I had heard rumours in the stock market that Sri Lanka Insurance (SLIC) was buying into Blue Diamonds (BD) but had dismissed them as being false. The market is full of such wild stories, the object in spreading them being to unload the shares on retail investors. I was therefore quite shocked to discover that this was indeed true.
The rescue of Sri Lanka Insurance from a botched privatisation is regarded as one of the triumphs of the regime. It is profitable, has pots of cash and is therefore now automatically seen as the vehicle of choice through which state investment can take place. It has its own funds and requires only board approval to buy into assets rather than the complicated process of cabinet papers and other procedures necessary for a Government department. There is also no delay in waiting for funds to be released from the Treasury, which is forever short.
Therefore it is not surprising to learn that SLIC is "aggressively looking for companies to turn around". SLIC has already participated in the bail out of Seylan Bank, bought control of Shell Gas and is now set to run restaurants on the new Southern highway.
The question this raises is whether conglomerate diversification adds too much risk to an insurance business. I don't have a clear answer and the regulatory guidelines overseas are a mess to wade through, but my initial instinct is that it does.
Quite apart from the more fundamental question, BD itself is, to put it mildly, rather a mess. A glance at the auditors report in the latest annual report reveals that:
1. A loan of Rs.203.5m that was obtained on the security of jewellery was written back to income in 2005, on the basis that the bank had taken over the security. The company has now been presented with a claim for US$4.32m, on account of this unpaid loan, which is not accounted in the books. If accounted for at face value it would wipe out half the equity of the company.
2. Th balances payable to related parties could not be verified, which means that further possible liabilities could exist.
3. Sales in the financial year 2010 were Rs.46m but the company had to recover Rs.39m worth of unsold stock from its overseas distributor, a related party. It seems that much of that years sales had simply been lying in stock.
When selling through distributors it is vitally important to monitor the off-take of stock from a distributor, this is what the consumer is actually buying. Crafty salesmen often attempt to dump stock on distributors when they need to meet their sales target, this is very common towards the end of the month/quarter/year depending on when the sales incentives are paid and is a source of dispute between the Sales and the Finance departments.
Looking at the balance sheet, trade receivables are equivalent to about half a years sales and stocks are over a years worth of sales, all of which indicate that the product does not seem to be selling well.
SLIC says they want to turn Blue Diamonds around, I think they will have their work cut out.