Debtwire announced that Noble Group may be nearing a deal to restructure its $3.5b debt with a debt-to-equity swap. Noble subsequently clarified that no agreement has been reached yet. If and when a deal is reached, creditors will have to approve it. This will not be straightforward as their interests strongly diverge. For example, the 2018 bondholders who expected to be repaid in two months are unlikely to like this deal.
Based on available information, it is clear that the framework has been poorly negotiated by the advisors who claim to represent creditors. The conditions are unfavourable to creditors and sometimes very naive. It seems the advisors had no knowledge or understanding of the accounting background of this company and its managers.
1. Management given additional incentives to manipulate earnings
Under the restructuring, Noble would set up a new company, in which employees would own stakes with the option to increase their share if performance targets are met. Have we learned nothing from the Noble scandal? Managers who created billions of fake profit won’t find it hard to reach their targets. They need a profit of $300m this year? Here is what Noble’s managers will do. Find three obscure and cash-strapped mining companies in Africa that almost nobody has heard of. They don’t produce anything. The mine is not built and will never be built. There is no financing. The location is so far away from the nearest port that their production is uneconomic and nobody will buy from them. It does not matter. Sign a 20-year contract with each of these companies. Book at least $100m of fair value on each contract the same day based on a series of imaginary assumptions. The contracts will never be executed. They are only “accounting contracts”. Done. You have just generated $300m of profit in your books. Needless to say, the performance objectives for the year are exceeded.
Although Noble is now in financial distress, the company continues to sign highly suspicious end-of-the-quarter deals with tiny mining companies. Here is another marketing agreement signed on December 22nd. Noble is agonising and continues to sign contracts with mining companies at exploration stage. Isn’t this the way Noble has always created fictitious profit? Are we supposed to believe there is no accounting game behind these contracts?
If the performance targets include more tangible financial indicators such as operating cash flow, then the company will probably use repos as it did in the past to manipulate these numbers.
Any suggestion that these manipulations will stop is extremely naive. Noble’s management has nothing to fear from EY, or the “regulators” in Singapore that are busy looking the other way. This is now well documented. Only lawsuits will stop Noble’s management and we will cover this critical issue in our next update.
2. The people who are the cause of this scandal will remain shareholders
Creditors are asked to swallow a massive loss in this debt-to-equity conversion. They are in this situation because a few managers around Richard Elman deceived them, manufactured the whole balance and filled their pockets in the process. We fail to understand why creditors who rank higher than equity holders need to share the residual value of this company with the few people who caused their loss.
In this poorly negotiated deal, the advisors did not understand the position of strength of the creditors. Noble’s management is forced to accept any condition imposed on them to avoid liquidation, even if the deal means Richard Elman or Will Randall’s equity is completely wiped out. The reason is that they fear liquidation far more than creditors do. Liquidation would mean that for the first time specialists from outside the company would have access to internal documents, emails, correspondence with the auditor, etc. Noble’s secrets will inevitably rise to the surface and make litigation for fraud even easier. This nightmare scenario allowed the advisors to dictate all the conditions they wanted and they failed to take advantage of it.
3. The entry of a strategic investor after the debt restructuring
At this stage, there are few details on the potential investor, the conditions and whether due diligence has already been conducted (unlikely), etc. What we know is that it is not the first time that Noble is trying to reassure the market with the entry of a “strategic investor”. This happened many times, and generally in a critical period when Noble needed to boost confidence. For example, the name of Sinochem was mentioned one year ago as a strategic investor when Noble was already in financial trouble. The short window of optimism brought by the Sinochem story allowed Noble to raise $750m and buy a few months time. The Sinochem deal never materialised and these bondholders can only regret the decision they made.
Two major Chinese investors have already been badly burnt with Noble (CIC and COFCO) and they would probably not repeat the same mistake again. We can assume that a new investor will conduct due diligence. In the past, many candidates ran away after they saw the books. There is no doubt the carrying value of the assets and liabilities is still completely false despite billions of impairment.
It is clear that the conditions of this outline agreement have been poorly negotiated on behalf of the creditors. The same structural issues that have plagued this company will remain in the future. Based on preliminary information available at the moment, we urge creditors to reject this proposal and demand much tougher conditions to safeguard their interests. Again, Noble’s management has no choice and will be forced to accept.