• Hotter on Metals: Noble and the shot glass ice cube

  • MetalBulletin
    18 March 2015

    Being in a group of one has its advantages, but it has its disadvantages too.

    It's a lesson that Noble Group learnt the hard way over the past several weeks, which has seen the accounting methods of the commodities trading firm publicly challenged by an anonymous entity called Iceberg Research.

    Noble - which has issued a detailed rebuttal of the claims in Iceberg's two reports - is something of a lone ranger within its peer group.

    It's been listed since 1997, a move that, of its commodities trading peers, only Glencore subsequently pursued before switching to an asset-heavy strategy when it acquired mining firm Xstrata.

    None of Noble's more asset-light commodities competitors - including Trafigura, Louis Dreyfus, Vitol, BTG Pactual and Mercuria, to name just some - are listed, leaving a stark difference between the reporting and shareholder-facing requirements of the two groupings.

    One key factor that has been clear throughout the whole Iceberg saga is that stakeholders, and the broader financial markets, can never get enough transparency. Noble has made it clear that it views transparency as a positive thing, and its CEO Yusuf Alireza said recently that more of it is needed.

    No doubt, balancing the need to provide this transparency to the regulators, shareholders and ratings agencies is at odds with the more private model that trading companies prefer to keep.

    For years, commodities trading firms - most of them based in Switzerland - were viewed as being shrouded in mystery and operating in ways that were little understood; few of them did much to enlighten the markets, either.

    Its public listing on the Singapore Stock Exchange means that Noble's private competitors have an idea of its strategy, including the asset-light business model it has transitioned to and the value it puts on building long-term relationships.

    And now, it would seem, the Iceberg reports mean the market is demanding to know even more. Or, as Noble's Alireza put it: "We unfortunately live in a world where knowing that you run your business professionally is not good enough. You need to be able to prove it." Perhaps unfortunately for Noble, most of its peers do not have quite the same level of public scrutiny.


    Mark-to-market

    The company - which had probably hoped to use its 2014 results presentation to celebrate the sale of a stake in its agri business to a consortium led by China National Cereals, Oils and Foodstuffs Corp (COFCO) and another full year of profit - was forced instead to spend a significant portion of its conference call defending its accounting methods.

    The allegations by Iceberg have been well-documented, as have the rebuttals. But some of the issues being raised as a result appear to be somewhat silly.

    Did Noble, some are asking, announce the Yancoal impairment at its 2014 results and after the publication of the Iceberg report because it was previously and deliberately misleading the market about the firm's financial health?

    If that was the case, then every single company that ever announces a write-down is guilty of the same 'crime.'

    In recent months, the commodities market has seen Standard Bank take an $80-million write-down from its exposure to suspected aluminium financing fraud in the Chinese port of Qingdao.

    Jefferies took a $52 million goodwill write-down and an $8 million write-down related to the Bache unit, while Trafigura wrote down $90 million against its warehousing business, Impala Terminals Burnside.

    Glencore, meanwhile, took a $7.6 billion good-will write-down following the completion of the Xstrata merger and has made impairment charges related to platinum, iron ore and oil exploration activities since.

    The market has also seen Vale write down $1.135 billion against Guinea's Simandou project, and Nexans book an impairment of $220 million against its assets in Brazil, the USA, Australia and Russia.

    In other words, write-downs happen, and mark-to-market accounting methods mean values on the balance sheet change with market conditions.

    This fact goes to the very heart of the nature of physical inventory and mining assets - firms run their cash flow models on a quarterly basis, and would find it practically impossible to mark-to-market daily.

    Noble has said that not a single thing has changed financially as a result of the Iceberg reports, and that everything it did was already planned.


    Fair value

    Then there's the question of fair value.

    Iceberg said that Noble's fair value gains are overstated by $3.8 billion and should be impaired, an allegation the company denies.

    Again, this raises some questions over the level of understanding that the reports' authors have of both accounting and the underlying business being accounted for.

    Fair value gains can have nothing to do with profitability. A company like Noble, which is long physical inventory and hedges against that stock, will by definition see fair values rise in a bear market. If it is perfectly hedged, there will be no impact on its profit and loss statement (P&L).

    In contango trades, which it will undoubtedly trade plenty of, fair values can rise and short-term P&L can fall.


    Report no. 3

    What will be in Iceberg's third report, due out imminently, is unclear, although it has said it will show that the way Noble reports its debt and its liquidity headroom are highly misleading.

    Many expect a focus on off-balance sheet items, which already appears to be something of a red herring given how other trading companies fund their balance sheets.

    As a public company, Noble does not fund on a transactional basis; one of the benefits of being a public and rated firm is that it can fund its balance sheet overall.

    In the case in point, Noble has $17 billion in committed and uncommitted facilities and debt, and uses that entire amount to fund all of its inventory and trading. It doesn't finance its activities on repurchase agreements, or repos, because it does not have to.

    Ironically, the report perhaps couldn't have happened at a better time for Noble - with $1.5 billion of equity in the bank from the agri business deal and $1.8 billion of debt repaid, its balance sheet has arguably never looked stronger or more deleveraged, its liquidity never seemed greater.

    Iceberg claims its goal was to highlight accounting irregularities but its timing was completely in opposition to that stance: it released the first report in the middle of the Chinese New Year holiday after Noble's stock had rallied around 20% and a week before its annual results, and then issued the second report 24 hours before the results were due.

    If it had really wanted to highlight accounting irregularities, would you not wait until a company had released its results and use the most recent information?

    Iceberg's reports have left the auditor, ratings agencies and analyst community broadly unfazed; Noble seems equally confident that its stakeholders and the banks it deals with are unperturbed.

    Some hedge funds are perhaps less convinced, as the increase in the cost of buying protection against a default of Noble debt this week shows. But the commodities market has been here before; hedge funds were behind the credit default swap levels that Glencore experienced in 2008 and 2009, and look how that turned out.

    There's never a good time for a sacked former employee to get active with a typewriter, but it seems - so far - to be more of an ice cube in a shot glass than an iceberg about to bring down a giant commodities trading firm.