Saturday, November 11, 2006

What's wrong with NEP's Par Value.

According to an article entitled "The Government's Methodology" in The Sun:

Deputy Minister in the Prime Minister's Department Datuk Abdul Raman Suliman said par value was used in the calculation [of share ownership for the purposes of the NEP] because it could give a general view on the initial paid-up capital for the whole corporate sector.

"Market values can be used but only for listed companies. For unlisted companies, market values cannot be used because they are always changing and influenced by factors that do not reflect the true value of the shares and companies' performance, such as window dressing.
Well, what's wrong with Par Value?

1. Par value is meaningless in today's financial markets.

Take for instance, Berjaya Toto. It is being traded on the KLSE at a range of RM4.40-4.60 (October 2006) when the par value of the share is merely RM0.50. It is a simple case where the market value of the shares (and ostensibly the company itself) is worth nearly 9X its par value.

What using par value does is undervalue the company back to the value of its original capital injection at its formation (this initial capital is valued at par value). This ignores all the value created and assets gained by the company's operations since its formation.

Therefore, in the EPU's eyes, there is no difference between a very valuable listed share like Maybank (market value RM11.30 & a par value of RM1) and a much less valuable one in a dormant Sdn Bhd (Pvt Ltd) company which is worth exactly the 1 ringgit it has in it's bank account (market value RM1 & a par value of RM1)!

I can't say, without more analysis of the EPU's data, whether such a ridiculous conceptual base will swing the final percentages towards the non-bumi's or bumi's favour, but suffice it to say that the calculations from the application of the EPU's methodology can only be characterised as totally inconclusive and misrepresentative of the true situation.

2. Par value doesn't differentiate between the funding structures of the companies.

What this means is that a RM1,000,000 company funded entirely out of shareholders funds (initial capital injection) is worth RM1,000,000 to the EPU's methodology.

But a RM1,000,000 company funded out of RM2 shareholder funds and a RM999,998 govt loan is only worth RM2 using the same methodology.

It ignores the basic concepts of resource and control. Both companies have the same capacities or resources to buy a million ringgit of assets or pay a million ringgit of salaries. And both shareholders (one who contributed a million ringgit and the other who contributed 2 ringgit) have the same powers and rights to control that million ringgit of assets or employees.

The more astute readers of this blog will realise that the former is suggestive of the funding structure of a self-funded non-bumi enterprise and the latter is suggestive of a bumi company that is assisted by the NEP (albeit with some exaggeration to underline my basic belief that non-bumi companies are mainly self-funded and bumi ones are govt funded. And it also makes the calculations below a lot more intuitive).

For the sake of illustration, let's suppose that these 2 companies are the only ones in the market. Therefore according to the EPU's NEP methodology, the market is defined as below:
Total Market: RM1,000,002

Bumi Value: RM2
Non-bumi Value: RM1,000,000

Bumi %: zero or negligible
Non-bumi %: 100%

As absurd as this may seem, this is exactly what the limited disclosure of the EPU's methodology prescribes. Doesn't it mean that the NEP will have to produce 150,000 bumi 2-dollar companies worth RM1,000,000 each so that their calculation will yield a "bumi ownership share" of 30%?

Like the first reason above, this has the effect of making the EPU's calculations totally inconclusive and misrepresentative of the true situation. Only this time, my intuitive conclusion is no longer neutral. I reckon it results in the gross underestimation of the bumi share in the economy.

Can the methodology be improved? Of course it can, and in one of my next posts in the near future, I will reveal my thinking on how the share ownership can be better calculated with the information already available to the EPU. The proposal will be based on the concept of Beneficial Control of an entity and Net Tangible Assets (NTA).

A little bit more was said by our Deputy Minister regarding how 30% should actually be 60%?!
Quizzed by opposition Abdul Raman said based on the composition of bumiputra in the country, the objective of the bumiputra equity ownership should be 60%. Thus, he said the 30% bumiputra equity ownership objective set under the New Economic Policy (NEP) should not be questioned.

"The 30% is the minimum objective. If we follow the racial composition, it has to be 60%. If we want to look at this emotionally, then we (bumiputra) are also not satisfied," he said.
My friend, 30% is already a nearly unattainable goal given the deeply biased methodology the EPU has used, 60% will practically ensure that the NEP is aptly the Never Ending Policy.

Btw, what about foreign investors? Shouldn't the bumi's 60% be somewhat less in order to accomodate the foreigners? Or should their investments come out of the non-bumi's "allocation" only?


Ed said...

Slight correction: the par value for BJTOTO is now RM 0.10 after a recent capital repayment. So the bumi equity suddenly shrunk by 80% without any actual change in market price!

So what's next when the bumi equity reaches 30%? Set 60% as the next target to better reflect the bumi population in M'sia?

seantang said...

Thanks. You're right. Btoto's now a dime share.

seantang said...

>>> Another good argument against EPU's methodology. Very complete and discusses the folly of focusing on the concept of shareholding rather than the concept of wealth. Sent to me with no acknowledgement of the author. If you know who wrote this, let me know and I'll acknowledge it accordingly.>>>

The Methodology of the Economic Planning Unit (EPU) in using par value to compute corporate equity distribution


Example 1 :

Ali owns 100 Tenaga shares. Par value $100 ($1 per share). Market value $1,000 ($10 per share).
Ah Chong owns 1,000 Farlim shares. Par value $1,000 ($1 per share). Market value $430 ($0.43 per share).

EPU Methodology :

Ah Chong is 10 times richer than Ali. Therefore, Ali needs help to be on par with Ah Chong.


Par value has no relation to the actual value of shares. In fact, Ali's is richer than Ah Chong. If EPU does not take relative wealth into the equation, how does it know who to help to redress the equal distribution of wealth? Obviously, as this case shows, EPU may be helping the wrong guy!

Example 2 :

Ali owns 100% of Ali Berhad. 5 years ago, he sold off 90% of Ali Berhad at $100 million. He bought a property in London for $30 million and a property in Malaysia at $10 million after 7% discount; Invested in shares in Africa $20 million ; Spent son's wedding $10 million; Gave his first wife alimony $30 million after marrying his 2nd wife. Nobody knows anything about his foreign assets although his personal marital affairs became hot news in Utusan Malaysia.

EPU Methodology :

Ali is holding only 10% share in Ali Berhad now. Ali is marginalized because other races have 90% share. He should be given an additional 20% to make 30%.

Flaws :

1.It only takes Malaysian shares into account and omits other important assets such as properties, bank savings, foreign share investments, etc and
profits extraction (spendings). Ali was originally given 100% share but he divested his shares and converted his proceeds into foreign and other assets. If Ali were to invest 100% of his proceeds into shares of a Malaysian company, only then the actual bumi % can be correctly reflected.

2.It only captures the data at one point of time. If you look at the
statistics now, it will show that he only owns 10% share and not 100% as he was originally given.

Example 3 :

Ali owns 100% of Ali Berhad. He sells off 90% of Ali Berhad to a GLC controlled by UMNO

EPU Methodology :

Ali Berhad is no longer a Bumi company since GLC is not counted as a Bumi company. Ali share is 10%. Since the GLC doesn't want to sell down its shares, Ali should be given another 20% in another company, Ah Chong Berhad to make 30%.

Flaws :

1.Notice how this caused the overall bumi equity to drop by 90% viz-a-viz increasing the non-bumi equity % immediately upon the sale to the GLC even though nothing has been changed.

2.To alleviate this, there must be some bumi value ascribed to the GLC shareholding and not 0% as is presently the case. For guidance, The ASLI methodology of accounting 70% as bumi equity is fair as GLC's employees and contracts awarded are mostly opened to bumis. This also roughly reflects
the bumi population as the Government argues that it benefits all races. Use 68%, 65% or even 60% maybe, but to treat GLC's bumi share as 0% is even furthest away from justice and fairness than ASLI's methodology.

Example 4 :

Ali is given 30% share (30 million shares) in Muthu Berhad at an IPO price of $1.50 per share for a total sum of $45 million. After 1 year Ali sold off all his shares in Muthu Berhad at $10 per share for $300 million. He made a cool profit of 255 million which he keeps in the bank.

EPU Methodology :

Since he does not now own any shares, he is entitled to another bumi portion (30%) of IPO in Ah Chong Berhad at $1.50 in the 2nd year. Ali proceeded to buy Peter Berhad, Ranjit Berhad, Sayonara Berhad, etc, .... in the 3rd,
4th, 5th year…..using the same modulus operandi. All these years the bumi equity had never exceeded 30%!

Flaw :

It doesn't take into account how many times Ali applies for an IPO as long as he had sold off his shares before applying for another IPO or if he had used the name of his nominees. This obviously results in double (triple,
quadruple…etc) handouts as long as he keeps his money out of the system of calculation ( e.g. in the bank, purchased properties, foreign investments, etc).

As you can see in this example, there are ample opportunities for leakages (triple, quadruple, etc, handouts) without even disturbing the 30% equity barometer.

Example 5 :

Ali forms a $2 company called Ali Sdn. Bhd. in year 1. He found an
ingenious way to sell a piece of paper for an enormous amount of money and made $200 million a year. In the 5th year his $2 company company is worth $1 Billion (in cash).

Ahmad forms a $2 company called Ahmad Sdn. Bhd. in year 1. He has been given a huge number of taxi permits and made a reasonable profit of $10 million a year which he drew out as salary each year. In year 5 his company is still $2 but he had earned $50 million in salaries.

Aziz is a rich man but involved in a risky business where he feared creditors going after him. On the advice of his accounting firm, he
transfered all his assets worth $500 million into an Investment holding company called Aziz & Sons Sdn. Bhd. controlled by his nominee for $250 Ordinary shares and the rest in Preference Shares in year 1. His investment company earns $20 million a year in rental and dividends but in year 5 his
company's share is still $250.

Muthusamy forms a company called Muthusamy Sdn. Bhd. In year 1, he borrowed $1,000 from his relative, put this money into his company as capital and started a business selling "kacang putih" peddling his wares around Chow Kit road on a motorbike which his company bought on hire purchase. He made
$1,000 a year and re-invest $100 a year into his company as capital. In year five his capital has risen to $1,400.

EPU Methodology :

1. Year 1

Since the methodology counts only ordinary shares at its par value, the bumi equity is only 20% (254/(254 + 1000) x 100 = 20%) while Muthusamy has 80%. Therefore Ali, Ahmad and Aziz all need help and should be continued to be given assistance until the equity reaches 30%.

2. Year 5

Since the methodology counts only ordinary shares at its par value, the bumi equity is reduced from 20% to 15% (254/(254 + 1400) x 100 = 15%) compared to Muthusamy equity of 85%. Ali, Ahmad and Aziz performances have deteriorated. Muthusamy's equity has increased at the expense of Ali, Ahmad and Aziz. Muthusamy must share his knowledge with Ali, Ahmad and Aziz. In the meantime, Ali Ahmad and Aziz needs help badly and must be continued with assistance indefinitely until the equity reaches 30%.

Flaws :

Now, notice the biggest flaws of using par value to account for % equity:

1.Ali, Ahmad and Aziz are way, way richer than Muthusamy in wealth but using the par value methodology shows that Muthusamy is way ahead of them by 80:20.

2.Ali, Ahmad and Aziz Sdn Bhds. could continue to receive enormous
contracts without even increasing 0.01 % of their equity.

3.Ali, Ahmad and Aziz could increase their personal wealth (through market value of shares and profits extractions by way of dividends, salaries, management fees, etc) without increasing even 0.01% of their equity.

4.It's even mind bogging that Ali, Ahmad and Aziz Sdn Bhds. can even
continued to receive enormous contracts and increased their wealth beyond their wildest dreams and yet register a drop in their % equity, in this case, a drop from 20% to 15%!

This could be one of the reasons why the use of a flawed methodology, the actual bumi equity has dropped from 25% to 18.9% apart from the reason that
some bumis have sold off their shares.

Comments :

I deliberately put the names as they were in the examples to elicit attention. People tends to view such sensitive matters with a racial slant – that it's all about malay and non-malays. That's when prejudice sets in and people clam up and start to defend their positions rather than seeing
the need for and the good points of a possible restructure. What I want to stress to the readers is that it's not about malays and non-malays!

The Muthusamay in the EXAMPLE 5 above could well be Pak Dollah the
fisherman from Kelantan, or Aminah selling tradisional kuihs in the KL central market, or Ah Swee selling popiahs in Penang or even the aborigine rattan gatherer in the outskirt of Sarawak! Ali, Ahmad and Aziz could well be the elite, affluent and polically well connected Ah Chong, Vincent, Gonzales, Puspha or even Shahabbudin !

Try to substitute the names and you will see that it affects you in one way or another!

Conclusion :

1.Until and unless EPU is more transparent in their methodologies to rebuke the flaws, applying normal accounting principles and the knowledgeable public's perception, the methodologies used by EPU are seriously flawed! Serious, in the sense that the interpretation of the results derived from the methodologies used (as shown in the examples) can be disastrously wrong!

2.Par value accounting does not change whereas market value changes according to the performance and wealth of a company. It does not take a genius to figure out that if the par value of Ali Sdn. Bhd. is $2 in 2006 it will still be $2 in 2020 even though you award 10 billions in contracts for this duration of time unless Ali wants to change it! Par value has no significance in accounting at all but I wonder whether the authority has an agenda in using par value accounting.

3.The figure of 18.9% could well be derived from a flawed methodology used. We all can see with our eyes everyday that elite bumis are already much more affluent than a decade ago (although the average bumis have not achieved the same measure of success) but statistics show that there is a shrinkage from 25% to 18.9%? How could this be? More importantly, the present EPU methodologies have proven that it has failed miserably to redress the equal distribution of wealth among the ordinary Malaysians.

4.In fact, on the contrary, par value methodology does the opposite! Taking Example 5 – Ali, Ahmad and Aziz are way, way richer than Muthusamy but the par value methodology in fact showed the reverse – that Muthusamy is way
ahead of them. By not taking wealth into the equation helps to conceal the spoils of the elite group like Ali, Ahmad and Aziz (remember, who could well be the politically connected Ah Chongs, Vincents, Gonzales, Pusphas or
Shahabbudins) comprising of both elite bumis and elite non-bumis! Instead of helping politically connected people like Ali, Ahmad and Aziz, the governing authority should be helping ordinary people like Pak Dollahs, Aminahs, the aboriginal rattan gatherers, Ah Swees and even Muthusamys.

5.The present EPU's methodology of evaluating % equity based on par value of shares cannot achieve the objective of equal wealth distribution simply bcause "wealth" is not used in the methodology at all! If wealth (market value of shares) is not used in the formula then how can the answers lead you to equal wealth distribution? Because the methodology is tilted to elite group, I cannot but feel that the implementers of par value
methodology are less than honest with all those hardworking non-politically connected, average Malaysians irrespective of race.

The EPU's findings are used in the formulation of the NEPs and in many other areas including in planning and charting of the Nation's growth, investments and important policies making. Its impacts are so immense, far reaching and fundamental, not only to the daily lives of 26 million
Malaysians, but also to the bilateral relations between countries across the world. Countries, and recently Singapore (who is accused of marginalizing its minority population), are already moving away from using
the par value of shares in their system.

And yet Malaysia is still using par value (and possibly, far into the future, until the 30% equity is reached) which is so fundamentally flawed in charting the direction of the country!

How can a methodology so seriously flawed be used in making such important decisions for the country?

Ed said...

I think I've seen this on the MCA website.

Ed said...

Whoops! Make that DAP & Lim Kit Siang's sites:

seantang said...

Thanks Ed, for the pointer to Lim Kit Siang's article on his site. The veritable opposition MP from Ipoh Timur's indeed the author.