Mumias bailout: Will Kenyan taxpayer billions revive firm living on a wing and a prayer?

Kenya: In the coming weeks, the Government is expected to embark on a mission to rescue the ailing, loss-making miller, Mumias Sugar Company.

But analysts are grappling with some questions around this. The top ones are: Will the Treasury be throwing good taxpayer money after bad to keep the miller afloat? Is Mumias too important to fail? How did Mumias burn through the huge pile of cash it sat on nine years ago?

Further, whereas the Government has promised to inject Sh1 billion (to pay farmers their outstanding dues) into Mumias, hopefully by the end of this month after getting the go-ahead from KPMG auditors, Mumias needs a lot more cash to survive.

An analysis of the miller’s financial statements shows, to meet its obligations for the next year, it needs at least Sh7.1 billion.

Majority shareholder

Mumias has current liabilities (this includes what it owes suppliers) of Sh10.7 billion against current assets (what it is owed by customers and cash it has in its bank account) of Sh3.6 billion, according to its recently published half-year results for the six months to December 2014. This gives a difference of Sh7.1 billion.

But the Government, which is the majority shareholder with a 20 per cent stake in Mumias, is pressing on with attempts to get the miller back on its feet.

It is expected to rally other shareholders to a rights issue — the sale of additional shares in the miller, which is listed at the Nairobi Securities Exchange (NSE). The rights issue is expected to raise another Sh4 billion.

It means that even after receiving a Sh1 billion bailout and hopefully pulling off a Sh4 billion rights issue, Mumias will still be short Sh2.1 billion.

By cutting costs and laying off an estimated 300 employees, the Government hopes to make savings in the long term to get Mumias back to profit.

Although the timing of the rights issue has not been mentioned, it remains to be seen if — as a press release from the Deputy President Presidential Service (DPPS) put it — “shareholders will have the stomach to put in more money in the miller”.

Mumias’ shareholders have suffered over the past year, with the price of their stock tumbling to trade at Sh2.50 at the end of last week. This is a 35 per cent drop from a high of Sh3.85 12 months ago.

Further, the only sure source of cash for the miller is the Government bailout of Sh1 billion.

So when did sugar turn sour for Mumias?

One of the truisms that holds in business and that applies so fittingly in this case is this: turnover is vanity, profit is sanity, cash flow is reality.

“Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent,” wrote Warren Buffett, a well-respected investment guru, in his 2015 annual letter published last month.

The only thing that the Government, shareholders and management of Mumias are thinking about now is how and where to get cash now that their “oxygen” has run out.

However, looking back over the last nine years, Mumias may have been rather extravagant with its use of cash.

Trouble begins

From a strong start of Sh740 million in cash on its balance sheet in 2006 (about half of the Sh1.5 billion in profits it made that year), Mumias only had Sh31 million in cash at the end of December 2014.

Trouble began in 2011 when about half a billion shillings in cash was used up by the sugar miller, largely to invest in new projects, such as ethanol production and water bottling.

At the end of June 2011, Mumias held Sh642 million in cash, and a year later, this went down to Sh138 million.

Ironically, 2012 is when the sugar miller posted a record net profit of Sh2 billion. However, this appeared to be the calm before the storm, as revenue dropped, the company made losses and cash reserves dipped to their lowest level in nine years.

And it appears Mumias is now living on a wing and a prayer, with its future pegged on the generosity of the State and its other shareholders.

In his 2015 annual letter to shareholders, Mr Buffett mentioned three keys to financial staying power, which has seen his investment company, Berkshire Hathaway, become one of the largest conglomerates globally. These are: a large and reliable stream of earnings, massive liquid assets and no significant near-term cash requirements.

Unfortunately, Mumias fails on all three fronts. Although the miller has a larger share of sales compared to other millers in the country, its earnings are unreliable.

Cheap imports and a glut of sugar have seen the firm’s sales fluctuate in the last three years. From hitting record sales of Sh15.62 billion in 2010, Mumias’ fortunes have lost some of their shine, with revenues falling to Sh13 billion in 2014.

As much as Mumias blames external circumstances for its misfortunes, the miller occasionally shoots itself in the foot.

For example, it closed its factory in the peak months of October, November and December last year for maintenance due to what it termed “acute cane shortage”.

“The maintenance was prolonged to make up for the deferred 2013 scheduled maintenance, which never took place due to cash flow constraints,” said the company in a statement accompanying the 2014 results.

Sales drop

The closure resulted in a 62 per cent drop in sales to Sh2.6 billion in the first half ended December 2014, compared to Sh7.1 billion over a similar period a year earlier. Ethanol revenue also dropped 23 per cent due to less cane being crushed. Ethanol is produced from molasses, a by-product of sugarcane milling.

The losses Mumias has made since 2013 have helped wipe out its cash reserves in the bank. At the same time, with a drop in sales, the company has not been in a position to increase its current assets in terms of debtors.

The goings on at Mumias have reignited intense debate on whether the Government has any business being in business.

“‘The Government has no business in business’ used to be a popular phrase,” said XN Iraxi, an economics lecturer at the University of Nairobi.

“But the truth is, the Government will always be in business. It regulates businesses, influences interest rates, sets taxes and can make life easier or more difficult for businesses through the provision of public goods. The Government can also invest successfully.”

He gives the example of Temasek Holdings, a successful investment company owned by the Singapore government and whose portfolio covers a variety of sectors, from telecommunications and media to real estate and energy.

There is also the Norwegian sovereign fund, which recently bought into Equity Bank.

“That was probably the thinking behind setting up parastatals, with one firm, the Government, owning them all — like the Temasek structure,” said Dr Iraki.

“But this Government’s bold step in investing has been frustrated by our short-term thinking and politics that have seen firms looted or turned into fiefdoms. There is nothing wrong in Kenya that cannot be cured with what’s right, as  former laggards like Kenya Pipeline Company and Kenya Commercial Bank (KCB) have shown.”

Dr David Ndii, the managing director of Africa Economics, added: “There are good economic reasons for the Government to be in business. For instance, Kenya’s very successful smallholder tea industry would not exist had Government not nurtured it.

“No government in a democracy can stand by watching its economy collapse as a result of business failures — recall the US banking and auto industry bailouts during the financial crisis. The trick is to have an exit strategy from the outset.”

One of the best examples of a turnaround is that of KCB, in which the Government has a 17 per cent stake. KCB was on the brink of collapse in the 90s before a restructuring process.

Now, the bank has crossed borders and become a financial services powerhouse across East Africa.

Generate returns

For many Kenyans, the idea that the Government is pumping in billions to try and revive the ailing Mumias seems far-fetched and a matter that only touches a few thousand citizens, who include staff and sugarcane farmers in Mumias.

Should the typical Kenyan on the street really care about the Government bailout? The short answer is yes.

Perhaps it would help if Kenyans looked at the situation from the perspective that the Government is one big  investment group to which we all belong and contribute to monthly through the taxes on our salaries or on the basic goods and services we buy.

This ‘chama of chamas’ called the Government uses our contributions to pay for salaries, develop mega construction projects like roads and hospitals, and invest in running State-owned corporations and institutions.

The money the Government invests in its businesses is expected to generate a return.

Therefore, shareholders and chama members, or the general citizenry, should be interested in knowing what the Sh1 billion that is to be pumped into Mumias will bring back.