Growing List of Uncertainties for South Canterbury Finance

(UPDATED 4th April) There are a growing list of transactions and balances of South Canterbury Finance that don't quite add up, or provide serious concern about their substance or value. Here is a list of items:

1. Those loans to Lachie McLeod and two directors (or entities associated with them) for $20m, secured on Southbury Group shares, and allegedly made on a non-recourse basis, and without personal liability on the part of the beneficial owners. This transaction could be interpreted as $20m of phoney capital, since Southbury Group is now almost entierly made up of SCF. However, it could be worse than that: Southbury Shares are probably worth a small fraction of what they were at the time this loan was made, it could represent up to $20m in unrecognised losses.
2. Those SCF shares issued with the funds raised by Southbury Corporation convertible notes. Southbury Corporation now only owns SCF, and SCF provided a guarantee secured by prior charge security. So this is basically $27m of debt pretending to be equity. If Southbury Corporation produced consolidated accounts, this equity would disappear. The Companies Act 1993, sections 76-81, impose restrictions on a company providing 'financial assistance to a person for the purpose of, or in connection with, the purchase of a share issued or to be issued by the company, or by its holding company, whether directly or indirectly' (s 76 (1)). It would appear that these restrictions would apply to this transaction, given that 'financial assistance includes a loan, a guarantee, and the provision of a security' (s 76 (6)) and the company provided a guarantee and a security, and it was in connection with shares to be issued by the company. If this part of the Companies Act applies the company is obliged to send disclosure notices to shareholders, and I believe this would include preference shareholders. As far as I know, no disclosure notices have been sent to preference shareholders, so I have to question whether this part of the Act applies (if not why not?) and if so, did the company comply with this part of the Act?
3. The $15m loan SCF made to Southbury Corporation when it acquired Helicopters NZ and Scales Corporation, to pay off Southbury Corporation third party debt (I'm assuming that it does not include any funds owing on the convertible notes). For this point and the previous one see page six of this.
4. The $22m 'capital' raising announced on 31st March 2010 referred to here. Likely to be $22m more of phoney capital covering $22m in further losses booked. I will update this when there is full or more disclosure on this transaction, perhaps when they register their new prospectus.
   

That's a total of questionable equity of about $84m.

Some questionable assets:

1. Commtest instruments shares. SCF own 40.2% of this company, making it an associate company. They helpfully disclosed this company has assets of $14.5m, liabilities of 21.4m, revenue of $7m, and profit of -2.4m. That's got to be a great investment right? If you can over look the minor concern with liabilities being greater than assets and expenses being greater than income. Anyway, SCF valued the company as at 30 June 2009 at $17.5m, and its 40% share at 7m (Note 15). In fact the company paid $12m for this shareholding (see p 7 of this), so it has already recorded an impairment of $5m. Nothing dodgy about that, right? The company told me this is no error, and that a Crown expert agreed with the fair value, but I just find this a bit too difficult to accept, sorry.
   
2. Dairy Holdings shares. This is also an associate company, SCF's holding is 33.59%. Assets $666m, liabilities $408m, revenue $56m, profit -$66m. For a dairy farmer, this is considered very highly geared. Since the shares were acquired, the numbers of sales of dairy farms have reduced, and other large bundles of dairy farms being sold by CHH and Westpac/Crafer farms are not finding buyers. The National Business Review, paper edition, 12th March, p. 32, Tyre kicking article states 'Rural newspapers report right funding has led to a virtual standsill in farm sales'. Spot milk prices have been dropping lower in recent months, but the Fonterra payout remains fairly high. Dairy financiers such as South Canterbury Finance and Allied Nationwide have financial and liquidity problems, hence their lack of willingness and ability to fund these loans anymore. Given this is a minority shareholding, and the company holding the farms is highly geared with debt, I'd expect this $76m asset (30 June 2009) could realise a lot less if it had to be sold.
3. The advance to South Island Farm Holdings Limited. This was originally 67.2m preference shares in the company, issued at a price of $1 each, however the fair value of this asset was lower, and the company did not report this asset at fair value in its 30 June 2009 accounts (the auditor also missed this error). Subsequently, the company purchased 6.8m ordinary shares in the company, at an issue price of $1 each, making it an associate company. After this but before 31 Dec 2009 the company sold these ordinary shares to an independent third party for cash, and exchanged the preference shares for a subordinated loan of the same amount. This means that the company was not an associate at 31 Dec 2009, so we won't get to find out how much assets, liabilities, revenue and profit this company has, or the fair value of those shares. The company is left with an asset worth less than $67.2m, and the company has avoided disclosing to us how much it lost on the deal. So much for the company not losing money on related party transactions! It appears that the company in reality made a loss on its sale of the ordinary shares in SIFHL, because it had to make a loss on the associated loan. That loss could be more than the $6.8m it received for the shares. Should dairy farm prices continue to drift lower, the company's exposure to dairy in these two investments alone could leave the company with losses of over $100m. Or not. Perhaps farm prices will hold up, with news on the 7th April 2010 that milk prices have bounced back up recently.
   
4. As at 31 Dec 2009, the company now has $84m in Deferred Taxation asset, in its balance sheet. In note 2 of the 30 June 2009 accounts the company states 'Future income tax benefits attributable to temporary differences are recognised in the financial statements to the extent that it is probable there will be future taxable profit to utilise these differences.' If the receivers were called in, the company would be likely to end up with tax losses that cannot be used. Put another way, should the company (or the user of the company's financial statements) conclude that the company is not likely to make profits in the future, this $84m on the balance sheet would be written off (or considered written off). The amount may be increased now by another about $10m with apparently another $22m in losses being booked leadin up to the most recent 'capital' injection of that amount.
   

This is a total questionable assets of over $200m.

What is strange about some of these related party transactions is that some of the non-arms-length prices have had the result of making the company avoid booking losses it had made, while others have the result of making the company make and book losses it did not make. The effect is to cast doubt on the values in all related party transactions.