Waha Capital’s management report for 2017 “[Waha] reported net profit attributable to owners of the Company of AED 425.9 million…” As is my usual approach, I double check the financials. Looking at the bottom of the income statement I see a loss of AED 95m. That’s a difference of over half a billion dirhams.

Going up the income statement I find the number that the management uses under “Profit” and the number at the bottom of the income statement is termed “Total comprehensive loss.” The main difference is a loss of AED 543m on some hedges. Now, I confess not to be an expert in accounting but I know quite a bit about investing. Waha’s accountants may be able to persuade their auditors that this classification is correct but Waha’s management should have explained such a large discrepancy to its investors, regardless of what the accounts say. Transparency is the bedrock of good corporate governance and when Waha’s management report does not provide the correct transparency, then there simply cannot be good governance. Waha’s management had a duty to its shareholders to point out the half a billion dirham loss on the hedges and to explain why they where not included in the accounting of the P/L of the company as reported. There might well be a good explanation. But no explanation is not acceptable, especially for an investment company.

This brings us to the actual hedges. When an investment company has losses on its hedges equalling about 126% of the profit, one has to ask: do they understand what a hedge is? You see, a hedge is a type of insurance against market movements reducing the value of your portfolio. In such a case Waha’s hedges would be expected to generate a profit to offset the loss on the principal investments. Of course, if Waha’s principal investments do well, one would expect the hedges to lead to a loss that reduces the overall profit. The major question here is: why did Waha capital’s management deploy a hedging strategy that would wipe out all of the principal investment’s profits and more? For investors to have faith that Waha’s management are competent and are managing well they need an explanation as to the deployment of what on the face of it seems an irrational hedging strategy.

To try to ascertain what is going on, I went to the main statement that is most reflective of reality, the cashflow statement. Operations resulted in a cash outflow of AED 66.9m, which would have been much worse were it not for a large movement in working capital. This means that Waha’s operations used up more cash than they generated. In particular, the change in trade and other liabilities, companies and people who Waha must pay but haven’t yet has increased by AED 143.9m. Basically the asset management business isn’t funding itself. What about principal investments? Going to net cash used in investing activities we see a cash outflow of AED 1,059m. Principal investments certainly aren’t funding themselves. This brings us to cashflows from financing activities. Waha borrowed net about AED 1,071m. So basically, Waha management funded their operations and their investments with borrowings. Does it make sense for Waha to borrow to pay for its operations and to make new investments? Who knows, but it would have made sense for Waha to explain what it was doing. Especially since the asset-liability mismatch of illiquid new investments funded by borrowings is quite large.

I’ll close with something that is perplexing. Waha’s management report proposes a dividend payment of AED 367.7m. Now the cash for dividends didn’t come from operations and it didn’t come from investments. The proposed dividend is coming from bank borrowings. Waha’s management is borrowing money to pay its investors dividends. I was always under the impression that dividends should come from profits actually generated. Borrowing to pay dividends means paper profits, and paper profits can become losses. Waha’s management looks like it is leading the company into a liquidity trap.