11 April 2017

The Problems continue to mount for Toshiba

Last Thursday (March 30, 2017) shares in Toshiba fell in value by over 26%, representing Toshiba’s biggest one-day dive in share price in over 40 years. This fall in share price was triggered because of concerns over huge write downs with respect to the company’s nuclear business in the United States, and compounds the problems that occurred in 2015 regarding the announcement of false accounting practices adopted and pursued by Toshiba over an extended period of nearly eight years.

A Firstline Securities Blog by: Mike

Who is Toshiba?

Toshiba was formed in 1938 through a merger. Toshiba has made many acquisitions during since its formation including Semp in 1977, Westinghouse Electric (its nuclear business in the United States) in 2006, and IBM’s point of sale business in 2012.

Today, Toshiba is a multi-national conglomerate headquartered in Tokyo. Its diversified products and services include information technology and communication equipment and systems, electronic components, power systems, industrial and social infrastructure systems, consumer electronics, household appliances, medical equipment, office equipment, construction of nuclear power stations, lighting equipment and logistic services.

The Pressure to Deliver and a Case of Inflating Profits

A report into Toshiba’s false accounting (mentioned in the introductory paragraph above) concluded in July 2015 that its top managers – including several members of its board – colluded and played a role in a group-wide accounting manipulation that created false accounts that inflated net profit by at least $1.3 billion over a seven-year period.

The same report suggested that pressure to meet board set targets increased after the global financial crisis commenced and the nuclear incident at Fukushima occurred. Toshiba’s board and senior managers were totally derelict in their duty to stakeholders of the company. The Board failed to properly supervise the activities of the company, and the culture that was created – and demanded success – fed the fire that lead to the creation of false accounting information and the overstatement of profits.

Overall 15 Toshiba Directors were cast aside or resigned.

The Growing Issues Reach a State of Nuclear Meltdown

If that wasn’t enough, the problems compounded and hit a critical point in December 2016.

On the 27th December 2016 Toshiba admitted publicly that it would have to make write-downs of several billion dollars relating to its US-based subsidiary Westinghouse’s $229 million acquisition of Stone and Webster in January 2016. Stone and Webster are a company that is primarily involved in the construction of nuclear generating plants, and the write-downs relate to non-recoverable cost overruns on nuclear power plant construction taking place under the Westinghouse banner in the United States. Westinghouse is a Toshiba subsidiary.

Toshiba has suggested that the write-downs required will be between US $1 billion and $4.5 billion, while many commentators have suggested that the range given strongly suggests that Toshiba has no idea how much of a write-down will eventually be required. Any number could play and speculation suggests that that number may be as high as $8 billion.

What is False Accounting?

Despite being a truly international crime that occurs universally throughout the world, there is no commonly accepted definition of ‘False Accounting’.

Perhaps in lieu of such a definition the following comes close:

False accounting is the dishonest altering, destroying, hiding or fabricating of accounting records with a view of securing a gain for oneself, or causing a loss to another.”

And then there is the definition that I obtained from the Financial Times Lexicon. Per the Lexicon, ‘False Accounting’ is “the crime of dishonestly changing figures, records etc, or writing false information in a company’s financial accounts, deceiving people in order to obtain money by deceiving people.”

Hopefully you get the idea.

Why is False Accounting a Problem?

False Accounting is a significant problem and unfortunately it occurs throughout the world and is not isolated to Japan.

The reasons False Accounting is a significant problem are easy to document:

  • False Accounting Distorts the Market: If a company misleads the market with respect to its performance, then investors will make investment decisions based upon inaccurate and misleading information. This means that investors will not make efficient investments, which results in distorted markets.
  • False Accounting Destroys Shareholder Value: When it becomes known that a company has misled the market and published false accounts, an inevitable chain reaction starts. The value of the company’s shares fall and therefore the overall market value of the company falls. Moreover, the company is often exposed to significant fines which further reduce its value because they deplete the cash resources of the enterprise. The levy of fines by regulators often results in the company having to sell assets that under normal circumstances would not have been earmarked for disposal just so that they can pay the fine.
  • False Accounting is Unfair: The mere existence of one company adopting false accounting practices and distorting their financial performance is unfair on the numerous companies that do exist, act fairly, present accounts that show a true and fair view, and generally “play by the book.”
  • False Accounting has no Fair, Equitable or Efficient Remedy: Stakeholders who invest in a company that adopts false accounting practices have limited remedies when those practices are discovered and made public. In theory, a shareholder could sue the company and in some territories the directors as well, to recover any losses. However, to drag a company or a director through any legal system often requires deep pockets and it is not therefore a remedy that is available to all shareholders unless they decide to act together in a class action. In the final analysis, any remedy takes time, and often time is the one thing that is not on the investors side.
  • False Accounting Places Audit Firms in Jeopardy: Modern auditing is risk based with most audit firms designing their audit tests based on an assumption that they will have a reasonable expectation of discovering a material fraud or error. False Accounting, by its very nature, requires the collusion of many individuals within the company, including directors and senior managers. Arguably because of this element of collusion, and the level at which the collusion takes place, false accounting is a sophisticated fraud that is not easy for the auditor to detect. This argument is one reason why whistle blowing procedures have received greater focus and attention in public companies in recent years, because these types of frauds often require a whistle blower for them to be uncovered.
  • False Accounting Locks Investors In: Because investors make investment decisions based on false and misleading information they end up investing in assets that are effectively overvalued. If the false accounting is discovered the value of those investments will often fall quickly and dramatically before the investor can react. This leaves the investor with a difficult decision. Retain the investment (effectively locking in) until it recovers, or sell for less than they originally invested. This is not a situation anyone likes to be in.

At Current Prices is Toshiba Stock Worth Looking At?

Toshiba stock might properly now be labelled as a “beaten-up stock.” Many savvy investors would see value in investing in a “beaten-up stock” like Toshiba if they considered that the stock had reached a bed-rock bottom and had the underlying potential to recover over a defined time frame that the savvy investor was willing to live with.

While there may be talk of delisting Toshiba (as an ultimate sanction against the company) such a dramatic step is in the writers’ opinion, unlikely to happen.

If the underlying key performance indicators of Toshiba remain sound, and the company addresses the issues that have plagued it over the last decade, then as a potential “rebound investment” it might merit further analysis.

As with all investments, you should do your own analysis, and if you feel comfortable, come into Firstline’s offices for an informal discussion.

Talking – unlike False Accounting – never hurts anyone.

Closing thoughts – time to consider your investing strategies

Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers several unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

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