Commodities: Noble’s House of woe

Asia commodity trader brought low by weak markets after questions over accounting practices

Richard Elman has always dreamt big. The British-born scrapyard dealer-turned-billionaire commodity trader and founder of Noble Group spent more than a decade riding the wave of China’s growth. In April 2011 he promised investors there was more to come.

“We are in a position to be the best in the world,” he told shareholders in the Noble annual report as he boasted of record profits. “And among the biggest.”

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He had every reason to be confident. China Investment Corp, the country’s sovereign wealth fund, held a big stake in the company; Noble was expanding across the globe; and its market capitalisation had just topped $ 14bn.

But few fully understood at the time that a tight-knit group of executives had embarked on a course that would leave Noble on its knees .

Today the market value of the company — which is listed in Singapore — has collapsed to $ 1.1bn, its chief executive has left, and Mr Elman, 76, has announced he will step down as executive chairman in the next 12 months. In February, it reported annual losses for the first time in more than 20 years after taking $ 1.2bn in writedowns and charges, largely related to the value of long-term contracts it has been accused of overstating by short sellers, hedge funds and a former employee turned financial blogger.

Noble, which acts as a middleman for oil, coal, iron ore and metals deals, is now tapping its shareholders for $ 500m of cash and trying to sell prized assets in its efforts to pay down debt and free up capital for its trading operations.

A taste for sugar

Founded by Mr Elman 30 years ago with $ 100,000 capital, Noble rose to become one of Asia’s biggest commodity traders, helping meet China’s seemingly insatiable appetite for raw materials. At one point it was among the top 100 companies in the world in terms of revenue. Its rivals included Glencore, Vitol and Trafigura, companies that together ship almost 14m barrels of oil per day.

As commodity prices crashed the company went from a highly regarded member of Singapore’s stock exchange, with operations stretching from Brazil to Indonesia, to losing its blue-chip status and struggling to retain the confidence of lenders and counterparties.

The unravelling of the company, named after James Clavell’s Noble House, a novel about an intrigue-riven Hong Kong trading group, is not just another tale of a high-flyer brought low by the end of the China-led commodity boom. It is also a story about how the use of legal accounting techniques can paint a potentially confusing picture of a company’s financial health.

“Noble compounded its problems with aggressive accounting,” says Craig Pirrong, a finance professor at the University of Houston who has written on the industry for Trafigura. “The accounting issues took a big toll on management’s credibility, and that made it very difficult to climb out of the hole.”

More than a dozen former and current Noble Group employees interviewed by the Financial Times say the company’s problems started with its aggressive expansion plans once CIC bought 14 per cent of Noble in 2009.

Brazilian Ricardo Leiman, who joined the company in 2006 from Louis Dreyfus Company, was picked by Mr Elman as a successor who could lead the company’s growth. This would be done through purchasing assets like ports and mills to create what he coined internally a “pipeline of profit”.

Mr Leiman led the company’s $ 950m acquisition of two sugar mills in his home country in 2010, making a big bet on growing consumption in Asia. Two months after the purchase sugar hit a 30-year peak, but then abruptly halved over the next 18 months as production swamped the market.

This deal and others saw Noble becoming increasingly asset heavy and more leveraged. The company’s net debt rose from $ 2.9bn in 2009 to almost $ 4.9bn in 2011. Costs also rose. At its peak Noble employed 15,000 people. “Overheads were high,” says a former Noble executive.

Noble chart

Mounting debts and high costs began to weigh on the company as bets in niche markets such as carbon credits backfired. As a listed company, it wanted smoother earnings to keep the stock market happy, former employees say.

Noble did this by recognising upfront a portion of gains from long-term marketing and supply agreements and recording their value on its balance sheet, say ex-employees. This technique, while legal under accounting rules, has seen only limited use among Noble’s rivals who say it is risky because the volatility of commodity prices means the amount of cash eventually received from the deals can be lower than the recorded profits.

At Noble it became a large part of its shareholder equity. From $ 36m in 2009, the value of derivative contracts held by Noble and the net fair value of its commodity deals — defined as assets minus liabilities and excluding cash flow hedges — rose to $ 1.55bn in 2011.

Despite this increase, Noble recorded its first quarterly loss in more than a decade in late 2011 — the same day Mr Leiman departed the company. He was replaced by Yusuf Alireza, a polished Goldman Sachs executive.

At heart Mr Alireza was a salesman, contemporaries say, but above all he wanted to be in charge of a big company with global reach. During his 14 years at the Wall Street bank, he had helped build its securities business into one of the most powerful in Asia.

“He wanted to run a big business,” says one former colleague. “That’s why he left Goldman.”

Tip of the iceberg

Having spent his entire career in banking Mr Alireza had to learn about the commodities business including Noble’s use of mark-to-market accounting on its long-term deals which had provided the group with sizeable earnings in the past.

Under his tenure, they would continue to grow, almost tripling between 2012 and 2014 to $ 4.6bn. At that time, net fair value gains on contracts and financial derivatives were equivalent to more than 80 per cent of Noble’s equity value. It says part of that growth was related to short-term hedging positions used by its expanding business.

The company’s problems intensified 18 months ago as the sell-off in commodity prices focused the spotlight on the industry. This was compounded by a former employee, working under the name of Iceberg Research, who published the first in a series of hard-hitting reports on the company.

The research by Arnaud Vagner, who had worked as a credit analyst at Noble but left the company in 2013, highlighted how the company had generated higher net profits between 2010 and 2015 than it generated in cash — often a red flag for investors.

Iceberg also raised concerns about how Noble accounted for investments in other companies, in particular Yancoal, an Australian mining company, as well as the valuation ascribed to its agricultural business, which Mr Alireza sold to Cofco, the Chinese state grain trader, in two separate deals in 2014 and 2015 as he moved to simplify the business and pay down debt.

Noble initially dismissed Iceberg as the work of a “disgruntled” former employee. That changed once it published its third report in March 2015 with Noble launching legal action alleging conspiracy to injure.

“Iceberg are not the independent research house they claim to be,” Noble said at the time. “Their actions, and their timing, have been calculated primarily to inflict damage.”

Mr Alireza remained largely dismissive of criticism even as the share price started to tumble. He told analysts in early 2015: “Profit is only recognised for the portion of the contract where there is a high level of certainty of execution.” Mr Elman told investors in August last year that unnamed people were “unqualified” to criticise Noble.

But in an interview with the Financial Times, Iceberg claimed its reports were the result of detailed analysis. “It was a laborious job to go through all the financial documents published by Noble over a five-year period and create a comprehensive financial model,” says Iceberg.

Charts: Noble Group top shareholders and net profit

In February, Noble recognised $ 1.2bn of impairments and exceptional items, largely from coal contracts after deciding to use a lower external forecast for long-term prices. It formed part of a $ 1.7bn loss, the equivalent of wiping out the previous five years’ profits.

Noble has always defended its financial reporting and executives say it had to use mark-to-market accounting because of the way its contracts were structured. Last year it commissioned PwC to carry out an independent report. It found Noble’s treatment of the contracts met international accounting standards, though it made no statement on their value. The company also points out that coal and oil prices have rebounded since February.

Shortly after Noble announced the impairments Mr Elman told shareholders that talk from critics was “cheap” and coming up with strategies should be left to the ones “who have their boots on [the] ground”. Invoking Sir Winston Churchill, a former UK prime minister, Mr Elman said he had nothing to offer but “blood, toil, tears and sweat.”

What Noble really needed, however, was cash. Billions of dollars of credit lines were set to expire in May 2016 and the market was nervous. Cheap credit is the lifeblood of commodity trading, an industry where margins are razor thin.

Mr Alireza remained calm, saying Noble had a provisional agreement with its main lenders and would “move quickly” to close the refinancing. But discussions dragged on. Noble was eventually forced to reduce the amount of credit it was seeking by $ 500m to $ 3bn, money it desperately needed to finance its trading. The cost of its credit also rose sharply.

After first-quarter results showed that Noble had suffered a $ 1.5bn “reduction in the availability of bank lines”, senior traders and Noble executives started to push for more decisive action, according to sources. Mr Alireza dug his heels in fearing further asset sales would leave the company a shadow of its former self.

He insisted that Noble Americas Energy Solutions, a San Diego-based business bought in 2010, was declared “core” despite estimates it could bring in more than $ 1bn.

“There was a personal reluctance to downsize the business,” says a former colleague of Mr Alireza.

Less than three weeks later, Noble accepted the resignation of Mr Alireza, who declined to comment for this article, and put NAES up for sale, predicting it could fetch more than $ 1bn.

The company named William Randall, founder of its coal business, and Jeff Frase, a former chief oil trader at Goldman Sachs and JPMorgan who had grown Noble’s oil business since 2013, as its co-chief executives. A few days later Noble launched a rights issue to raise $ 500m and Mr Elman said he wanted to step down within a year.

“Something needed to happen,” says one banker involved in the refinancing.

Changes at the top

With new leadership and moves to raise additional money in place, Noble has bought itself some breathing space.

Executives say the sale of NAES should allow them to repay a $ 650m loan, maturing next May. The remaining capital would go towards funding its main divisions — oil trading, largely in North America, and coal in Asia.

Rating agencies still have concerns. Standard & Poor’s yesterday downgraded Noble’s debt further, into junk territory, citing its need to refinance $ 3bn of credit lines next year.

These are the challenges facing Mr Randall and Mr Frase as they try to restore confidence and lift Noble’s share price, which has fallen from a high of S$ 2.30 in early 2011 to just S$ 0.23 today.

As for Mr Elman, his presence is likely to be felt in the group’s Hong Kong headquarters for some time to come. After he steps down as chairman, the septuagenarian founder, is expected to remain on the board with a significant shareholding of more than 10 per cent, even after it is diluted in the rights issue.

Despite his advancing years he told staff in a recent email that he planned to be around for “the next 50 years”.

“Trust me,” the email said. “You won’t get rid of me that easily.”

Duo chosen to steer Noble
 

Tasked with salvaging Noble Group are two men steeped in trading and the commodity markets.

“Hardcore business guys are now in charge of Noble,” says one banker. ”People who are in the trenches”.

Jeff Frase, 48, who as co-head will run the company’s energy business from Connecticut, is a well-known figure in the tight-knit oil trading community, having helped turn Goldman Sachs into the most powerful commodity bank on Wall Street during his 17 years at the company.

Following a short stint at Lehman Brothers, the ill-fated US investment bank that collapsed in 2008, he joined JPMorgan. Under its then commodities boss Blythe Masters he was tasked with running oil at her fast-expanding energy and metals operation, which aimed to topple Goldman from its perch.

Since Mr Frase joined Noble in 2013, its oil business has grown into one of the most profitable parts of the company.

In contrast to the bespoke suits of former Noble chief executive Yusuf Alireza — another Goldman alumnus — Mr Frase cuts a more relaxed figure. But the Ohio-born former college athlete has a strong competitive streak, according to contemporaries, as well as a former American football player’s heavier frame.

Unlike Mr Frase, much less is known about William Randall, 41, who has spent his entire career at Noble. Raised in Newcastle, Australia, home to the country’s biggest coal port he joined the group in 1997 soon after leaving university, where he studied marketing and finance.

A protégé of founder Richard Elman, he built Noble’s coal business into one of the biggest in Asia and rose quickly through the ranks. He was promoted to executive director in 2012 and under the new structure will run Noble’s hard commodities and liquefied natural gas business from Asia.

His promotion to co-chief executive came as little surprise to bankers, even though many of the long-term commodity deals that have been criticised by Iceberg Research and others were in the coal business that he runs.

Mr Randall has kept a low profile throughout Noble’s recent troubles, although he did take questions from analysts after the company launched its $ 500m rights issue earlier in June. He pledged Noble would remain an “asset-light company” but offered few new pointers on his vision for the group.

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