1MDB's explanation, once again

I had not too long ago insisted on

The need to convincingly explain 1MDB

And 1MDB had actually obliged several times such as this one,

1MDB clears the air

Alas, many however were not satisfied with such too technical explanation.

The 1MDB issue had since become the biggest threat to the leadership of PM DS Najib Razak as his critiques from both sides of the political divide use it as their most potent political weapon.

And once again 1MDB had come out with another explanation,  this time by Tan Sri Lodin Wok Kamaruddin who is chairman of the Board of Directors of 1MDB.

Hopefully his explanation this time is convincing enough for readers of this blog.

Here is Lodin Wok's explaination:
  

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 the 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 continues 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 Sultan Besi earmarked for Bandar Malaysia - a mixed-use urban development, and 234 acres of land in the centre of Air Itam, Penang.

The total value of the company’s assets (RM51.4 billion as at the financial year end of March 2014) comfortably exceeds the value of its total debts (RM41.9 billion for the same period). This means that the company has net assets of close to RM10 billion, representing the value it has created since its inception five years ago.

Furthermore, 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 de-leverage the group and contribute towards reducing its debt profile.

Finance costs and 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 three 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.

It is also important to note that since acquiring its first energy assets in 2012, 1MDB has built this into the second largest independent power producer in Malaysia, with a strong presence in international markets within three years.

In total, 1MDB’s energy business has consolidated 5594MW of net capacity, comprising both gas and coal fired plants.

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 overall package and awarded the contract on that basis. – December 22, 2014.