Tuesday, 16-Oct-2001 3:39 PM

The decline and fall of a paper empire

By Bill Guerin

JAKARTA - Debt? How about a staggering US$12 billion, enough to sort out the Indonesian economy good and proper?

Indra Widjaya, son of Eka Tjipta Widjaya, said last week that his father, who founded the Sinar Mas Group, which owns Asia Pulp and Paper, would not surrender his personal guarantees. The family claims that Eka should not be held liable for the debts, as he is no longer a shareholder of the group.

Indonesia's third largest Indonesian-Chinese conglomerate is an empire which owes the equivalent of a third of the Indonesian national debt. Sinar Mas has concentrated over the years on pulp and paper, plantations, finance and property. The group consistently performed well with exports, mainly in the pulp and paper business, and like most of its ilk, was highly skilled in raising finance, and institutionalizing its businesses through the capital markets. So what went wrong?

The conglomerate has been trapped under huge debts, with many of its businesses badly affected by the ongoing economic crisis and falling commodity prices.

Ninety percent of this debt, the biggest by far in the history of corporate Asia, has been run up by the group's Singapore-based Asia Pulp & Paper (APP), one of the world's largest pulp and paper groups, owning 17 manufacturing facilities in Indonesia, China and India, with markets in over 65 countries. APP has announced a standstill over payments for debts worth $13 billion.

Creditors, on the other hand, have been running round like headless chickens trying to gain some control over APP and Sinar Mas assets to protect themselves against the risk of default.

The huge debts of Sinar Mas and consequent headaches for the government are proof that the modus operandi of such massive enterprises would always leave them highly vulnerable to drastic changes in the playing field.

The change that brought about this dwarfing of a giant was, of course, the regional monetary crisis that hit in mid-1997. However, the scene was set far earlier, and was inherent in the way these Indonesian-Chinese conglomerates dominated the private corporate sector here.

Eka Tjipta Wijaya's Sinar Mas family enterprise was always seen as a great success story for Indonesia. The business environment of the mid 1980s to early 1990s encouraged entrepreneurship, with its blend of fast deregulation of trade barriers, the opening up of previously closed sectors for investment, and a fast track deregulation of the financial sector which created large pools of domestic funds.

Liberalization of the financial sector and capital markets went ahead at a fast clip, with the total number of banks increasing threefold from 1988-92, creating enormous amounts of funds available for domestic credit. At the same time there was a major increase in the capitalization of the brand new Indonesian capital market. These conglomerates, then, though still operating in a closed and protected environment, thanks to Suharto ties, were accorded access to pots of gold to fund expansion and leverage, a veritable pioneering scenario. The temptation to borrow and expand must have been overwhelming.

Leveraging upon their excellent trading abilities, Sinar Mas (and the others) took advantage of the export incentives to expand to other markets, diversifying to offshore and regional production bases in a classic strategy to reduce their risk in any single country.

The fundamental shift to a competitive arena, brought about by government policies, and a global decline in commodity prices, meant the Sinar Mases of Indonesia had to somehow change from corporate "family" enterprises to professionally managed businesses able to compete internationally, and thus expand their dynasties. Sinar Mas bit the bullet and hired professional managers, many from India and the Philippines, to hone the skills of their own people.

Acquisitions and joint ventures added to the dynamic growth, and their pride and joy, the Asia Pulp and Paper Group based In Singapore, floated on the New York Stock Exchange in 1994. Bold expansion into global bond markets culminated with a 30-year bond issue in 1997, a maturity term rarely seen in Asia.

Expansion in three continents supported by production in the Far East completed the picture. The massive tracts of forests they had acquired in Indonesia bolstered core paper and pulp expansion. Also, some 60 percent of the group's pre-crisis revenue came from the financial sector through their own subsidiary, Bank Internasional Indonesia (BII), to which the group still owes US$1.059 billion plus 1.8 trillion rupiah (around $180 million). The money was used for expanding their business in China and India before the crisis.

Unfortunately, few had seen the innate problem with the logic of borrowing in the world's strongest currencies, and servicing the loans with receipts in one of the world's little known currencies, the rupiah. The mismatch of currencies was made even worse by the maturity mismatch inherent in borrowing short and paying long. Straying too far from core businesses into property and infrastructure projects meant the whole pyramid was a disaster just waiting to happen.

Such legal lending limits as were in place were ignored, and the key was leverage. Growth came from leverage and drove returns on equity ever higher, thus perpetuating the rosy scenario.

Fundamental principles of banking were widely ignored by both lenders and investors, encouraged by the Asian Tiger syndrome and the obvious success achieved in Indonesia in the Suharto development era.

All this was taking place in a country notorious for its poor protection of creditors and without bankruptcy laws. The upshot, in many cases, was unsound investments and over-capacity, which left these "mega" enterprises vulnerable and exposed to the crisis when it came.

They had been able to use debt to leverage the value of their companies and subsidiaries without losing controlling share, and raised funds in the capital market while cleverly retaining majority control by restricting the share issues. The weak regulatory environment meant that new shareholders and institutional and domestic investors were never able to exert control.

Seizing these opportunities, the conglomerates had changed their core businesses, expanding from the trading activities in which the Chinese are so skilled globally, to raw material sourcing for the Indonesian manufacturers, and eventually to their own manufacturing units.

The ability to borrow at cheap offshore interest rates for domestic oriented projects led to the faulty premise that Indonesia was one of Asia's most rewarding economic tigers.

In an incestuous "money go round", creditors and banks had been lending to their own group of companies in a "Wild West"-like financial environment with little or no governance. The rest is history. The potential of the Chinese market, expected to need a huge amount of paper products, had been too much to resist, and APP went for gold.

Unfortunately, Sinar Mas had not done their homework and found that their more luxurious grades of paper were sorely out of place in a pioneer and very basic market. This venture cost APP US$4 billion in state-of-the-art factories and a China-wide network of sales offices. Worse, the timing coincided with a depression in pulp and paper prices

The Indonesian government has now taken a first charge on group assets, with the Indonesian Bank Restructuring Agency (IBRA) giving a blanket guarantee over the group's debts to prevent a rush against BII. IBRA deserves credit for this astuteness, as deciding to guarantee the Rp12 trillion (US$1.2 billion) in BII credits to the Sinar Mas Group, rather than swapping these incestual intergroup loans for government bonds, gave BII a chance to get back on an even keel. Also, of course, IBRA saved the government a substantial amount in interest costs.

The deal was that Sinar Mas would transfer assets worth at least 145 percent of the group's debts to BII. Many legislators were against the deal because of the high risk of default.

This "best of a bad set of options" guarantee certainly will save BII, and will not further impact on the state budget, unlike the previously proposed asset swap scheme, under which the government would have taken over responsibility for Sinar Mas's debts and would also have had to inject recapitalized bonds worth $1.4 billion into BII. Had BII then failed because of the debts, the injected funds would have gone down the drain and the government would also have had to replace depositors' funds totaling Rp27 trillion.

This is a heavy chain around the necks of generations of Indonesians to come, who will be paying taxes to pay back this burden, let alone investors who have been led a merry dance for years. The 78-year-old Eka, however, travels around in a flashy sports car, flamboyantly dressed, and with a penchant for women.

Old man Widjaya does like the simple things in life. He is said to have as many as 12 wives who have brought a total of 40 little Widjayas into the world, many of them now running the businesses.

In 1997, Forbes named him the 45th richest man in the world, with a net worth of over US$5 billion.

At least there is pressure from some legislators for the Widjaya family to do the honorable thing and pledge their vast personal assets, including those of Eka. APP's responses, however, have been to wring the last drop of goodwill out of the kitty by asking for more loans to stabilize its operations and better enable it to repay the debt.

Amid ongoing suspicion that the group had pledged assets more than once, in order to convince IBRA that it made sense for the government to pledge public money to guarantee their high risk debts, a document turned up, dated January 26 this year, which showed that only Muktar Widjaya, Teguh Ganda Widjaya, Franky Oesman Widjaya and Indra Widjaya were personal guarantors in the asset transfer between IBRA and Sinar Mas.

Indra flatly denies there was any double pledging, saying, "How can we double pledge our assets if IBRA has our land certificates?"

The due diligence process which was insisted on by the government in its plan to merge BII with state-owned Bank Mandiri showed that Sinar Mas had also transferred some $250 million to China to pay back debts there, thus increasing the level of mistrust and suspicion.

Shareholders are fighting back and several groups have filed law suits in the US against APP, alleging fraud. The main thrust of the allegations is that APP indulged in cover-ups so that major shareholders were bereft of true information on the state of the company's balance sheet.

The game seemed to be up in April when APP announced that it had failed to include a US$220 million loss on two currency swap contracts in its financial statements, quickly followed by an official announcement that earlier financial statements for 1997 to 1999 "should not be relied upon".

The 1997 financial crisis exposed these empires for what they were. They talked themselves up as conglomerates and stake-holders in the country's future but were, in fact, bereft of management skills and financial prowess.

The birds are coming home to roost now and creditors, including the Indonesian government, investors and minority shareholders, are left to sort out the mess, while the conglomerate owners walk off into the sunset still proud and rich.

The Indonesian people, especially the urban poor, have suffered untold misery from the economic crisis and prices of basic commodities such as kerosene, paper products, cooking oil and electricity have risen to a level which severely reduces their standard of living. How much of the billions of dollars of borrowed money ever has, or ever will, find its way into their pockets?

The country's bankruptcy judges consistently fail to rule against well-connected debtors, so the chances of redress through the courts, if IBRA were to force bankruptcy over the personal guarantees, are remote.

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