Nov 09, 2012
The IEC is piling up more and more debt, creating a giant overhang that it will inevitably have to deal with some day.
The auditors lending their stamp of approval to the Israel Electric Corporation’s financial statement for the third quarter of this year will have to think about this carefully. Should they tack a going-concern warning on its report?
They didn’t on the state-owned monopoly’s second-quarter statement. But meanwhile the IEC is scrambling for cash by issuing more and more bonds backed by the state just in order to meet its cash liabilities for the year.
Beyond the short-term question of its liquidity, the IEC is inflating its red ink, creating a giant overhang of debt that it will inevitably have to deal with some day. There are any number of examples around the world, not only in business circles but of whole countries: That debt will certainly come home to roost.
Even before the latest mishap, in which the IEC admitted to an accounting booboo that left its cash-flow projection short a huge NIS 1.4 billion, the second-quarter report demonstrated the company’s desperate straits. This is all the more true given the various forms of relief the company enjoys thanks to being owned by the state, such as a break on adjusting its financial statements for inflation, and especially if its financial statements are viewed through the prism of international financial-reporting standards for public companies – the IFRS.
At the second-quarter’s end, the IEC reported having shareholders equity of NIS 15.7 billion. But going by IFRS, its shareholders equity is just a smidge more than half that, at NIS 8.6 billion. If we deduct the increase in pension liabilities that will kick in at the start of 2013 because of an IFRS amendment, its shareholders equity drops to NIS 7.4 billion.
Also at the second-quarter’s end, the company’s outstanding liabilities totaled NIS 66.5 billion. Of that, financial debt totaled NIS 51 billion.
In other words, by IFRS, the IEC’s leverage ratio (a measure of its ability to meet its financial obligations) is below 10%. Its an indicator for financial robustness – approaches 90%. Both are bad, including to other electric companies around the world; both attest that the company’s leverage levels are dangerously high, imperiling its very financial stability.
To illustrate the weakness of these ratios, if it were another company, the bondholders would be entitled to call in the debt immediately. Among industrial companies rated BBB or below, alarm bells would have started ringing at leverage ratios of 30% and debt to capital ratios of 50%.
Worse, the IEC’s ratios will be declining even more. It borrowed NIS 3 billion by selling state-backed bonds in July, and will be borrowing even more to dig itself out of the financial hole it’s now in.
The company’s profit and loss statement also looks a lot bleaker seen through the lens of IFRS. The IEC reported a loss of NIS 1.7 billion for the first half of 2012. But going by IFRS rules, its loss was a towering NIS 4.3 billion.
Yet even those ugly figures don’t truly measure the performance of the IEC as a stand-alone entity. By backing its bonds, the state is heavily subsidizing its cost of interest. If the company had to pay interest that would reflect its true risk to bondholders, it would be running a much bigger loss and its capital wouldn’t last long.
Any other company in its condition would get a going-concern warning slapped onto its financial statements. The warning conveys that management believes the company will survive in the foreseeable future, but the auditors are dubious.
It is worth noting that the rules set a minimum for “foreseeable future,” but no limit; problems far off on the horizon may cause auditors to apply a going-concern warning.
It is broadly assumed that the state won’t let the IEC collapse, because it’s an all but total monopoly over the supply of electricity in Israel. That is probably why there is no going-concern warning on its reports. But that is no trivial assumption, as there is no formal broad undertaking by the state to support the IEC.
The state has helped the company out here and there, helping it narrow its spending deficit as its cost of fuel soared. But the latest development concerning the giant hole discovered in the company’s cash-flow estimate, and the public debate on breaking down the IEC into separate smaller companies (such as one handling power generation, one handling logistics and so on) mean that nothing should be taken for granted.
At ordinary companies, when survival depends on the owner giving it money, the owner has to formally state as much for a going-concern warning to be avoided.
The thing is that any such warning could be ruinous for the IEC. Deterioration of its business or financial situation imperils the company’s ability to meet its obligations towards borrowers, giving the borrowers the right to call in their loans. The warning could be taken as sufficient indication of just such deterioration, leading to the company’s bankruptcy.
In theory, the company is just like any other. But one cannot ignore that its financial statement deviates from accounting standards and that its identity is intertwined with that of the state, whether as sovereign or controlling shareholder. The paradox is that the horrific implications of a going-concern warning bolster the likelihood that the state will simply continue to serve as a crutch that helps the company limp along. But that warning could still appear one day.