In Singapore: Truth is No Defense

A number of years ago when I had finished my manuscript for my book on sovereign wealth funds, I realized that there was potential legal risk arising from the litigious nature of the Singaporean government.  My publisher arranged to have a well known American lawyer with experience in Singapore on freedom of the press and defamation review the book.

When I met with him to review the manuscript in detail and make edits, he explained the legal standard for writing in Singapore.  It is frighteningly simple and draconian: truth is not a defense.  Everything I wrote in my book was fact checked multiple times by multiple people but as he emphasized in Singapore, it simply does not matter.

Yesterday in the damages portion of the lawsuit against Roy Ngerng by Prime Minister Lee Hsien Loong, the absurdity of this legal standard was on full display.  In response to the inquiry whether the facts on Mr. Ngerng’s blog were accurate the son of the first prime minister of Singapore responded “the quotes are factual but the article is not.”  Mr. Lee has presented no evidence to refute the facts, that even he does not dispute, or demonstrate how the facts presented by Mr. Ngerng are constructed to create a false narrative.  Mr. Lee refuses to even argue about the truth.  He later argued that “…there’s not point going through it again other than to aggravate damages.”

Put this dispute in perspective.  Mr. Lee is not disputing facts presented by Mr. Ngerng but rather that his feelings were hurt.  The problem the son of the first prime minister faces is that he cannot argue facts with Mr. Ngerng.  There is clear public evidence that the Lee family has personally benefited from the financial dealings of Temasek which could be presented in open court.  There is clear evidence that public Singaporean funds have been used to subsidize Temasek owned firms.  There is clear evidence that enormous discrepancies exist in Singaporean public finances.  $822 billion SGD in free cash flow over 40 years cannot earn 16% and 7% and be transformed into $834 billion.  These are facts.

It is only in the Kafkaesque world of the Singaporean system that facts are irrelevant.  $800 billion discrepancies mere inconveniences compared to the over sensitive feelings of pampered children.  I have always offered to come to Singapore and allow myself to be sued and this offer still stands.  It reveals the weakness of the sons position that he refuses to discuss facts but rather the sensitivity of his feelings.  If I could not argue on the merits, it makes sense to exclude truth as a defense.  Welcome to Singapore Mr. Ngerng.

S&P Looks at Temasek Part II

The S&P criteria for evaluating investment holding companies (IHC’s) has the potential to move Temasek from a AAA rated credit firm to Greece as the headlines have noted.  While this headline does accurately capture the potential impact, too many have focused on the outcome and a misreading of the its implication and not enough effort focusing on how the proposed methodology arrives at the new rating.  In fact, the potential outcome of the S&P proposal rests on much more technical reasons than a sudden belief that Temasek is a low credit quality firm.

The biggest proposed change is the importance S&P gives to liquidity in their risk assessment of IHC’s noting that “we propose to give a greater weight to our assessment of asset liquidity than to our assessments of asset diversity and asset credit quality.”   S&P stresses the importance of liquidity “…because the ability to sell assets quickly is the ultimate source of debt repayment if an IHC cannot refinance maturing debt.  Our assessment reflects how quickly we expect the entity can liquidate assets at a reasonable price.”

There are solid financial reasons, especially for a firm like Temasek, to accept higher liquidity risk by holding lower liquidity assets.  Studies have found that asset liquidity is valued so that financial firms, such as hedge funds, willing to hold lower liquidity assets receive a premium for bearing that risk.  University endowments have targeted lower liquidity investments given longer investment time horizons and the ability to sell at their discretion.

The second major proposal is to use “spot prices” rather than some “average price over n trading days – to value listed assets.”  Related to but also distinctly different from liquidity, this focuses on what price could assets be sold to cover debt payments.  This debate has raged for how banks should value their loan portfolios in what is typically called “mark to market” by valuing a bond or loan at the market price the bank could expect to sell it at or at some other less potentially volatile rate such as a long term average or expected stream of cash flow basis.

There is reasonable and straightforward logic as to why spot prices should not be used.  Let’s use a simple scenario to illustrate why.  Assume the market price of an asset declines and a financial institution reaches a level where they have to sell the asset to cover their debt payment.  When they sell an asset this further depresses the market price potentially causing other firms to be forced to sell.  It is also possible to recreate this scenario in reverse when prices are going up.  Fundamentally, there is a solid argument that using market prices can increase volatility.  It should be strongly emphasized that reasonable people have reasonable disagreements on this very tricky issue.

While these two concepts need to be considered separately, they also need to be considered jointly.   S&P is proposing that we ask the following about credit risk as it pertains to IHC’s: if an IHC needs to sell assets to repay a debt, how easily can it sell its financial assets and at what price?

How do these concepts apply to Temasek specifically?  Temasek can reasonably be considered a somewhat less liquid IHC for two reasons.  First, Temasek asset holdings are relatively concentrated.  Temasek holdings are concentrated with significant stakes in key firms like Singapore Telecom, DBS, Standard and Chartered, and China Construction Bank.  As one article noted, approximately 50% of Temasek assets are concentrated in ten firms.  If Temasek needed to sell some of these stakes, given the large size of the holdings, this would reduce the liquidity by pushing down the price if Temasek needed to sell a significant amount or if the market found out Temasek was selling a sizable block.  Also, if Temasek ever needed to sell its entire stake in a major holding, this would significantly reduce companies with the ability to finance large acquisitions.

Compare this to Norges Bank Investment Management (NBIM) which manages the Norwegian sovereign wealth fund.  They have limited themselves to 2% of outstanding equity of any company they hold.  While this essentially turns them into an index fund as they hold 1-2% of most every listed company, this also means that they remain very liquid.  NBIM is able to easily sell stakes in entire companies in relatively short periods of time or in many companies when needed.  In short, there is elevated liquidity risk due to the concentration of Temasek’s portfolio.

Second, there is what I will term political liquidity risk.  Look at the major holdings in Temasek’s portfolio and you will see politically strategic firms like Singapore Telecom, DBS, and Singapore Airlines.  Those are for all practical purposes completely illiquid investments where Temasek depends on dividend cash flow for debt repayment.  Removing firms from the Temasek portfolio that are for all practical purposes illiquid, reduces Temasek liquidity to cover debt repayment even further.  The S&P concern over liquidity risk has a significant impact when focusing on Temasek.

Turning to the question of what price Temasek might be able to secure for its assets under different market conditions returns us to the issue of asset concentration and political risk.  Not only is the Temasek portfolio concentrated within its portfolio, it is concentrated by industry and geography with an increasing allocation to higher risk assets like financial and natural resource firms.  For example, three of the top four holdings are in financial firms and Temasek remains closely linked to Singapore and surrounding countries.  This implies a high degree of correlation among their holdings.  If the market is declining, then Temasek would need to price any significant asset sale at an even larger discount.  Conversely, in a rising market Temasek might be able to extract a sizable premium for one of its strategic stakes.  However, given the concern about debt coverage from asset sales, we should focus on down markets and again there is cause for concern.  There would be significant pricing pressures on any significant asset sales by Temasek.

There would also be pricing pressure due to potential political risk.  Let’s assume for one moment that Temasek decides to sell a significant stake Singapore Telecom, DBS, or Singapore Airlines.  Given the long historical record, key personnel through each firm, and political significance, any buyer would be enormously concerned about undue influence exercised after the sale.  The same could also be said about most Asian holdings for instance in China Construction Bank or Bank of China.  The Chinese government would most likely have a strong opinion about Temasek selling its holding to anyone else.  Political risk is likely to impact the final sales price and not positively.

The primary risks the S&P is proposing to increase in its credit model for IHC’s are the ability to sell and the price it will receive for selling.  I believe there is a fair and reasonable case to be made that when Temasek is narrowly analyzed against these two criteria, it does have an elevated risk level.  There is good reason to have some concern over liquidity and asset pricing risk should it need to sell assets to cover debt repayment.

As noted at the beginning of this article, while the S&P frameworks does raise the risk profile of Temasek, it is important to note the reasons why.  Their reasoning focus on specific and technical issues and not due to a new belief in the underlying quality of Temasek assets.

Note:  Part III will cover the Temasek response, whether they should be considered as risky as Greece, and other bigger picture issues.

S&P Looks at Temasek and Sovereign Wealth Funds Part I

Somehow I missed the November release of the credit ratings agency S&P asking for comments on its proposal for updating standards of investment holding companies (IHC) and government related entities (GRE).  This is both a somewhat technical exercise and discussion by credit ratings agencies that takes place to reassess their standards for evaluating credit risk but also has very tangible impact on Singaporeans and can be explained in ways that make sense.

Before beginning to analyze the proposed S&P standards and Temasek’s response, let me try and provide some background to better understand the overall situation.

  1. S&P is one of the three major global credit ratings agencies along with Moody’s and Fitch.  Their market dominance stems primarily from their oligopolist position conferred by the US government within the American market.  Less than 10 credit rating agencies in the United States are recognized as “nationally recognized statistical reporting agency” which allows a privileged position for instance in rating investment grade debt held by a large variety of institutions.  The big three are estimated to control approximately 95% of the credit rating market in the United States which they leverage into dominant positions throughout the world.
  2. S&P, in putting forth generalized standards, is trying to create a clear, transparent, framework that they can use to compare different companies rather than make every analysis unique.  To take a simple scenario, they might state that companies with a debt to equity ratio of greater than 3:1 will receive a B rating while a company under than will receive an A.  Framework standard sacrifice detail and uniqueness, which individual analysts will provide later when researching companies, for broad standards than can be applied throughout the world.
  3. The broad framework standards used by every credit ratings agency can be used to disguise the true risk.  Frameworks to assess credit risk are generally solid guidelines but like all rules can be used to manipulate the overall system.  During the global financial crisis, many mortgage linked products met the technical guidelines to receive a high rating even if it clearly masked the true level of risk for that financial instrument.  Guidelines laid forth by ratings agencies should be considered fallible frameworks that attempt to capture common risk factors but they absolutely should not be considered final and perfect assessments of individual risk.
  4. Credit rating agencies are riddled with group think and conflicts of interests, but at the same time historical data reveals a very clear relationship between defaults and ratings.  The riskier the rating the higher the probability of default (PDF).  Credit ratings are imperfect by any measure with a systematic downward risk bias, but they should be ignored at your peril.  There is a strong relationship between both initial rating and adjusted rating and default probability.
  5. Credit ratings rarely change so consequently, there is a lot more interest in the framework or the rules that allow firms to receive top credit ratings.  Unlike credit default swaps (CDS) which trade daily and can be used to predict default probability, bond ratings typically go years without a ratings change so the initial rules of the game matter a lot more.  According to S&P, the last time it changed its IHC framework was May 2004 when it was entitled “Rating Methodology For European Investment Holding And Operating Holding Companies.”  The “European” in the title should giveaway how outdated the S&P framework is.
  6. Every firm that does not receive the rating they feel they deserve will loudly protest that there are factors unique to their situation that the ratings body is not accurately weighing.  Most of the time, but definitely not always, firms arguments that the ratings agencies fail to accurately understand their industry or firm are poor attempts to gain a better ratings.  Credit ratings by the large agencies on average accurately assess the credit risk associated with firm issued debt.  If anything, credit ratings agencies on average understate rather than overstating the risk associated with debt products.
  7. S&P in its framework creation rarely deals with the type of issues I raise such as accounting or corporate governance problems but rather on much narrower concerns focused on whether debt can be repaid and potential stress concerns.  For instance, two issue which S&P raises which may seem technical are liquidity and mark to market vs. trailing average over some period.  Again, these are broader framework issues narrowly focused on repayment rather than the specific corporate concerns.

So as not to turn this into an excessively lengthy post, I am going to limit this post to the broader framework and background surrounding this issue.  This is a very important issue that has very real ramifications for Temasek, Singapore, and everyday Singaporeans.  I want to make sure the background and broader issues are understood so that when I turn to analyzing S&P’s proposal and the Temasek argument, everyone is aware of what is unfolding.

This may seem somewhat technical and boring but let me assure you it is vitally important and will be very important.

Subsidizing Profits, SMRT, and Temasek

In 2008 during the global financial crisis, United States politicians debated whether bailing out failing banks would set the precedent of ‘privatizing profits and socializing losses’.  Economists call this problem “moral hazard” when companies are not forced to recognize their risks and consequently accept higher risks knowing a third party will absorb their losses.  While the debate rages about whether major US and international banks privatized the profits and socialized the losses, this is standard practice with many Singaporean and specifically Temasek owned companies.

SMRT is probably the best example of this practice within Singapore.  As I have noted elsewhere,   SMRT and other Temasek firms enjoy tremendous privileges that other foreign or even other Singapore firms simply do not enjoy.  For many year, the Singaporean government has paid for the capital that that SMRT uses everyday.  The tunnels, the rail lines, the subway cars, and buses that SMRT uses everyday have been purchased by the Singaporean tax payer.

The financial effect is simple.  SMRT as a publicly listed company and a portfolio company owned by Temasek makes money only because of the generosity of the government and the Singapore tax payer.  Despite having recently declared a $62 million SGD net profit for the year, SMRT depends heavily on the gifts of the Singapore tax payer through gifted buses and other infrastructure.  If SMRT had to make principal and interest payments on the buses alone, it would require yearly payments of $150 million SGD.  The financial effect is this: SMRT profit is entirely attributable to subsidies given to it by the Singaporean tax payer and not high quality management at Temasek.  Put another way, Temasek and its senior executive are only able to declare a profit for SMRT because the Singapore government gives it money.

There are three more philosophical reasons this matter.  First, most people appreciate and respect the success of other when gained through skill, talent, and hard work but resent unfairly gained benefits.  This is why few people complain about companies like Apple or Google, they make a good product and compete with others.  SMRT has not achieved its profitability due to providing a top quality product against fair competition, but through political manipulation and public bailouts.

Second, SMRT is socializing the risk and privatizing the profits.  When losses are incurred it is the Singapore tax payer that suffers but when profits received, it is the executive of Temasek that enjoys the benefit.  SMRT is placing the risk on the tax payer but capturing the benefit for itself.  While individuals or firms taking individual or corporate risk should be allowed to keep those profits private or socialize risk and profits, it is truly objectionable to socialize the risk but privatize the profits.

Third, the true financial and economic cost of SMRT and related infrastructure is not being recognized.  As one economist noted, if something cannot go on forever it will stop.  Singapore, SMRT, and Temasek cannot maintain a loss making firm dependent on regular bail outs to report profits or eventually it will stop.  By hiding the true cost of ownership, maintenance, and investment, the government is attempting to protect its Temasek owned asset rather than the tax payer.

Mass and public transport is a notoriously difficult and generally loss making industry.  It is however, morally reprehensible to pretend that a company is making money and use tax payer money to create  profits for the investments of family members.  The people of Singapore are being defrauded by bearing the risk of investment but seeing none of the profits.

Note: This piece was prompted by a post in the last week asking whether SMRT was a public or private company.

Why is SMRT Raising Fares?

Lost amid the Anton Casey mess was the announcement that SMRT would raise fares by more than 3% in 2014 and additional 3% in 2015.  With yesterdays announcement that SMRT profit had fallen by more than 40%, SMRT appears destined to take increasingly stronger steps to maintain profitability.  While people have understandably been upset by the fare increase, there appears to be a poor understanding of how this fits into the larger picture of Singaporean public finances and the Temasek portfolio.

  1. Transportation companies and especially public transport companies are notoriously unprofitable.  There is a reason there are virtually no listed public transportation companies and that is because they are unprofitable.  Throughout the world, whether it is North America, Europe, or even Asia (Singapore and Hong Kong excluded) public transportation companies like bus and rail companies do not make money.  Public transport train, subway, and bus companies from Japan to Germany are rarely profitable enterprises.
  2. SMRT is an immensely profitable firm.  Despite being in a difficult industry, SMRT has posted net profit margins of nearly 20% as recently as 2010 and even in its most difficult recent year still managed to post a net profit margin of 7.3% equaling $83 million SGD.  In other words, despite declaring a healthy net profit, SMRT has also declared its business model “unsustainable”.  This begs the question: what is driving the unreliability and financial problems at SMRT?
  3. SMRT is receiving subsidized profits via government funds.  Though most people are aware of the subsidized fares available to seniors and students, there are two much larger and less obvious ways the government subsidizes SMRT.  First, the Singapore government has been gifting buses to the SMRT most recently to the tune of $1.1 billion SGD resulting in an annual implied subsidy.    If we take a simple scenario assuming this money was loaned to SMRT over 10 years at 5% annual interest, this would necessitate annual payments of $142 million SGD.  Consider, that SMRT only recorded net income of $161 million in 2011 declining to $83 million for the year ending March 31, 2013.  It becomes obvious how important this implicit subsidy become to SMRT reporting yearly net profits around 10%.


Second, though there is no public statement about the agreement between SMRT and the government on the rail, subway, and light rail assets, given the generosity of the government to SMRT with regards to buses, it stands to reason that they are displaying a similar level of generosity with regards to rail assets.  The government of Singapore paid for out of public funds and built rail and subway lines and then reach an agreement for SMRT to pay the government for the use of these assets.  If the government is not charging SMRT a cost plus rate for the use of those rail assets, as is the most likely scenario, this represents an additional significant subsidy.  Given the large amount of money invested by the Singaporean government over time but the longer expected of life span of rail assets when coupled with the bus subsidy, it would be conservative to estimate an implied subsidy of greater than $200 million SGD annually to SMRT.  Given their recent net profit of $83 million and their $163 million in 2010, this implied subsidy represents between 125-250% of net profits.


  1. This matters because SMRT is a publicly traded firm and a portfolio company of Temasek.  SMRT is publicly traded and counts Temasek as its dominant shareholder.  Temasek repeatedly boasts its superior asset management in producing 16% annualized returns since 1974 and SMRT has produced consistently high rates of return producing an 18% net profit in 2010.  Given the close links between the government and Temasek, each has an incentive to ensure continued profitability even if that means the government gives money to Temasek managed firms so they can declare a profit.  SMRT is only making a profit because of government subsidies not due to superior management.  If the government wants to give money to SMRT for the purpose of maintaining service, this would be a reasonable use of public funds.  However, the government giving money to SMRT so it can declare a profit and increase the rate of return for government linked shareholders is nothing less than cronyism.

Let me strongly emphasize that given the difficult nature of the public transportation industry, I am not philosophically opposed to public private partnerships in this area.  However, it seems to be a clear conflict of interest and inappropriate for the government to be subsidizing the profits of a publicly listed firm that is owned by a government owned investment firm.  SMRT clearly has no profits without government subsidies and the subsidies should not be used to allow Temasek or other executives to meet profit or return targets for bonuses.

The Real CPF Scam

I recently read Part I and Part II by Leong Sze Hian and Roy Ngerng on the Central Provident Fund of Singapore and commend them for their level of detail and analysis.  I would urge everyone to read and re-read their work to understand what is going on financially in Singapore.  Rather than revisiting or reanalyzing their work, I would like to emphasize a couple of points which I believe are of central importance to understand the financial management of Singapore.

First, the CPF acts as an implicit tax on Singaporeans forcing you into lower earning CPF investments.  Currently, CPF returns 2.5-4% beneath returns on other assets and beneath the rate of inflation incurring large losses on savers.  What makes this forced saving is that it is regressive in nature.  In other words, it penalizes the poor more than the wealthy.  This is simply immoral.  Ask yourself whether the wealthy in Singapore who make little if any forced CPF contributions would accept earning 2.5% on their investments?

Second, given that CPF contributions are invested with either GIC or Temasek, the government is essentially confiscating all returns above the CPF rate of return.  This is best noted in Chart 6 of Part II.  The implication here is that the Singaporean government is keeping an enormous amount of money using the retirement savings of its citizens.

Let me try and make this concrete and use a hypothetical scenario.  I am an investment manager and you have money for retirement savings you want to invest.  Like any informed consumer you ask me how much I will charge you to be the investment manager.  I reply, if you invest your money with me, I will keep most of the money you make and if I lose money, well you lose.  Would you invest your hard earned money with anyone who gave you that sales pitch?

If this one-sided deal sounds too absurd to believe then look no further than Temasek Holdings and GIC.  While there are valid unanswered questions about the returns of Temasek which have been written about in great detail, all Temasek money belongs to the citizens of Singapore not the government, executives, or other special parties.

Public surpluses and CPF capital saved by the citizens of Singapore is used to fund Temasek and GIC.  Yet, the government of Singapore only pays savers 2.5-4% despite claims of earning 7 and 17% respectively between GIC and Temasek.  That claimed 7%  earned by GIC in USD belongs to CPF savers and the people of Singapore.  The claimed 17% earned by Temasek in SGD belongs to the people of Singapore who provided the public surpluses and capital investment to build companies.

CPF contributions are borrowed to finance investment.  The CPF saver receives a guaranteed 2.5-4% while the borrowing party, GIC or Temasek receive all returns in excess of 2.5-4%.  The government via GIC and Temasek is confiscating returns that belong to CPF savers and taxpayers.

This is not an insignificant amount of money that the government of Singapore via CPF contributions is confiscating for its own use.  As I estimated here, an average Singaporean earning an average wage with CPF contributions and CPF interest would have approximately $537,000 at the end of their working career.  However, if we took those contributions and they earned GIC interest, they would now have $799,000.  If they earned the Temasek rate of return the average Singaporean would have $4 million SGD in the bank after a career of hard work.

That means that if the average Singaporean was not confined to earning below market returns in CPF savings, they would be $300,000-3,500,000 richer!  Put another way, the Singaporean government is keeping all money in excess of the 2.5-4% CPF return from your savings.  Put yet another way, this is an implicit wealth tax on the average Singaporean worker amounting to $7,500 annually or more than 10% of per capita GDP.

The most important point is this: CPF is your money and investment returns are the investment returns of hard working Singaporean savers.  The investment returns from CPF capital and public surpluses do not belong to the government, the PAP, Temasek, or GIC but to the Singaporean people.

CPF, GIC, and Temasek returns are not the governments money.  They belong to the savers and tax payers of Singapore who have made it a great country.  Remember: this is your money.

Note 1: Part of this post is from a previous post.

Note 2: Here is a spreadsheet that details the calculations made here.

Note 3: My apologies for not writing more pertaining to Singapore recently, I have been quite busy and pulled in numerous different directions

Note 4: I have a long awaited update to my original paper on Singapore and Temasek that I am working on and hope to release before the end of the year.

One of the Many Things I Don’t Understand About Temasek

I am reviewing the Temasek 2013 Annual Report when I come across this interesting picture on page 7 of the report (page 9 in the PDF viewer).

It says that investments made by Temasek prior to March 31, 2003 have earned an annualized rate of return of 16% over the last decade.  It also says investments made after March 31, 2003 earned an annualized return of 20% over the last decade.  I don’t have their portfolio so I can’t prove or disprove that, but here is what I don’t understand.

If you go one page up to page 6 of the report (page 8 in the PDF viewer), you get this interesting picture.

In this picture, Temasek says that its 10 year return ending March 31, 2013 was 13%.

So here is my question: how do investments made prior to March 31, 2003 earn 16% over the last decade and investments made after March 31, 2003 earn 20% over the last decade magically average out at 13%?

Update: I had a loyal reader point out that I had glossed over a very important distinction: the top figure uses “annualized” while the bottom figure uses “compound” so they are not using the same numbers.  Let me explain.  Let’s assume I invest $1,000 and in year 1 I earn a 50% return.  Then in the second year, I take the money I started with and the interest reinvest it and also earn a another 50% return.  I now have $2,250.  1,000 +(.5. x 1,000) = 1,500 + (1,500 x .50) = $2,250.  My compound return is 50%.  My annualized number however is 62.5%.  I made $1,250 over 2 years from a $1,000 investment so my annualized rate of return is 62.5%.  Thanks to a loyal reader for pointing out the wording issue.  It should be noted that using the “annualized” rate of return is a sneaky way of inflating returns.

On Princes, Generals, and Temasek

Leo Tolstory wrote in his epic masterpiece on Russian aristocracy War and Peace, while generals and princes believe they determine the course of history it is the soldier and unknown man that create the events we come to know as history.  The deterministic evolution of history resigns princes and generals to actors in their own play.

The announcement that Lim Boon Heng would replace S. Dhanabalan as the Chairman of Temasek Holdings is the changing of generals with nothing but the delusion of control over the course of history.  It is an announcement full of sound and fury signifying nothing.

From my personal conversations with people, I have actually heard generally complementary comments and anecdotes about Chairman Dhanabalan.  However, the control over Temasek is dominated by a small number of people and filling the Chairman’s seat requires above all the ability to know how and when to say yes.

The appointment of Lim Boon Heng ultimately comes as no surprise.  With no experience that would appear to suit him for the chairmanship of a major institutional investor other than being a PAP loyalist, he will fulfill the most important mandate of executing the policies faithfully as they are handed to him.  The position could have ultimately gone to any number of PAP men that know where power lies and what their role is within the larger power structure and at Temasek.

More problematic is that Temasek is beset by an insular culture.  It is noteworthy that  the only significant outsider in recent history at Temasek are Chip Goodyear and Gregory Curl.  Goodyear has quite literally vanished after a few months preparing to head Temasek.  Curl is the Temasek President focusing on its America’s business who helped bring Bank of America to the edge of bankruptcy with their ill fated acquisition of mortgage lender Countrywide and the investment bank Merrill Lynch.  In short, PAP sycophants and failed retired American bankers are the backgrounds of Temasek executives.

Given the enormous discrepancies concerning the claims of Temasek returns and Singapore public finances coupled with the staggering debt load, leadership cannot run the risk of having people who ask questions or want to change things.  Acceptance and compliance are what is required.

Despite the announcement flourish and the expectation for change, I doubt this will result in any significant impact to Temasek.  You do not rise to the top by questioning authority.

In the end, the history of Singapore will be made by the people not the princes and generals.  The people of Singapore control their fate and what they expect of their leadership.  It is the people of Singapore with the sound and the fury signifying the values they hold and the future they want that matter, not the whims of princes and generals.

This change in leadership will in time be viewed as sound and fury signifying nothing.

Temasek and the Case of the Undervalued Assets

I am amused and intrigued by people who have no understanding of the implications of their own arguments or do not carefully read what I have written.  In his “rebuttal of a rebuttal”, Mrs. Snook further attempts to convince myself and others about the correctness of her position that Temasek undervalued assets when it received them from the Singapore government therefore allowing Temasek to earn 17%.  Let us take a minute and explore his position and its importance.

Let me begin by clearly stating: the analysis of Temasek receiving undervalued assets to boost their claimed returns is entirely true.  Read my previous rebuttal (and related posts about Temasek accounting here and here) on the matter and you will clearly see that I never disagree with her or rebut her facts.  (Expecting her to respond as she did, I was kind of saving this part in reserve.  My apologies if that means I played a little dirty).  The only thing that I do is warn her about the implications of what her argument means.  Now let’s explore the facts and additional implications of what Temasek receiving undervalued assets means.

A basic argument is made about the original legacy holdings of Temasek with a simple illustration.  If the owner of a $1 million in financial assets transfers them to a holding company that they own at a nominal value of $100, nothing has changed.  The original owner of the assets, owns them, which owns the assets so there has been no change in the wealth of the owner.  The same argument is made about Temasek companies transferred from the government.  As is written “it was just an administrative exercise with no implications for the tax payer or citizen….I now own a company which owns $1 million in shares.  I have lost nothing.  I am still a freaking millionaire.”  As elegantly freaking stated as that is, let’s examine this claim closer.

First, this poorly constructed analogy overlooks the implications of how returns are claimed.  Let’s assume the owner of $1 million in unlisted financial assets, as the Singapore government was in 1974,  transfers its ownership to a company she owns for a nominal value of $100.  There is no change in wealth.  However, one year later, the owner cannot go out and claim that his company has an annual return of 999,900%!  This would be considered absurd by everyone who knew how that return was calculated.  Yet this is exactly what is claimed.  When Temasek receives assets at a “zero or nominal value” which are worth significantly more and then claims high returns, this is not a true or accurate picture of its actual performance.

Second, the reason I agree so strongly with the theory that Temasek is receiving undervalued assets is that purchasing or receiving undervalued assets is one of the best ways to cover up investment losses.  Let’s take a hypothetical situation.  The owner of the $1 million in unlisted assets transfers it to her new investment company at a nominal value of $100 and convinces her grandmother to give her some money to invest in the stock market.  Let’s assume, hypothetically of course, this new investment mogul guarantees Grandma a return of say 2.5% on her investment of $10,000.  This talented CEO takes this $10,100 into the stock market and let’s assume she buys some bank stock.  Then assume that the bank stock bought by this investment genius declines in value to say $5,000 a loss of 50.5% at which point it is sold.  Rather than going and telling Grandma she lost a lot of money, this talented investment guru revalues the unlisted assets from $100 to $6,010.  The official capital is only $5,000 but after revaluing the unlisted assets, the firm value is $11,010 allowing the new firm to declare a 10% return.  Grandma is impressed and keeps investing with her talented offspring.  This firm with the enormously undervalued assets as a cushion, can endure a lot of investment losses before encountering problems.

The question then becomes has this undervaluation of assets acquired or received by Temasek actually taken place and has the tax payer been hurt by this practice?

Due to the lack of data and their refusal to release the data, we cannot analyze in great detail the value of the assets transferred from the Singapore government at Temasek’s inception.  However, given the number of companies that were transferred, the aggregate value they were transferred at, and their size, it is quite probable they were significantly under valued when transferred to Temasek.  This would be a good start to many years of over stating returns and covering up losses.

Worryingly, this pattern of the Singapore government providing or selling Temasek significantly undervalued assets continues to this day.  There are two recent and obvious examples of how this behavior which is used to pad Temasek returns and harm the tax payer.  First, the Singapore government is paying $1.1 billion SGD to purchase buses for the SMRT.  The problem with this arrangement is that SMRT is a publicly listed, private company owned by Temasek that declared a $120 million SGD annual profit for the year ending March 31, 2012.  The government of Singapore is obviously subsidizing the profits of a Temasek company by transferring public assets to a private company incurring a tax payer loss.  To put this arrangement in perspective, if SMRT had to pay a 10 year bond with annual payment at a 4% interest rate on the $1.1 billion SGD in buses: it would pay $136 million SGD in principal and interest costs making its yearly profit disappear.  Given this information, it seems highly unlikely SMRT would have a $2 billion SGD market capitalization if the Singapore government was not subsidizing Temasek profits by billing the taxpayer for the capital used by a private company.

Second, as was pointed out by Steve Wu, Temasek with the help of a $3.2 billion SGD capital injection from the Singapore Ministry of Finance paid $3.2 SGD billion to acquire Changi airport.  This transaction is notable for a few reasons.  For instance, according to one document from Changi Airport, the government since the late 1970’s has invested approximately $5.68 billion SGD.  This implies that in pure dollar terms, the Singapore taxpayer lost approximately $2.5 billion SGD.  If we however assume, a purely hypothetical return on these airport investments by the government of 5% or 17%, the Singapore tax payer would have had an asset worth $13.3 billion or $202 billion respectively.  If the airport “investment” by the government earned a low yielding 5%, the Singapore taxpayer would have lost $10.1 billion SGD and if it earned the Temasek rate of return an astounding $198.8 billion loss.

Furthermore, by numerous valuation methods, it appears that the Changi Airport was significantly undervalued.  For instance, in its first full year of operation, the Changi Airport group earned $337 million SGD.  That is a 10.5% rate of return an incredible return for an airport.  Its profits ending 2012 was $553 million a 17% cash flow rate of return while the tax payer incurred a $2.5 billion SGD loss.  Temasek obviously received a sweetheart deal in acquiring Changi Airport at the expense of the tax payer.

To briefly recap the implications of receiving assets at “zero or nominal cost”.  First, Singapore tax payers are suffering losses by subsidizing Temasek profits.  Second, Singapore and Temasek are engaging in Mickey Mouse accounting.  Third, Temasek returns are inflated by the “zero or nominal cost” assets it received.  Fourth, Temasek accounting does not consider the cost of capital.

I completely agree that Temasek and its subsidiaries are receiving capital and companies at “zero or nominal cost”.  Unfortunately, this has disastrous and chilling implications for Singapore and Temasek.



Rebutting Nonsense: The Implications of “Zero or Nominal Cost”

I was recently notified of a rebuttal to some of my writings and specifically attempting to clarify how Temasek Holdings has earned 17% annually since 1974 as they claim.  The author claims that Temasek investment returns are entirely reasonable because Temasek received these companies at “zero or nominal cost”.  Consequently, earning 17% annually is relatively easy given the low initial valuation.  I will begin by discussing the implications of what the author claims and then in a later piece move to analyzing if what the author claims actually happened.

The Implications:

  1. Despite the author writing that I was “hinting that the returns are unbelievable and must be the result of Mickey Mouse accounting by TH”, the author states that the returns are unbelievable and are the result of Mickey Mouse accounting.  Let me explain.  The author correctly notes that the government of Singapore “started certain enterprises” in the 60’s and 70’s but then transferred those holdings to Temasek at “zero or nominal cost”.  Ask yourself this: when the government of Singapore started these capital intensive enterprises in shipping and airlines which required large investments, did it start them at “zero or nominal cost”?  Definitely not.  The government invested large amounts of money to start those companies but then transferred those assets to Temasek well below value, if what the author claims happened.  The first implication: the government is absorbing significant losses to start companies with large initial investments and subsidizing the profits of Temasek by transferring these corporate assets at “zero or nominal cost” incurring a loss for the government.
  2. The second implication of the authors claims: Temasek is engaging is Mickey Mouse accounting.  The author claims that the government of Singapore can transfer companies to Temasek at “zero or nominal cost” because these were not publicly traded companies at the time.  That is incorrect.  Just because these companies were not publicly listed does not mean that Singapore and Temasek can value the transfer of assets at “zero or nominal cost” or whatever value it wants.  As the primary or sole shareholder, those assets even in the absence of a public market, the government should have transferred those assets to Temasek based upon some measure of historical cost.  Let’s take a simple example.  If the government of Singapore creates the Acme Manufacturing company and invests $1 billion SGD and is the only or the majority shareholder, it should transfer the Acme company to Temasek based upon some value of the historical cost after accounting for profit and loss of the company say $1.1 billion SGD if the company made a profit.  The Singapore government cannot invest $1 billion SGD and then transfer that $1 billion SGD asset to Temasek at “zero or nominal cost” because it wants to artificially boost their returns.  That is truly Mickey Mouse accounting.
  3. The third implication of the authors claims:  Temasek returns claims are only “accounting” returns and not actual returns.  Just as Temasek declared a significant profit from its sale of Virgin Atlantic despite purchasing the stake for $1.65 billion SGD and selling it for $360 million, the author is saying the same thing about all Temasek returns.  By transferring the assets at “zero or nominal cost” as the author claims, this significantly increases Temasek’s accounting returns  but lowers the actual returns.  Let’s take a simple example.  Let’s assume that the government of Singapore spends $100 million SGD to create Acme Manufacturing, transfers it to Temasek at “zero or nominal cost” of say $50 million SGD, and Temasek then takes it public after which the market capitalization is let’s say $100 million.  Temasek enjoys a $50 million SGD profit and declares a return of 100%.  If Temasek receives the asset for $1 million SGD its profit is $99 million SGD and it declares a return of 9,900%!  The Singapore taxpayer however, suffers an offsetting loss of $50 million SGD (or $99 million) to subsidize Temasek “returns”.  In other words, the author is saying Temasek returns are inaccurate and should be considered accounting returns similar to declaring a profit after selling an asset for $360 million purchased for $1.65 billion.
  4. The fourth implication of what the author says: is that Temasek accounting does consider the cost of the capital.  This might be the most damaging and concerning implication.  Just as employers pay employees in the form of wages, companies have to pay and account for the cost of capital.  Capital may be a financial asset like stock in a company or a machine used to make things.  However, companies must account for their cost of capital.  A bank with deposits has to pay its depositors a small amount of interest.  A real estate development firm typically borrows money to builds a new apartment building or mall and it pays interest to a bank.  If Temasek is receiving assets for nothing then of course their returns should be enormous.  Let’s return to Acme Manufacturing for a moment.  What if they received their building and machines for free and didn’t have to pay for the cost of the building and machines?  Of course they would make a lot of money.  They should make a lot of money.  The author of this piece is stating that Temasek and other companies are not paying for their capital.  That is an enormous problem.

To briefly recap what this author has stated.  First, Singapore tax payers are suffering losses by subsidizing Temasek profits.  Second, Singapore and Temasek are engaging in Mickey Mouse accounting.  Third, Temasek returns are inflated by the “zero or nominal cost” assets it received.  Fourth, Temasek accounting does not consider the cost of capital.  Mind you this is what this anonymous author has said by arguing assets are transferred at “zero or nominal cost”.  Their argument not mine.

As I have repeatedly said, Temasek and Singapore have created an enormous problem for themselves.  If they try to tell the truth in one area, the enormity of the deception increases in other areas.  Today, I have focused only on the implications and arguments made by this anonymous author.  Next week I will examine what the data shows about whether what this author says is true.

Update: Thanks to a loyal reader for catching a small typo.