The name of the Parmalat Company might not be familiar to many people, but the lessons from the collapse of this giant Italian food company has ramifications for us all in the financial and investment world, and especially in Saudi Arabia’s emerging capital markets.
Parmalat was founded by a Calisto Tanzi , as a milk conglomerate based in Milan. Tanzi aspired to make Parmalat the “Coca-Cola” of the milk world, and he introduced long life in milk products and the famous Tetrapak carton for dairy products. From this success, Tanzi took Parmalat public in 1990 and listed it on the Milan Stock Exchange, and expanded internationally by buying out foreign food companies. Parmalat also branched out in meat and other dairy products. In the 1990’s Parmalat was one of Italy’s biggest publicly quoted companies and one of its greatest success stories.
Success went to Tanzi’s head, and in common with many other successful businessmen who play around with investor’s money, and are not held accountable if the company is doing well, Tanzi bought South American football clubs, toured in the company private jets, and gave a lot of money to local charities and even Italian politicians, which according to investigators, amounted to around 13 million euros.
So far so good. Where was the problem then? In 2003, rumors spread in the market that Parmalat was not paying its farmers for products purchased, and some were asking why the giant company was not using its apparently healthy cash in the balance sheet to pay off some of the debts. The company continued to be quoted at “investment grade” by the stock market, creating an illusion of normality for investors. In December 2003, the bubble burst, as it emerged that a $4 billion cash deposit supposedly held in a Bank of America account in the Cayman Islands did not exist. The company went down like a sinking ship, with debts of 13 billion euros (SR64 billion), making it Europe’s worst business crash.
How could this happen? Parmalat’s insatiable appetite for credit and loans for its expansion made it a valued client of numerous Italian and foreign banks who did every thing possible to get it as a customer, but did very little in really determining what the true picture of this giant company was. Accountants failed to spot the big black hole in the company financials, and the credit rating agencies routinely gave it a clean bill of health. While Tanzi and his associates are now standing trial and await judgment on these massive financial frauds, what lessons have been learned?
Firstly, Italy started to take action to introduce regulations to strengthen control over companies and the information required for listed companies. Secondly, banks yet once again, learned that for a company to be “very big” does not necessarily mean “very good”, especially for multinationals operating in many countries. Thirdly, investors must really learn to use their voting shareholder power and start to question companies who seem to be selling them ever-brighter stories about the company’s performance. But it takes investor education and critical analysis of balance sheets and market information to do that. Who would want to rock the boat and ask questions when dividends seem to be rolling in? The same seems to be true of the Middle East capital markets.
The lessons for us in the Middle East and Saudi Arabia, are that we require even more transparency in company records and appropriate regulations in place to protect investors as well as punish those with insider information. To its credit, the Saudi Capital Market Authority is doing just that, but the punishments are still too small to deter fraud, despite massive fines imposed recently on insider dealers on the Saudi stock market. The liquidity in the region and Saudi Arabia, as evidenced by the huge oversubscription of share flotations, can both be an opportunity for new viable projects to be undertaken, as well as for possible scandals to break out from floatation of companies whose balance sheets have not been adequately analyzed.
And where does Parmalat stand today? The good news to bond and loan lenders is that their debt has been swapped into equity. The second good news is that Parmalat was re-listed on the Milan Stock Exchange at an initial par value of 1 euro, but on the first day’s trading the share price went to 3 euros on rumors of a buy out by rivals.. The bad news — for banks — is that Parmalat is suing multinational banks such as Credit Suisse, First Boston, Bank of America, and Citigroup for billions of euros, on the basis of failing in their fiduciary responsibilities. Parmalat will not be the last scandal to break out, as greed is the one commodity that is truly international.
(Dr. Mohamed A. Ramady is visiting associate professor of finance and economics at King Fahd University of Petroleum and Minerals.)