Nepali Times
Buyers beware


Two years ago a new Kathmandu hotel issued shares to raise Rs 160 million. By the time the public issue had closed it had requests for Rs 260 million worth of shares. To accommodate the rush, Taragaon Regency Hotels Limited retained 20 percent more shareholders than it had initially planned.

The scramble for shares was re-enacted this year when Oriental Hotels Ltd (which owns the Radisson property in Lazimpat) went public three months ago. Oriental wanted to raise Rs 125 million. There was a rush to subscribe and by the end more than 94,000 had requested shares. To accommodate the high demand, Oriental was allowed to retain 20 percent more money than what was initially announced.

But there is a growing group of accounting and financial professionals who question the method in which the public issue of the Oriental shares was handled-particularly the incomplete financial information that painted a false picture about the true state of the business vis-?-vis its outstanding loans. Sources blame regulators and the company for not providing adequate information to the public buying the shares.

"The financial information in the prospectus is incomplete, even professional accountants find it difficult to assess the investment," a financial analyst told us.

At first it was only Kathmandu's close-knit circle of chartered accountants , financial analysts and stock dealers who became suspicious after uncanny similarities in the share issues of both the Hyatt and Radisson were noticed:

. Both hotels had hired the same financial consultant, an Indian chartered accountant, to prepare the financial analysis in their prospectus, which was sketchy and incomplete;

. both hotels hired the same issue manager and there was a similar information flow pattern-where news of over-subscription of shares found its way to the media within the first week of the issue; and

. eventually both hotels managed to retain more capital than what they wanted to raise.

After Oriental announced its public issue, one alert investor even wrote down his concerns and approached the Securities Exchange Board (SEB) with questions. The unnamed applicant was worried that there was a deliberate attempt to cover up the real face of the business. The applicant had questioned the valuation of assets, including the Rs 170 million worth of shares allocated to the owners for a property which stands on less than 14 ropanis of land (in comparison, Hyatt's 150 ropanis of land and development at Chabahil was valued at Rs 220 million). In the absence of chartered engineers to valuate land, valuation has always remained controversial, especially when it has been used as collateral for bank loans.

Other concerns relate to inadequate financial disclosures in the prospectus. "In many countries this would have immediately triggered a thorough investigation before the issue was approved," a chartered accountant told us. "But in Nepal we have this lackadaisical yo Nepal ho attitude."

But since public money is involved, the public has a right to full financial disclosure. It has now emerged that even the regulator, the Securities and Exchange Board (SEB) was not satisfied with a notice in the Nepali daily, Kantipur, of 19 July, and it promptly asked Oriental to correct the disclosure. The hotel complied, but got away by taking the unusual step of publishing the corrected version in a newspaper with a much lower circulation, Nepal Samacharpatra. Potential share buyers who read only Kantipur were therefore unaware of the correction.

Four banks, 17 financial companies, and the issue manager, NIDC Capital Markets, seem to have been unconcerned or decided to look the other way rather than question what professional accountants now say were holes in the disclosure and accounting statements made public before the issue. For instance, the prospectus for buyers came with a balance sheet for a year, without the profit and loss schedules. It had a balance sheet for 1998-99 showing a profit of Rs 1.54 million, but without a profit-loss statement for the same year.

We have obtained a copy of the hotel's audited accounts for the same year and the accompanying profit-loss account schedule, showing Rs 1.54 million as profit. But it does not show any allocation made for employee bonus, as required by law. Instead there is also a note that says: "Since the hotel has come into trial operation only, provisions for bonus and staff housing have not been made."

Potential investors rarely have time to pore through complicated financial documents, and anyway most wouldn't understand them even if they did. That is why they rely and trust the regulators to do their homework in vetting a prospectus. By law and also SEB directives, the issue manager is expected to check the books of the company it is selling. In Nepal, because the general public is even more illiterate about financial statements, the role of regulators becomes so much more important. But in the case of the Oriental issue, neither the regulator nor the issue manager seems to have fulfilled their role. The SEB approved the prospectus, which highlights on its front cover an "operating profit", an accounting terminology that tells little about actual profitability. The issue manager, NIDC Capital Markets, went ahead with the issue. What they should have insisted on was disclosure of "net profitability".

Oriental used a loophole in the Company Act, which does not specify what kind of profit figures should be disclosed. A financial consultant who has studied the Oriental issue told us: "Any hotel can have an operating profit if you don't make provisions for interest and depreciation-the two major costs in the industry. If the hotel had indeed made a profit it should have also paid bonus to employees."

Other players in any public issue are underwriters who are paid a fee for guaranteeing purchase of shares not taken by the public. Oriental advertised that its underwriters had "immeasurable trust" in the hotel's shares. It is unclear who regulates the underwriters because they function under the Nepal Rastra Bank. Going by the trend, underwriters in Nepal rarely have to worry about actually having to buy shares they vouch for. They know all too well that in a country where interest earned on savings has remained lower than the rate of inflation, the public would not waste time studying the project before rushing to line up for the shares.

Commercial banks have the capacity to scrutinise projects but again they have their own secrecy rules. For many banks, public issue of shares of borderline projects to which they have lent money means there is a better chance of payment of instalments on the interest and principal. In fact, the lending terms of many banks in Nepal are so stiff that most borrowers, including five-star hotels are forced to default. That is when they raise public money through issues, and that is why banks keep mum.

That thinking is reflected on page 24 of the 6th annual report of the Everest Bank Ltd, one of the eight banks in the consortium that put up Rs 770 million (as reported in the prospectus) into Oriental. The Bank reported an income of Rs 6.37 million from the hotel as interest even though the payment had not been made. It added that the interest income was shown because the hotel had given its word in writing that the money would be paid after the share allocations were made.

The present status of the loans remains unclear, and apart from overdue interest payments, the prospectus does not tell how much of the Rs 770 million loans is capitalised interest (which is interest that is merged with the principal and which indicates that a company is not meeting interest payment commitments). Only the auditors of the hotel and its financial consultants may be able to explain these highly technical accounting questions. But someone will have to ask them on behalf of the investors.

By the end of the week of 25 July, when Oriental Hotels opened the public issue, the press was already reporting breathlessly on how it had been oversubscribed many times over. Only those that were counting the change-in this case the issue manager-could have had that information. Yet, the information found its way to the media despite a written directive from the SEB against that, and the issue manager, NIDC Capital M arkets, admits providing the press with tentative estimates of the capital subscribed "in the name of transparency".

One early news report said 75,000 applicants had requested shares worth Rs 860 million. Word of the over-subscription soon spread and many who remained undecided joined the bandwagon. By the time the issue closed, there were a total of 95,708 investors were ready to invest Rs 942 million in Oriental. The hotel then went back to the regulator seeking permission to retain 100 percent of the over-subscription-with a recommendation from the issue manager. The regulator refused total retention, but it did allow Oriental to keep an additional 20 percent.

Now the hotel is richer by Rs 150 million in cash, but an increase in shareholder numbers means that future profits will now have to be distributed to a larger pool of shareholders. The hotel also did not point out in the prospectus that it could exercise the option to retain more money by accommodating more shareholders.

A notice on the new allocations was published in Nepal Samacharpatra on 13 October. The notice details the new capital structure and changes made in the composition of the board of directors to take into account the new changes. But all of that happened only after the 94,000 people had applied for the shares.

We asked Damber Dhungel, chairman of SEB, what was going on and he told us that his office had made all efforts to safeguard shareholder interest. He expressed helplessness saying, there's very little a regulator can do when so many financial institutions, including banks that invest in projects, screen and even underwrite the issues. "We felt the disclosure was inadequate so we asked it to make more information available," Dhungel said. "We don't have adequate intermediate mechanisms to punish anyone for non-compliance with our directives, and so sometimes implementation suffers."

Clearly, the regulator has problems implementing the law, but that is little consolation to the retail investors among the public who may be surprised how long they may have to wait for their money to start yielding returns. Dhungel also told us that it was his office that had asked the hotel to add footnotes to its balance sheet to clarify its profitability.

We tried to talk to Oriental's financial consultant about the share issue but he asked us to talk to NIDC Capital Markets. There we were told that the detailed footnotes in the prospectus provided perhaps more information than any issue the company has handled. "Oriental may be the only company that has detailed what made its operating profit," says Sunanda B. Shrestha, manager, merchant banking department, NIDC Capital Markets.

"As far as scrutinising accounts is concerned, we are forced to rely on assessments made by banks and other financial institutions." We worked on the Oriental issue for about a year, Shrestha says, adding, although everything may not be perfect, no effort has been spared to ensure that both the shareholders and the hotel get the best deal. Some believe at least the latter half of this is true.

(11 JAN 2013 - 17 JAN 2013)