Cash Piles

23^rd November 2007
The Malta Independent - Friday Wisdom

We had two different types of cash piles in the news this week. The one closer to home was discussed at the general meeting for the shareholders of Maltacom plc, now officially renamed GO plc, where the shareholders rightfully queried the company executive what it plans to do the some thirty million liri of liquidity sitting in the company’s books for which there is no evident purpose.

Given the very low level of market price at which the shares of Maltacom have been trading on the Malta Stock Exchange, some 12 per cent below privatisation price on the sale of majority shareholding to TECOM which of itself was some 25 per cent below the last trading price before the announcement of the acquisition price, shareholders rightfully demanded why the executive should not put their money where their mouth is and start buying back the company’s own shares on the market. This would be a very powerful signal to the shareholders that the executive considers that the market is seriously undervaluing the company and could kick start fresh demand for the Company’s shares which would drive the price to a more realistic level.

Rather than accept such suggestion as a practical way of returning funds that the company does not need for its own development to its shareholders, the Chairman was reported as defending the holding of such excessive liquidity to finance overseas projects being eyed by the company.

I would not wish to enter into the merits of how appropriate it is for Maltacom to give priority to such foreign acquisitions over returning capital to shareholders as obviously I have no access to information on how attractive such foreign investments could be. However I know that there are not many acquisition targets with a price tag of thirty million liri. On top of that I feel that shareholders never invested in Maltacom to finance foreign acquisitions. Given that the majority shareholders ought to have no problem to finance their acquisitions themselves outside the Maltacom framework it is prudent to give Maltacom’s small shareholders the final say as to whether they want their executive to use the company’s excess liquidity to finance foreign acquisitions or to return capital to shareholders.

However this brings home another important point that I had raised at the time of the sale of a majority stake in Maltacom by government to Tecom. Given that the share price was arrived at on the basis of estimation of future operating cash flows from the core Malta operations rather than on the value of present assets, why did government not distribute the excess cash, surplus to operational requirement, to the shareholders (itself included) before the transfer to TECOM?

This is an enigma that was never satisfactorily explained or answered and together with the failure to transfer out of Maltacom the valuable Qawra land before sale to TECOM, makes this one and only privatisation under the Gonzi administration a failure. Whether it can be justified in a wider context on the basis of TECOM’s investments in Smart City remains to be seen even though the government had itself insisted that the two matters are not connected and each deal had to stand on its own two feet.

The other cash pile in the news is the foreign reserves in the hands of the oil exporters and emerging markets economies, including China, India, Russia and Brazil who among them are now holding 75 per cent of the global foreign exchange reserves. This is a far cry from the Asia crisis and Russia default of 1998 when such countries had very thin foreign exchange reserves to withstand the sudden outflow of hot money from their economies.

The US dollar keeps falling and comes within a whisker of a landmark of 1.50 for every Euro. The argument is being heard more insistently whether the USD still has the merits to remain the principal reserve currency of the world and the unit of account for pricing international commodities such as oil, metals and wheat amongst others.

As the US economy slows down under the weight of its housing crisis and seems to be moving closer towards the edge of a recession, the outlook for the USD, at least in the short term, remains poor. If the Federal Reserve has to cuts US interest rates still further to protect the economy from a recession, this will continue to devalue the external value of the USD and will give rise to continued concern to emerging economies about the wisdom of continuing to accumulate such USD amongst their foreign reserves.

With the Euro just about to celebrate its ninth year of existence its fate of becoming a reserve currency with comparable weight to the USD seems to be materialising much earlier than anyone could have imagined especially when just 5 year years ago the Euro was trading at some 80 cents for every USD. It has nearly doubled its value against the USD in just over five years.

The status of reserve currency brings much greater responsibility as well as considerable pain at the adoption stage as the rate tends to overshoot causing problems of competitiveness for domestic producers. But if this is accepted as a challenge of creative destruction, i.e. the replacement of non competitive units by new investment in higher value-added competitive units attracted by the reserve currency status, then the long term benefits from the switch the cash piles of emerging countries from USD to Euro could be enormous.