Temasek and the Case of the Undervalued Assets

Balding's World

I am amused and intrigued by people who have no understanding of the implications of their own arguments or do not carefully read what I have written.  In his “rebuttal of a rebuttal”, Mrs. Snook further attempts to convince myself and others about the correctness of her position that Temasek undervalued assets when it received them from the Singapore government therefore allowing Temasek to earn 17%.  Let us take a minute and explore his position and its importance.

Let me begin by clearly stating: the analysis of Temasek receiving undervalued assets to boost their claimed returns is entirely true.  Read my previous rebuttal (and related posts about Temasek accounting here and here) on the matter and you will clearly see that I never disagree with her or rebut her facts.  (Expecting her to respond as she did, I was kind of saving this part in reserve.  My apologies if that means I played a little dirty).  The only thing that I do is warn her about the implications of what her argument means.  Now let’s explore the facts and additional implications of what Temasek receiving undervalued assets means.

A basic argument is made about the original legacy holdings of Temasek with a simple illustration.  If the owner of a $1 million in financial assets transfers them to a holding company that they own at a nominal value of $100, nothing has changed.  The original owner of the assets, owns them, which owns the assets so there has been no change in the wealth of the owner.  The same argument is made about Temasek companies transferred from the government.  As is written “it was just an administrative exercise with no implications for the tax payer or citizen….I now own a company which owns $1 million in shares.  I have lost nothing.  I am still a freaking millionaire.”  As elegantly freaking stated as that is, let’s examine this claim closer.

First, this poorly constructed analogy overlooks the implications of how returns are claimed.  Let’s assume the owner of $1 million in unlisted financial assets, as the Singapore government was in 1974,  transfers its ownership to a company she owns for a nominal value of $100.  There is no change in wealth.  However, one year later, the owner cannot go out and claim that his company has an annual return of 999,900%!  This would be considered absurd by everyone who knew how that return was calculated.  Yet this is exactly what is claimed.  When Temasek receives assets at a “zero or nominal value” which are worth significantly more and then claims high returns, this is not a true or accurate picture of its actual performance.

Second, the reason I agree so strongly with the theory that Temasek is receiving undervalued assets is that purchasing or receiving undervalued assets is one of the best ways to cover up investment losses.  Let’s take a hypothetical situation.  The owner of the $1 million in unlisted assets transfers it to her new investment company at a nominal value of $100 and convinces her grandmother to give her some money to invest in the stock market.  Let’s assume, hypothetically of course, this new investment mogul guarantees Grandma a return of say 2.5% on her investment of $10,000.  This talented CEO takes this $10,100 into the stock market and let’s assume she buys some bank stock.  Then assume that the bank stock bought by this investment genius declines in value to say $5,000 a loss of 50.5% at which point it is sold.  Rather than going and telling Grandma she lost a lot of money, this talented investment guru revalues the unlisted assets from $100 to $6,010.  The official capital is only $5,000 but after revaluing the unlisted assets, the firm value is $11,010 allowing the new firm to declare a 10% return.  Grandma is impressed and keeps investing with her talented offspring.  This firm with the enormously undervalued assets as a cushion, can endure a lot of investment losses before encountering problems.

The question then becomes has this undervaluation of assets acquired or received by Temasek actually taken place and has the tax payer been hurt by this practice?

Due to the lack of data and their refusal to release the data, we cannot analyze in great detail the value of the assets transferred from the Singapore government at Temasek’s inception.  However, given the number of companies that were transferred, the aggregate value they were transferred at, and their size, it is quite probable they were significantly under valued when transferred to Temasek.  This would be a good start to many years of over stating returns and covering up losses.

Worryingly, this pattern of the Singapore government providing or selling Temasek significantly undervalued assets continues to this day.  There are two recent and obvious examples of how this behavior which is used to pad Temasek returns and harm the tax payer.  First, the Singapore government is paying $1.1 billion SGD to purchase buses for the SMRT.  The problem with this arrangement is that SMRT is a publicly listed, private company owned by Temasek that declared a $120 million SGD annual profit for the year ending March 31, 2012.  The government of Singapore is obviouslysubsidizing the profits of a Temasek company by transferring public assets to a private company incurring a tax payer loss.  To put this arrangement in perspective, if SMRT had to pay a 10 year bond with annual payment at a 4% interest rate on the $1.1 billion SGD in buses: it would pay $136 million SGD in principal and interest costs making its yearly profit disappear.  Given this information, it seems highly unlikely SMRT would have a $2 billion SGD market capitalization if the Singapore government was not subsidizing Temasek profits by billing the taxpayer for the capital used by a private company.

Second, as was pointed out by Steve Wu, Temasek with the help of a $3.2 billion SGD capital injection from the Singapore Ministry of Finance paid $3.2 SGD billion to acquire Changi airport.  This transaction is notable for a few reasons.  For instance, according to one document from Changi Airport, the government since the late 1970’s has invested approximately $5.68 billion SGD.  This implies that in pure dollar terms, the Singapore taxpayer lost approximately $2.5 billion SGD.  If we however assume, a purely hypothetical return on these airport investments by the government of 5% or 17%, the Singapore tax payer would have had an asset worth $13.3 billion or $202 billion respectively.  If the airport “investment” by the government earned a low yielding 5%, the Singapore taxpayer would have lost $10.1 billion SGD and if it earned the Temasek rate of return an astounding $198.8 billion loss.

Furthermore, by numerous valuation methods, it appears that the Changi Airport was significantly undervalued.  For instance, in its first full year of operation, the Changi Airport group earned $337 million SGD.  That is a 10.5% rate of return an incredible return for an airport.  Its profits ending 2012 was $553 million a 17% cash flow rate of return while the tax payer incurred a $2.5 billion SGD loss.  Temasek obviously received a sweetheart deal in acquiring Changi Airport at the expense of the tax payer.

To briefly recap the implications of receiving assets at “zero or nominal cost”.  First, Singapore tax payers are suffering losses by subsidizing Temasek profits.  Second, Singapore and Temasek are engaging in Mickey Mouse accounting.  Third, Temasek returns are inflated by the “zero or nominal cost” assets it received.  Fourth, Temasek accounting does not consider the cost of capital.

I completely agree that Temasek and its subsidiaries are receiving capital and companies at “zero or nominal cost”.  Unfortunately, this has disastrous and chilling implications for Singapore and Temasek.