AURORA RESEARCH. 7 th REPORT ON OHL MÉXICO, S.A.B. DE C.V., NOW ALEATICA, S.A.B. DE C.V. ( ALEATICA )

Transcription

1 AURORA RESEARCH 7 th REPORT ON OHL MÉXICO, S.A.B. DE C.V., NOW ALEATICA, S.A.B. DE C.V. ( ALEATICA ) December 12, 2018 We are increasingly populated by a class of people who are better at explaining than understanding. Nassim Taleb

2 Disclaimer By reading the contents of this report, you agree that use of research produced by Aurora Research is at your own risk. The research published in this website includes forward-looking statements, estimates, projections, and opinions prepared with respect to, among other things, certain accounting, legal, and regulatory issues that IFM Investors ( IFM )Obrascón Huarte Laín, S.A. ( OHL Group ), Aleatica, S.A.B. de C.V. ( Aleatica ) and some of its subsidiaries, particularly Concesionaria Mexiquense, S.A. de C.V. ( Conmex ), face and the potential impact of those issues. Such statements, estimates, projections and opinions may prove to be inaccurate and are inherently subject to significant risks and uncertainties beyond our control. Research published in this website expresses our opinions, which are based upon generally available information. Aurora Research has made every reasonable effort for all information contained herein to be accurate and reliable. It has been obtained from public sources we believe to be accurate and reliable. However, such information is presented without warranty of any kind, whether express or implied. Aurora Research makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice. In no event will you hold Aurora Research or any related party liable for any direct or indirect trading losses caused by any information in this website. The research published herein is not investment advice or a recommendation or solicitation to buy or sell any securities. You agree to do your own research and due diligence before making any investment decision with respect to securities covered herein. Aurora Research does not hold any position, whether directly or indirectly, in OHL Group s, OHLMEX s or OHL s securities; and does not stand to profit in the event the issuer s securities depreciate in value. Aurora Research does not assume any obligation related to the content of this website, so no third party can claim damages or losses caused by decisions based on the information published herein. On April 12, 2018, IFM Global Infrastructure Fund completed the second of a series of transactions through which it acquired a stake of more than 30% in OHL Mexico s equity (and a controlling stake). For reasons that we have discussed in our previous reports, such an acquisition violates Mexico s Securities Law, as well as OHLMEX s bylaws. In the following months, IFM decided to change OHL Mexico s corporate name to Aleatica. Therefore, throughout this report we will refer to Aleatica and OHLMEX indistinctly.

3 Remember why IFM Investors ( IFM ) considered it appropriate to value OHLMEX s shares at a much higher value tan its market value? Remember how IFM justified violating its own Valuation Policy regarding the valuation of listed equities such as OHLMEX (now Aleatica)? As we said in a briefing, IFM and its independent valuator BDO considered OHLMEX s book value to be a more accurate valuation than its market value, because it includes guaranteed return mechanisms, which culminate in large balloon payments at the end of the concession. We have consistently said that no such guaranteed return mechanism exists, and that, therefore, OHLMEX s financial statements include a non-existent asset and a non-existent revenue. In the past, our claim has been confirmed by the CNBV. In fact, the CNBV ordered OHLMEX to modify its financial statements in order for them to exclude any assets and revenues related to the non-existent guaranteed profitability. OHLMEX has not yet complied with this instruction. In fact, IFM (now OHLMEX s controlling shareholder) has kept lying to its clients by claiming two false things: (i) that OHLMEX has an unconditional right to obtain cash from the Government of the State of Mexico, in the form of a guaranteed profitability ; and (ii) that the CNBV authorized OHLMEX to keep registering the assets and revenues related to such

4 guaranteed profitability in its financial statements, as long as it changed the names under which those entries were booked. In addition to everything that we have said in our previous reports and briefings, two events that recently came to light are incontrovertible evidence that IFM is lying to its investors in order to charge them hefty performance fees based on a non-existent performance. The first of these events is the response submitted by the Governor of the State of Mexico to the Congress of the State of Mexico on December 3, 2018, in which the Governor explicitly states: (i) that neither the recovery of Aleatica s investment nor any returns are guaranteed by the State of Mexico; (ii) that the recovery of Aleatica s investment and any returns depend exclusively on the tolls charged to users of the toll roads; and (iii) that the Government has no obligation (neither conditional nor unconditional) whatsoever to pay Aleatica any amount of cash. The second event is the CNBV s resolution denying Aleatica its authorization to keep registering the assets and revenues related to the non-existent guaranteed profitability under any name whatsoever. Throughout this report we will show evidence of IFM s false claims. We will also provide evidence regarding the two events mentioned in the previous paragraph, which will, in turn, show that IFM s claims are false. I. IFM claims that Aleatica has an unconditional right to obtain cash from the Government of the State of Mexico, in the form of a guaranteed profitability. OHL Concesiones (now Aleatica Spain) consolidated financial statements for the year ended 31 December 2017 were approved by Aleatica Spain s board of directors on March 16, The financial statements were audited, as is usual with OHL and IFM, by Deloitte. In its audit report, Deloitte specifically states the following: these arrangements include most notably certain concessions in Mexico totalling EUR 5,395,438 thousand, which include, as a form of remuneration, certain mechanisms that guarantee an unconditional right for the concession operator to recover a minimum revenue.

5 Deloitte also says that if the time to return these [the concessions] is reached without the guaranteed minimum revenue being obtained, Aleatica will recover its investment and obtain its returns by means of a final payment in cash. In page 17 of its financial statements, Aleatica Spain claims that: in the case of certain Mexican concessions in which the Group holds interests, the concession arrangements grant the operator an unconditional right to recover, as appropriate, either the equity invested or the total investment made, plus an annual guaranteed internal rate of return (IRR), expressed in real terms and net of tax ( guaranteed revenue ), which would give rise to an unconditional right to collect cash if, at the end of the concession term, the guaranteed revenue had not been obtained.

6 In page 27 of its financial statements, Aleatica Spain claims that: it is estimated that the guaranteed minimum revenue recognized will be recovered through the collection of tolls over the normal concession term, over the corresponding concession term extensions or, if necessary, through ultimate payment by the grantor. Moreover, as we discussed in a short briefing we issued a couple of months ago, IFM decided it was OK to violate its own Valuation Policy in its valuation of Aleatica. Even though IFM tells clients (through the Valuation Policy it distributes) that listed equities are valued at its market value (i.e. quoted price), IFM and its independent valuator BDO decided to value Aleatica s shares (which are listed equities) using their book value. The reason, according to BDO, was that Aleatica s book value includes guarantee return mechanisms, which culminate in large balloon payments at the end of the concession. From all of the statements quoted in the previous paragraphs, it is clear that IFM, with the aid of two independent parties (i.e. Deloitte and BDO) claims that: (i) Aleatica has a guarantee, issued by the grantor (in the case of Circuito Exterior Mexiquense and Viaducto Bicentenario, the grantor is the State of Mexico), to recover the investment made in its concessions, plus and annual guaranteed rate of return ; (ii) the returns in Aleatica s concessions are guaranteed by large balloon payments to be made by the grantor at the end of the concession ; and (iii) Aleatica has an unconditional right to obtain cash from the State of Mexico. ALL OF THESE CLAIMS ARE FALSE. And they are deliberately stated by IFM in order to deceive its clients. Claiming to have a guaranteed profitability allows it to recognize revenues (and net incomes) that may never materialize, and to overstate the value of its assets (and their rate of growth), in order to charge its clients hefty performance fees based on non-existent returns. It is important to bear in mind that, according to the firm overviews that are distributed by IFM Investors to clients and prospective clients, Aleatica makes up about 20-25% of IFM Global Infrastructure Fund s investments. Therefore, Aleatica s valuation is critical to IFM s clients. Let us now turn to the new evidence that shows that IFM s claims are false, and that they are misleading investors, with the help of Deloitte and, more recently, BDO. II. The Governor of the State of Mexico replies to Congress: Aleatica has no guaranteed profitability. On November 15, 2018, the Congress of the State of Mexico issued an official resolution (Punto de Acuerdo) pursuant to which, among other things, it urged the Governor of the State of Mexico to inform Congress and the CNBV whether the Government of the State of Mexico had granted Aleatica or its subsidiaries a guarantee regarding the recovery of their investment and a return in

7 the Circuito Exterior Mexiquense and Viaducto Bicentenario, and if the Government had an unconditional obligation to pay cash to Aleatica or its subsidiaries. In its resolution (which can be found in our webpage), Congress specifically stated that no guaranteed profitability could legally exist, because such a guarantee would have to be considered public debt, which can only exist if it has been previously approved by the State Legislature, which, according to the State Legislature itself, has not occurred in this case. However, it demanded an answer from the Governor. On December 3, 2018, the Governor of the State of Mexico replied, through his Secretary of Communications. A copy of this reply, as well as a translated version, can be found in our webpage. However, we will transcribe some very important quotes from the Governor s reply: The Government of the State of Mexico has not granted the concessionaires any guarantee whatsoever. According to the Concession Agreements no guarantee has been granted in terms of Mexican Law. The source of payment of the investments and the liabilities acquired directly by the concessionaires consists of the cash flows generated by tolls collected from users. The source of payment for the concessionaires consists of the tolls collected from users. The exploitation of toll roads to which the concessionaires are entitled is not an obligation to pay cash by the Government of the State of Mexico. From these quotes, it is evident that all of IFM s claims examined in section 1 of this report are FALSE. According to both the Governor and Congress of the State of Mexico: (i) Aleatica does not have a guarantee issued by the State of Mexico to recover the investment made in its concessions plus an annual rate of return; (ii) the returns in Aleatica s concessions ARE NOT GUARANTEED by balloon payments to be made by grantor ; and (iii) Aleatica DOES NOT HAVE and unconditional right to obtain cash from the Government of the State of Mexico. With this reply from the Government of the State of Mexico s, IFM s house of cards can no longer be kept standing. BDO allowed IFM to value Aleatica s shares at their book value (currently $47.42 pesos per share) instead of their quoted market value (currently $24.10 pesos per share) because IFM convinced BDO that there were guaranteed return mechanisms in the form of large balloon payments to be made by grantor. The State of Mexico has explicitly denied the existence of such guaranteed return mechanisms. Aleatica has an illegal consolidated book value of $102.3 billion Pesos because it books an $89.2 billion Pesos non-existent asset relative to its non-existent guaranteed profitability. The State of Mexico has explicitly denied the existence of such guaranteed profitability, so that entire asset must be eliminated from Aleatica s financial statements. More importantly, Aleatica s false earnings grew by 55.4% during 2017, because they included a $16.2 billion pesos revenue relative to its non-existent guaranteed profitability.

8 The State of Mexico has explicitly denied the existence of such guaranteed profitability, so, in fact, Aleatica s earnings did not grow by 55% during Aleatica did not have earnings during either 2016 or In 2016 it had losses of $2.9 billion pesos, while in 2017, those LOSSES CLIMBED to $3.4 billion pesos. After the Governor s reply, the 55% growth in earning becomes a 15% growth in losses (or decrease in earnings). Finally, during 2017 Aleatica s false book value grew by 24.2% because it included a $16.2 billion pesos increase in the valuation of the asset related to its nonexistent guaranteed profitability. After the Government of the State of Mexico s reply, no such increase can be justified. III. Aleatica s absurd response to the Government s notification. The Government of the State of Mexico gave IFM, Aleatica, Conmex and Viaducto written notice of its response to Congress. This triggered an obligation for Aleatica to publish a Material Event through the Mexican Stock Exchange, regarding an event that directly affected its financial and legal position. According to article 50 of the Circular Única de Emisoras, individualized governmental resolutions that relate, for instance, to concessions, licenses, authorizations, exemptions, and subsidies are Material Events that, in accordance with the Mexican Securities Law must be revealed to the Mexican Stock Exchange immediately after they are known to the issuer (in this case Aleatica). Situations that affect the financial structure or results of an issuer are also considered Material Events. In any case, once it received the Government s reply, Aleatica had an obligation to reveal such reply to the investing public through the Mexican Stock Exchange. The Material Event issued by Aleatica should have been limited to say that it had been notified by the Government of the State of Mexico that it does not have a guaranteed profitability in the Circuito Exterior Mexiquense and the Viaducto Bicentenario, and that the recovery of its investment and a return depend exclusively on the tolls charged to users. However, Aleatica made several other false and/or misleading statements in the Material Event published on December 6, In this section, we will address each of these false or misleading statements. In the Material Event, Aleatica admits that the Government specifically said that no guarantee has been granted for the recovery of its investment and a return in its concessions, and that the Government has no obligation whatsoever to pay Aleatica. However, Aleatica then tries to mislead investors by making the following false and misleading statement: FALSE/MISLEADING STATEMENT 1: There is a contractual obligation to pay, contingent on the performance of the toll road during its term of validity, which allows concessionaires to recover their investment plus the agreed upon return. WHY IT IS FALSE: This statement is both false and misleading. Vaguely worded as it is, it tries to convince investors that should the toll roads (either Circuito Exterior Mexiquense or Viaducto Bicentenario) underperform, the Government of the State of Mexico would have an obligation to pay Aleatica the shortfall between the actual returns and the agreed upon returns. This is most certainly not true. In fact, the Government says the exact opposite in its response to Congress. While Aleatica falsely claims that there is a conditional obligation to pay, the Government

9 explicitly stated that: the right to exploit the toll roads granted to the concessionaires is not an obligation to pay cash by the State Government and that the source of payment for the concessionaires consists of the tolls collected from users. It is very important to note that the Government s response denies the existence of ANY OBLIGATION WHATSOEVER. So there is no conditional or unconditional obligation to pay Aleatica any amount of cash. If the term of the concession cannot be legally extended, then the concession must revert to the State of Mexico at no cost to the State, even if Aleatica did not recover its investment plus the agreed upon return. FALSE/MISLEADING STATEMENT 2: The contractual provisions that grant this right to the concessionaires and the right to extend the term of the concession are not exclusive of concession agreements in the State of Mexico; they are a common practice in the toll road industry. In Mexico, there are multiple concessional projects that operate with provisions that grant the concessionaire the right to recover its investment plus a return, that is, they are identical or similar to ours. WHY IT IS MISLEADING: This statement is misleading, as Aleatica tries to equate a right to recover the investment plus a return during the term of the concession through the collection of tolls (which concessionaires do have), with an unconditional right to recover such investment plus a return (that is, a guaranteed profitability ) from the grantor (which no concessionaire has). Granting concessionaires the right to recover their investment plus a return during the term of the concession through the collection of tolls is, in fact, common practice. What this right means is that concessionaires are allowed to collect tolls from users of the infrastructure during the term of the concession in order for them to recover their investment and a return. However, this right DOES NOT transfer demand risk from the concessionaire to the Government. In other words, if not enough tolls are collected during the term of the concession to recover the investment plus a return, the concessionaire has to bear the loss (not the Government). That is the essence of a concession. It is true that both the Law and specific concession agreements give a partial remedy for the case in which the term of the concession comes to an end without the concessionaire having recovered its investment plus the agreed upon returns for causes not attributable to the concessionaire. This partial remedy is a right granted to the concessionaires to demand an extension in the term of the concession, in order to be able to recover their investment plus a return. The remedy is partial, however, because extensions to the term of concessions are limited by Law. In the specific case of the State of Mexico, concessions can only be granted for a maximum of 30 years, while the extensions cannot surpass another 30 years. Therefore, the term of a concession in the State of Mexico cannot surpass 60 years (including any extensions granted). If those 60 years are not enough for the concessionaire to recover its investment plus a return, it only means the concessionaire made a bad business decision, and must bear the losses associated to the risk it undertook when entering the concession agreement. This paragraph describes the right that concessionaires (including Aleatica s subsidiaries) have, and which is common practice in the toll road industry.

10 This right is radically different from the right Aleatica falsely claims to have: an unconditional right to recover its investment plus an agreed upon return from the grantor, according to which under no circumstance would Aleatica be unable to recover such investment plus a return. The evidence to show that this right DOES NOT EXIST is simple. The Government stated in its reply to Congress that the source of payment for the concessionaires consists of the tolls collected from users. Aleatica can only collect such tolls during the term of the concessions, which cannot exceed 60 years (with extensions included). If Aleatica is unable to recover its investment plus a return during those 60 years, then it will have no further source of payment and will therefore have to bear the losses. After all, the concessionaire bears the demand risk. For a more detailed explanation of this mechanism, we refer the reader to our previous reports on OHLMEX/Aleatica. In this regard, we will only add that a look into Aleatica s competitors financial statements is enough evidence that what Aleatica falsely claims to have is not common practice in the toll road industry. Aleatica is the only one of the three toll road concessionaires listed in the Mexican Stock Exchange that has consistently booked net incomes that are substantially higher than its operating cash flows. In fact, in every year since 2010, Aleatica s net income has been substantially higher than its operating cash flow. The opposite happens with both of its competitors. PINFRA s net income for every year since 2010 has been lower than its operating cash flow. And IDEAL s net income for every year in that same period has also been lower than its operating cash flow, except for one year (2016), when its net income was extraordinarily high due to the sale of shares in a subsidiary for $18.2 billion Pesos. This can be seen in the graphs to the right. The reason for the divergence is that, despite all three concessionaires having the same right to recover their investment and a return, only Aleatica falsely claims to have a guaranteed profitability (the existence of which has been denied by the Government before the Local Congress). That is why Aleatica consistently fails to convert earnings into cash flow. This evidence shows that no other listed concessionaire claims to have a guaranteed profitability, and that such a claim is not common practice in the toll road industry. Having demonstrated that Aleatica does not have a guaranteed profitability in its

11 concessions, as confirmed by the Government of the State of Mexico before Congress, that Aleatica does not have an unconditional right to obtain cash from the Government of the State of Mexico, and that Aleatica bears the demand risk in its concessional projects, we will move on to the next section of this report, in which we will address IFM s other lie: that the CNBV authorized OHLMEX to keep registering the assets and revenues related to such non-existent guaranteed profitability in its financial statements, as long as it changed the names under which those entries were booked. IV. IFM s misleading claims about the CNBV s authorization On March 15 the CNBV instructed Aleatica (then OHLMEX) to restate its financial statements in 2016, in order to fully eliminate the assets and revenues related to the non-existent guaranteed profitability. For some time after such instruction was issued, Aleatica correctly (but only partially) modified its financial statements. The correction was only partially made, because it was not reflected in the actual financial statements, but in the notes, which is not allowed by the IFRS. Aleatica said that the financial information shown in such notes reflected the accounting treatment required by the CNBV. As we explained in detail in previous reports, the modifications were dramatic. Aleatica s (then OHLMEX) financial statements as of December 31, 2015, as prepared by Aleatica, showed concessional assets allegedly worth $120.9 billion Pesos; in the note where the accounting policy required by the CNBV was applied, that number went down to only $47 billion Pesos (a 61% decrease). Aleatica s financial statements as of December 31, 2015, as prepared by Aleatica, showed a book value of $61.4 billion Pesos; in the note where the accounting policy required by the CNBV was applied, that number went down to only $26.3 billion Pesos (a 57% decrease). Finally, Aleatica s financial statements as of December 31, 2015, as prepared by Aleatica, showed a net income of $7.5 billion Pesos; in the note where the accounting policy required by the CNBV was applied, that number went down to a LOSS of $242 million Pesos (a more than 100% decrease). For readers interested in understanding the modifications in detail, we refer you to our previous reports on Aleatica/OHLMEX. On February 17, 2017, however, Aleatica asked the CNBV for its authorization regarding a new accounting treatment for its concessional investments. Aleatica s proposal, however, did not comply with what the CNBV had instructed. Instead of totally eliminating the assets and revenues related to the non-existent guaranteed profitability, Aleatica proposed keeping the book value of its assets and revenues intact, only changing the names of the entries under which they were booked. The asset s name would change from guaranteed profitability to deficit to be paid by grantor and portion of intangible assets recoverable through future toll collection. The revenues name would change from other operating revenues to revenues from valuation of deficit to be paid by grantor and revenues from valuation of portion of intangible assets recoverable through future toll collection. The essence (and value) of the assets and revenues would remain unaltered, while only the names would change. Aleatica s request was left unanswered by the CNBV, but Aleatica did not even wait for the authorization to arrive. As soon as

12 it requested the CNBV s authorization, Aleatica began implementing the accounting policy that it was requesting the CNBV s authorization to implement, as if the CNBV s silence should be taken as an authorization. But here is the lie that IFM has perpetuated, or, more accurately, the very important fact that it has tried to keep hidden from investors: on May 22, 2017, the CNBV DENIED ALEATICA S REQUEST. According to article 419 of the Mexican Securities Law, if the CNBV leaves a request unanswered for 3 months, the request shall be considered to be denied. Evidence that Aleatica s request was denied because the CNBV left it unanswered for more than three months (it is still unanswered) is simple to obtain. On May 31, 2017 (more than 3 months after the CNBV received Aleatica s request), the CNBV s Transparency Committee confirmed that the CNBV had not issued any document in response to Aleatica s request. Aleatica Spain itself has admitted, as recently as March 16, 2018, that no such authorization has been issued by the CNBV, which means that, according to Mexican Law, the authorization has been denied, as can be seen in the following image taken from Aleatica Spain s financial statements as of December 31, 2017.

13 The consequence of the CNBV s denial is simple: Aleatica must restate its financial statements in order for them to reflect the accounting policy required by the CNBV (i.e. totally eliminating assets and revenues related to the non-existent guaranteed profitability ), and must be held criminally liable for providing false information to the investing public. That way, its financial statements will not only reflect Aleatica s true financial position and performance, but they will also show the reality of its concessions: that Aleatica (IFM) bears the demand risk, and that there is no guarantee regarding the recovery of its investment and an agreed upon return. V. Conclusions As we have consistently said throughout our previous reports on Aleatica/OHLMEX, Aleatica is a scheme of smoke and mirrors designed to fool good intentioned investors. Who profits? IFM does, by charging its clients hefty performance fees based on a non-existent performance. According to IFM, Aleatica makes up about 20%-25% of IFM Global Infrastructure Fund s Investments. Clients should be asking: how much of that value actually exists? IFM has tried hard to convince its clients that Aleatica has a guaranteed profitability. The Government of the State of Mexico, the Congress of the State of Mexico, and the CNBV have all explicitly denied that claim. It is time for IFM to face the consequences. The Governor s reply to the State of Mexico s Congress, as well as the CNBV s resolution should convince BDO that IFM may not value Aleatica using any method other than its quoted market value. Anything else is not only a violation of IFM s valuation policy; it is also a crime punishable under Mexican law. Finally, IFM has the obligation to restate Aleatica s financial statements, in order for them to show a true picture of its financial position and performance. Changing book entries names is not enough. The restatement must show a total write-off of the assets related to the non-existent guaranteed profitability, and the elimination of the accumulated revenues related to such nonexistent guaranteed profitability. For those who were fooled by IFM into thinking that Aleatica had a guarantee to recover its investment plus a return granted by the Government of the State of Mexico, both the Local Congress and the Governor have finally been clear: there is no guaranteed profitability, and Aleatica bears the demand risk in its concessions. If its investment and a return cannot be recovered through toll collections during the term of the concessions, Aleatica must bear the losses. The problem is that IFM still wins. It is its clients (pension funds and, ultimately, savers) who lose.