GFH announced to the Dubai Financial Market on August 7, 2019 that it would be holding a webcast on its H1 2019 financials on August 8. That’s not a lot of time to prepare by analysing the financials. More surprisingly the actual financials were publicly released on August 14 so I’m not sure how any analysis can happen, and this is clearly shown in the webcast transcript that shows no questions were asked. How could they be, when the financials were released a week later? In this article I analyse the financials and compare and contrast my analysis with the webcast presentation.
Revenue Analysis: Comparing apples to oranges
The first bullet point of the webcast presentations is:
Total income of the Group was US$163.5m for the first half of 2019 compared to US$134.1m, an increase of 21.9%. This increase is primarily driven by the increased contribution from Investment banking, Proprietary investments, Treasury, and Real Estate business lines. Excluding the one-off recovery income and restructuring income in the first half of 2018, total income of the Group for first half of 2019, grew by 114.3% compared to the comparative period.
I’ll take this sentence by sentence. First “This increase is primarily driven by the increased contribution from Investment banking, Proprietary investments, Treasury, and Real Estate business lines.” This needs some clarification.
- Investment Banking income: This increased to USD 43.4 million in H1 2019 up 32.7% from USD 32.7 million in H1 2018. Note 18 on related party transaction shows that in H1 2019 USD 43.3 million came from related parties, in particular it came from assets managed by GFH. In H1 2018 the related party investment banking income was USD 31.6 million, split about equally between deals from assets under management and companies in which GFH’s directors have an interest. This is usually considered low quality income as it is driven by related parties and not by independent clients. Adjusting for this, the higher quality investment banking income from independent clients is USD 0 for H1 2019 and USD 1.1 million for H1 2018, a drop of 100%.
- Treasury income: This increased in H1 2019 to USD 27.4 million in H1 2019 up 13.7% from USD 24.1 million in H1 2018. However, the average size of the portfolio (taken by averaging the start of the period size and the end of the period size) increased substantially. Calculating the average assets we have:
- USD 1.7 billion (H1 2019) – USD 0.8 billion (H2 2018) = average portfolio size of USD 1.25 billion. For H1 2018, I could not find information on the treasury portfolio, so I will assume it remained stable at USD 0.4 billion. This means that the average assets of the treasury portfolio grew by 212.5% but the returns only grew by 13.7%. Not a good sign.
- Looking at return on average assets for the treasury portfolio we have 2.2% in H1 2019 down from 6.0% in H1 2018, a deterioration of about 73%.
- Real Estate income: This increased to USD 14.8 million in H1 2019 up 155% from USD 5.8 million in H1 2018. This income suffers the same quality of income issues as investment banking, as detailed in note 18. In particular, real estate income benefitted from USD 9.2 million in H1 2019, zero in H1 2018. So adjusted for quality income the H1 2019 becomes USD 5.6 million high quality income from independent clients, a slight decrease from H1 2018. No quality growth in this business line.
Then the webcast presentation gives us this little gem: “Excluding the one-off recovery income and restructuring income in the first half of 2018, total income of the Group for first half of 2019, grew by 114.3% compared to the comparative period.” First, if there was one-off non-recurring income in 2018, why didn’t GFH report it as a separate line item, as I argue in a previous article. Second, why is GFH excluding one-off recovery and restructuring income in H1 2018 but not in 2019?
The implied ordinary operating income, excluding one-off items, for H1 2018 can be calculated by dividing the H1 2019 reported income (USD 163.5 million) by the growth (114.3%). This gives us H1 2018 income excluding one-off items of USD 76.3 million as calculated by GFH. By my calculation, the reported H1 2018 total income is USD 134.1 million and deducting the reported restructuring income of USD 35.3 million, I get ordinary operating income of USD 98.8 million. If there was more one-off items then GFH should be explicitly clear what they are and how much they were, so that investors can verify the numbers. As such I will use the H1 2018 ordinary operating income that I computed.
As I said, it is not useful to compare this to the reported H1 2019. The one-off items for H1 2019 need to be removed as well so that we are comparing apples to apples.
There is a single one-off item reported in the H1 2019 financials. This is described in note 16 restructuring related income. In summary, a subsidiary of GFH settled a liability for less than its carrying value, resulting in a one-off profit reported as “restructuring related income.” Going to the income statement we see that for H1 2019 this amount is USD 29.4 million, meaning that without this one-off item the ordinary operating income of GFH for H1 2019 is USD 134.1 (163.5 – 29.4). So putting this all together, we have that ordinary operating income, excluding one-off items, is USD 134.1 million in H1 2019 up 35.7% from USD 98.8 million in H1 2018. That’s still a good number. But you have to keep in mind that total average assets grew by 31.8% in the same period. So not as good once the asset growth is factored in.
Leveraging GFH was negative to profits
The third bullet point of the webcast presentation states:
Finance expenses of the Group increased from US$15.4m for the first half of 2018 to US$53.7m for the first half of 2019. An increase in the money market as part of the Group’s growing treasury portfolio and increased revenue generation from that business line also led to an increase in related costs.
It is true that the treasury portfolio grew 313.2% as a result of the 184.5% increase in leverage. The problem is that finance expense increased 248.7% while the treasury portfolio income increased by only 13.8%. It would seem that GFH is either leveraging too fast, i.e. not being able to deploy funds productively, or it is incapable of generating a return that pays the finance costs.
GFH’s transparency could be improved
Financial analysis involves a degree of subjective interpretation. It would have been of great benefit to GFH’s shareholders to receive the audited financials of the company in a timely manner before the webcast and the question and answer session. If shareholders are not able to effectively review the financials on their own, then all they have is the analysis of the management, which as the principal-agent problem shows creates a conflict of interest. The webcast then becomes a PR event rather than a meaningful shareholder event.
Furthermore, if GFH’s management presentation is going to rely heavily on differentiating between extraordinary income and ordinary income, it should follow guidelines that any reasonable shareholder would expect:
- Compare ordinary income to ordinary income, and do not cross compare ordinary income in one year to extraordinary income in another year.
- Give concrete details on what is considered extraordinary income to see if the shareholders agree. Better yet, on the audited financial statements, report ordinary income and extraordinary income as two separate line items with accompanying notes to explain the classifications.
To be clear, I am not attempting to analyse GFH’s actual performance. I am simply trying to present a lens that is more transparent and therefore shareholder friendly. It is up to shareholders to decide what, if anything, they find useful.