Case 1- Noble Write Down
Many of us will be aware of Noble’s huge write down on its financial derivatives and the subsequent loss in shareholder value. All these while, an independent research house, Iceberg, has been indicating that Noble had over-valued its financial derivative assets. What made it worse was that Noble’s own external auditor, Ernest & Young, had for years been giving Noble the clean bill of health. While it is true the methodology is sound, the inputs/estimates Noble had given was unrealistic.
This begs the question: Are our auditors really looking at the authenticity of numbers by thinking on the inputs or are senior partners just blindly signing off? After all, many university students have learnt of the idiom – “Rubbish in, Rubbish Out”; hence I wonder if many of our practicing auditors do take heart of this idiom when doing their work. This brings me to the second case.
Case 2- Hyflux and Tuaspring.
This is another classic story of “Rubbish in, Rubbish Out”. Hyflux is now in financial limbo and at the heart of it is its largest asset- Tuaspring which is worth $1.4 billion in book value with a lifespan of 20 more years. How did Hyflux value $1.4 billion? Well Hyflux had based it by estimating the total economic value its power plant will bring based on 2011’s electricity price of $200+ per unit and extrapolated it until the duration end of 2038.
Fast forward to its completion in 2015, prices hit its low points and in 2016 it went down to below $70+. One may argue that electricity prices will rise back to $200+ to match Hyflux’s estimates, but common sense and Google searching would have showed that Singapore’s power industry was oversupplied where power output supply was double that of demand. Even if the upward reversion is true, it will take time. Hyflux definitely could have taken an impairment n for the poor outlook that is happening now.
Unsurprising Hyflux’s external auditor, KPMG, are still giving the OK for Hyflux’s stated book value until FY2017. With the recent need to sell Tuaspring to rescue itself, I am pretty sure Hyflux will be booking an impairment on its own and not because KPMG has realized the inputs to Hyflux’s valuation model does not hold true.
It makes me wonder if our auditors are indeed verifying the authenticity of the reported balance sheet numbers of our companies. In addition, with recent times, we have noticed how many companies with overseas operations have been found to report non-existent cash balances in their balance sheet. The most recent example was Midas Holding (External Auditor: Mazars)
It makes one wonder the robustness of our auditors in conducting their due diligence on overseas operations of listed companies here. In fact, if I am in to indulge in my clairvoyance ability, my crystal ball says a listed company starting with “S” is dodgy. The company’s market capitalization is much lower than its stated net asset value and will easily pass any CNAV analysis value investing model; surprisingly no hedge fund or investment fund is invested in it!
Conflict of Interest
It is worth noting that under Singapore’s current financial regime, companies themselves have to hire the auditors who will be checking on them. This is a potential conflict of interest because the current practices means Audit firms have to rely on these companies for their livelihood. Hence should audit firms give a bad report on their own customer (these listed companies), it is likely the auditors will lose their business.
In Pritam Singh’s word, it iscalled “Ownself Check Ownself”
So naturally if an auditor feels that a certain company is giving dodgy inputs to makes its balance sheet look great; would auditors flag it out to warn the public knowing that they will lose a potential source of income? I think you and I know the answer.
Instead we should consider asking companies to pay their audit fees to a central regulatory body who will then appoint an auditor on their own for a period of time (e.g. 5 years). Extra Financial Incentives can be given to auditors should they spot a fraud or dodgy practices done by their audited company; and if a fraud or massive impairment happens during their watch, they face a financial penalty.
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