Unfortunately Shuaa Capital did not provide pro forma comparative 2018 financials, after it acquired Abu Dhabi Financial Group (“ADFG”) in 2019, for its 2019 audited financial statements. The board of director’s report states “…comparatives within this report for the newly combined segments are not provided, as they are no longer relevant.” This seems odd, at least on the asset management side as both companies had asset management businesses during that period.
Shuaa Profit Questions
There are a number of questions regarding the profits of Shuaa Capital after it acquired ADFG.
Large drop in profits
The combined entity announced a profit of AED 45.7 million in 2019. The profit for ADFG in 2018 was AED 57.2 million and that for Shuaa in 2018 was AED 28.5 million. To calculate the pro forma consolidated profit in 2018 needs related party and consolidation information in terms of profits of 2018 profits of Shuaa derived from ADFG and vice versa. At one end of the scale, if there was no related party or consolidated profits between Shuaa and ADFG, the pro forma profits would be AED 85.7 million, i.e. the 2019 profit of AED 45.7 million is a decrease of -47% from the pro forma of 2018.
Admittedly the board of directors report points out that 2019 was a challenging year. On the other, Shuaa’s 2018 press release states “While total Group revenues increased by 23% to reach AED 165.2 million for the year, net profit fell 63% year-on-year to AED 27.2 million with the Company taking mark-to-market charges on its investments in in Q4 2018 and additional one-off provisions on legacy assets.” I’m not sure it makes sense to keep blaming the markets for losses. Otherwise why bother paying management?
Comparative profits: normalizing for dilution
So how can one look at the actual profit performance? The answer for Shuaa lies in note 25 of its 2019 financials. The auditors calculate the earnings per share (“EPS”), adjusted for the exchange ratio of shares during the merger. The earnings per share attributable to owners drops -50% from 4 fils per share to 2 fils per share. This is consistent with the analysis in the previous section.
Profits from continuing operations
During the year Shuaa and ADFG sold / unwound some of their businesses. The profit from the remaining continuing operations is AED 12.3 M, only 27% of the total AED 45.7 M profit. The EPS from ongoing operations is only 1 fils, or 25% of the overall EPS of 4 fils. For Shuaa’s 2020 profits to equal 2019 the company needs to increase its profits from ongoing operations by c. 300%.
So why did Shuaa / ADFG dispose of such profitable operations? The cashflow statement offers some insight: the 2019 cashflows from discontinued operations was negative at AED -318 M.
Profit versus cashflow
The cashflow statement also shows that cashflow from operations before working capital changes was only AED 16.6 M relative to the profit of AED 45.7 M. Something worth understanding further.
ADFG’s quality of profits
Shuaa’s 2019 profit for the year is stated as AED 33.4 M. Note 34 on loss of control of subsidiaries states that Shuaa recognized AED 106 M in profits based on an accounting change due to the company’s loss of control of it’s subsidiary Qannas Investment Ltd (“QIL”). This is basically a negative goodwill transaction, similar to the one I wrote about regarding Shuaa’s Amwal transaction in 2018. Compare this amount to the total profit of Shuaa of AED 45.7 M. This indicates that 232% of Shuaa’s profit came from a loss of control accounting entry.
Further questions
ADFG’s 2018 dividend
ADFG’s 2018 profits were AED 57.2 M, their cashflow from operations was AED 49.9 M, after working capital this was AED -88 M, and cash flows from investments was AED -92.8 M. Why would ADFG then pay a dividend during 2018 of AED 150 M? This may have been a 2017 dividend, but since ADFG started 2018 with AED 17.6 M in cash, was it sensible to pay out so much cash? And where did the cash come from? ADFG borrowed a net AED 390 M in 2018.
Shuaa’s investment advisory
In note 29 of their 2019 financial statements Shuaa states that it “…provides investment solutions to clients with a focus on alternative investment strategies.” This business line generated an incredible AED 118 M of revenue in 2019, equivalent to approximately 55% of total asset management revenue and 42% of total revenue. With such a dominant contribution from a single business line a little more transparency into what this business actually is, and why these clients are willing to provide such high fees for advice as opposed to performance, would be useful. Of course there should be no expectation of transparency as to who these clients are, since clients paying out at these high levels would be expected to be rare and a closely guarded secret.
Closing: Thank goodness for high paying clients
With income from a loss of control accounting treatment representing c. 232% of total profits, and income from discontinued operations representing c. 75% of total profits, it would appear that Shuaa faces a challenging year to maintain their profit levels in 2020.
Perhaps their investment solutions clients will pay them more fees to close the gap.