Loam also often disguised its declining performance and increased its return on investments y recognizing non-cash accounting gains derived from negative goodwill and biological assets. This was a significant source of profit for Loam from 2010 to 2012. Since managers themselves decided upon assessed profits and this is what determines the amount of negative goodwill that arises on acquisition, managers could easily manipulate profits using this avenue. Furthermore, recognition of biological assets depended on Loam’s internal pricing model that could be manipulated by top management.
Finally, the company did not sufficiently disclose reasons behind large amounts of expenditure on fixed assets. Muddy Waters was concerned if Loam could earn enough returns on those expenditures and questioned where the money was channeled. Major Concerns Raised by Muddy Waters Over Loam’s Operation Loam had a large amount of maturing liabilities that Muddy Waters was concerned about because the company could possibly be unable to pay them off due to its relatively lower cash balance and insufficient earnings and external finances.
Furthermore, a significant portion of its cash balance consisted of withdrawals from its brokerage accounts and bank account overdraft. This puts them in a less solvent position. Also, the refits Loam was making from its subsidiaries in Nigeria and Gabon were not sustainable in the long run due to corruption and political issues in the two countries. Furthermore, a significant portion of these subsidiaries’ profits was earned from yearly government grants that may be terminated or reduced as and when the government deems fit. This poses as a major risk to Loam’s earnings.
Loam however can benefit from the trend of increasing other subsidies and incentives that are being provided in the countries. Finally, Muddy Waters is concerned with Loam’s risky and possibly costly business strategies that other layers in the industry stay away from. Muddy Waters also questions Loam’s poorer position in the non-niche commodity trading market since it is a new entrant and does not have as well developed a supply chain. Consequences of Muddy Waters Allegation Loam suffered substantial fall in stock price, nearly 20%.
Muddy Waters’ allegation also shaken investor confidence in the company. After Carson Block of Muddy Waters challenged Loam during his speech at the investment forum in London, on 19 November 2012, Loam applied for a temporary suspension of its shares. Once trading resumed, Loam’s shares fell 1 1. 5% to SAG 1. 545 before closing down 7. 5% at SAG 1. 61 . Loam responded to this by highlighting that the company was audited and all of its accounting policies adopted complied with Singapore Financial Reporting Standards.
Loam also filed a petition against MM and Block with the High Court of Singapore on 21 November 2012 because the CEO of Loam, Verges, claimed that Block’s comments were not backed up by evidence. By 26 November 2012, Loam’s shares increased by 0. 6% to close at SAG 1. 66. After MM published its research report on Loam on 27 November 012, Loam’s shares fell 6% and closed at SAG 1. 56. Loam’s shares continued to fall and hit SAG 1465. Loam then announced that it would make a thorough response and did so on 28 November 2012 via a bulletin. Following this, share prices increased.
Reasons behind the reactions of investors to this sequence of events include firstly, investors’ loss aversion. Upon knowledge of Blocks brief criticisms of Loam, its investors immediately sold shares in the company because they had foreseen a fall in share price and therefore potentially less returns on their investment. Without detailed knowledge of the issues and if issues could be resolved, investors herded towards selling shares. This is because the comment signaled bad press and poor representation of the firm by its financial statements.
Secondly, Capital Market research supports the fact that when Muddy Waters released the unexpected new information, investors of Loam did in fact revise their prior good expectation of the company’s future cash flows. This lead to the investors deciding to sell the shares and this is what resulted in the fall in share price. The bad news Muddy Waters announced proposed that here would be negative unexpected earnings and, according to the study of (Ball and Brown, 1968), this associated with negative abnormal returns.
Because the investors initially expected high earnings but then news was communicated that earnings was significantly low, there was an equally significant fall in share price (Beaver, Clarke and Wright, 1979). Finally, the investors also reacted according to their level of confidence they had in the future of the company beyond this crisis. This explains the slight rise in share price once Loam assured them, of no fraud r misappropriation of financial statements first of all, and also that they were taking actions to improve earnings.
This leads to why Loam cared and responded quickly to Muddy Waters’ allegations. Loam lost the publics trust and was exposed of its poor performance in the recent years. In order to restore investor confidence and to announce to investors their plans to improve performance, Loam proceeded to address the issues raised by Muddy Waters. If Loam did not respond in a timely manner, investors will perceive this as defeat and could sibyl encourage even more negative response. Loam’s Response To address the concerns and restore investor confidence, Loam announced its plan to raise SAG 1. 5 billion by issuing bonds and additional shares on 3rd December 2012. Following this, Loam’s shares increased 5. 4% to SAG 1. 665 and then to SAG 1. 71 . This was when Loam further announced that the issuance of 5-year corporate bonds and 5-year warrants, which were backed by one of its major shareholders and Singapore state investment agency – Tamales, had been approved by Singapore Exchange. Tamales went further to subscribe to all bonds that it was eligible to purchase and promised to assume the remaining inscribed bonds left by other shareholders.
Loam’s CEO also purchased 100 million company shares. The company also switched strategies and cut down on its debt-financing activities and reduced investments for cash. By 17 December 2014, share prices fell drastically to SAG 1. 395. In the event of any crisis, controlling shareholders and institutional shareholders should step up as owners and become better stewards of the companies they invest in (Wong, 2010). In his case and aspect, those of Loam did a good job. Tamales and Verges took ownership of Loam and did what they could and should, which was to save the falling company.
This could effectively restore the confidence of Loam’s investors because it assures them that the company could go back to being thriving given the efforts put in and faith its controlling and institutional shareholders have in the survival of the company. The decision to switch strategies also showed investors the intention of ensuring Loam is sustainable in the long run. Major Weakness of Loam in its Corporate Communication Loam’s plan to silence Muddy Waters was not a plan of corrective action.
Loam accused the critic to be “backless” but then responded disproportionately by proceeding to suspension of its shares. It communicates panic rather than confidence that the issue can be resolved. Furthermore, the immediate actions undertook by Tamales and Verges did not solve the problem of the excessive capital expenditure and leverages (Muddy Waters, 2012). This showed poor leadership. There was a lack of corrective action undertaken to address the real issues pointed out by Muddy Waters.
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