The TransCentury Profit Warning In Ordinary English
TransCentury Limited announced that its profit this year is expected to be more than 25% lower than last year’s profit. See the notice here. This post analyses the notice paragraph by paragraph in ordinary English. 🙂
As required by the Capital Markets Authority and the Nairobi Securities Exchange regulations, TransCentury Limited (“TransCentury” or “Group”) would like to announce that the projected profit for the Group for the year ending 31 December 2014 may be more than 25% lower compared to the earnings of the prior year owing to a fair value loss realised from the sale of the company’s 34% stake in Rift Valley Railways (“RVR”). The impact of the RVR transaction has been reflected as a post balance sheet event in the Group’s audited results of 2013.
Why are companies required to issue a profit warning? A profit warning is an advance notice that a company’s anticipated profit for the current period will not comply with the expectation or previous year profits.  Issuing a profit warning gives the investors and the market time to adjust accordingly before the company’s profits are officially announced.  This gives the investors and the market more time to adjust accordingly before the public release, ideally taking some of the sting out of the expected price adjustment. If no profit warning is released, the earnings announcement is called a negative earnings surprise and could crash the stock price affecting both the company and investors adversely.
The Group, through its wholly owned subsidiary, Safari Rail Company Limited, disposed of its entire 34% shareholding in KU Railways Holdings Limited, the lead investor in RVR to Africa Railways Limited, a core subsidiary of Citadel Capital on 31st
March 2014 by exercising a PUT Option. The decision was made owing to the delayed turnaround of RVR,
which meant that this investment failed to meet return targets set by the company.
What is a PUT Option: Some investments give the investor the  the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time.  RVR was owned by Citadel (51%), Transcentury (34% through subsidiaries) and Bomi Holdings 15%. At the time of investment, March 31st was set as the deadline for Transcentury to exercise its option to sell its shareholding to Citadel. Citadel had the obligation to buy the shareholding at a price that was defined when the investment was made.
What is the benefit of a PUT option;Â When making a high risk investment, an investor may use the PUT option as a form of insurance against price falls or to speculate on the investment. Â
As a result, the Group realised USD 43.7m (KES 3.8Bn) from the sale, which saw it recover its entire cash investment in RVR. However, the sale proceeds were below the historical fair value of the investment. The cash realised from the disposal of RVR will be redeployed towards other higher return investment opportunities that will improve both the financial
position and future profitability of the Group.
Historical fair value of the investment : Fair value, also called fair price, is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of goods, services, or assets, taking into account such objective factors as acquisition/production/distribution costs, replacement costs, or costs of close substitutes, supply vs demand, actual utility of the asset and subjective factors such as risk characteristics, cost and return of capital etc.
After the announcement, TransCentury’s shares dropped to an all time Kshs 20, a 26% drop from Kshs 27 previously traded settling at Kshs 25 at the close of trading yesterday. The share listed in July 2011 at Kshs 50.
This move may be painful in the short term for TransCentury Limited, but it is bound to pay off if the funds are invested in more profitable ventures. In highly publicized investments as this one was, businesses tend to shy away from exiting, a phenomenon called “escalation of commitment”, which could save the company’s share price in the short term, but proves to be costly long term. Read more on “escalation of commitment” here
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