value and opportunity

In April, I invested ~1% of my portfolio into Portugal Telecom because I found the merger situation with Brazilian Telco OI very intersting.

In the last few days, the stock price dropped like a stone because they disclosed a 900 mn “investment” into the troubled Portuguese “Espirito Santo” Group

Reader benny_m post a very good comment on the old post, asking where to find in the balance sheet those 900 mn EUR.

Looking into the 2013 annual report and the Q1 2014 report, there are only 2 possibilites:

1. Cash and Cash equivalents
2. Short term financial investments

Those are the respective amounts:

	Q1 2014	2013
Cash	1.276	1.659
ST investments	1.071	914

So theoretically, the could be within either category. However two important caveats from my side:

– if they would book this under Cash and Cash equivalents, this would be scandalous and reminds me very much about the Royal Imtech fraud
– in the annual report, the comment to short term investments reads as follows:

24. SHORT – TERM INVESTMENTS
This caption consists of short-term financial applications which have terms and conditions previously agreed with financial institutions.

They disclose 750 mn of “debt securities” which are described as follows:

(i) This caption includes primarily debt securities issued by PT Finance and Portugal Telecom that had an average maturity of approximately 2 months and were settled in 2014 at nominal value plus accrued interest.

This makes no sense. “Issuing” a security means actually receiving money. They cannot own their own issued securities as those would have to be consolidated out. Also the second part of the sentence makes no sense at all. Those amounts were not “settled” as the total amount even increased in Q1 2014.

To add insult to injury, Portugal Telecom actually discloses “related party transactions” with Banco Espirito Santo (BES) on page 219 of its annual report as they are a significant shereholder, but there is no word of the loans to “Rioforte” another Espirito Santo group company.

Let’s look back at the “official” press release of PTC:

PT subscribed, through its former subsidiaries PT International Finance BV and PT Portugal SGPS, a total of Euro 897 million in commercial paper of Rioforte with an average annual remuneration of 3.6%. All treasury applications in commercial paper of Rioforte will mature on 15 and 17 July 2014 (Euro 847 million and Euro 50 million, respectively). Treasury operations are carried out in the context of analysis of various short-term investment options available in the market and taking into account the attractiveness of the remuneration offered and are monitored and approved by the Executive Committee.

Additionally, it is thus important to note that the subscription of commercial paper of Rioforte is based on the 14-year long adequate experience in treasury applications of Banco Espírito Santo (“BES”) and GES entities, in the context of the strategic partnership signed in April 2000 between both parties. This strategic partnership contemplated the cross shareholding between both entities as well as the designation of PT as a preferred supplier of telecommunications to BES Group and the designation of BES as preferred provider of financial services to PT.

Both sentences are in my opinion a clear prove of dishonesty of PTC management. No, lending 900 mn EUR to a troubled financial institution IS NOT part of normal treasury operations. And second, if you have a “strategic partnership” then you shoul disclose this under the relvant section in your annual report instead ogf hiding it behind nonsensical comments.

I have actually send some simple questions to PTC IR (where did they book it etc.) but received no answer.

Summary:

At this stage, I cannot say for sure if this is “only” dishonesty on part of PTCs management or if there is even fraudulent activity involved. In any case this looks really bad and as a result I will sell my PTC shares at current prices (2,18 EUR) and take the loss (~-27%. This is a company where you can’t trust management and even less their accounts/disclosures and this is an absolute “no go” for me.