KESM: Playing That Funky Music!

'See the person and not the looks', that has always been my Granny's advice. Do not judge a book by its cover. Its character and what it does is just as important.

Does this advice hold true in the stock market?

Meaning to say if a company starts to play some funky, funky corporate exercise, what do you want to do?

Are you going to forgive the company because the company earnings are still looking nice? And since the company still look nice, you do not really mind dancing to the funky music they are playing.

Or are you going to walk away because you know very well that by playing the funky music, you begin to lose faith and trust with the management. And these are the action that most likely damper future earnings. So you rather walk away.

How? Take the issue mentioned in the ROI of Fima Corp. Do you think it is wise to dance along while the management continue to play their funky music? Or should you walk away?

Anyway, let's look at another example. KESM Industries. Back in Feb 23rd 2005, Kesm made the following announcement , in which..

• KESMI is seeking the ratification and approval of shareholders on the provision of financial assistance by way of corporate guarantees of approximately RM134 million granted to various financial institutions which have extended credit facilities to KESM Test (M) Sdn Bhd ("KESM Test"), a subsidiary of KESMI, for the duration of the credit facilities granted to KESM Test ("Provision of Corporate Guarantees").

A corporate guarantee of rm134 million to its subsidiary of KESM Test sounds like a fairly innocent exercise. However, consider this issue. KESM owns 65.38% of Kesm Test while KESM majority shareholder, Sunright, owns the other 34.62% of KESM Test.

Now the issue here was why KESM was the one taking full responsibility of the corporate guarantee?

This issue was actually highlighted in the Edge Weekly.

• The question is, should the parent company bankroll the business activities of a subsidiary that it does not wholly own? "It would be prudent for Kesmi to provide guarantees to up to its portion of Kesmi Test, which is 65.38%. It should not bankroll the entire financing requirement of Kesmi Test. The rest should be put up by Sunright," says a minority shareholder.

See the point made?

• Independent adviser says it is okay
• The deal's independent adviser, OSK Securities Bhd, has recommended that shareholders vote in favour of the resolution to provide financial assistance to Kesmi Test. OSK says it came to the conclusion based on the rationale for the corporate guarantees, the financial effect, the risk factors and Kesmi's future prospects. It states that the provision of corporate guarantees does not require immediate cash outlay. The effect will only come if the guarantees crystallise. As an illustration, if the corporate guarantees crystallise, Kesmi's borrowing will increase from RM41.7 million to RM144.8 million, assuming that there is a full drawdown of the facility and the guarantees are called upon.

Now this part highlights clearly the poor quality of advice given by the 'Independent Adviser'. The Independent Adviser should really look into the mirror and ask themselves 'For who are they writing for?'. For the company involved or for the minority shareholders?

Look at what they are saying, 'the effect will only come if the guarantees crystallise.' Oh my. What a Sherlock!

And when the guarantee is needed, Kesmi's borrowing will increase from 41.7 million to 144.8 million!

Why should KESM and its minority sharholders bare this loan?

If i am not mistaken Sunright is listed on the SGX. Is there any valid reason why Sunright cannot work out a loan in Singapore? Err.... is there something wrong with Sunright?

And a commonsense thingy, if the parent company is not willing to bear the risk of the corporate guarantee, doesn't it smells? Surely, Shirley there is something wrong somewhere, right?

How much more funkier can a corporate exercise get?

• despite the increase in borrowings from RM34 million to RM51.8 million in the FY2004 ended July 31. "This indicates that the company is currently in a better position to service a higher level of gearing. Based on the foregoing, we are of the view that the rationale for the provision of corporate guarantees is fair and reasonable," it says.

Huh? What kind of rationale is this? Gosh! What poor advice!

• At the moment, Kesmi Test's paid-up capital is RM2 million. The minority shareholder points out that if the venture fails for whatever reason, the liability for Kesmi is the entire RM134 million, while Sunright's losses would be confined to 34.62% of the share capital of RM2 million.

That's precisely the problem isn't it? I wonder how on earth does the independent adviser not realises this grave issue! If and if the venture fails, KESMI bears the full 134 million! And Sunright? Well, it losses would be confined to 34.62% of KESM Test share capital.

So such funky corporate exercise, how would you judge the action of the majority shareholder?

From a business perspective, from a commonsense perspective, do you think it is wise to be a business partner with such buggers?

For me.. if one cannot trust - dun invest in dat stock ... this rule never fails for an investor lor

That was Feb 2005.

Was that a good time to kiss and say goodbye to KESM if one owned shares in it?

The above is KESM current 2 year chart. Look at where KESM was trading in Feb 2005. Compare the price then and now.

See how important it is for an investor not to dance with a company that plays the funky music?

And here is another good exercise back in Feb 2005. I have said Sunright is listed in the SGX. Well, wouldn't it be a good idea to use the internet to check the dude out? Good idea?

Here is SGX website.. http://info.sgx.com/ ... try searching for Sunright earnings... :p

Anyway... back in Feb 2005... this was what i saw...

CONSOLIDATED PROFIT/LOSS ACCOUNT FOR THE PERIOD ENDED 31 JUL 2003 (SGD'000)
Gross turnover : 102,090
Gross sales : 102,090
Net operating profit : (5,624)
Interest/Investment income : 239
Interest paid : 1,286
Directors' renumeration : 806
Profit before tax : (1,526)
Profit after tax : (3,287)
Profit available to shareholders : (3,287)

Ahhh... see onot? How brown cow? Good ah?

ps...

KESM announced its earnings last nite...see how KESM current year-to-date sales and profit is much lower than its last fiscal year?

   KESM Industries Bhd. (9334.KU) - Malaysia
   2nd quarter ended Jan. 31:
   Figures are in Ringgit (MYR).
                                 2006               2005
Revenue                 MYR35,554,000      MYR43,333,000
Pretax Profit               4,425,000          5,174,000
Net Profit                  3,025,000          3,606,000
Earnings Per Share           7.00 Sen           8.50 Sen
Dividend                     1.75 Sen           1.75 Sen
   6 months ended Jan. 31:
Revenue                    69,214,000         90,967,000
Pretax Profit               8,381,000         11,074,000
Net Profit                  5,821,000          7,522,000
Earnings Per Share          13.50 Sen          17.60 Sen
Dividend                     1.75 Sen           1.75 Sen