A closer look at its values or passion or a frank talk with the people behind ERI could succeed in dispelling a lot of untruths or allegations and even misconceptions. However, the company, Environmental Resources Investment Plc (ERI), cannot be spared of its share of controversies. This could be partly due to its aggression or methods of achieving a very straightforward end. A lot of the controversies also could be due to a lack of understanding of the means of ERI to an end that is normal. Allegations range from money laundering and share price manipulation, etc. Knowledgeable investors, given its business model, saw future value in ERI share and warrants issued. Perhaps in the Bull Run as part of natural herd instinct, less-sophisticated retail investors followed suit. The meteoric rise of its share price and trading volume among other issues prompted the Securities and Exchange Commission (SEC) many months ago to launch its own investigations, perhaps to verify certain market assertions or assumptions and the company itself has been forthcoming with disclosure; nothing so far has been conclusive. To its credit, a critical analysis of ERI suggests it has carried out an unprecedented business model. Perhaps unique to Sri Lanka, but prevalent elsewhere globally, within a span of less than two years it has made seven acquisitions with an investment of Rs. 3 billion in addition to an exposure of Rs. 2 billion for a BVI company. Via acquisitions ERI is sowing the seeds for turning around distressed companies. The predecessor of ERI is Walker and Greg, incorporated in 1910, i.e. 100 years ago and listed 40 years ago, in 1970. Lionhart entered Walker and Greg in 2006/7 and from June 2007 acquired control and management from when it was almost a shell company with a few investments from Brown and Company. From an asset base of below Rs. 85 million by 31 March 2007 and eight financial years and Rs. 385 million in 2008/9, today the figure has grown to over Rs. 7 billion. Whilst ERI may have been subjected to too many allegations, at least to thousands of employees of these distressed companies, it has given new hope. The Daily FT in this special report reviews ERI’s recent performance as well as the controversies, powered by a series of acquisitions at rapid speed.
On that premise, is there anything wrong in making money by endeavouring to turn around distressed companies? If not, then that is what exactly Environmental Resources Investment Plc – popularly known as ERI – says it does. In doing so, ERI, which is 93% owned by Lionhart Investments Ltd., a foreign fund cum manager, has adopted strategies that could be unconventional and new to Sri Lanka, but practiced globally.
The Board of ERI vouches for ethical and best practices and to its credit has been forthcoming in disclosures. The company’s 2009/10 Annual Report sheds fair insights to its transparency and is detailed, unlike some other listed companies, which despite least disclosure, have managed themselves from public scrutiny.
Lionhart and ERI
Lionhart (http://www.lionhart.net) is a global alternative investment manager that delivers strong, absolute, and non-correlated annual returns in the following areas: Asian multi-strategy, global distressed and credit, natural resources and private equity. It advises multiple portfolios in a risk-averse manner on a global, multi-strategic arbitrage basis, including private equity/venture capital in natural resources. Lionhart has offices in Singapore, London, New York and Toronto.
As per its website, Lionhart was founded in 1993 by Terrence Duffy with less than $ 10 million; the genesis of Lionhart was Asian convertible bonds and warrant arbitrage traded from London. Lionhart has evolved into a truly global organisation that allocates capital across different strategies in various industry sectors and asset classes.
Its core expertise complements its vigorous commitment to innovative investment strategies and in-depth risk management. This philosophy has allowed Lionhart to produce above-average returns sixteen out of the last seventeen years. The character and the values which drive Lionhart can be seen in ERI and some of the acquisitions it has done so far.
The background to Lionhart entry into Sri Lanka stretches back initial days of two friends Kosala Heengama and Gregory Scott Newsome. Kosala is the son of Lalith Heengama, a former civil servant since 1965 whose positions included Director General of Customs and Secretary to the Ministry of Trade, Commerce and Food under the UNP regime.
After their initial acquaintances they became good friends and now are executive directors as well as livewires of ERI but guided by a professional Board of Directors. All are highly qualified professionals with the senior members being some of long-standing and highly respected civil servants.
When Lionhart entered ERI or Walker and Greg as it was known in 2007/8 it was almost a shell company with assets being worth less than Rs. 85 million and loss making. From June 2007, control of Greg went to Lionhart whilst management was given to Browns. In 2008/9 Lionhart decided to restructure the company to make it a fully-fledged investment holding company. It sold the consumer division of the former Walker and Greg to Brown and Company which managed the company after the ownership changed in 2007.
Via the sale at Rs. 38.4 million, it earned a profit of Rs. 35 million. This helped ERI to end 2008/9 with a profit of Rs. 13.6 million as opposed to a loss of Rs. 13 million in 2007/8.Nevertheless it moved into 2009/10 with a retained loss of Rs. 12.6 million whilst stated capital had increased to Rs. 382.8 million following a Rs. 347 million infusion via Rights, from Rs. 35 million in 2007/8.
The Rs. 347 million raised via Rights in March 2009 was to invest approximately Rs. 250 million in bank, finance, insurance, trading sectors.
In the 2008/9 Annual Report ERI’s intention to purchase foreign assets following feasibility study was communicated to shareholders and specifics stated in developments under post-balance sheet information.
In August 2009 the Board announced that it has finalised the terms and conditions for the acquisition of Environmental Resources Limited (ERL) which is a company incorporated in British Virgin Island and is a company holding assets of equity and debentures focusing in the platinum mining industry in South Africa. Fifty two percent of the asset base of ERL consists of equity of Eastern Platinum Limited.
The said company (ERL) is an investment vehicle that will allow ERI to invest and take advantage of opportunities within the South African mining industry. The largest equity holding is that of Eastern Platinum Limited (52%) a publicly listed company on the Toronto Stock Exchange and is Canada’s leading group metal producer. http://www.eastplats.com/.
The Board also said that all regulatory approvals (the Central Bank of Sri Lanka, the Controller of Exchange and the Minister of Finance and Planning) for the said investment have been obtained.
ERI is expected to hold 100% equity of Environmental Resources Limited and a further announcement would be made to CSE upon conclusion of the transaction.
Furthermore at an Extraordinary Meeting held on 7 July 2009, the shareholders approved a Rights Issue with Warrants attached, details of which are as following; Proportion:- Three (03) Ordinary Shares for every One (01) existing Ordinary Share held, at a price of Rs.20.00 per share. It also announced an issue of warrants on the basis of 2010 Warrants: One (01) Warrant for One (01) Right at a price of Rs. 22.
This Rs. 2 billion fund raiser was to finance various investment opportunities that meet with the company’s objectives and risk control thresholds.
Perhaps little did the Board realise then that these two announcements would later on be the spark for various allegations as well as bringing ERI under greater spotlight.
The investment in ERL triggered allegation of money laundering whilst the warrants, which followed several more such issuance, figured in the speculation that their prices were artificially propped up along with share prices. Whilst there had been warrants issued by other listed companies in the past, most original investors in the Colombo Bourse aren’t savvy of warrants, which is a derivative.
Via issuance of several warrants, ERI has secured a future cash infusion to the tune of Rs. 44 billion in the next five years. However, with enhanced knowledge, warrants of ERI were heavily sought after, whilst it also prompted several other listed companies to twine their rights issues with warrants. This recently forced the Securities and Exchange Commission (SEC) to come with new directives on issuance of warrants.
The acquisitions
In mid 2009 ERI made its first local move. It acquired the stock broking operations of HNB for Rs. 151.4 million with the approval of the SEC as well as CSE. This saw the debut of DNH Financial (Pvt) Ltd., from October 2009. Whilst most analysts viewed this acquisition as most likely to be the only move by ERI, then all were proved wrong. What followed was unprecedented and kept the market and business press busy.
Within a year between October 2009 and October 2010, ERI has in sheer speed completed six more acquisitions. Though rapid all acquisitions had been well researched and via hard negotiations and midst some frustrating developments and misunderstanding and allegations. ERI had to go through several stages of acquisitions when it came to some companies given the complexities as well as cash requirements. Acquisitions were also done via investments in a mix of ordinary shares and preference shares.
The six acquisitions involved listed and unlisted companies, but almost all were in some form undergoing difficulties or underperforming. The six companies were Ceylon Leather Products Ltd. (CLPL), Dankotuwa Porcelain Ltd. (DPL) and more recently Colombo Pharmacy, all of which are listed and the unlisted South Asia Textiles (SAT), Olancom Ltd. and Enterprise Technologies Ltd.
In CLPL, ERI now has 72% shareholding with an estimated investment of Rs. 1.37 billion. ERI’s direct shareholding in South Asia Textiles is only 8%, amounting to Rs. 160 million, but CLPL holds 51%, whilst in DPL it has a direct holding of 58% worth Rs. 380 million and 8% via CLPL.
Acquisition of unlisted entities as well as Colombo Pharmacy caused no ruffles but DPL did to a large extent and CLPL to a lesser extent. Via Olancom and ETPL, ERI new growth sectors (for Sri Lanka but proven growth drivers globally) are IT and ecommerce, whilst SAT has national significance because it was acquired from a Singaporean investor and provides key raw material for the export-driven apparel sector.
CLPL and DPL are also nationally important with exposure to both local and export markets and have a large employer base. Outside this list was a 10% investment worth Rs. 100 million in People’s Merchant Bank as a portfolio investment. Now the stake has been reduced to around 6%. Furthermore it invested in 1.5 million shares of Namal Acuity Value Fund for Rs. 75 million.
It was between the acquisition of CLPL and DPL that ERI sparked lot of investor play, market talk, business press spotlight and regulatory scrutiny. This was after the decision to invest in the BVI company ERL earlier on had a thorough regulatory scrutiny.
Share price: Booms and busts
The height of investor interest can well be exemplified by the highest ever share price of Rs. 274.50 in the past one year (first quarter of 2010 calendar year and last quarter of 2009/10 financial year) with massive trades in mid 2010, whilst the negativities are reflected by it dropping sharply following direct and indirect regulatory action such as suspension of trading as well as the temporary introduction of the across-the-board 10% price band.
With regaining of credibility as well as better understanding on the part of investors, ERI has covered lost ground (last week it was trading between a high of Rs. 93.80 and low of Rs. 80.50) before closing at Rs. 81.70 whilst its 52-week lowest is Rs. 28.25.
In calendar year 2009 ERI ranked within top 30 with over 200% gain to Rs. 62.75 as against Rs. 20 closing in 2008. In that context to gain from Rs. 62.75 to Rs. 274.50 between January and March 2010 was exponential though ERI closed the 31 March quarter at Rs. 102.50. Its peak as well as high price propelled ERI from nowhere to the elite league of Top 10 most valuable companies and thereafter to Top 20.
Last week it was ranked as the 22nd most valuable stock with a market capitalisation of Rs. 25.5 billion, down from Rs. 86 billion at March quarter peak. Its warrants too gained sharply. In some sense ERI has enhanced shareholder value in addition to bringing more stakeholders to the market.
The level of investor interest is also well amplified by the wider base of stakeholders. As at 31 March 2009, ERI had only 739 resident ordinary shareholders whilst one year later the figure had risen to 2,465 though this was in tandem with two rights issues. Of that 1,758 shareholders were holding between one to 1,000 shares only accounting for a mere 0.41% of the total.
The second biggest group in terms of numbers were 1,001 to 10,000 shares with 584 shareholders accounting for 1.38% whilst a further 113 shareholders owning 2%. So whilst the numbers are considerable, the effective ownership is small. The number of warrant holders is over 2,000.
ERI also got lot of flak or attention because of the share price movement of companies it acquired or was to acquire. A classic case was the 1,000% rise in Dankotuwa Porcelain on the news of ERI interest, whilst CLPL also gained sharply in between its acquisition. Whilst ERI has claimed no responsibility for price manipulation of either its own share or others, the talk in the market was that on account of higher share price of investee companies as investor, ERI gets better mileage and credit.
For example, its deal to buy over DPL was at Rs. 9 per share whilst in the market DPL was trading five times higher. It meant two things. With the acquisition ERI was telling its shareholders (including 90% owning parent) and financiers that it was buying cheap into a company which has a much higher market value. Such valuations, it was argued, would rate well for the management in owners (Lionhart) analysis.
Some investors simply valued the ERI buy of DPL at prevailing market prices. This perhaps would reflect well if ERI had made such investments strategic in intent but as part of trading portfolio. This wasn’t the case. Given the volatility, ERI issued clarifications clearing itself of any manipulation or responsibility for hike in share prices in addition to cautioning investors. The ERI Board also welcomed regulatory scrutiny and assured extension of cooperation when so required.
It categorically said that all its activities and flows of foreign funds into the company were in strict accordance with the laws and regulations of Sri Lanka and that it would continue to source such funds in the future to provide much-needed equity for the purpose of investment in the development activity of the country. There was a play on the part of brokers as well in propping prices and the SEC through investigations has zeroed in on several for a severe reprimanding.
ERI management told the Daily FT that for foreign funds including hedge funds, volatile markets and prices aren’t the best yardstick. In contrast, they look for stability and fundamentals driven scenario than irrationality.
In that sense, the phenomenal price levels of ERI as well as several of the companies it invested in did more damage than good for ERI. The volatility came amidst ERI management’s efforts to get Lionhart more involved in Sri Lanka in tapping post-war rebound opportunity in Sri Lanka.
Being over 90% owned by Lionhart, it automatically has to subscribe to rights and warrants announced, indicating an inflow of further foreign investment as opposed to flight of capital, though to some extent ERI’s investment in the BVI-registered ERL open doors for such a development in a phased manner. How the investment in ERL fares and whether or not it provides returns will prove ERI’s business acumen and whether it was a prudent move or not.
Business model and value creation
Some analysts view that the fiasco in the stock market and controversy over prices had unfortunately brought unwarranted discredit to ERI when in fact it deserves commendation for what it has done in a very short span for the country.
Apart from Lionhart being a foreign investor, via ERI and its management there had been key strategic investments to resuscitate key manufacturing companies in the case of Ceylon Leather, Dankotuwa Porcelain and South Asia Textiles. They were almost like bailouts as some companies faced severe cash flow problems to service debt and secure jobs. The anticipated turnaround of some of these companies will ensure their viability, securing income and employment generation.
Another important facet is that unlike some foreign investors, Lionhart or ERI hadn’t taken the route of delisting ventures after acquisition. Most likely it will explore opportunities to take some of its unlisted ventures public.
Located in Pugoda on a 76 acre site, SAT is a manufacturing company with an ultra modern manufacturing plant, producing exceptional quality knitted fabric for a wide range of apparel and industrial uses. It was set up in 2004 as a BOI venture with a $ 15 million investment from South Asia Textile Industries of Singapore, a pioneer in the field in Singapore for 25 years.
SAT has a high production capability, with the current capacity of production being 1.5 million lbs of knitted fabrics per month. The company recorded positive results from the inception and recorded an annual turnover of Rs. 3.6 million and Rs. 4 million in 2007 and 2008 respectively.
Olancom (Pvt) Ltd. (OPL) was formerly known as Roomsnet International (Pvt) Ltd. It is the largest e-commerce operator, based in Sri Lanka having transacted nearly Rs. 10 billion in online sales globally over the past few years and is also a leading provider of enterprise technology solutions to businesses and organisations in Sri Lanka.
Enterprise Technology (Pvt) Ltd. (ETPL), a fully-owned subsidiary of OPL, consists of an award-winning, highly-skilled staff who are professionals in providing state-of-the-art communication systems and designing network systems which enhance the productivity of businesses.
According to ERI philosophy, its core investment banking business practices are used internally to invest in company funds, and also used for selected foreign and local partners to invest in large and specific minded opportunities either as a service or as a partner. ERI’s local knowledge and experience coupled with its proven success makes it the foreign investors’ premier choice when dealing in Sri Lanka’s infinite opportunities.
ERI explains that rather than creating new businesses, its Board of Directors have focused on investing in potential companies which are affected by the global downturn and in desperate need of infusion of funds. With the motto of ‘We Make It Work,’ the Management uses new methods and techniques introduced by the Board to turn around such companies.
Its vision is to become one of the most valued companies in Sri Lanka and the mission statement is “To explore all dimensions of the corporate world and widen our scope of activities without restricting ourselves.”
In that context, the financial year ended 31 March 2010 is a major step forward, in addition to being a breakthrough.
The year saw a dramatic change in the financial and liquidity position of ERI. It also turned a new page in its operational history by transforming from a company into the position of a Group in the third quarter.
Consider some of the achievements. Revenues grew to Rs. 233.7 million from Rs. 1.6 million a year earlier; pre-tax profit amounted to Rs. 134.7 million as against Rs. 26.5 million in 2008/9; after tax profit improved from Rs. 13.6 million to Rs. 109 million in 2009/10; total assets increased to Rs.3.4 billion from Rs. 385 million in 2008/9; cash and short term investments increased to Rs.1.6 billion from Rs.357 million; total shareholder funds increased to Rs.2.5 billion from Rs.373 million; and total debt increased to Rs.414 million from Rs.11 million, whilst debt to equity ratio was 5.62%.
Profitability of the Group in relation to sources of long term financing of the company is reflected through this measurement method. ERI as a company has recorded a ROCE of 7.11% and as a group has recorded a ROCE of 5.01%.
In order to provide a broader view, the ROCE of the subsidiaries and the holding company are as follows:
CLPL, a manufacturing company, has recorded a negative ROCE in the previous financial year as a result of the impact caused by a high rate of borrowings amounting to Rs.151 million and relatively lower revenue of Rs.368 million. However, with the investment of ERI along with proper financial and operational controls, CLPL increased its revenue by 53%, recording a higher ROCE of 2.74%
DNH operated with a very high debt amount of Rs.4.5 million in the financial year of 2008/09, which caused a negative impact of 1.73% on its ROCE. As it became a subsidiary of ERI on the 1 October 2009, a dramatic change in its long term liabilities was seen, with a reduction of an approximate 100%, resulting in a higher ROCE of 11.04% operating over a short period of six months.
Capital structure of ERI (the Group) consists of shareholders funds amounting to 75% of financing of the total assets,13% of minority interest, 4% long term debt and 8% of short term financing.
Debt component of the total Group amounted to Rs. 414 million which has increased from Rs. 11 million since the last financial year. This increase is a result of the liabilities of the subsidiary companies. CLPL total debt amounts of Rs. 367 million and that of DNH is Rs. 36 million. However a point to be noted is that the debt component of CLPL has reduced by 8% while that of DNH has increased as a result of an increase in its interest bearing borrowings.
A striking increase in the cash in hand from a Rs. 358 million in the previous financial year to a Rs. 1.4 billion in the current financial year is mainly due to the cash in hand of the two subsidiaries (Rs. 16 million of CLPL and Rs. 42 million of DNH) and the funds raised through the rights issue held during the financial year.
Continuous growth is evident as in the first quarter of current financial year (2010/11), Group asset base of ERI amounted to nearly Rs. 7.7 billion and that of the Company was Rs. 6.8 billion, up from Rs. 3.3 billion and Rs. 2.4 billion as at 31 March 2010. Group Revenue in the 1Q of 2010/11 was Rs. 272 million surpassing the amount achieved in the full year of 2009/10 and post-tax profit was Rs. 52 million as against Rs. 109 million achieved in the full year of 2009/10.
ERI is likely to maintain this significant growth momentum during rest of 2010/11 as well as in the medium to long-term.
A new concept being developed by ERI Board of Directors is that of micro investment banking, the idea of investment banking structured to accommodate the needs of very small companies. Using the idea and success of micro finance banking, ERI hopes, by offering this new concept, it will allow new businesses to access the Sri Lankan capital markets. The Board is optimistic that the bold and courageous steps taken would enhance the shareholder value of the company, whose vision is to become one of the most valued companies in the country.
Early this year ERI disclosed that over the next five years it would seek investment opportunities in both private and public listed securities in sectors such as banking, financial and insurance, construction, healthcare, hotels, property and land, plantation, natural resources, mining, power and energy, chemicals, beverage, food and tobacco, footwear, investment trust, IT, manufacturing, motors, services, store supplies, telecom, trading and other diversified sectors. Already investments or acquisition had been made in some of these sectors.
“Continuing with the growth of our holdings and group expansions, we look to do so with a mind for social responsibility. We are truly excited about the opportunities that lie ahead,” ERI Chairman Lalith Heengama has said in his review in the 2009/10 Annual Report.Thus far, ERI has made it work and is working overtime to realise its vision of becoming one of the most valued companies in Sri Lanka and a blue chip to reckon with. Results released so far point to what is likely to be a high growth trajectory. Despite reservations by some and certain stakeholders being unjust, many have been quick and early to realise the potential and the upside. Release of second quarter/first half results will shed light whether its means to the end are right or wrong.
ERI’s investments in ERL
ERL is a private company incorporated in the British Virgin Islands under BVI business Companies Act, 2004.
ERI signed the purchase agreement to acquire 100% of ERL on the 15 of January 2010. As per the agreement ERI will pay a sum not more than US$ 76 million as the purchase price of ERL and will follow a 10 tranche payment schedule as per approval of the Exchange Control approval and subject to the receipt of funds by ERI from Lionhart through periodic Rights Issues and Warrants by ERI.
Last week ERI made the following disclosure further to the previous disclosures of December 2009, January 2010, April 2010 and August 2010. ERI said the third tranche of Rs. 606 million was made on 2 November to Osiris International of BVI from funds raised through the conversion of 2010 warrants in June 2010 in accordance with the Exchange Control approval.
Total funds raised through the conversion of 2010 warrants in June 2010 were Rs. 2.3 billion out of which major shareholder’s (Lionhart) contribution was Rs. 1.6 billion. As per the Exchange Control approval, 38% of the said major shareholder’s funds, Rs. 606 million or $ 5.4 million were paid out of Osiris International BVI, whose ultimate beneficiary is the same said major shareholder. First tranche payment was done on 6 April 2010 amounting to Rs. 738.4 million ($ 6.4 million) and the second tranche payment was done on 19 May 2010 amounting to Rs. 714.7 million or $ 6.2 million.In total via three tranches ERI has paid Rs. 2 billion or $ 18 million. The price of the company (ERL) was based on a valuation of the portfolio obtained from Baker Tilly, a reputed accounting firth with an international presence. The amount of each tranche payable will be based on a valuation of the portfolio prior to the date of payment (subject to the overall cap of US$ 76 million) thereby allowing for any additional appreciation above US$ 76 million to pass freely to ERI. If the value of the portfolio is less than US$ 76 million then the lesser value will be paid. The main activity of ERL is to act as an investment holding company, which will be used by ERI to participate in opportunities, arising in the global market. Currently ERL is concentrating on investing in the commodity sector. ERL holds assets of equity and debentures focusing in the platinum mining industry in South Africa. Fifty two percent of the asset base of ERL consists of equity of Eastern Platinum Limited. The largest equity holding is that of Eastern Platinum Limited (52%) a publicly listed company on the Toronto Stock Exchange and is Canada's leading group metal producer. http://www.eastplats.com/ Assets include two unlisted corporate bonds. Since there were concerns that the bonds included were illiquid, ERI further succeeded in having them replaced with a portfolio of shares. The shares that replaced the bonds are Mukuba Resources Ltd which is a explore or copper mine in Zambia and is listed on the Toronto Stock Exchange and shares of Ferrox Holdings company, unlisted and incorporated in South Africa engaged in the exploration of natural resource of iron ore and Titanium dioxide in South Africa.
All securities owned by ERL BVI are presently held in a custodian relationship by a company named Photon Global Ltd which is also incorporated in BVI for the reason that PGL provides ERL BVI with custodian and settlement services and trading access on the Toronto Stock Exchange. ERI is seeking to make arrangements for its securities to be held through a Sri Lankan custodian.
source - www.ft.lk
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