In April of this year I talked about  some of the puzzling moves at Shuaa Capital, one of the better known investment banks in the region which is headquartered and listed in Dubai. Last month Shuaa released their H1 2017 financial results and there was quite a bit of commentary around these results. This commentary seemed to contradict the behaviour that I outlined in April. So I waited and read through the results, the press releases, the news articles and TV interviews. Now I’m ready to give a more realistic analysis of the results. My analysis will be dual, of the actual performance and of how the performance is reported. The latter is critical, as I have pointed out earlier this year on less than optimal reporting or commentary by First Abu Dhabi Bank, Abu Dhabi Commercial Bank, Emirates NBD, Mashreq Bank, Arabtec and Etisalat but stellar reporting by Dubai’s SWF ICD (all links are to my articles on reporting and transparency by these companies which were published in The National).

First a disclosure: I was Chief Investment Officer of Shuaa, but I left in 2013.

It makes sense to start with Shuaa’s official earnings release. The title is:

SHUAA Capital Half Yearly Profits Highest Since 2009.

Financially this is true. But there is important context here, usually given in the main text but I believe should be considered in the title given its importance. The first major issue to review is that 2009 is the first year after the global financial collapse. It is like someone saying that they are in the best shape since their heart attack 8 years ago. That really doesn’t tell us much, now does it? The second issue is the massive convertible bond that Shuaa had issued and which ran into complications as the holder of the bond disputed the convertible price. This had a massive affect on P/L for years to come. So a more balanced announcement might be “SHUAA Capital Half Yearly Profits Highest Since Global Financial Collapse”. What do you think?

We go to the first line of the text and it says:

Group achieves 124% growth in profits quarter on quarter reaching AED 12.1 million (Q2 2016: net loss of AED 50.8 million).

This is a great achievement, but I have an issue with saying that there was growth in profits of 124%. You see, Q2 2016 was a loss, if it grew it would be a bigger loss, if it shrunk it would be a smaller loss. A more balanced replacement would be that “Group swings into profit” which Shuaa uses in other parts of the report. You will notice that The National’s article on the matter does not make this mistake, even though they correctly report percentage changes of other financial numbers.

Further down, there is the statement:

…with the continued swing back to profitability driven by proprietary investments, advisory transactions and management fees of real estate funds.

The National’s article, on the other hand, states:

The return to profit came even as revenues remain flat compared with the first quarter, falling 32 per cent year-on-year to Dh30.4m for the three months to the end of June.

The bank’s provisions bill fell to Dh11m during the quarter from Dh57m in the same period last year, while general and administrative expenses fell 42 per cent to Dh17.8m over the same period”. So Shuaa says that its profitability came from revenue generating activities whilst The National’s journalism identified the source to be massive cuts in expenses. Let’s go to the source, the unaudited financials.

Shuaa’s quarter on quarter total revenues dropped AED 14.2 million from AED 44.6 million to AED 30.4 million. On the other hand, total expenses improved by AED 56.6 million shrinking from AED 94.9 million to AED 38.3 million. This clearly supports The National’s journalistic integrity. We’ve covered three important points on how things are reported and I think we can stop here.

Now on to actual performance. The previous article I had written that I referenced above looked at some of the related party transactions and corporate governance issues for which best practice would dictate far more transparency. So let’s see what is happening here.

We start with the income statement and the AED 63 million swing from loss to profit made by Shuaa. This comes from an AED 14 million drop in revenue (bad), an AED 52 million drop in expenses (good), and an AED 20 million increase in investments (good). So revenues, which includes Shuaa’s core business, dropped indicating weaker core business. The expenses, which also includes expenses for core business, improved dramatically. But the problem is that expense reduction is simply not sustainable. Revenues can grow forever but expenses stop shrinking when they reach zero. If it wasn’t for the investment swing of AED 20 million then Shuaa would not have made a profit of AED 12 million. We have an unexplained situation with Shuaa’s core business.

My next stop after the income statement is the cashflow statement. The beauty about the cashflow statement is that it is easier to interpret because there is far less leeway on what goes into it. The cashflow statement only gives H1 2017 versus H1 2016. As usual it is split into three parts: cash generated from operating activities, cash used in investing activities, and cash used in financing activities. The total cash and equivalents dropped from AED 309 million to AED 135 million. This is not necessarily a bad thing, in fact having 36% of your equity sitting idle in cash is probably not what you want. The question is, was the cash deployed to productive projects or not?

There are three main movements of note on the cashflow statement. The easiest is a repayment to banks of AED 100 million. Regardless of whether this is a scheduled loan repayment or a voluntary repayment, this is probably a good move, especially given the amount of liquidity that the company has. The next one is a receivable of AED 97 million from a related party based on:

…an agreement to sell part of [Shuaa Group’s] stake in a regional bank listed on Bahrain Bourse…

Selling an investment is part of an investment bank’s normal business. However, doing it with a related party creates the potential for a conflict of interest and there really should be far more transparency here. The final question was a large increase in receivables, which when traced led me to a note disclosing loans and advances to related parties of AED 26.6 million. In 2016 this was zero. This is an extremely large amount to be lent to a related party without further disclosure on who it was as well as how and why the loan was made.

There is no right or wrong here, simply a matter of interpretation as to what is best practice. In terms of reporting it is understandable that a company should try to position itself in the best light, but all companies should carefully consider how to maintain a fair and balanced picture. Similarly, the transactions I covered aren’t necessarily bad, in fact they may well be in the company’s best interests. My question is about transparency. Related party transactions need far more transparency than normal market transactions.