Iceberg Research

Update on Noble (July 21st)

July 21, 2015
Confidence in Noble is clearly eroding

Noble has been unable to address concerns over its financials. The share price has fallen by 43% since our first report despite the share buyback program. Sell side analysts slashed their target price by 30% from a year ago. Credit spreads have widened substantially. The International Financing Review Asia reported that the bank syndicate for the recent revolving credit facility was the smallest in five years for a Noble loan.

In the past few weeks, the most important development has been the revision of the rating outlook by S&P from stable to negative. The investment grade rating is crucial for Noble. If Noble is downgraded to junk status, this group will have substantial margin calls and its cost of funding will increase dramatically. The rating, not the share price, has been the main reason why Noble has manipulated its financials. Noble’s financial reporting has been a magic show performed every quarter for one specific audience: the credit agencies.

S&P’s June 11th opinion, published one month after Noble released its quarterly results, underlined the main concern: the fair values. “Noble’s trading risk position has weakened because of the growth in net fair value gains from long-term commodity offtake contracts the company entered into over the past three years. In our view, the long-dated nature of these contracts creates a mismatch between profit recognition and cash realization.”

The investment grade has always been an anomaly. From a creditor point of view, it is very difficult to understand why a company who has recorded abysmal operating cash outflow, for example ($1.15b) since 2012 when Yusuf Alireza was appointed (despite a combined net profit of $940m during the same period) is still investment grade. Noble has been unable to explain this divergence contradicting themselves every time. Credit agencies will inevitably be forced to correct this anomaly. The revision of the outlook is only the first step, which puts Noble in a vulnerable position.

There are still believers in Noble’s stock but the foundation of this support is shaky:

  1. Noble itself who has launched a share buyback program. As expected, the effect was short-lived. The share price is marginally higher than the 63c low on June 11th, when the share buyback program was launched. Every round of share buyback weakens the balance sheet. Companies that buy back their shares usually have positive cash flows. Noble’s operations burned $660m in the last quarter.

  2. Existing shareholders. The most common argument is that Noble must be cheap trading at 0.67x its book value. Of course, these shareholders assume that the book value is a reliable number. The 13% stake in Yancoal looks “very cheap” with a current market value of US$14m compared to a carrying value of US$322m. Mr. Alireza thinks the market is unable to value Yancoal: Noble knows better. For the valuation of the $4.2b net fair values, Noble also knows better, using exactly the same accounting tricks. We regularly talk to hedge funds or even shareholders of Noble. Doubts are growing over Noble. Investors are increasingly frustrated by the inability of Noble’s management to answer straight questions with straight answers.

  3. Some ETF investors passively hold Noble’s stock because it is a constituent of the STI index. The problem is that Noble is now among the three lowest market caps in the STI with a market cap of S$4.45b, marginally larger than Olam (S$4.31b) and SIA Engineering (S$4.32b). At the time of writing, two of the five companies in the STI reserve list have a market cap larger than Noble’s and four companies have a market cap larger than Olam/SIA Engineering. Noble is at risk of being dropped from the STI, which would have a negative impact on its share price.

The “Assurance Review”

We have always strongly criticised the role played by EY in Noble’s situation. Our opinion has not improved after the downfall of Hanergy, a company audited by EY Hong Kong, the office that audits Noble. Because Noble is unable to address doubts, the company commissioned an “assurance review” conducted by another Big Four, PwC. Will the appointment of PwC solve the problem? Unfortunately, the answer is no.

1) The most obvious issue is that Noble has not clearly defined the scope of the review. Noble has not published the letter listing PwC’s assignments. We believe that PwC will merely work on the valuation framework rather than the valuation of the portfolio itself, counterparty by counterparty.

2) Importantly, PwC will not answer the question that the market is asking. This gives us an opportunity to re-present the key issues with Noble’s mark-to-market (“MTM”) accounting. Noble has $6.7b commodity contracts positive fair values on its balance sheet, i.e. 131% of its equity. These fair values are calculated by using a certain number of instruments, in particular a forward curve (series of sequential prices for future delivery). People may think that there is one forward curve for every commodity in the world and for any maturity. The job of an auditor would be simple: to make sure that its client uses these universal forward curves.

The reality is very different. Many commodities do not have any forward curve. When there is a forward curve, it is for a standard commodity with specific chemical composition. The physical cargoes traded every day differ from this standard (this is a notable difference between MTM in hedge funds and MTM in physical traders). The maturity of forward curves rarely exceeds a few years while contracts can exceed 15 years. In other words, physical traders often find themselves in a situation where there is no available forward curve. In this case, they draw their own forward curve. This is a major loophole. Enron famously used aggressive forward curves to manipulate its MTM.

In February, Noble explained that its 13% stake in Yancoal that was worth $11m on the Australian stock exchange should be valued $522m on its balance sheet. Of course, they refuse to release the mysterious forward curve or the tonnage projections supporting this valuation. The valuation was $522m at that time (before Noble was forced to bring it down to $322m following our first report) but it could have been $1b, or $2b or even more. Just move the forward curve and you will get any valuation you want.

Investors may think that when a client uses an aggressive forward curve, its auditor immediately rings the bell and refuses to sign off. Again, the reality is different. Auditors tend to focus on the existence of valuation processes, not on the assumptions themselves. For example, do not count on them to assess the counterparty risk of highly speculative companies such as Sundance Resources. It is not their job. Did EY assess the counterparty risk of Hanergy’s parent when they signed off on Hanergy’s accounts? No. They just recognised receivables between Hanergy and its parent.

By using loopholes, companies such as Enron or Noble follow the letter of the law while completely violating the spirit of the law. They mislead investors who believe that accounting rules are straightforward and that there is little room for manipulation. Andrew Fastow, Enron’s former CFO, recently said in a FT conference: “There may be a fundamental difference between a company following the rules and a company presenting a true picture of its financial position”.

PwC, hired and paid by Noble, will answer the question that Noble wants them to answer: does Noble formally respect the letter of the law? This is the same question that EY has been answering for years. PwC will not answer the question that investors and creditors want them to answer: does Noble violate the spirit of the law, for example by using unrealistic forward curves or tonnage projections, to vastly overstate its MTM? The difference between the two questions is billions of market cap. Creditors and investors are only interested in the second question. The first one is completely irrelevant.

3) There are also obvious issues with the audit committee. Three out of four members of the new audit committee including the committee chairman are already members of the old audit committee. Who can seriously believe that the persons who have been involved in the audit of Noble will publicly admit that they were wrong? One more example of Noble’s dysfunctional governance. Finally, the public will only have access to a summary giving them little information.

Noble is just buying time with this assurance review. We believe the primary regulator in Singapore (the Monetary Authority) and the regulators in other countries have to address the problem directly with the assistance of independent specialists in commodity contracts valuations working for them, not for Noble. Hanergy, Noble, Toshiba… If the regulators do not want investors to lose confidence in the financial statements issued by Asia largest companies, they have to enforce market discipline. They have to take decisive actions before the crisis spreads. Noble operates in many countries and it is just a matter of time before one of these regulators decides to take action.

What is next for Noble?

Noble’s credibility will keep falling. Too many of their arguments do not make any sense or never answer the point. Michael Dee correctly underlined that Noble never answers important questions. The analysts who carefully read Noble’s rebuttals have certainly remarked Noble’s trademark ability to maliciously distort what their critics write before answering. If there is one competence that the management of Noble has, it is this one. Investors will not accept the PR tricks forever.

Although Yusuf Alireza has desperately tried to discredit us, the market lends more credibility to our research every day. Noble is unable to understand that every time this company defames, sues and threatens critics, or when a chairman disrespects his own shareholders during the AGM, this company loses the support of its investors. This futile corporate bullying will not help them regain control of the situation. It will make things worse.

We know that Noble will eventually be forced to recognise that its financials have been vastly manipulated for years. The only thing we do not know is how many months we will need to get there. It took nine months for Enron to collapse, a period during which Enron’s CEO, Jeff Skilling, denied the reality and aggressively attacked his critics.

Facing a deepening crisis, Noble’s management will have no choice but to look for a white knight. Noble needs a group (1) with deep pockets, (2) who has no clue as to mark-to-market valuations and off balance sheet commitments, (3) willing to invest in a company that has recorded massive cash outflows and fast growing debt, (4) willing to take the risk of future regulatory actions in markets where Noble operates.

There have always been inexplicable transactions in capital markets, and transactions that are not driven by a business rationale. Still, this will not be an easy job. The traders such as Glencore, Cargill will never touch Noble at this price. They know how to value the MTM. After a few days of due diligence, they will find more skeletons on Noble’s balance sheet than in a cemetery. They will also want a complete picture of the off balance sheet commitments. CIC recently stated they will “continue to support Noble”. This seemingly positive statement comes from a shareholder that cut its stake by one third last September. We believe that what CIC wants is to isolate Noble Agri, 51% controlled by a COFCO-led consortium, from Noble’s deepening crisis. This is probably the reason why the director they appointed comes from COFCO, not from CIC. Large Chinese groups interested in acquiring a stake in Noble will ask CIC what is going on in this company. As for Temasek, they only have a small interest in Noble Agri, not in Noble Group. Unlike Olam, Noble is not a Singaporean company.

Noble is facing very large cash outflows, fast growing debt. Its management is losing control of the situation. Support is weakening and there is a limited pool of potential buyers. There are compelling reasons to be pessimistic about Noble.


  1. does Noble Agri have the same mark to market valuation problems or is Noble Agri immune from it?

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