Posted by: donmihaihai | November 19, 2007

FRS 39 sunk Labroy Marine?

The adoption of FRS 39 is creating trouble for me especially on the part where derivative instruments are use for hedging purpose. It become a growing part of the financial statements where unavoidable, I have to face it in either P&L or B/S or both. It was being ignored by me in the 1st place, hoping the pains(of not knowing) will goes away as compare to the pain of trying to understand it which include the most common type of derivative instruments and how they are presented thru FRS 39. The pain of understanding it is just started with no ending in sight.

Is FRS 39 easily understandable? I think not. In a recent case I was shock that the CFO of my previous holding said that she does not fully understand what is it all about and put it up due to auditor request. Beside from that, as a former auditor herself, she was unable to see it that is a possibility of wrong classification(a big error if I am right) in the annual reports. I pushed it to the Independent director which is a CFO of another local listed company and Auditor and was greeted with instant recognition of possible errors. Worse of all, up till now, there is no announcement of any sort from the company. With other disappointments during AGM, it becomes my previous holdings.

I will do it myself… with a help of a stranger.

In investing, it is always “do it myself” as there is no one to turn to for help but for the case of FRS 39(and some other), there is a helpful stranger, not a total stranger I must say, pointed me to the correct direction and examples he know. Due to laziness, I am still far from having a compete understanding of the subject but thank you very much for pointing me to the direction of light.

Labroy Marine unrealised forex losses of $207 million on derivative

How can that be happened? I was surprised but it does provided a good learning example on FRS 39. 1st of all, let make it clear how the losses come about. 1) Labroy wanted to hedge their future cashflow on their building of 2 rigs which worth about $567 million thru derivatives like swap, forward contracts and exchange options. 2) From 2006 Annual report, FRS 39 which required Labroy to mark to market of their derivatives as those are not consider as prefect hedge.

So Labory entered into various derivatives, hedging their future cashflow thru derivatives, as the foreign exchange rate move against Labory and FRS required the derivatives to value at market value at the end of 3Q2007, Labory reported a losses of $207 million, which is unrealised of course. Due to the fact that these are unrealised losses and if exchange rate move in favour of Labory, it is likely that Labory will reported gain in derivative in 4Q2007, which also mean the real losses can only by know by the end of the contract. And because of the hedging nature, the real movement in foreign exchange will results in gain which will offset each other which mean no losses or gain. But as far as I know, there is no prefect hedge so there is always been some losses or gain in the end.

Now here is the problem, regardless what are the ends results, $207 million are about 37% losses from total contract value of $567million. Even if I take an amount of $1 billion for revenues and all kind of purchases of materials, it still represented a 21% loss for one quarter. The percentage is big, how can that happen without speculating in the forex? Remember the purpose of entering derivatives is to hedge forex losses not to incur more losses or the potential of huge losses in Labory case. The conclusion I can draw is operation failure since if there is no speculative trade involved. I have never done a hedging myself but from all information I gather, it is not as easy as ABC as if I can easily hedge whatever amount I want. It is almost pretty clear to me that the most likely case is that the whole hedging operation in Labory was in a mess which led to this kind of results.

Side notes

Prior to reading up on Labory 3Q2007 results, I met a friend who likes to speculate in stock work in one of Labory associate company. When I met him after the announcement of huge unrealised losses, without a good picture of what happened, my initial conclusion to him was operation failure. While his mind was clearly on the takeover bid(his company is not the main operation of Labory)he said the person doing hedging is totally inexperience. . Will he be chop? Hedging is not one man shows which also mean the whole operation process is very weak. And if it is not going to be tightened by the new owner, this thing will just continue.

More cockroaches in the kitchen?

I did not get a good impression reading Labory 3Q2007 results. In fact it was so bad that I had to go back reading 2Q2007 to confirm it is not a one off case. Despite Labory being one of the favourite in the Offshore vessels and rigs sector, the disclosure was so bad that I almost get nothing out of it. There was no explanation or whatever that distribution expenses was positive(what is the reasons?) in 3Q2007 and what dido the same on such a big diff in admin expenses for ytd2007 results. What about the provision for foreseeable losses of $7 million? Is it the rig building segment as Labory is an old hand in other segments? Neither did Labory provide any information in the reviews of operation — it was so short that as if there is nothing to say all along.

Just by looking at 3Q2007 results alone, even without the unrealised losses, Labory results is not as good as it seem. Just like Warren Buffett said : “There’s never just one cockroach in the kitchen.”

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Responses

  1. I share the same sentiments as you.

    In fact, I called up the CFO, Phoon to ask for explaination and was greeted with a blank answer.

    It looks like this hedging thingy is going to surface more often as singapore companies become more internationalized.

  2. Possible.

    Not sure is it the same for larger companies but for many smaller companies, years of internationalisation and growth created talents and management depth shortage. And it is not one of the top urgent matter for almost all listed companies.

  3. Frm my experience, FRS39 is ambigious and even the big name auditors have problems defining it for their clients. There is seldom any precedence on the classification and each client’s case is unique.

    FRS39 can hit the financials in 2 ways – the P&L or BS. If the hedge is effective, it goes into the BS and can disappear under the Assets/Liabilities until the contract comes up for recognition. However, if it is ineffective, the full weight of the mis-hedge will be fully taken in the P&L. A extreme example of a mis-hedge would be my biz in USD and workers paid in SGD but I hedge with Euros….duh!….your P&L yo-yo like crazy.

    If operations was really the issue, then corporate governance inside really liao liao….their IA also liao liao….their external auditor is also liao liao…Board esp Finance Committee liao liao…and lastly their CFO already liao.


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