In recent months, the board of Israel Electric Corporation (IEC) has revised downwards targets for important financial ratios that indicate the company's financial instability, a "Globes" investigation has found. The targets, chiefly the leverage and debt to EBITDA ratio targets, were gradually lowered over several months, without publicity beyond a note in the board's report attached to the financial statements.
The facelift for the financial targets started to happen even before the plan to reform IEC ran aground, before CEO Eli Glickman announced his resignation, and before chairman Gen. (res.) Yiftah Ron-Tal wrote in a direct letter to the prime minister that the company would find itself in a critical position unless immediate steps were taken to strengthen its financial stability.
One of the two main targets that was changed is the financial leverage, a ratio that expresses the risk level at which the company operates. Examination of the company's financial statements reveals that, nine months ago, the board's financial leverage target was 60%, which is to say that the board's aim was that total debt should be 60% of the balance sheet footing, a fairly ambitious target given IEC's huge losses in recent years.
In fact, IEC's total debt is more than 80% of its balance sheet footing, and, surprise surprise, in the board's second quarter report released in August, the leverage target is revised to 81%. The large gap between the original and updated targets has tremendous financial significance for the Israeli power generation monopoly that has a balance sheet of nearly NIS 100 billion. It means that the board has in effect foregone the huge sum of NIS 20 billion, the amount by which IEC was required to increase its shareholders' equity and reduce its debt in order to meet the ambitious 60% target.
At the same time as the retreat from the financial leverage target, a similar process took place in another important target, the debt to EBITDA (earnings before interest, tax, depreciation and amortization) ratio. This financial ratio gives an indication of the number of years the company will take to repay its debt in full. The debt to EBITDA ratio enables banks to assess whether they should extend loans to the company. The IEC board's target at the beginning of 2014 was to reach a ratio of 4:1. But in the second quarter report, released as mentioned in August, the target ratio is shown as 6.5: 1. The actual ratio is 8: 1. Here too, the target is highly ambitious considering the company's position.
The big question is, what happened in the intervening months to make the IEC board change so dramatically the targets that it set for the company's management? For the most part, what took place actually indicated a degree of stabilization in the company's financial situation, at least in the short and medium term: the end of the Egyptian gas crisis was on the horizon, the high electricity tariff on the one hand and lower fuel costs on the other were generating substantial operating profits, and, most importantly, in July 2014 international rating agency Standard & Poor's raised IEC's credit rating from BB+ to BBB-, and restored the company's debt from speculative grade to investment grade.
"Globes" has also learned that the IEC board recently cancelled its ambitious plan to reduce the company's debt by NIS 9 billion (NIS 1.5 billion annually over six years), and has now approved a more modest and realistic plan to try to reduce total debt by just NIS 500 million annually. This move seems to indicate that the directors have started to understand the company's real situation.
A senior financial consultant who is thoroughly conversant with IEC's situation told "Globes" that he thought that the sharp downward revision of the financial targets and the cancellation of the debt reduction plan arose from the fact that "in recent years the board ignored the actual state of the company, and did not properly analyze the financial projections and the economic risks and the deficiencies that have existed for a decade in the basis of the electricity tariff, among them subsidizing of electricity to consumers."
The consultant said furthermore that there "the suspicion arises that the board knowingly allowed management to carry out huge investments, amounting to billions, in projects, without first ensuring that they were backed by the electricity tariff, thus materially endangering the company's stability." He added that "in a situation in which government ministers pressure the board of a government company to undertake a loss-making venture, the Government Companies Law requires the government to apply in advance for special permission from the Knesset Finance Committee, but for some reason the government decided to take a shortcut and apparently forced the board members' hands."
IEC stated in response, "The company's financial targets and work plan are coordinated with the balance between resources, regulatory requirements, and the responsibility imposed on the company as a national company to supply the economy in times of emergency, under the method applied in Israel whereby projects required for the stability of the economy or that are forced on the company are recognized in the tariff retrospectively. All these factors are considered by the management and the board, day-to-day and when they come to approve work plans. In the work plan for 2015, the changes arising from the postponement of the necessary reform in the company and in the power industry are taken into account.
"The claim that the board does not examine the financial consequences of regulatory decisions and national projects that the company decides to carry out arises from ignorance, given the countless significant decisions that the board adopts or imposes on the management routinely, including scaling down or cancellation of projects, and its full involvement in all decisions with long-term financial consequences, to the extent of cancelling, reducing or postponing them. Evidence of this is the quantity of documents sent to the relevant parties in government setting out changes in work plans and board decisions with consequences for the economy and the company, including the significance of the postponement of the reform at the present time."
Published by Globes [online], Israel business news - www.globes-online.com - on October 14, 2014
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