tiger will show, he answers nothing.

Just before Christmas, the 1MDB chairman responded to recent press outbursts over 1MDB’s activities, expressing surprise over suggestions that the strategic development company has not responded to questions.

In a lengthy 2,500-word statement (reproduced in full at the end of this TigerTalk for those who would like to hear it from the horse’s mouth) he proceeded to give 1MDB’s version of unfolding events. It was a crafty piece of work, using half-truths to mask the shenanigans taking place at 1MDB, wholly owned by the Minister of Finance Inc to bring strategic investments into the country.

Let Tiger demolish some of Lodin’s arguments by simply extracting the relevant paragraphs and giving his own take on what the chairman says. The reader can judge for himself and if he wants context he can refer to Lodin’s statement reproduced in full without any alteration.

Lodin: In fact, in terms of actual funding, the company has only ever received RM1 million in equity, which was provided by the Ministry of Finance at the time of its inception. Given that 1MDB does not receiving any funding from the Government, it is therefore simply not true to claim that the company is investing or worse, wasting, the state’s – or the people’s – money.

Tiger: How Lodin forgets! Remember, the government injected two prime parcels of land cheaply into 1MDB – the air force base in Sungei Besi and other land between the air force base and the KLCC twin towers where the Tun Razak Exchange or TRX will be put up. 1MDB has since revalued the parcels upwards by nearly RM4 billion in its accounts. Without these revaluations, 1MDB would have made losses since its inception in 2009.

As Lodin himself admits, 1MDB’s assets are built on an edifice of debt – about RM37 billion. Almost all of these are guaranteed by explicit government letters of support. If 1MDB goes under, then the government will be left holding the baby – it is the government’s money which is at risk. Remember, 1MDB has no money save for the RM1 million the government originally injected. The rest is debt for which the government and the taxpayer is eventually responsible for.

Lodin: As 1MDB funds its own operations, it should not be surprising that, from time to time, the company raises capital on the international debt markets in order to finance some of its projects. However, all of this debt is backed by solid assets.

Tiger: Solid assets? Initially some RM 7 billion were put into Petro Saudi for some Caspian Sea investment and then taken out, and then put into vague investments in Cayman Islands. Most of the money is overseas in indeterminate investments. What kind of strategic investing is that? And then it used over RM11 billion to buy power assets, all of them from Malaysian companies with some of the power asset concessions to expire not long from the time of purchase. It overpaid for these assets giving the sellers massive extraordinary gains. And out of total debt of some RM37 billion, some RM23 billion are in cash or near cash items. Why borrow and then keep over half of your assets in cash? Most are in liquid assets. Why? These are just some of the questions Lodin has yet to answer.

Lodin: To the best of our knowledge, the only Petronas-related bond issued in 2009 that carried a coupon rate of 3.6% was for a RM100 million bond with the tenure of only 3 years, whereas the 1MDB bond (RM5 billion) had a tenure of 30 years. As such, given the significant difference between the maturity periods, it should not be surprising that the bond issued by 1MDB had a higher interest rate (5.75%).

Tiger: The government has long-term bonds for 20-year maturities which carry an interest rate of about 4.8%. Given government guarantees, 1MDB bonds for a similar period should be perhaps 30 basis points higher at 5.1%. Adding on a further 30 basis points for a longer maturity, would bring a fair interest rate of perhaps 5.4% for 30 years. But what Lodin fails to mention (see our article here for details) is that the debt was issued at 88 sen to the ringgit, raising the effective yield to 6.71%. The effective mispricing could have lost 1MDB and the country RM1 billion for the RM5 billion loan, according to KiniBiz calculations with the help of bond specialists. For RM20 billion, that could have amounted to RM4 billion and for RM37 billion, as much as RM7.4 billion.

Here are some more questions for Lodin: Why was it necessary to issue debt with a maturity period of 30 years, even longer than the concession period for power assets? Was that to ensure substantial mispricing which can be realised by those who flip the bonds for a gain from the market price of the bonds? Is it not a fact that 1MDB’s bonds increased substantially in price after issue? Why borrow far beyond your capacity to use the funds? Was that to cream off front-end gains through bond mispricing?

Lodin: Repatriating these funds (some RM7 billion in Cayman Islands) to Malaysia would have exposed them to fluctuations on the foreign exchange market, as being witnessed at the moment. In order to ensure that 1MDB maintained a strong liquidity position with a truly diversified global portfolio, these funds were invested in a 1MDB subsidiary that was registered in the Cayman Islands.

Tiger: Come, come now, are you taking us for fools? You can invest your portfolio funds from anywhere and you can hedge these funds (at a price of course) to avoid foreign exchange risks. You don’t have to be in Cayman Islands to have a truly diversified global portfolio of funds. You can be in Kuala Lumpur. More questions: What benefit comes to Malaysia from making portfolio investments overseas with borrowed funds for which you are already paying 6.71% in interest costs? Should this not be done by sovereign funds? At your admission you are not a sovereign fund, you are a strategic company. So why are you doing this?

Lodin: This portfolio (power) provides the business with healthy cash flows and enables 1MDB to participate in bids for coal and gas fired plants, the two primary fuel source for power generation assets in the markets that the company operates in, allowing it to create further value and drive future growth. As such, the economic benefit gained from these assets means that the company has recuperated any excess value it may have paid at the time of the acquisitions.

Tiger: Let’s face it – 1MDB bought these power assets from Malaysian companies which were spawned by the expensive privatisation ( to the government and the people) of power assets in Malaysia and some of which had acquired international capabilities. All 1MDB did was to re-nationalise some of these power companies but by paying an exorbitant price to take them back into government hands. Better that Tenaga Nasional Bhd had never given over power production to independent power producers in the first place instead of the government privatising assets expensively and buying them back at prices even more expensive than that!

And now that 1MDB has overpaid for these assets, the only way it can recover from this is to inject value into the portfolio. This was done by an award of a slew of power contracts to 1MDB which will increase the value of the portfolio and thereby mask the overpayment of the earlier assets. More questions: Is that not true? By listing the power assets and realising its value, don’t you hope to mitigate the losses at 1MDB and cover them up?

Well, that covers some of the key points Lodin makes in his statement. If he wants more questions, then here are 10 more groups of questions he should answer. Until he gives comprehensive and clear answers to these and the other questions posed here, Lodin answers nothing in his statement.

GRRRR!!!!

Full text of statement by Lodin Wok Kamaruddin, chairman of the board of directors, 1Malaysia Development Bhd dated Dec 23, 2014:

As the Chairman of the Board of Directors of 1MDB, I have viewed with surprise recent statements, both in the media and by certain individuals, suggesting that the company has failed to respond to various questions that have been directed at it over the past months.

As a Board of Directors, we welcome debate, and as a company that is wholly owned by the Ministry of Finance – and by extension the people – we believe that public scrutiny of 1MDB is a good thing, and will only serve to strengthen the company and its governance.

In the interests of increasing the company’s transparency, I have held meetings with members of the media where I listened to and responded to their concerns. Furthermore, the company has taken various other measures such as issuing multiple statements responding to allegations directed at the company, publishing a detailed document answering frequently asked questions, and releasing a public statement outlining key highlights from 1MDB’s last financial results – the first time 1MDB has done so since the company’s inception in 2009.

All of this information is freely available on 1MDB’s website, and we believe that these actions reflect our efforts to engage in a more open and constructive dialogue than has perhaps been the case in the past. Despite this, issues that have previously been raised and subsequently addressed by the company continue to be regurgitated by certain individuals. In the interests of providing clarity, we would once again like to respond to the various concerns.

1MDB’s funding and debt levels

Contrary to claims, 1MDB is not a sovereign wealth fund but rather a strategic development company. In practice, this translates into a company that is independently run and funded, but one whose investment decisions are driven by the interests of the national economy.

Whilst a sovereign wealth fund and a strategic development company may not sound very different, there is an important distinction between the two: whereas a sovereign wealth fund is directly funded by the government and invests on its behalf, 1MDB raises and invest its own capital. In fact, in terms of actual funding, the company has only ever received RM1 million in equity, which was provided by the Ministry of Finance at the time of its inception. Given that 1MDB does not receiving any funding from the Government, it is therefore simply not true to claim that the company is investing or worse, wasting, the state’s – or the people’s – money.

As 1MDB funds its own operations, it should not be surprising that, from time to time, the company raises capital on the international debt markets in order to finance some of its projects. However, all of this debt is backed by solid assets.

At present, this includes the 15 power and desalination plants in five countries that comprise our energy business, as well as our extensive property portfolio which includes 70 acres of prime real estate currently being developed as TRX – Kuala Lumpur’s first dedicated financial district, 495 acres of land on the site of the old airport in Sungai Besi earmarked for Bandar Malaysia – a mixed-use urban development, and 234 acres of land in the centre of Air Itam, Penang.

Furthermore, all of this does not take into account the expected benefit to be realised from the initial public offering of the group’s energy portfolio, which will help deleverage the group and contribute towards reducing its debt profile.

Finance costs & interest rates paid by 1MDB

Like any business, 1MDB attempts to secure the lowest rate of interest and finance costs when taking out a loan or conducting a bond issue. However, in certain instances, these interest rates and finance costs have been towards the higher end of the market rate.

It has to be understood that, when it comes to raising debt on the financial markets, there is no one size fits all solution. A number of factors determine the finance costs and the interest rate applied to a loan or bond issuance. These include the length of maturity, whether the loans are underwritten or guaranteed, macro-economic factors, and many more.

To take one example, we are aware that concerns have been raised about the 5.75% interest rate assigned to a RM5.0 billion Islamic bond that was issued by 1MDB in 2009. As a comparison, it has been noted that another government-linked company Petronas paid an interest rate of 3.60% on a bond at the same time.

This is an unfair comparison that does not take into account a number of important factors. To highlight just one: when subscribing to a bond, lenders take on a certain degree of risk and the longer the tenure, the higher the risk for the bondholder. Therefore, bonds that have a longer maturity period typically have a higher interest rate.

To the best of our knowledge, the only Petronas-related bond issued in 2009 that carried a coupon rate of 3.6% was for a RM100 million bond with the tenure of only 3 years, whereas the 1MDB bond had a tenure of 30 years. As such, given the significant difference between the maturity periods, it should not be surprising that the bond issued by 1MDB had a higher interest rate.

More broadly, it is important to note that the bond issued by 1MDB in 2009 was the first Malaysian bond with a 30-year tenure, and the first Islamic bond to be issued with a maturity period of that length. Given the economic climate at the time, the fact that 1MDB successfully managed to raise this amount of capital reflects the support, goodwill and confidence placed in the company.

Funds regulated by the Cayman Monetary Authority

There has also been substantial debate about funds invested by the company regulated by the Cayman Monetary Authority. However, anyone familiar with the financial world should be able to confirm that there is nothing unusual about companies of this size investing their funds in the Cayman Islands, which is one of the largest registered fund jurisdictions internationally, with the Cayman Monetary Authority recognised as one of the leading fund regulators in the world. Thousands of international blue-chip companies have funds regulated by the Cayman Monetary Authority, including over 200 Malaysian companies, many of which are household names.

To provide some background with respect to 1MDB’s investment: In 2009, 1MDB and a Saudi Arabian company entered into a joint venture to facilitate long-term economic cooperation between Malaysia and Saudi Arabia. As part of this, a joint-venture fund was set up to undertake investments on projects which would generate financial and strategic benefits to both countries. However, due to various factors, both parties eventually decided not to proceed with these plans.

As a consequence, 1MDB’s investment in the company was converted into a fixed income instrument in the form of Murahaba notes, essentially a loan, with an annual interest rate of 8.75%. This loan was paid back in full, for US$2.318 billion with a profit of US$488 million, in 2013.

Repatriating these funds to Malaysia would have exposed them to fluctuations on the foreign exchange market, as being witnessed at the moment. In order to ensure that 1MDB maintained a strong liquidity position with a truly diversified global portfolio, these funds were invested in a 1MDB subsidiary that was registered in the Cayman Islands. However, the company has already redeemed a significant portion, US$1.4 billion, of the fund and expects to redeem the remaining amount in the coming months.

Overpaying for power assets

In line with the Government’s strategic aim of ensuring Malaysia’s energy security, 1MDB has acquired a number of energy assets since 2012. These acquisitions have allowed the company to diversify its fuel mix and country risks, as well as benefit from healthy cash flows and the expertise of their excellent management teams.

The claims relating to the amounts 1MDB paid for its energy assets revolve around values that were attributed to the assets at the time they were acquired and on the basis of certain assumptions made by external parties. However, the company takes a long term view and consider broader synergies for the group, as well as the social and economic impact on the country, when we evaluate assets and forecast economic returns. As such, it is the management team’s strong belief that the value paid for these assets, which may have involved a premium in certain instances – as is common when acquiring another business, is commensurate with their existing and future potential.

This portfolio provides the business with healthy cash flows and enables 1MDB to participate in bids for coal and gas fired plants, the two primary fuel source for power generation assets in the markets that the company operates in, allowing it to create further value and drive future growth. As such, the economic benefit gained from these assets means that the company has recuperated any excess value it may have paid at the time of the acquisitions.

Overpaying for land

Any decision the company makes to invest in real estate is reached following an extensive period of due diligence, which includes the appointment of independent appraisers to determine the value of the land at the time of the acquisition, whilst also taking into account the value the company can add to it. All of 1MDB’s investments are undertaken in line with the best interests of the business, and with a view to stimulating economic growth and prosperity in Malaysia.

We understand that there has been some speculation about the value paid by 1MDB for a land parcel in Penang. This land is located in the centre of the town of Air Itam, a much sought after area where property prices have seen a substantial increase in recent years.

This is reflected in the prices that other developers have paid to acquire land in neighbouring areas which, at over RM200 per sq ft, is substantially higher than what 1MDB paid. In fact, in one instance dating back to 2013, approximately 9.8 hectares in Air Itam were purchased for RM267.4 million, about RM251 per sq ft, for a mixed-use development. In another, approximately RM251 per sq ft was paid for a mixed development project near the Kek Lok Si Temple.

Given the general difficulty companies face in finding sizeable plots of land in prime areas of Penang, that are suitable for carrying out large-tier development projects, the amount paid by 1MDB for this land was not only commensurate with its value but highly attractive.

Preferential treatment on power contracts

Any award takes a number of factors into consideration: the technical standards of the bid, the track record of the company, the bidding price, the urgency of the project and the whole systems cost of the bid to name a few. The projects that 1MDB have been awarded, in Malaysia and abroad, have been on this basis.

Earlier this year, a joint consortium consisting of 1MDB and Mitsui & Co, Japan’s second-largest general trading company, participated in an open and competitive tender exercise for a 2,000MW coal-fired power plant known as Project 3B. Following due consideration of the various bids, the Energy Commission announced that the joint 1MDB-Mitsui consortium had been chosen as the preferred bidder.

Subsequently, there have been suggestions that 1MDB received preferential treatment, and the basis of these claims is that the company’s bid was not the lowest offered. This rationale is flawed as it fails to take into account the fact that any award is based on a number of considerations, not just the tariff.

Whilst there was a bid that was slightly lower than the one presented by 1MDB, the fact is that 1MDB’s was the lowest compliant bid, with a proposed levelised tariff of 25.33 sen/kWh. There was a bid that was fractionally lower, of 25.12 sen/kWh, but this proposal did not comply with a number of requirements set out by the Energy Commission, key amongst which was their lack of experience operating a coal plant.

As the Energy Commission announced in a public statement, the 1MDB-Mitsui Consortium won the bidding exercise “in a fair and square manner with a well-proven technology that would enhance security of supply expected of a 2000MW coal-fired power plant operating in a grid system of our size”.

It is also important to note that there are other tenders that 1MDB has participated in where the contract has been awarded to other parties. For example; despite 1MDB offering the lowest bid for a gas-fired plant in Prai, another company was deemed as offering a better over-all package and awarded the contract on that basis.