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4th October 1998

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Mind Your Business

By Business Bug

Crash headaches

The disappearance of an aircraft of a popular domestic airline this week had many consequences apart from the fate that befell the fifty-four passengers aboard.

Tour operators were flooded with inquiries from charter flight operators, most of them based in European capitals querying whether it was safe to continue flights.

Then of course, there was the decision by the many other domestic carriers to suspend all flights until the security situation is assessed - a prospect that insurance companies dread.

Shoe merger

The announcement by a footwear company that it was closing shop saw a flurry of activity in the trade.

There were many in the industry who were bidding to takeover operations.

But the winner is likely to be the market leader in the field, those in the know say.


Capital requirement to be raised

C B to tighten finance companies

By Mel Gunasekera

The minimum capital requirement for all finance companies will be increased to strengthen the existing market. The present Finance Companies Act No: 78 of 1988 stipulates a Rs. 5 mn capital requirement for finance companies .

But Central Bank has administratively increased it to Rs. 25 mn.

Central Bank Governor A S Jayawardene is keen to raise the administrative requirement further to Rs. 100 mn, a Senior official of the Department of Non-Banking Financial Institutions told "The Sunday Times Business."

"The proposed amendments would give the monetary board the authority to raise the capital requirement in keeping with the changing economic needs of the country," he said.

This would eliminate the red tape involved in raising the capital requirement whenever necessary.

There are 25 companies at present, with three large players LB Finance, Central Finance and The Finance Company.

The Rs. 25 mn capital requirement was enforced in October 1996, when Asian Finance was granted a licence to operate. Since then there have been no new applicants.

When the capital requirement was raised to Rs. 25 mn, existing companies were given time to raise their capital requirement.

While the proposed amendments would apply to new applicants, existing companies would be given time to raise their capital. Capital could be raised either by a rights issue or by retaining profits.

The proposed changes may see smaller finance companies merging in the future, if they are unable to raise the required funds internally.

Though the finance companies have reached a level of stability after the crisis, the Central Bank official feels it is difficult to supervise 25 companies as their resources are stretched to the maximum.


Settlement dates shortened

The Colombo Stock Exchange (CSE) is to shortly change the settlement dates for debt securities.

At present listing rules for equity and debts are the same. The settlement cycle for equities is T+5 (trading plus five market days) for buying and T+6 for selling.

"We want to shorten the settlement cycle for debt to a single tier T+1," CSE Director General, Hiran Mendis said.

The CSE rules, automation rules, CDS (Central Depository System) rules and the rules for the condition of sale would have to be amended to accommodate the new settlement dates.

"Work has begun and we hope to submit the report at the next board meeting," he said.

Though the present rules permit brokers to trade debt, the lack of an active secondary market is a deterrent to the debt market taking off.

In developed markets, debt instruments are traded almost three times that of equities. Sri Lanka has seen a reverse, partly due to the debt market being in its infancy and the lack of properly trained investment advisors dealing in debt.

Some developed markets have a separate membership for brokers dealing with debt securities, while existing brokers could become a member of both equities and debts. Since our market is in its early stages of development, this idea seems a bit too premature for the Sri Lankan market.

However, regulators feel that most brokers lack=in depth knowledge of dealing with debt securities in a properly managed financial market.

As a positive step towards this direction, the CSE together with the SEC (Securities and Exchange Commission) is to shortly commence a series of intensive training programmes for brokers on the mechanism of debt securities.

These programmes would be conducted, in addition to the normal training programmes being conducted at present, SEC Director General, Kumar Paul said.

The first of the series of programmes is due to commence this month, and conclude with an examination.

"We need broker specialists," Mr. Paul said. "To get the debt market going, we might consider getting in people only to deal with debt," he said.

The authorities are having discussions with the Primary Dealers' Association (PDA) to see the possibility of admitting them as members to the CSE.

Primary Dealers are licensed by the Central Bank to deal in government debt. For primary dealers, the licence to trade in corporate debt, dealers would first have to get membership in the CSE.

Primary Dealers could also align themselves to a broker who is already a member of the CSE, if they do not wish to become a member on their own.

In Sri Lanka, most primary dealers have their own broking firm. For instance, Vanik Incorporation's brokerage arm is Forbes and Walker, Asia Capital's broking firm is Asia Securities and Hatton National Bank could use their subsidiary Jardine Fleming.

"Primary Dealers are interested in this proposal," Mr. Paul said. "We need to have experienced people or the secondary corporate debt market will not flourish," he added.


Reactivate construction and get on track with software

Thilan Wijesinghe, Chairman of Sri Lanka's Board of Investment (BOI) says that government policy initiatives like reducing the budget deficit, managing the inflation rate and ensuring there are no reversals to economic fundamentals, should be continued to withstand any negative fallout from the East Asian crisis.

He told 'The Sunday Times' in a recent interview that there were sectors that could withstand the troubled external environment and investment should be generated from these areas.

Trade in areas where Sri Lanka has a comparative and competitive edge like shipping-related services would go on regardless of the external crisis. Sri Lanka can retain its competitive advantage in terms of its location and the predominant position of handling transshipment cargo, he added.

In this context, he said, it was important to expand the Colombo port and raise capacity, which would be done under the P & O deal. This would be the single largest construction project undertaken, at a cost of 240 million dollars, in Sri Lanka.

Wijesinghe also emphasised the need to generate adequate economic activity in construction, in a bid to pick up the anticipated slack from the manufacturing sector, and promote and facilitate the implementation of viable projects.

He said there was a need for projects in low to medium cost housing, theme and recreation parks, hospitals, commercial complexes and other port construction.

The BOI has been focussing on creating the enabling environment for the private construction sector to thrive, actively working with other connected government agencies to identify land use, among other needs.

Three to four projects are under implementation - a housing development scheme at Athurugiriya on 80 acres of land, development of the Wellawatte Spinning and Weaving Mills site by a Hong Kong-based developer, a high-rise residential complex by a Chinese developer and a 32-storey office complex by a Japanese investor.

On the Colombo-Katunayake expressway project - in which the planned investment from Malaysia did not materialise-, Wijesinghe said that the BOI and the Road Development Authority were jointly preparing an international tender that would be placed by the end of this month.

Wijesinghe said that the government was trying to re-activate the construction sector by providing land, reduced finance facilities and prompt infrastructure facilities.

He said software development was also essential to take the country forward and the lack of a management pool of trained professionals was affecting Sri Lanka's growth.

"By and large we have gone on the wrong track because we have not anticipated the new trends in software development and the post 2000 problem. India has achieved its growth significantly on the year 2000 problem. We need to look at emerging trends in software development and train our people in that sphere. The current number of graduates and professionals with the relevant skills is negligible. We should have a strategy of increasing the numbers by a 1,000 percent over three years."

Wijesinghe said that an Institution of Information Technology, affiliated to the Moratuwa University, would be set up as a degree-awarding institute aimed at increasing the pool of skills. Two private sector initiatives for software parks, training centres and ancilliary facilities are being set up at Kesbewa and Battaramulla.

"I firmly believe that these overall strategies in maintaining good economic management, and boosting growth in the construction and software developments sectors would enable us to cushion against any fallout from the East Asia crisis and ensure reasonable economic growth," he added.


Debentures oversubscribed

  • Seylan Bank

The Seylan bank debenture issue had been subscribed up to Rs. 500mn, on the second day of issue, bank sources said.

The issue opened on the 30th of September with the issue of Rs. 300mn unsecured redeemable subordinate debentures, at a par value of Rs 100 each, with an option to issue a further 300mn in the event of an over-subscription.

The bank has made applications to the CSE for permission to deal in and obtain a quotation for the debenture.

The debentures are of three different interest rates, the first payable monthly at the rate of 13.5 per cent, the second payable annually at the rate of 14.37 per cent and the last a floating rate debenture one per cent above the weighted average of the one year Treasury bill. The debentures are issued for a 5-year period.

Bank officials said that the rural public subscribed to about 90 per cent of the issue so far.

The debentures were issued to mobilize long-term funding to match long term lending via the Piyasa housing loan scheme and Piyasa Velanda Nivasa loan scheme. The fund will also be used to expand the capital base of the bank and improve the capital adequacy ratio of the bank.

  • Commercial Bank

The Commercial Bank's issue of Floating Coupon Interest Rate Debentures worth Rs. 250 million was over subscribed within a few hours of opening on September 28, the Bank has announced.

The first such instrument to be issued to the investing public of Sri Lanka, the debentures which are of Rs. 1000 denomination carry a maturity period of five years.

"The over subscription within a few hours of launch reiterates the public's confidence in the strength, stability and future profitability of the Commercial Bank," a spokesman for the Bank said. He said this was also reflected in the Bank's previous issue of Rs. 250 million in Fixed Interest Rate Debentures which was also over-subscribed on the opening day, says the bank's new release.

The spokesman said the bank will obtain formal approval for trading of this Debenture on the Colombo Stock Exchange as soon as the Debenture Certificates are sent to applicants or their CDS accounts are credited.


Improved trade balance '98

One swallow does not make a summer, nor does a single month's trade gains an annual trade surplus. The trade surplus of July this year is not necessarily an indication that we would register a trade surplus for the entire year.

The country has gone through about two decades of trade deficits and it is unlikely that we can look forward to trade surpluses for quite some time.

Nevertheless, our trade performance in the last few months, particularly our exports, is commendable in a global context of slow economic growth and reduced imports of many of our trading partners.

Although we had a trade surplus in July, we had a significant trade deficit in the seven months of this year. It is therefore a good opportunity to look at our trade performance this year. In the first seven months of this year, the country registered a large trade deficit. This deficit was as much as US $787 Mn. However, compared to the trade deficit of US $920 Mn for the first 7 months of last year, this was 14.5 per cent less.

The main reason for the reduced trade deficit this year is the continued growth of exports, particularly agricultural exports, and reduced growth in imports.

Compared to last year's first 7 months, total exports grew by 8.4 per cent with agricultural exports increasing by 13.8 per cent and industrial exports increasing by 8.4 per cent. There was a significant decline in mineral exports, mainly owing to a reduced demand for gems.

The country's imports, which are much larger than her exports, grew by only 2.3 per cent during this period, compared to the corresponding period last year. Both consumer goods and investment goods imports increased. The growth in consumer goods imports was modest at 5.7 per cent.

The slow growth in consumer goods was due to a lesser domestic demand, partly owing to a better agricultural performance and partly due to reduced prices of several import commodities. Investment goods imports increased by a significant 16.6 per cent.

This is a healthy trend for the long term. However, intermediate goods imports fell by 4.1 per cent. To the extent that these imports decreased due to reduced import prices, it is favourable.

If the investment goods import cost was less owing to reduced quantities of such imports then this is indeed an unfavourable development. Reduced imports of intermediate goods in quantity terms imply reduced industrial output. This is particularly so as most of our exports are based on imported raw materials. Therefore, some of the gains in our trade balance may be an unfavourable development.

The available statistics do not enable us to make a definite judgement on this. However, the fact that the growth rate in manufacturing in the first half of this year was 7.6 per cent compared to a 10 per cent growth in the first half of 1997 is indicative of such an unfavourable development.

We should also turn our attention to some aspects of our balance of payments and external reserves. At the end of July, the country's external reserves had declined from US $2822 Mn to US $2608 Mn. This is a substantial drop of 7.6 per cent.

Yet, the level of external reserves is not a reason for anxiety as it could finance about five months of imports. The most striking feature of the drop in external reserves is that official reserves had declined by 10.7 per cent since end December 1997.

Private remittances, on the other hand, increased. The net position with respect to private remittances is an increase of 14.6 per cent.

While we are celebrating an improvement in our trade balances and a trade surplus in July, we must not lose sight of the fact that our external reserves' position is weakened. Besides this, our trade and external reserves have been maintained with a significant depreciation of the Sri Lankan rupee.

At the end of September our exchange rate to the US Dollar was about 12 per cent less than it was a year ago. In terms of Pounds Sterling, the exchange rate had depreciated even more by about 15 per cent in a year. It is only against the Japanese Yen that we have maintained our exchange rate from that of a year ago, and that is due to the weakness of the Japanese economy.

An analysis of the country's external trade does not give us adequate reasons for optimism. A proper appraisal of our trade situation requires us to view the emerging trade performance and external reserves cautiously and ensure appropriate action to maintain our export strength.

Let us not come to conclusions on the basis of a single month's trade performance. Let us look at the picture in greater depth and understand the forces moulding the country's external trade and finances.


Case study by Sivendran Vettivetpillai

Managers becoming owners

The case study is based on the successful management buy-out of Sun Open System, a division of Company X. Company X was incorporated in 1986 as a trading company dealing in hardware equipment for the IT industry. Their largest revenue generator was the sale of computers for the PC segment of the local market.

They were the market leaders in the PC segment of the market. Since commencing operations Company X had diversified into other related areas of the IT industry such as client-server technology, software development and engineering.

In 1994 they started a new division called Sun Open Systems (SOS) to provide client-server solution to large corporations in Sri Lanka. Tony Weerasinghe was recruited to start the division and subsequently employed a twenty-member team of highly qualified computer professionals.

The first major contract to be won was the implementation of the Central Depository System (CDS) for the Colombo Stock Exchange. This was successfully implemented within budget and time. The greatest achievement of SOS was the development of the CDS software package that was considered to be one of the best in the world.

New technology

On the back of this in 1995, competing among several international IT companies, SOS was awarded the implementation of the CDS for the Mauritius Stock Exchange. This required substantial investment in additional capital equipment and human resources for which Company X did not have the financial resources.

To overcome this problem and looking at the future potential of the division as a serious player in the client-server segment of the market locally and internationally, Mr. Weerasinghe felt it would be advantageous if the division was run as a separate entity thus allowing the SOS division to focus and take advantage of the new technology developed by the division.

Since Company X did not have the financial resources to support SOS's growth potential and strategy Mr. Weerasinghe and the managers decided to acquire the division, in business circles referred to as a management buy-out (MBO). The initial step taken in January 1996 was to incorporate a limited liability company named Millennium Information Technologies Ltd. (MIT).

Thereafter MIT acquired the assets and liabilities of the division from Company X. The MBO was funded by two main parties, the employees of SOS division and venture capitalists contributing 62% and 38%, respectively. The issued capital of MIT became the purchase price of the division since no debt was used in buying the company.

The financial benefits from the MBO have been enormous considering that MIT's turnover has grown from Rs. 50 mn in 1995/96 to Rs. 300 mn in 1997/98. Also the number of employees has grown by approximately 300% over the same period. A unique feature of MIT is that 90% of the current employees are shareholders.

A successful MBO

The main ingredient or catalyst for the MBO in this case was the fact that Company X did not have the financial resources to fund SOS's growth. Also the managers had a much larger plan for the division than the owners which was not aligned to the overall corporate strategy of Company X. This was a typical case where a division of a large company in a high growth stage of the industry life cycle needed substantial investments to fund its growth. In view of this Mr. Weerasinghe and the managers of SOS were able to buy the division from the owners of Company X.

Role of the Venture Capitalists

The venture capitalists had two major roles to play. Firstly, providing equity capital to bridge the funding gap, and secondly, enhancing the status and credibility of the new company. In addition the venture capitalists continue to contribute towards strategic planning, recruitment of key employees and other value added services. This includes introducing good corporate governance in the areas of operational procedures, reporting requirements, and finally but not last financial management and advice. Venture capitalists are also in a position to fund future growth.

Advantages to Company X in selling the division:

Sale of the SOS division brought in much needed cash to pay off creditors.
Reduced capital expenditure in technology and operating costs, thus increasing financial flexibility.
By disposing of a non-core activity Company X were able to focus on the area of its largest revenue generation.
Reduce gearing thus decreasing financial distress.

Advantages to SOS employees

Greater financial reward, in sharing the profits of MIT.
Focus on achieving growth by taking advantage of the technology developed.
Ability to raise capital from the open market.
Managers are in control of the company's business and its future.
Turnover of key employees is minimised as they are also owners of the company.

The writer is a Senior Investment Analyst from Ayojana Fund Management (Pvt) Ltd., managers of NDB Venture Investments and Ayojana Fund.


Telecom users' proposals for a better phone system

The Telecommunication Users Association has made the following submissions concerning bills and billing related problems to the Director General of Telecommunications of the Telecommunications Regulatory Commission of Sri Lanka in response to the advertisement inviting written submissions regarding subscriber bills and resolution of billing related disputes:-

* If requested by the customer, itemized bills, for all calls as in the style of IDD bills, should be provided for a reasonable additional charge not exceeding Rs. 100.

* Bills should be computed on a monthly basis. Billing should be current, so as to avoid a strain on a subscriber's resources.

* If delay is caused in billing, reasonable time must be given for payment, or payment in four equal instalments for outstanding bills must be allowed.

* Matters which cannot be resolved by the respective customer service section of the operator should be referred to their Billing Complaints Committee.

* If such complaints cannot be resolved within a period of 14 days the committee should personally meet with the complainant subscriber and reach a decision within 30 days.

* If the customer is not satisfied with the decision given, he should have the right of appeal to the Regulator.

* The Regulator should refer such matters to an advisory body consisting of representatives of the operator, subscriber association and indepdendent consultant who could offer voluntary services.

* The recommendation of the Advisory Committee, once acted upon by the Regulator, shall be final.

* Once a quarter the Advisory Committee should present the common complaints received, together with advice, to the Regulator.

* The Regulator should take up these matters with the operators to resolve problems on a general basis.

* The Regulator should publish at least once in three months, names of all authorirzed service providers and their approved tariff rates for information of all users.

* The present system of charging different rates for the same service by different providers in the same exchange area for a eg: fixed lines to cellular should be discontinued.


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