10-point plan of tough love for Olam

SINGAPORE - OLAM'S announcement of a major financing package this week has been characterised as ranging from a "government bailout" to a "vote of confidence".

Either way, it is time for Olam to get serious about creating long term sustainability.

Having missed the point earlier this year from the Feb 21 CLSA report, the emergence of a significant short position, a 30 per cent decline in Olam's share price since and the resignation of Olam's 20-year CFO in June, Olam's management and board remain in denial.

The short-seller research firm Muddy Waters produced an extensive 133 page report which Olam dismissed as out of hand and responded to with a lawsuit which dilutes management bandwidth, wastes shareholders' money and does not address the root causes of Olam's problems.

In short, Muddy Waters is not the issue here, it is Olam's strategic and financial decisions that have brought this situation to a head.

The latest Temasek-backed transaction raises significant issues, as it is extremely expensive debt and equity capital, capital that Olam spent a week telling the market it didn't need.

The package of US$750 million of five-year debt and so-called "free" warrants are hardly free as they have tremendous value. Black-Scholes models have valued these warrants to be worth an estimated US$127 million.

Since Olam's proposed US$750 million of debt is priced at 95 per cent of par, the proceeds, before fees, are actually US$712.5 million including the warrants.

By backing out an estimated warrant value of US$127 million, the true bond value is actually only US$585 million, equal to 78 per cent of the original bond value.

Thus, the true yield on the bond is not the 8 per cent that Olam would like investors to believe, but rather a whopping 13 per cent.

Given the generous nature of these terms and Temasek's commitment to fully take up the rights issue, one has to wonder why Olam is paying US$15 million in underwriting fees to the banks who are taking no risk.

If you back out those fees, the cost of this debt is an even more eye-popping 13.7 per cent.

In other words, Olam is offering existing investors a bond yielding an estimated 13 per cent and at-the-money warrants which can only be exercised in years 4 and 5. No wonder Temasek wants to underwrite the entire deal - this is the sale of the century, just in time for Christmas.

But before shareholders get too excited about shiny packages under the tree, they should consider that this is just a left-pocket, right-pocket deal.

The shareholders are paying for this lavish set of terms.

The real losers are the bondholders, not to forget the investors who only a few months ago bought the US$275 million perpetual preferred shares issued at 100 per cent that are now quoted at 82 per cent.

Their already over-leveraged securities just got more risky and they get no benefit from this package.

And of course any investors unable to take up their rights will see them go to Temasek, who has no shortage of capital.

Muddy Waters' boss Carson Block did not magically create these concerns. He merely capitalised on a well-researched bet.

This process is explained with wit and insight in The Big Short by the author Michael Lewis and is a healthy aspect of capitalism.

Now the market is left to sort out what is true and what the end game is. Since this has not been done yet, I hereby submit to Olam's shareholders a 10-point plan of "tough love" to restore credibility and take definitive actions to reposition a great company for a healthy future: 1) End the war of words.

Anyone reading Muddy Waters' 133 page report will see a credible work of research.

The market has not been impressed with Olam's attempts to discredit Muddy Waters with ad hominem attacks and lawsuits.

What's needed now are strong actions, not words.

2) Raise equity, not more debt. Olam made a strategic error in saying equity was not needed until 2015.

It needs equity now. Its net gearing of 248 per cent is well in excess of industry norms and the US$750 million new debt makes matters worse and adds USD/SGD foreign exchange risk to boot.

Olam should cancel the egregiously expensive debt issue and execute a meaningful equity rights offering giving the KC Group, Temasek and management the opportunity to take up rights that are unsubscribed, if any.

This will underpin Olam's equity capital while demonstrating the commitment of its largest shareholders and management.

Selling 13 per cent debt with at-the-money warrants is a sign of desperation.

3) Immediately stop the capital expenditure programme.

This is essential as the supply of cheap debt is over.

Olam's board must stop the acquisitions, conserve cash and prove the value of the acquisitions to date.

4) Focus on generating positive cash flow as soon as possible.

Rule No 1 of battlefield triage is to stop the bleeding.

Negative cash flow while executing a capex and acquisition programme with ever increasing leverage is untenable.

5) Sell secured receivables.

Olam has said that its secured receivables are as good as cash.

It should demonstrate that by selling a meaningful amount, raising cash, paying down short term debt, creating liquidity and convincing the market of these receivables' cash-like properties.

6) Draw down a portion of both committed and uncommitted bank lines.

Olam is currently closed out of the fixed income capital markets and the availability of its undrawn, fully committed and uncommitted facilities remains in question.

In light of Olam's significant upcoming 2013 debt maturities, showing the availability of committed and uncommitted facilities would boost market confidence.

7) Get the debt rated. Olam has raised billions from the Singapore debt markets with no independent rating of creditworthiness.

An independent assessment of Olam's credit is required for investors, many of whom are individuals.

The argument that others in the industry do not have a rating is untenable and specious.

Olam's net gearing of 248 per cent far exceeds Noble's at 107 per cent and Wilmar's at 88 per cent.

The MAS and SGX, whose silence have been deafening, should also publicly back this initiative.

8) Do not buy back stock.

A stock repurchase programme burns valuable cash, increases leverage and will not impact Olam's share price.

In fact, it would likely only further worsen the precipitous declines in its bond and preferreds prices.

9) Declare if management shares are on margin or pledged.

While in the past, it could perhaps be argued that this is a personal matter, with so many questions hanging over the company, management needs to treat its shareholders as partners and declare if any shares are encumbered and could be force-liquidated at a given price point and if so, what that is.

Olam should also disclose the timeline of the events leading up to the announcement of the Temasek underwriting as the storyline has been shifting.

Olam claimed this was its idea over the weekend and had the bankers take it to Temasek.

Yet Olam also said last Friday that the CEO and two board members bought significant shares in the company.

Did the idea emerge after those purchases were made and if so, when and how?

There is no need to have questions about possible conflicts of interest when a simple timeline can put the issue to rest.

10) Don't rely too much on Temasek in future.

Too often the market believes that when Temasek is invested for over 15 per cent, they will underwrite problems that occur and banks, investors, management, and boards can then get sloppy and lazy.

As a professional investor, Temasek will do what is in its commercial interest and those who bet on additional bailouts may one day have a rude awakening, as has happened in the past.

The US$750 million debt and warrants package is one sweet deal for Temasek and is not being done for charitable reasons.

Olam, as a trading business, has failed to grasp the realities of the post-financial crisis era.

Today balance sheets, accounts and financing must be beyond reproach.

Olam has not achieved this, but has continued to travel a dangerous path in recent years fuelled by readily available credit.

It has a fiduciary responsibility to its equity and debt investors to respond with a credible and thoughtful plan of action to preserve and enhance value.

Olam has paid an extremely dear price to Temasek to buy some time. How it proceeds from here will be the existential question. Michael Dee, an investment banker for over 30 years, was Morgan Stanley's regional CEO in Singapore and a Senior Managing Director of Temasek Holdings from August 2008 to April 2010.

He has no position in any Olam securities.