Chesapeake Energy and Temasek: A Tale of Two CEOs and Shareholder Democracy
Recently Chesapeake Energy, the second biggest US gas producer, has been much in the news. The company has been having cash flow problems since the CEO, Aubrey McClendon, took a wrong bet on the direction of gas prices and bought back its hedges. This has left it exposed to a big decline in natural gas prices in the US and a market glut.
Why this is a cause for concern is that the company has large spending commitments which leave it facing a liquidity crisis. It has said it must sell assets worth between US$11.5 billion and US$14 billion this year to pay down debt and finance its capital requirements. Shareholder unhappiness with the performance of the CEO and some of the sweetheart deals and excessive compensation he has received from the company boiled over at the AGM on 8 June. The two directors on the company’s slate standing for re-election were overwhelmingly rejected by shareholders. A majority of votes were also cast in favour of a nonbinding proposal to allow major shareholders to nominate board candidates. In another manifestation of shareholder anger, 80% of shareholders voted to deliver a stern reprimand to the company over its pay to and supervision of the CEO, Aubrey McClendon.
McClendon recently also had to settle shareholder lawsuits over the company’s preferential treatment of him in 2008 when he faced margin calls on the stock he had borrowed to buy. This included having to pay the company back the US$12 million it paid him to buy his collection of antique maps which now adorn Chesapeake’s boardrooms. And very fine maps they are too, or so it appears. Perhaps Temasek’s management have been lucky enough to see the maps when they visited the company! However I am confident that the excitement of seeing these fine examples of early cartography did not cloud the excellent judgement of those entrusted with managing our citizens’ forced savings.
The upshot of Chesapeake’s liquidity crisis is that unless the company achieves its asset sales targets it may have to declare bankruptcy in order to get out of its capital commitments. The problem is that when a company faces cash flow problems buyers tend to hang back in the hope that they may be able to get the assets cheaper if those problems get worse. Of course they face the risk that a competitor might step in to buy them but by waiting they might also learn of new potential contingent liabilities that might affect the value of the assets. Another possibility is that a suitor steps in to buy Chesapeake and makes what is known as a “takeunder” offer where the price is less than where the stock price is currently trading. The well-known activist investor, Carl Icahn (who is almost as venerable as our dear former Minister Mentor), clearly is hoping for a much higher takeover offer or a bidding war because he has accumulated about 8% of the company. However there is still the risk that a bidder might wait for the company to enter bankruptcy and then make an offer at an enterprise value that leaves nothing for equity holders.
This brings us to Temasek and its holding in Chesapeake. It must sometimes seem to Singaporeans that the management of Temasek and GIC have an unerring ability to find every banana skin in the room and promptly slip up on it. That would be amusing if it was a slapstick movie but not so entertaining when you know that these investments are financed through your taxes and lack of free education and healthcare while citizens in countries that you are helping to bail out receive theirs free. They have also been financed by the relentless rise in government debt. In his Economics Society speech PM Lee hinted this debt will have to be paid off through tax increases down the road because our overseas investments have not done as well as expected.
Actually Chesapeake does not look quite as bad as some of the other notoriously poor investments by Temasek and GIC that have been the cause of so much scorn from Singaporeans for the management of these companies. Temasek’s investment is at least in the cumulative convertible preferred stock which ranks above the common equity but carries no voting rights. The preferred stock pays a fixed dividend of 4.5% which might seem attractive in comparison to a common equity dividend yield of around 2%. However, unlike straight debt where a failure to pay the coupon would be an event of default entitling the holders to put the company into bankruptcy, the company can pass on the dividend if it does not have the cash to pay it. Missed dividends on the preferred stock accumulate and the backlog must be paid off before the company can resume paying dividends on the common shares.
So there is relatively weak protection for the preferred holders. It does have the benefit of being convertible into common stock. However the strike price for the conversion is around US$43 so at the last traded price of US$17 the equity option is quite far out of the money. Thus movements in the stock price will not have a big effect on the convertible price. This will be mainly determined by the likelihood that the company can continue paying dividends.
Temasek’s 2011 annual report says that they purchased S$700 million of the cumulative convertible preferred during the course of 2010. It traded between US$80 and US$100 over that period. Assuming they bought it around US$90, then at the last traded price of US$78.76 Temasek has ONLY lost around 12.5% of its investment (and that is before taking account of the dividends it has received since 2010).
However, even if Temasek is able to get out with only a small loss or, miracle of miracles, to break even on its investment, there are still several lessons that we should learn. It is instructive to contrast the power of shareholder democracy in shining a spotlight on management conflicts of interest and excessive compensation with our own powerlessness in finding out what is the real picture at our own sovereign wealth funds. Of course an incorruptible government ensures that there is no egregious wallowing at the corporate trough, like the shenanigans at Chesapeake, even though the PAP elite believes it is not in our interests to be told very much of what is going on. Even our (s)elected President has little power, and seemingly little interest, in keeping an eye on the investment performance of our SWFs, despite his choice of a pair of spectacles as his electoral symbol. He has still not replied to my straightforward question as to whether presidential approval was sought or given for our republic’s loan commitment to the IMF. Presumably this is because it is not in the public interest for anyone outside the ruling elite to know the answer to this question, just as Tharman said it did not serve the public interest to tell us why Chip Goodyear would not be taking up his post as CEO of Temasek.
Recently I wrote an open letter to the Finance Minister asking him to explain some apparent discrepancies between the governments’s annual Statement of Assets and Liabilities (ALS) and the reported general government surpluses. Using the IMF’s own figures as well as those kindly provided (after much prodding, to be explained in a separate post) by the Department of Statistics, I pointed out in my letter that the total reported surpluses are of the order of S$429 billion since 1980. This contrasts with my calculations from the ALS which show that real net assets (excluding land) are only some S$280 billion as of 31st March 2011.
Yet much of the valuation of the net assets is underpinned by an enormous rise in the value of unquoted investments which have gone from S$53 billion as at 31st March 2004 to S$172 billion as of 31st March 2011. Since 2008 the price of KKR stock, which is a private equity fund manager and thus a good proxy for the value of the funds it manages and has equity in, has halved from over US$20 to around US$12 today. At the same time government debt has increased to over 110% of GDP.
It might be argued that the increase in debt is merely the result of the government’s sterilization operations to mop up the liquidity stemming from our current account surplus of over 20% of GDP. However in that case why does Norway, which runs a large current account surplus of about 15% of GDP and whose sovereign wealth fund has over US$600 billion in assets, have a debt to GDP ratio of only some 50%. Saudi Arabia, which also had a current account surplus of around 24% of GDP in 2011, has a debt to GDP ratio of around 7%.
So far the Finance Minister has not deigned Singaporeans important enough to need to know the answers to these questions. An American political economist in Hong Kong, Chris Balding, has been asking the same questions, though in a much blunter manner (Americans are not used to what we feel is a need to continually abase ourselves before our servant leaders due to our fear of defamation suits, even as we agree to pay these servant leaders millions of dollars). So far there has been only a deafening silence.
The productivity of civil servants at the Ministry of Finance is clearly much poorer than those who work at MICA. There the Minister was able to use state resources to fire off a malicious and defamatory rebuttal of my letter to the WSJ within days. Past precedents, where trade restrictions were invoked by LKY against foreign newspapers and their countries took no action to protect their legitimate trade interests seem to have been enough to cow the WSJ into not printing my response.
Since I entered politics I have been consistent in calling for transparency and accountability in the management of Singapore’s reserves and in particular at our SWFs. In fact since 2009 I called for their privatization and listing on the stock market with equity to be distributed to Singapore citizens. However my proposal has not been reported in the State media which has had a permanent media blackout on me since before the GE.
Interestingly, when TJS called for the dismantling of our SWFs, which I think would be a disaster and rife with conflict of interest problems if done too quickly, his proposal was immediately picked up by the State media. Clearly the PAP elite are continuing their long-standing policy of favouring an approved Opposition, while denying the oxygen of publicity to anyone they think might pose a threat to their hegemony.
This deliberate favouritism was also seen when the former civil servants and government scholars, who moved from WP to RP and then found a more congenial home, at least for now, at NSP, asked some questions about the high levels of Temasek’s administrative expenses. In stark contrast with the lack of response to my questions, there was a swift response from Temasek that this also included the equity accounting of the expenses of group companies like SIA, PSA and others.
However the answer to this question (which should have been obvious by looking at the accounts) makes it plain that as a first stage to transparency and the privatization of our SWFs we need to separate the stakes in domestic companies from foreign investments. Temasek should be split in two. In fact if it had been a listed company in the US, for instance, management would have taken that route in order to raise shareholder value. With the split, the market is likely to value the two successor companies as a whole more highly than the original. This is because of the improved management focus and transparency resulting from the split. As a rule investors prefer to construct their own bundles of different businesses rather than have to invest in a company where management have made that choice for them.
Another reason for privatizing and listing Temasek and GIC is so that management compensation and incentives can be made transparent. Shareholders can check whether the incentives of management then are in alignment with the objective of increasing shareholder value. If there is excessive compensation for mediocre performance, then shareholders can vote against management at the AGM just as at Chesapeake. In the last resort they can vote with their feet by selling their stock which is why companies with poor corporate governance trade at a lower multiple than similar companies, ceteris paribus.
While Temasek makes much of high-sounding phrases in its discussion of its Compensation Framework in its Annual Report, it does not actually provide any details. Though it says prior year bonuses are clawed back in bad years, there does seem to be a gaping disparity between Temasek’s glowing self-description of its performance (22% p.a. annualized over two years and 17% p.a. annualized since inception) and the bigger picture as shown by the ALS. With a listing and independence from the government, we would be able to see the full compensation of all the management, including the CEO, and also demand their removal in the event of poor performance.
The shareholder revolt at Chesapeake shows us very clearly the accountability we as shareholders in Singapore Inc. have a right to expect and should be demanding from our government and the management of our SWFs. Without privatization of our SWFs and a change of government we are unlikely to get it. PM Lee has already promised us higher taxes. If we do not take action now who knows how bad the situation will be with a further five or ten years of poor investment performance. I am prepared to accept that I may be completely wrong and our investment managers are the best since Warren Buffet. However if that is the case why will the Finance Minister not answer my perfectly reasonable questions? Since he clearly will not respond to me my suggestion is that as many of you as possible write to him to urge him to answer my questions.