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23
Jan
2011
My eleven findings from the debt mess

I have been consulting many clients over financial and investment management for last five years. But in December 2010 one of my friends contacted me for his interesting and lessen oriented bunch of problem. He has a petrochemical company in Ajman U.A.E. and his debt level was extensively critical regardless of some good business attributes his company carried on financial and marketing fronts.

I want to share some key lessons that I have taken from his problem that I want to share with my readers without mentioning the name of his company. In this regard I shall focus on the findings rather than the extensive data of his company so that I can avoid people gets an understanding of the concern because the market in Ajman is very small.

Actually the majority of his problems are related to financial psychology rather than a mere financial management chaos. His company had a good financial health in the start of 2006. His company was working on a debt level 10% of his total capital structure with his time interest earned ratio of 19.5 AED for 1 AED interest as on Dec 31 2005. Majority of his debt was raised from banks just to facilitate his expansion in factory.

The bottom line is that I found really a good scenario of his business as on Dec 31 2005 when I view his statements and financial records. He had good mix of capital structure, highly probable cash flows, maintained and affordable cost of finance, good profitability in business and his excellent professional grip over his business. Indeed there were some risks that were more related to macro economic factors and global inflation in oil prices etc.

Before discussing what happened from 2006 to 2009, I just want to reveal some financial facts of his company as on Dec 31 2010. His debt level had risen to 93% of his capital structure as on Dec 31 2010. The earning of his company has reduced to AED -350,000 [loss] p.a. from AED 11, 00,000 [on Dec 31 2005]. There is no need to calculate time interest earned ratio as he has no financial room to pay his outstanding interest. The principal payments of corporate debt those are due in 2011 stand at AED 1.8 million. His total debt tally stands at AED 8.76 million that he has to payoff by 2015.

I think the above financial facts are enough to understand the generic financial problems that his company is facing today. After loosing employees and labor [due to non payment of salaries & wages] the production resources of the company even exists but staying static. As the U.A.E. laws are so strict on bounced cheques but he is still free of imprisonment due to the time grace he gets from the market on debt due to his sound character and great reputation of his business for over 15 years in U.A.E.

Now let me discuss what went wrong:

In 2006 when his company was going great guns he had desires to expand his business that he was very sound at in term of skills and expertise. In the same time he was seeing real estate and stock markets growing at good pace in Middle East. He got an idea that if he multiplies his excess funds in realty and stock markets he can have good financial returns that can help him in accomplishing in his future plans.

He started the game with few properties that he bought in Dubai for short term selling objectives. This went really good and he got ROI 200% within 6 months of time. This gave him a lot of courage and he became addicted of it. In a year time he earned a lot that induced him to take exposure on realty and stock markets via his business debt facilities.

He took massive exposure over investment in real estate and stocks that reached total investment of his companyother than her operation to AED 12 million. This investment tally represented 70% being leveraged by debt. He was so confident on the forecast of realtors and consultants. Even none of his consultant was suggesting him the risk of investment in real estate and stocks.

And then it arrived 2008; the property market in U.A.E. started tumbling. The biggest concern that I sorted out in his financial statements was his losses from operations that even turned overall profitability courtesy to his other investments in realty and stocks as on Dec 31 2007.

The biggest mistake he carried even after seeing the property markets declining that he took further exposure of market debt to keep his investments in property alive in anticipation of bounce back of the markets in six months time. But unfortunately and even logically haven’t happed as yet.

The basic 11 findings I have got from this case or myth is below:

1-Never get over excited over returns in prevailing interesting scenario of investment without understanding her risks and drawing a risk management framework to address her volatility.

2-If you acquire debt based on the risk level of operations that you are good at, so invest it in the same level of risk that can provide the rationale of investment and your financial plan work more logical. Even it is recommended to invest in 15% plus of your corporate risk if you want to do something as adventure in general course of business. Know yourself before getting excited over your incomplete knowledge of attractive investment opportunities.

3-Doing what you don’t know is not a risk it is a blunder. It is better to understand investment first and then invest rather than investing in it and then waiting to see what it is.

4-Always establish SPV [Special Purpose Vehicles] or a new corporate entity to take exposure on risk business. It is better to hire any proper investment professional that better manages your risk investments far away from your original corporate entity. This actually saves your business and due to limited liability of separate company it can not hurt your other businesses.

5-Attractive opportunity is always a weaker term before feasible opportunity. The things that you can manage in bad times are always good than those that you can only enjoys when the markets are brisk.

6-When the markets go brisk establish a working framework that can welcome your goodness in bad times. Never forget that there is no brisk that can stay long than normal or bad market conditions.

7-It is so unprofessional to plan profits rather better to plan your cash flows and consider them lesser even if they look more than enough to put in any adventure of new business.

8-Don’t be conservative but equally grip your liberties via discount factors and risk considerations.

9-If the risk of your new investment is 100% more than your current business invest 50% lesser than what you have to invest. The remaining funds must be invested in lesser risky opportunities that can diversify the investment and ensure you shall have your principal intact for any bad time that you can have from your risky investments.

10-If you find a hint of decline in property markets sell off your investments rather than waiting for things gets better. In every five year you shall have another opportunity to see the new scenario prevailing after getting the markets burst. Try seeing 25 years rather than having greed to be great in couple of years. This even helps you to work great in couple of years.

11-High risk investments are like an unfaithful but beautiful girl friend. If you don’t know the art of flirting then better stay away. The business in which you have expertise is like a faithful wife that you can get back anytime even loosing millions on the bitch. But try to have a little room that you can not breach tolerance limit of your faithful wife. Don’t forget that your existing business in which you have expertise is your strength. Never neglect your prime shot when occasional investment opportunities are rocking the numbers on financial statements.

At the moment I am trying to give a plan to my friend and talking his lenders to restructure his debts. I am sure that even now if he gets a little room and work his original business he can get out of this crisis in next five years. I will surely write for my readers about the recovery of my friend’s company as it goes on.


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Mr. Omer

Mr. Omer [1982 born] started  his professional career as a commercial / investment banker after achieving Gold Medal in Finance at master level from University of Karachi in 2006.

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