Water Damage

We are taught that investing in water concessionaires is a sound investment proposition due to the perpetual demand for water and wastewater services. The need for more water-related infrastructure prompted the government to extend the water concession agreement between the Metropolitan Waterworks and Sewerage System (MWSS), DMCI Holdings Inc (DMC), Manila Water Company (MWC) and Metro Pacific Investments Corporation (MPI) from 2022 to 2037. But investors were shocked when the MWSS revoked the extension of the water concession agreement after the Department of Justice (DOJ) stated that it had no legal basis while several provisions had been found to be onerous and disadvantageous to the government. Most notable were the provision against government interference in water rate setting and the provision against possible losses in the event of government interference. DOJ argued that these onerous provisions were the reasons why the Singapore-based Permanent Court of Arbitration ruled in favor of the water concessionaires and ordered the government to pay them an estimated P10.8 billion to cover the foregone revenue as a result of government refusal to increase water rates. Threats of expropriation and charges of plunder forced the water concessionaires to delay the water rate hike, abandon the arbitral tribunal award and renegotiate the water concession agreement. We do know that the willingness of the water concessionaires to cooperate would be advantageous to the government but what we do not know is whether investor confidence could recover from a regulatory debacle. The damage was done and investors would consider government contracts as a high-risk factor. Although the intention is to renegotiate government contracts with onerous provisions, the government should uphold the sanctity of contracts. Breaking the rules and changing the game would increase the Country Risk Premium (CRP) that could have adverse impact on valuation calculations. CRP is the incremental required rate of return which results from the increased risk inherent in an emerging market investment. Investors sold down the water concessionaires and based on the 52-week high and low share price performance, DMC decreased by 61.9% from P13.00 to P4.95, MWC decreased by 82.3% from P28.25 to P5.01 while MPI decreased by 49.1% from P5.28 to P2.69. Although the share prices bounced back from the 52-week low we expect them to consolidate in a narrow trading range until the water concession agreement is sorted out. Unless the regulatory environment becomes stable, investing in water concessionaires is an unsound investment proposition.

Party Rules

To strengthen corporate governance and shareholder protection, the Securities and Exchange Commission (SEC) will require all publicly listed companies to submit a policy on material Related Party Transactions (RPT) by October 28. RPT are allowed on condition that when it amount to at least 10% of the total assets, it must be considered as material subject to the Material RPT Rules. Transactions covering at least 10% of the total assets involve, on average, an amount of P3,498,121,059.28 taking into account the total assets of all publicly listed companies for the year ended 31 December 2017. Considering the magnitude and impact of these transactions to the financial position of the company and to the interest of its shareholders, the SEC considers 10% of the total assets of all publicly listed companies as the materiality threshold for RPT covered under the Material RPT Rules. The 10% of the total assets has been acknowledged by the World Bank as an acceptable threshold in determining the materiality for RPT based on international best practices. Based on the disclosure and reportorial requirements, the Advisement Report on material RPT must be filed within 3 days after the execution date of the transaction; the Material RPT Policy with accessible link must be posted on the website within 5 days from submission to the SEC; and a summary of material RPT entered into during the reporting year must be disclosed in the Integrated Annual Corporate Governance Report of all publicly listed companies. For non/late filing or incomplete/incorrect signature in the Material RPT Policy, the imposable penalties are a basic penalty of P10,000 and monthly penalty of P1,000, which will continue to accrue until the Material RPT Policy is submitted to the SEC. For non/late filing or incomplete/incorrect Advisement Report, the imposable penalties are a basic penalty of P30,000 to P40,000 and daily penalty of P200 to P400 without prejudice to administrative penalties that may be imposed by the SEC. Although all related parties of all publicly listed companies can be disqualified on the basis of a final judgment rendered by a court of competent jurisdiction against them for abusive material RPT, the imposable penalties are comparable to a slap on the wrist. Perhaps the SEC should increase the imposable penalties for abusive material RPT to stratospheric level or else related parties will have the ability to bend the Material RPT Rules without breaking.

Last Resort

Tough times never last but tough companies do. But there are some companies that cannot handle the pressure of intense competition and investor expectations. The latest among them is Travellers International Hotel Group Inc (RWM), owner and operator of Resorts World Manila, which will delist from the Philippine Stock Exchange (PSE) in response to the changing marketplace without compromising its business strategies to competition. Change is constant while competition is intense in the gaming industry so it is bothersome to hear a lame excuse from a renowned gaming company run by postgraduate degree holder management team. In accordance with the Securities Regulation Code of the Philippines and the delisting rules of the PSE, RWM will conduct a tender offer of up to 1.58 billion common shares held by the shareholders other than First Centro Inc, Adams Properties Inc, Megaworld Corporation, Asian Travellers Limited, Alliance Global Group Inc, Premium Travellers Limited, Star Cruises Philippines Holdings BV, and the members of the board of directors. Upon completion of the tender offer, at least 95% of the total listed and outstanding common shares will be held by the private shareholders. The tender offer will be from 19 August 2019 to 23 September 2019 while the delisting date will be on 15 October 2019. RWM will buy out the minority shareholders at P5.50 per share using the fairness opinion of PricewaterhouseCoopers and Isla Lipana & Company. Based on a weighted average cost of capital of 12%, the discounted cash flow approach yielded a fair value ranging from P5.00 to P5.80 while the market approach yielded a fair value ranging from P5.00 to P5.70. Despite a tender offer price at the higher end of the fair value range and a premium to the volume weighted average price of P5.49 for the past 3 months and P5.46 for the past 6 months, there are some minority shareholders who felt shortchanged. Most of them argued that the tender offer price must be the same as the initial public offer price of P11.28 per share. A preposterous idea that is contrary to common sense. Although a historical cost method used in accounting in which the price of an asset is based on its original cost when acquired, the same cannot be used for the tender offer price for the reason that value changes over time. As Benjamin Graham stated, price is what you pay; value is what you get.

Save More

Philippine government must declare retirement as a national wealth emergency for the reason that most Filipinos are not prepared to do so. Even the law governing employment practices and labor relations are not enough to provide Filipinos with a decent retirement. Based on the Labor Code of the Philippines, the minimum retirement pay is 1/2 month salary for every year of service while a fraction of 6 months is considered as 1 year. The 1/2 month salary will include the 1/12 of the mandatory 13th month pay; 15 days salary based on the latest salary rate; and cash equivalent of 5 days service incentive leave. Manulife Investor Sentiment Index (MISI) conducted by the Canada-based insurance and financial services provider Manulife Financial Corporation showed that Filipinos have an average retirement savings worth 3.6 months while Asians have an average retirement savings worth 2.9 years. MISI is an annual survey measuring and tracking Asian consumer behavior related to personal financial planning. Respondents are middle class investors who are at least 25 years old and who are the primary decision makers on household financial matters. We are astounded by the low retirement savings of Filipinos but what concerns us the most is the reason behind it. MISI showed that the low retirement savings of Filipinos is based on the expectation that family members will support them upon retirement. We do know that strong family ties is one of the core values of Filipinos but what we do not know is whether Filipinos have a retirement plan when family ties get untangled. Filipinos must work toward financial independence with enough retirement savings to maintain their desired lifestyle even without a regular income. MISI showed that Filipinos believe that an average retirement savings worth 2.1 years is enough as compared to the ideal retirement savings worth 10 years. The ideal retirement savings is based on the average life expectancy of 70 as compared to the average retirement age of 60. Filipinos must start to save more to catch up with the ideal retirement savings for the reason that no amount is enough once the dreaded inflation sets in. Inflation is the rate at which the general level of prices for goods and services is increasing while the purchasing power of currency is decreasing. We must protect the purchasing power of retirement savings by investing in asset classes that can provide capital preservation and appreciation.