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Author Archives: Sabah al-Binali
Your employee stock ownership plan probably increases company risk
Employee stock ownership plans (ESOPs) are supposed to align employee and company interests and in theory decrease risk. But as an employee, you actually materially increase risk if you get paid stock rather than cash: if your company gets into trouble you lose your job and your savings (stock price drops).When things go well for a company it should take more risk, but ESOPs might make employees take less risk, in essence locking in their profit.
When things don’t go so well a company should reduce risk. But employees, who might feel they are about to lose everything, might gamble with the hopes of saving their jobs and savings.
Entrepreneurs' Dreams
Noon, the online retailer, was announced in November 2016 with a launch date of January 2017. Last week, word began to emerge that Noon, now almost five months late on its originally announced launch date, might be moving many of its staff to Saudi Arabia. Why, when a venture is already delayed five months, would you make such an important shift? More perplexing is why a venture that is less than a year old would suddenly have to move people? Was the earlier plan wrong in its emphasis on Dubai? Aren’t businesses supposed to pick Dubai as their regional hub? This was perplexing, so I tried to look at it from different angles.
One angle is that since Saudi’s Pension Investment Fund (PIF) was investing half of the US$1 billion into Noon then PIF wanted to domicile the company in its own country. Wouldn’t PIF have thought of that when it decided to make the investment? It is, after all, known to be sophisticated and professional. All things being equal, it would have made that decision at the beginning. If by some oversight it didn’t, PIF would understand the high risk of moving the operational base of a late-to-launch start-up. There must have been another reason.
Perhaps looking at what little publicly available information there is on Noon might shed some light on the matter. A quick survey of relevant announcements reveals: (1). A five-month delay in launch; (2). A last-second offer for Souq.com; (3). The acquisition of JadoPado, an existing online retailer; (4). One month later, senior people from JadoPado and Noon left the venture; and (5). The announcement of the move of the operating venture to Saudi.
The first four points signal negative events for Noon. The last one simply looks like PIF, the 50 per cent shareholder, deciding to exercise some corporate governance and move the operational base to Riyadh so that it could have better oversight over the venture. This is, of course, simply my theory since as of writing this nobody from Noon has provided a rational explanation to what is going on.
One of the heartbreaking issues is that JadoPado, a great entrepreneurial start-up story in the region, seems to have been unnecessarily shutdown. Is this a sign of things to come? People who have, or control, large amounts of financial assets harming our nascent venture capital ecosystem because they think they know what it means to be an entrepreneur? Will other entrepreneurs who have spent years building up their companies face the same fate because established interests are suboptimal in how they handle their acquisitions?
This reminds me of a poem by William Butler Yeats:
Aedh Wishes For The Cloths Of Heaven
Had I the heavens’ embroidered cloths,
Enwrought with golden and silver light,
The blue and the dim and the dark cloths
Of night and light and the half-light,
I would spread the cloths under your feet:
But I, being poor, have only my dreams;
I have spread my dreams under your feet;
Tread softly because you tread on my dreams.
In the end, that is the only thing that true entrepreneurs have – dreams. People who have money and business success handed to them will never, can never, understand this. When entrepreneurs ask in vain where the funding part of the ecosystem is, perhaps they should look to those who have received business and support in excess of the value they produced. If those who can be commercially successful can’t find funding because those who aren’t commercially successful keep hoovering it up, perhaps we should rethink the ecosystem.
I spent three years building an investment bank in Saudi Arabia dealing with regulators, government departments, investors, and staff. They are competent and professional. I hope that they can help what is left of JadoPado and invigorate Noon. Unicorn should mean sold for a billion dollar valuation, not destroyed a billion dollar valuation.
I also hope that we can rebalance the venture capital ecosystem in the UAE to support entrepreneurs.
This article was originally published in The National.
Your understanding of “win-win” can harm you
The idea of win-win outcomes is seductive, it implies that everybody gets what they want. This belief can harm you for three reasons:
- You cannot know what a win means for the other party. After all, negotiation 101 teaches us that one should never reveal their goals to the other person.
- Life is not a zero sum game, but neither does it provide unlimited resources. You are competing for the same resources.
- This only works if the other person is playing the same game, otherwise you will get slaughtered.
Better to aim for “satisfied – satisfied.” More realistic.
No values? Here's a promotion!
My insight into how those with no values are promoted: If a supervisor instructs an employee to do something, then an employee with values will push back if the action conflicts with their values. The employee with no values will immediately execute the instruction without hesitation. From the supervisor’s point of view it can look like the former employee is obstinate and the latter employee is loyal.
Of course this false view can easily be corrected by remembering that it is final outcomes that count and ensuring that long term performance is measured and reviewed. Not to mention that the mirage of the loyal employee is the foundation of the fraudulent employee (no values, remember?).
I got this insight from a young compliance officer who was struggling to do his job and keep it. I was told that a bank CEO was let go precisely because of this. The list continues. Is this a self-reinforcing downward spiral? Of course what’s true of governance is also true of risk-taking.
Unmasking business shenanigans
I have recently pointed out that one of the warning signs that a business is facing issues is when core revenue, ie revenue from the main business lines, is down but profit is up.
Why the combination? Why not simply flag a drop in core revenue? Because it is normal for revenue to fluctuate – especially in a challenging economy. But if revenues go down and profit goes up, it means the business has miraculously had a major increase in non-core revenue or, worse, has made large cuts to expenses.
Large jumps in non-core revenue are rarely sustainable. They usually come from either re-valuing assets, an exercise that does not affect cash flow nor is it recurring, or from the sale of an asset at a price higher than it was held on the books, which helps cash flow but is non-recurring and may reduce income-generating assets.
On the expense side you have actual cash expenses that are reduced, usually employee compensation or number of employees, but this can also include things such as rent. These have a positive cash-flow effect but are limited in the number of times they can be done, not to mention that it can affect revenue generation by losing employees or reducing morale.
The red flag is when non-cash expenses change drastically, such as depreciation, amortisation and impairment charges. This is a red flag because it is relatively easy to massage these numbers, plus it has no impact on cash flow. Continue reading
Real alternatives to the game of monopolies in the GCC
As the economy continues to be under contractionary pressure, it is high time we took an in-depth look at one of the major constraints to its growth. As we know, it is entrepreneurs building start-ups that form the foundation of any economy. However, as I have argued before, monopolies stifle entrepreneurship. The greater the number of monopolies, the greater the value destruction in the economy.
I have argued this many times. Now I’d like to show exactly how much all these monopolies, the agencies on electronics, restaurants, medicine, etc might cost the economy in dollar terms. You will be shocked.
Before we get to pricing let us understand the value of a commercial licence to operate a business. In a free market capitalism framework, the value is close to zero. For example, in the GCC, most businesses require a licence that costs a few thousand dirhams at most. If you pay much more than that then you are paying for a regulated activity or something exclusive. This insight allows us to understand the value of monopolies.
Board drama, and crunching the numbers on oil
A few weeks ago I pointed out that Etisalat generated earnings of Dh0.97 per share and paid out Dh0.80 per share, which is a payout ratio of 82 per cent. I further pointed out that paying out such a high percentage of profits was consistent with a status quo strategy and inconsistent with an expansion strategy, which would need to use the earnings to expand. Last week Etisalat bid for Oman’s third mobile operator license.
The question is, is it rational to pay your shareholders nearly all of your profits and then to go on to expand? Etisalat saw its revenue drop in the first quarter although it managed to grow profit by cutting expenses. Still, with revenue falling, earnings being paid out and an expansion strategy, one is walking a tight rope.
I also recently analysed the 2016 financial performance of Gulf Finance House (GFH), a financial services group, in particular with respect to announced discussions with Shuaa Capital for a merger. The analysis showed a large loss from normal operations of about US$230 million masked by a one-time litigation award to show a profit. I was curious to see why Shuaa would be interested in GFH and so reviewed GFH’s Q1 2017 financials that were recently released. Perhaps GFH could engineer a miraculous turn around in normal operations.
The report showed that GFH has indeed achieved a profit of $33.5m for the quarter. An astounding achievement. I dug deeper. Financial services can have notoriously volatile earnings but one thing caught my eye: a profit of $25.6m from the sale of a subsidiary.
Upon closer examination, the profit came from selling a stake in a school.
The shares were received as part of the litigation settlement in 2016 and GFH valued this part of the stake at $29.4m. A year, or less, later they sold the stake for $55m for a profit of $25.6m. That is a return on investment of 87 per cent in at most one year. Did GFH generate a fantastic 87 per cent return in one year by its skill in operating the school?
Perhaps the whole market went up 87 per cent? Possibly the buyer and their advisers are clueless and overpaid by nearly double?
This one-off extraordinary transaction explains 76 per cent of the profit. I considered analysing if the other 24 per cent was one-off or normal recurring business, but why bother?
Union Properties last week announced that three of the directors of the board had resigned right after an AGM that appointed them. The three directors publicly denied resigning. There could be some chance that this is just a big misunderstanding. The more likely scenarios are less than salubrious.
Board drama is a red flag suggesting serious internal issues at a company. The number of such incidents in the market, along with going concern warning, capital injections at loss making companies, and law suits, will be a gauge of how much the oil price drop from 2014 is affecting our economy.
On Thursday, the price of oil dropped to its lowest level in five months. The main benchmark Brent fell below US$50 a barrel, followed by a modest comeback on Friday to about $49; as of Monday afternoon it was still at that level.
One reason for the drop was reported in a Financial Times article that quoted Jamie Webster, a fellow at the Center on Global Energy Policy at Columbia University: “Opec extension is baked into market expectations, but roaring shale growth makes the sizeable but too small a cut completely lose its potency.” A separate FT article stated that although the agreed Opec production cuts amount to 1.4 million barrels per day (bpd) the actual cut to exports might be as little as 800,000 bpd.
It is a little worrisome that Opec cuts production and oil prices pop up for only a short while. We keep hearing how oil prices will go up because of a lack of investment in oil infrastructure. Oil prices might pop up, but they keep dropping back down. If what you are hearing is different than what you are seeing, which should you believe?
In the investment world we have a phrase, “talking one’s book”. This describes the natural human trait of speaking positively about something beneficial to you, in this case the investments an investor has made. As investors and individuals who must make a myriad decisions based on the economy we should ask ourselves: if doing the same thing but expecting different results is a sign of insanity, then what is listening to the same thing and expecting different results a sign of?
This article was originally published in The National.
Q1 results in the UAE mask less than stellar fundamentals
We have recently seen a flurry of reports regarding the financials for the first quarter of this year.
Despite happy headlines, the fundamentals are not good. I will use some examples to show how to dig under the rosy announcements to get a better idea of the situation.
Let’s start with the banking sector, the blood flow of the economy. In their publicly presented financials there is a wealth of information from the two largest domestic banks in the UAE, First Abu Dhabi Bank (FAB), the merged FGB-NBAD, and from Emirates NBD.
Consolidated FAB net interest and financing income was year-on-year (y-o-y) for Q1 4.9 per cent lower – ie, Q1 2017 showed a decline of 4.9 per cent over Q1 2016. This is the income predominantly generated from the core business of a bank – lending and borrowing.
Souq’s success reveals the kind of CEOs we need
Souq.com, a private entrepreneurial company, sold for more than Dh2 billion this year while in the same period at least two large listed companies, one with a sovereign wealth fund backing it, required Dh500 million to Dh1.5bn in new capital.
Understanding the difference between why an entrepreneurial company was so successful in a period when organisations previously perceived as successful now need huge amounts of capital injections and/or lay-offs is key to understanding the future of our economy.
I have been on both sides of the equation – an executive at Union National Bank, Shuaa and Credit Suisse Saudi Arabia as well as an independent investor and entrepreneur. Importantly, these are not two separate parts of my life, I have crossed back and forth several times.
I have spoken numerous times on how our social culture, which is non-confrontational, is unfortunately transferred to our business culture, leading to a large number of “yes” men.
Here is why this is not optimal. CBS News has an article that describes the institutionalised management environment that I have seen. The article uses as its basis a study by researchers from Northwestern University’s Kellogg School of Management and the University of Michigan, Set up for a Fall: The Insidious Effects of Flattery and Opinion Conformity toward Corporate Leaders, in Administrative Science Quarterly.
The study finds that chief executives “who have acquired positions of relatively high social status in the corporate elite tend to be attractive targets of flattery and opinion conformity from colleagues”, which can harm the company increasing the “CEOs’ overconfidence in their strategic judgment and leadership capability”, which results in a reduction in “the likelihood that CEOs will initiate needed strategic change in response to poor firm performance.” Importantly, the study found that this leads to a long-term continuation of the company’s bad performance.
The former British prime minister Tony Blair says it more succinctly: “The art of leadership is saying no, not saying yes. It is very easy to say yes.”