Accounting for gobbledegook
TIM HUNTERTIM HUNTER
Opinion & Analysis
They can turn an otherwise pleasant period of self-assembly into the release of terrible destructive power and may cause bleeding.
Their evil lies in presenting a desirable goal while sabotaging its achievement by suggesting part in box fit sugary template on president cowling.
It's unacceptable. Communications should make sense and convey understanding, not confusion.
However, at least the Chinese have an excuse - they were brought up speaking Chinese, not English. The same can't be said for many accountants.
Fortunately the damage accountants do with their gobbledegook is limited because they don't often try to communicate with normal people. But the Government's move to float Mighty River Power will force the two into contact and results could be volatile.
You only have to look at Mighty River's annual result posted on Tuesday to see how misunderstandings could occur. On one hand revenue goes up from $1.2 billion to $1.5b, on the other net profit plummets from $127 million to $68m.
Was it a shocker of a result? No, because a big factor was a $118m negative accounting entry of zero relevance to the company's actual performance.
The official jargon is "change in fair value of financial instruments" and it relates to Mighty River's efforts to control the cost of its borrowing.
The company has about $1.2b of borrowing, comprising an assortment of bank loans, bonds and so on. Interest on the borrowing ranges from 3.4 per cent to 8.2 per cent.
Much of the debt was accumulated to pay for investment in geothermal power stations and Mighty River was keen to ensure its interest costs on such large sums didn't blow out. Hence it contracted with financial institutions to fix its rates for the duration of the loans.
However, for some arcane accounting reason these interest rate swaps must be valued every balance date, with the change in value reflected in Mighty River's profit statement.
The way those values work, a minor interest rate fall could produce a multi-million dollar hit on profit, even though there has been no change in Mighty River's actual costs. Conversely, rising rates could trigger a profit boost.
Make sense? Of course it doesn't.
Whether there is scope to adopt a more meaningful approach, through hedge accounting perhaps, is anyone's guess, but it's clear the current method is nonsensical.
Potential investors in Mighty River may note the apparent contrast between the slumping profit and the increased dividend - up 9 per cent on last year to $120m.
However, the dividend payout, the likely focus of most shareholders, is sensibly based on 75 per cent of net profit after adjusting for fair value of financial instruments, net of tax, which comes to about $159m, up from about $143m last year.
Yet even this figure wasn't referred to in Mighty River's own report on its performance, which talked about net profit, underlying profit, and "earnings before interest, tax depreciation, amortisation, financial instruments, impairments and equity accounted earnings" (ebitdaf), all of which are different.
Given the Government wants to spread Mighty River's ownership far and wide it would be good to come up with a meaningful way to report on performance and stick to it.
You could hardly blame mums and dads for staying away from share offers when companies - often through no fault of their own - come out with such twaddle.
Looking forward, how good Mighty River will look to investors will depend on how the shares are priced and not much can be said about that until the prospectus comes out.
It's interesting to speculate on one issue, though, which is the future of fellow powerco Meridian's $320m contract with the aluminium smelter at Tiwai Pt near Bluff.
We now know the smelter's majority owner Rio Tinto has sought to renegotiate the supply contract, whose new term begins in January. The new take or pay contract is for 572MW, up from 543.75MW under the previous deal. It's reasonable to assume Rio Tinto wants to change the terms and reduce its obligations because the aluminium business is going through a bad patch - aluminium prices are down about 20 per cent on a year ago.
The talks are important to Mighty River because the smelter is New Zealand's biggest single power user and the Meridian deal could influence how much power it buys. A significant reduction in the smelter's demand could flood the market with supply and depress prices for years - affecting all power companies.
However, analysts reckon the smelter contract specifies a two-year lead-in period to any wind-down at Tiwai, which itself must take three years. Hence the talks shouldn't directly affect Mighty River's ability to come up with prospectus forecasts.
Valuation, of course, is another matter. And when you also factor in the Waitangi Tribunal water challenge, it's turning into a more interesting partial float than National bargained for.
Tim Hunter is deputy editor of Fairfax's Business Bureau.
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