WORTH A SOVEREIGN
With sound financial management, Petronas has woven its magic around the markets. But is the oil giant as independent as it looks?
By Tom Leander

Datuk Ishak Imam Abas, the CFO of Malaysian oil giant Petronas, is the perfect foil for his mysterious company. Dressed soberly in a grey suit and royal-blue tie, with a full head of reassuring white hair, he exudes corporate responsibility. His title of datuk, granted two years ago by the late king, signifies his service to the nation and is unique among CFOs in Malaysia.

Consider this accolade for a moment. Ishak has not, like a knighted British executive, founded a company or run committees to fund cancer research. He's spent most of his career sorting out the finances of Malaysia's most powerful company, with US$19.3 billion in revenues the only one in the Federation to earn a place on the Fortune Global 500 ranking. His brief, after he arrived in 1981, was to transform the oil company into a showcase, with all the trappings of internal corporate governance, information resources and the capital structure of a publicly listed multinational oil giant. Petronas is how Malaysia Inc. would like to see itself, and Ishak is one of the men who built its reputation.

Yet Petronas is really a company with two identities. One resembles the efficient multinational, the other a secretive giant with the Malaysian government as its sole shareholder. One identity gained the confidence of global bond investors, who, seeking safe harbor from the ravages of indebted telecom companies and the shaky US economy, took up a US$2.7 billion benchmark offering, boosting confidence all over Asia this May. The other identity seems to be a political entity as well as a financial one, controlled directly from the office of Dr Mahathir Mohamad (who has also assumed the role of the nation's finance minister). One has a balance sheet that would be the envy of any publicly owned oil multinational; the other has been drawn into politically motivated projects that position the company as a kind of safety net for burdened domestic industries. The contradictions built into Petronas make it hard to sort out whether it has created a new kind of Asian business model, or if it is the state-owned beast of yore dressed up in sheep's clothing.

"Petronas has woven its magic around the markets," says Raja Visweswaran, who heads debt capital markets research at Bank of America in Hong Kong, "and for now the question of government intervention seems to be less of a possibility." As evidence of this reduced risk, Petronas can point to the BAA1 rating by Moody's Investors Service for its foreign currency debt, one notch higher than Moody's rating for Malaysia itself.

But intervention, even if remote, remains a possibility. And that's where Ishak's skills come into play. "Over the years," he says, "the rating agencies have developed a good understanding of Petronas as a business entity, despite the fact that the government is the sole shareholder." Adds Ishak: "When we hired a consultant to benchmark us against other national oil companies, they returned to us and told us that we essentially were in a unique situation. We operate like one of the oil majors, not a national oil company." Internally, Petronas looks more like Spain's Repsol-YPF - or for that matter Shell - than the Venezuelan oil giant, Petroleos de Venezuela, now run by an army general, or Mexico's Pemex. Says Ishak: "Our peers in the majors tell us the same thing."

But Petronas is, like Pemex or the Venezuelan giant, the single-largest contributor to its nation's federal government. An astonishing 27.5 percent of all expenditures by the Malaysian government come from taxes, royalties and dividends paid by Petronas, according to Standard & Poor's (S&P). Petronas is also awash with cash, with some US$9.2 billion parked in money market funds in Malaysian banks as of June 31, 2001 (the date on Petronas's last public financial reports, much to the chagrin of its bondholders). These deposits amount to an estimated 5 percent of all bank deposits in Malaysia. Analysts quip that if Petronas withdrew its cash suddenly, Maybank, Malaysia's largest financial institution, would have to go on a bank holiday.

Normally, the company's importance to the health and livelihood of Malaysia's provinces goes unseen. But occasionally a political event emerges that demonstrates how important the company's income stream is to both Malaysia's federal government and its oil-producing states. A suit filed by Terengganu state and the federal government is one such example (see box).

The Datuk Is In

Ishak seems to float above these contradictions. His background exemplifies the foresight and methodical planning that has so soothed analysts and bondholders. He was born in Petak province in central Malaysia, a tin mining province during the country's years as a British colony. He attended a military college and studied accounting at a university in England. He then worked for an Australian carpet manufacturer, as treasurer for Malaysia's national university, then for two American companies, Western Digital and Pfizer. In 1981 a friend of his, at the time the finance director of Petronas, talked him into joining the oil giant.

These may seem modest beginnings for the CFO of a company the size of Petronas. It turned out the resumé was perfect. In 1981, Petronas had not yet tapped the capital markets, but the board was mulling the possibility. The company's charter, written when it was incorporated in 1974, provides for Petronas to develop all of Malaysia's oil reserves, currently estimated at 18 billion barrels of oil and oil equivalent. Facing the prospect of diminishing reserves, the board recognized that the company's future would eventually lie in moving its business offshore and into joint ventures with foreign national oil companies and the oil majors, as well as potential acquisitions. But they needed money for this, and to enter the global debt markets they had to invite the outside world in to pore over Petronas's financial statements.

In 1991, the company sought a rating from the major rating agencies, including S&P and Moody's. "It was quite a culture shock initially," Ishak recalls, "to have a bunch of Americans walking through asking for the minutes of our board meeting." Working closely with Tan Sri Mohd Hassan Marican, the former finance director who is now president and CEO, Ishak made the argument that it was necessary. Ishak adds: "We needed to be exposed to the requirements of US GAAP: it's what investors were looking for in terms of timely disclosure." It took Petronas six years to change the company's internal reporting, mostly with the help of the consulting arm of Arthur Andersen (now Accenture). As part of the process, they installed an SAP enterprise resource planning system. Ishak continued the process, even after the accounting conversion was complete, using metrics culled from ERP as the cornerstone of a value-based management (VBM) program. He was inspired by publicly listed companies that linked VBM to incentive schemes for management compensation, in an attempt to link creating shareholder value to line business activities.

These internal measures were complemented by sound financial management. Before its benchmark US$2.7 billion bond offering this March, Petronas's gross debt was US$10.6 billion. Some US$8.5 billion of this debt is denominated in US dollars. Petronas's US dollar cashflow, estimated by analysts at around 70 percent, furnishes a natural hedge against risk in the portfolio. The company has a policy of limiting debt to 30 percent of total assets, and is sticking to the pledge. The debt-to-asset ratio stood at 28 percent in the latest reported figures. "We're very prudent in terms of keeping debt to a minimum and having highly liquid, excess funding on our balance sheet," says Ishak.

A question of proceeds

The company's substantial cashflow makes the recent benchmark bond offering a bit of an enigma. It was one of the most positive developments in Asia for the year, a sign that Asian economies could remain on the path of reform and economic growth despite troubles in the US and Europe. It was a triumph, too, for Petronas, which had visited the global debt market in 1999 and met with tepid response by bond investors. At the time, Ishak says, "we were lumped by investors that made no distinction between the various credits of the region." Now, it seems, Ishak has vindicated the company's solid financials.

The company cited funding for its involvement in a venture to build a 1,070-kilometer pipeline between Chad and Cameroon. Petronas is a 35 percent equity partner with ExxonMobil, which holds 40 percent, and Chevron, which holds 25 percent. The total cost of the pipeline is estimated by the World Bank to be US$2.2 billion, making Petronas's stake worth US$770 million.

Petronas also said that the remainder of the proceeds would go toward undisclosed additional projects. Bond traders have said that Petronas plans to reserve some of the remaining funds for a stake in PetroChina's West-East gas pipeline, according to Petroleum Intelligence Weekly. Ishak contradicts this report, saying the unspecified investments include exploration in Bahrain and assessment of a gas field in Algeria, but would not estimate their cost.

Some analysts say that even accounting for these projects, there's still too much money left on the table. No source would go on record for fear of nettling the oil giant. One speculated: "The money is for an acquisition that didn't come off or is still being negotiated."

Another theory in play is more far-fetched, given the current success that Malaysia's government has enjoyed in its corporate restructuring efforts, yet has the incidental utility of describing the temptations open to Petronas's owner. Suppose one extra billion US dollars, or 3.8 billion ringgit, remained for strategic investment. That amount would be equal to 3 to 5 percent of Malaysia's total corporate debt. The money would be hard currency from the outside world introduced into Malaysia's protected currency market, adding new liquidity that could be used to retire corporate debt. "It would be enough to kick-start and drive the government's policy of lowering banks' loan levels to troubled companies, freeing up liquidity to drive a consumer-driven boom," says a regional bank economist who did not wish to be identified.

"We would not support corporate Malaysia by injecting cash," says Ishak. Such scenarios are dismissed as speculation by most analysts and don't seem to unsettle bondholders, who are convinced by the company's reassurances.

To allay any skepticism, company officials are telling bond investors that it will not concentrate more than 10 percent of its assets in non-core businesses. "They have reassured investors for some time," says Goh How Phuang, who manages the debt markets portfolio for Schroder in Singapore, "that they wouldn't exceed 10 percent, and in fact, current levels are nowhere near that." He adds: "I am more reassured than I was in the past."

But the specter of government intervention has been very real in the recent past. In 2000, the company acquired a 27 percent stake in the national car manufacturer, Perusahaan Otomobil Nasional Berhad (Proton), for US$263 million. This troubled company was a banner project of the Mahathir government, and an attempt to build a national car company that would also stimulate domestic sales. Petronas has recently sold off its stake in the car company, and Ishak, who was on its board, resigned. Petronas also has large real estate holdings, including a 49.5 percent stake in the Kuala Lumpur Center Project, which includes the Petronas Towers, and a 40 percent interest in the development of Putrajaya, a new government administrative center. "There are risks associated with the government's ability to direct Petronas to make investments peripheral to its core business in support of riskier policy-related objectives," writes Standard & Poor's.

These non-core investments now represent less than 2 percent of assets, nowhere near the 10 percent threshold quoted to investors. The gap between the current level and the threshold suggests that the company is holding open an option to increase non-core investments in the future.

A Certain Uncertainty

Analysts are quick to point out that the government doesn't need Petronas's funding to intervene in the corporate sector. Intervention could easily be funded from the sovereign bond market. Ishak agrees, saying that: "The government is not overly dependent on Petronas for funding."

And it does seem that Malaysia is going through a sweet spot in the international capital markets. Most recently Malaysia reopened its ten-year benchmark with a US$750 million issue whose pricing indicated that global investors saw Malaysia as a safer bet than in the past. In another positive development, S&P upgraded Malaysian sovereigns to triple B-plus from triple B. S&P cited less uncertainty in the political climate following prime minister Mahathir's announcement that he would retire in 2003 and progress in corporate restructuring of debts left over from the Asian financial crisis.

Amid the glow of good news, it almost seems churlish to point out that the dangers threatening Malaysia's stability have not vanished. The transition of the Mahathir government is far from assuredly stable. The Pan-Malaysian Islamic Party is a strong presence, and the demons of Malaysia's recent past - including the protracted trial of former finance minister Anwar Ibrahim - may well come back to haunt the transition period. And although the Malaysian government can tap bond markets now, one hiccup in the political climate and it will be far more costly to lure global investors.

If push comes to shove, it's anybody's guess which commitment - Petronas's contract with the Malaysian federal government and the nation's people or its covenants with global investors - will be honored. The confidence that Visweswaran referred to could be pierced easily.

Ishak says with certainty: "Over the years, events have proven that the government intends to regard Petronas solely as a business entity."

Like magic, Ishak and Petronas seem to be floating above it all.

Tom Leander is Editor-in-Chief of CFO Asia