Competition in the telecommunications industry in the US is intense and increasing from time to time. Throughout the years of establishment, the group has experienced competition from many communications service providers including cable operators, wireless carriers, VOIP providers, long distance providers, competitive local exchange carriers, internet providers and other wireline carriers across all products and in all of our The Frontier business experienced erosion in access lines and switched access minutes of use in 2006 as a result of competition and responded to this competitive environment with new product offers and by bundling products and services together with an end user contract term commitment. Revenues from data services and packages continue to increase as a percentage of our total revenues.
In order to strengthen its position as one of the largest providers in the industry, the group has sold non-core business or assets. In 2005 and 2006, the group has disposed its shares in the Prudential Financial, Inc. (Insurance Company) for approximately $1.1 million and real estate business for $255.3 million respectively. In the meantime, the group also has acquired several companies since 1991 to expand its operations in the telecommunication industry. This strategic move continues to be the group’s practice from time to time to evaluate potential acquisitions and other arrangements, such as the Commonwealth Inc. acquisition, that would extend geographic markets, expand services, enlarge the capacity of networks or increase the types of services provided through the networks. Citizens has completed the acquisition of Commonwealth on March 8, 2007. The total value of the transaction was approximately $1.1 billion and as a result of the Commonwealth transaction, Citizens expects to obtain approximately $30 million in annual synergies.
MAXIS COMMUNICATIONS BERHAD
Maxis Communications Berhad (Maxis) is a telecommunications service provider, offering mobile, fixed line and international network services in Malaysia. Set up as a private company in 1995, its range of mobile services include postpaid services offered under the maxis brand and Hotlink for prepaid services. The fixed line network service offers voice and data solutions including broadband, internet and other specialised solutions such as VSAT services to the enterprise market. The group’s international network supports the mobile and fixed line services requirement for international connectivity as well as provides wholesale services to other service providers.
As a relatively young organization, the Group has enjoyed a successful track record since it commenced commercial operations. In just a few years, it has become one of the most successful and fastest growing corporations in the country, as well as a household name for mobile communications. In 2002, Maxis was listed on the Kuala Lumpur Stock Exchange (KLSE) and consistently ranked among the top 10 public companies in Malaysia. To date, Maxis has won several domestic and international awards. In 2006, Maxis was voted as the “Most Admired Company in Malaysia” in a survey by Wall Street Journal Asia.
In order to strengthen its position as a leader in the telecommunication industry, Maxis has expanded its operations to India and Indonesia. In March 2006, Maxis has completed its acquisition in Aircel being one of the fast growing telecommunication industries in India. As of end-2006, India’s total mobile subscriber base stood at 142 million subscribers (approximately 7 times total current Malaysian industry size) with a penetration rate of 12.7%. This is expected to grow to approximately 340 million by 2010 (approximately 13 times the projected Malaysian industry size). At present, the group’s subscriber growth rate in India was the second highest among the 7 GSM operators in India. In the meantime, the operations in Indonesia remain restricted to a small customer base in Surabaya. Indonesia is a significant market (226 million population) with a relatively low mobile penetration rate of 29% as of end-2006 and a large addressable market yet to be fully tapped. By the end of 2006, the Indonesian mobile market stood at 66 million subscribers (approximately 3 times the current Malaysian industry size) and is expected to grow to approximately 122 million by 2010 (approximately 4 times the projected Malaysian industry size). Also, the very high industry churn rate of about 9% (around 6 million subscribers) per month provides good opportunity for new players to switch users from incumbent operators.
In may 2007, Maxis has been delisted from Bursa Malaysia (formerly KLSE) due to the acquisition of shares by an individual shareholder, Ananda Krishnan. Today however, Maxis has always been in the forefront of the industry’s growth and perceived as a premium and innovative service provider. However
JUSTIFICATION: CITIZENS (USA) VERSUS MAXIS (MALAYSIA)
Both citizens and Maxis are reputable companies in their respective countries showing a remarkable performance for the past five years in building up investors’ confidence. They share a lot of similarities in many aspects. One of the examples is that they never record a loss for five years in a row. Due to the profits, Citizens and Maxis provide dividends for their shareholders. One interesting aspect about the dividend of Citizens especially to the Malaysian investors is that the average total dividend annually distributed since 1957 by Citizens is $1.00, which is considered high for a listed company and the group never misses to pay except for six years from 1998 to 2003. In 2004 however, its dividend has been increased normal than usual to $2.50 to make up the “loss” in the previous years for its shareholders.
In addition, Maxis and Citizens share market prices are considered “stable” and do not volatile in the past two years (Year 2005 and 2006). In order to expand further their operations to pursue their growth objective, both of them practice the acquisition concept. For example, Maxis has acquired Aircel in India in the year 2006 for the value of USD1.08 billion whereas Citizen has completed its acquisition over Commonwealth Inc. in March 2007 for the value of USD 1.1 billion. The only difference in this aspect is that Citizens for instance never has the intention of expanding the operations outside the United States even though the group is an established company incorporated in 1935. The comparison of Citizens with Maxis then will be interesting for the Malaysian investors to view Citizens’s competitiveness in deciding such strategic move.
ECONOMIC SITUATION
USA
The US economy grew at a 3.8 percent pace in the second quarter of 2007 indicating strong momentum heading into the turbulence from housing and credit woes. It was the strongest year-on-year growth spurt since the first quarter of 2006, but the economy is reported to be slow in the third quarter, hurt by a severe housing slump and the recent credit squeeze. In other words, this suggests the economy had a strong momentum in the April-June quarter before being hit by the tightening of credit and rising housing loan defaults.
According to final estimates released by the Bureau of Economic Analysis, real gross domestic (GDP) has increased at an annual rate of 3.8 percent in the second quarter of 2007. In the first quarter, real GDP was up about 0.6 percent. The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures (PCE) for services, exports, nonresidential structures, federal government spending, state and local government spending, and equipment and software that were partly offset by a negative contribution from residential fixed investment. The acceleration in real GDP growth in the second quarter primarily also reflected a downturn in imports.
While export has increased by 7.6 percent, import was down by 3.2 percent in the second quarter. Consumer spending, which accounts for as much as two-thirds of the economy, rose a revised 1.4 percent, slightly higher than the 1.3 percent estimated in June 2007. But this was still a major slowdown from the 3.7 percent pace in the first three months of the year. The housing slowdown caused the real residential fixed investment fell 11.8 percent in the second quarter, steeper than the 9.3 percent drop first reported but not as steep as the 16.3 percent drop in the first three months of the year.
In 2006, real GDP has increased 3.4 percent compared with an increase of 3.2 percent in 2005. The acceleration in real GDP primarily reflected an upturn in inventory investment and accelerations in exports, in nonresidential structures, and in state and local government spending. While residential fixed investment turned down, decreasing in each quarter of 2006, businesses increased real inventory investment in 2006 by $26.8 billion. The accumulation contributed 0.26 percentage point to real GDP growth; in contrast, declining inventory investment in 2005 subtracted 0.30 percentage point from real GDP growth. Exports accelerated in 2006, increasing 8.9 percent, following an increase of 6.8 percent in 2005. Export growth exceeded import growth for the second consecutive. The acceleration was largely due to accelerations in non-automotive capital goods and in industrial supplies and materials.
MALAYSIA
The Malaysian economy continued to expand by 5.3% in the first quarter of 2007 (4Q 2006: 5.7%). Domestic demand driven by the private sector consumption and investment activities was reinforced by the increase in public investment spending. Domestic demand strengthened in the first quarter to record an annual growth of 7.6% (4Q 2006: 7.1%), underpinned by strong private consumption and increased public investment spending. The steady increase in disposable income in an environment of stable labour market conditions and firm commodity prices contributed to the continued strong growth in private consumption of 8.6%. Gross fixed capital formation recorded a growth of 5.4% (4Q 2006: 9.8%) reflecting the positive growth in investment expenditure by both the private and public sectors.
The headline inflation rate, as measured by the change in the Consumer Price Index (CPI), continued to moderate, averaging 2.6% in the first quarter of 2007 (4Q 2006: 3%). The slower increase in prices mainly reflected the lower contribution of the transport category to the headline inflation rate, following the lapse of the effects of the March 2006 increase in the prices of retail petroleum products.
On the external front, the surplus on trade account narrowed to RM21.3 billion (4Q 2006: RM30.2 billion) as growth in imports of 5.4% (4Q 2006: 6.8%) outpaced growth in exports of 1.1% (4Q 2006: 6.6%). Despite the moderation in demand for computers and parts, manufactured exports grew by 1.5%. The Growth was supported by the continued increase in exports of semiconductor chips to the non-US market, expansion in resource-based products such as chemical and rubber products, as well as the sustained growth in exports of consumer products. Meanwhile, agriculture exports rose by 7.7% during the quarter, supported mainly by the substantial rise in palm oil exports attributable to the strong increase in export prices. This is largely due to the continued high global demand for palm oil, particularly from the People’s Republic of China (PR China), European Union (EU) and the US, amidst declining production and stocks, as well as the rise in soybean oil prices due to switching of the crops to corn planting in the US to fulfil domestic demand for biofuel. Receipts from mineral exports declined during the quarter due to lower exports of crude oil arising from the decline in prices, while export volume continued to increase.
The overnight policy rate (OPR) was left unchanged at 3.50% throughout the first quarter of 2007 as the prevailing level of the policy rate is consistent with the medium term outlook of relatively low and stable inflation and steady pace of economic growth. Reflecting the unchanged OPR, interbank rates of all maturities remained stable during the quarter. Retail lending and deposit rates also remained relatively unchanged. The real fixed deposit rates, however, rose significantly in March following the decline in inflation.
Financing to the private sector remained firm, with banking system loans and private debt securities (PDS) outstanding expanding at a combined annual rate of 6.1% at the end of the first quarter. Banking system loans outstanding increased at an annual rate of 6.2%, with loans outstanding to businesses and households expanding by 6.3% and 7.8% respectively. The major loan indicators were higher on an annual basis. Loan applications and approvals were notably higher, driven by increased demand by businesses.
Net funds raised in the capital market by the public and private sectors increased to RM9.4 billion during the quarter. Although gross funds raised in the PDS market were lower than in the previous quarter, net funds raised were significantly higher at RM1.2 billion, due to the lower redemptions during the quarter. Funds raised in the equity market were also higher, amounting to RM795 million.
M1, or narrow money, increased at a stronger annual rate of 17.9% as at the end of the first quarter of 2007, reflecting mainly the increase in demand deposits placed by business enterprises and, to a lesser extent, the higher amount of currency held by the private sector. The growth in M3 was sustained at 12.8%. The expansion in M3 during the quarter was driven mainly by the increase in net foreign assets following higher inflows in the form of export proceeds, net foreign direct investment and portfolio investments.
The ringgit appreciated against the major currencies in the first quarter of 2007. The ringgit appreciation was generally in line with the major regional trading partners. The ringgit appreciated against all regional currencies, except the Thai baht, in the first quarter. For the period 1 April – 28 May 2007, the ringgit appreciated against the major currencies. The ringgit recorded a mixed performance against regional currencies. The ringgit appreciated against the Singapore dollar (2.7%), Korean won (0.9%), Chinese renminbi (0.9%) and Thai baht (0.9%), but depreciated against the Philippine peso (2.9%). As at June 29 2007, the exchange rate against USD 1 was RM 3.45 (Central Bank).
THE IMPACT OF ENVIRONMENTAL FACTORS ON ACCOUNTING PRINCIPLES AND PRACTICES
The differences between accounting standards of different countries are due to environmental factors. Mueller (1968), identifies environmental circumstances affecting the national determination of accounting standards. Generally, currency stability, legislation and shades of political persuasion, separation of ownership and control, management sophistication, size and complexity of firms, speed of innovation, economic development, and education as a major factor influences the environmental constraint.
Apart of that, environmental constraints strongly influence the element of management process which in turn affect management and managerial effectiveness, which determines firm efficiency. To large extend, corporate accounting and information disclosure practices are influenced by a variety of economic, social and political factors. A model of the environmental influences on accounting development is presented in Figure 1 below.
Figure 1: Environmental Influences on Accounting Development
a) Accounting Regulations
National accounting standard issued by FASB. As stated by the Commission on the Regulation of U.S Capital Markets, SEC and FASB needs to work with their international counterparts towards global convergence of U.S. which required to be completed within five years. The securities and Exchange Commission (SEC) is the dominant influence on accounting regulation in U.S. Dealing in securities and investor protection are regulated and enforced at the level under the Securities Act in 1933 and the Securities Exchange Act of 1934.
However in Malaysia, accounting standards are issued by the Malaysian Accounting Standard Board (MASB). Currently MASB is still working on adopting certain IFRS standard into MASB standard which can benefits more on corporation revenue and FDI to enter in Malaysia market.
b) Culture
In accounting, the important of culture and its historical roots is now increasingly being recognized. Culture is considered an essential element in the framework for understanding how social system change because culture influences norms and values and group behavior within and across system.
The influence of culture (i.e, societal or national values) on accounting traditions and practices are adopted by Gray (1988), are linked with the study on cultural elements done by Hofstede in 1970s. The four accounting values implemented by Gray consist of:
- Professionalism versus statutory control
- Uniformity versus flexibility
- Conservatism versus optimism
- Secrecy versus transparency
The culture influence the accounting values in United States and Malaysia more or less are similar. In terms of professionalism of accountant U.S and Malaysia the public regulation has been implemented by legal and tax regulatory requirement. In addition, when uniformed the accounting plan and imposition of tax rules for measurement purpose is more flexible in U.S compared with Malaysia. U.S is also less conservative as their fundamental value. In terms of secrecy, the level is quite low in U.S in terms of disclosure of financial information into public. As far as public accounting and reporting in the market economies are concerned, professionalism and uniformity for both countries (US and Malaysia) more or less is similar due to security exchange requirements by NYSE and KLSE.
c) International factors
International factors bringing changes in the environment that are creating harmonization in international accounting. It grows the international interdependencies. IASB and the International Federation of Accountants (IFAC) as a professional organizations are involved in harmonization. Typically, the next evolutionary step is the establishment of a foreign operation of some kind. It also involves developing an accounting system to monitor contract performance. International accounting differences has been concerned to develop more uniform standards to facilitate cross-border capital raisings and stock exchange listings. The significance in international accounting diversity for the global investment community and the problems of international financial statement analysis have received increasing recognition towards globalization. As a result the impact of differences in accounting principles tends to reflect the dominant stock market focus for investors in U.S and Malaysia.
d) Finance & capital market
Corresponding to the growth in the number, size and complexity of corporations was the demand for finance in the form of shares, or what is termed equity investment as well as loan. This gave rise to the development of capital markets where the raising of finance could be facilitated. A major factor influencing accounting was the emergence of stock exchange or securities market which has their origins in the desire of shareholders to trade their investments without liquiditing the company.
Government policies can generally play an extremely important role in stimulating foreign direct investment (FDI). International openness to investment and trade combined with highly flexible and lightly regulated markets and an environment that fosters innovation. The capital deepening has played a significant role in U.S. productivity growth Efficiency gains resulting from more flexible and competitive labor markets have been another important reason why the United States was able to benefit from recent shifts in technology. The United States ranks first among G7 countries in the World Bank’s Rigidity of Employment Index, indicating very flexible labor markets relative to other G7 countries. Low costs of business entry with relatively few administrative hurdles have also contributed to greater efficiency gains in the United State.
In contrast, Malaysia monetary policy is the process by which governments and central banks manipulate the quantity of money in the economy to achieve certain macroeconomic and political objectives. The targets are usually: - economic growth, changes in the rate of inflation, higher level of employment, and adjustment of the exchange rate. The tools used in monetary policy hinge on manipulating variables that either directly or indirectly change interest rates. The most common monetary-policy instrument entails decisions by the Bank Negara to change interest rate.
e) Taxation
A lower effective tax rate raises the after-tax return to U.S. which based investment relative to foreign investment, making U.S. investment relatively more attractive to both domestic and foreign investors. The tax system creates a “tax wedge” for investment, making the pre-tax return on investment higher than the after-tax return on investment. This is important because investors require the pre-tax return to cover both the opportunity cost and the tax cost of investment. If the tax wedge is large, fewer projects will be undertaken because the after-tax return for some projects will be below the opportunity cost of investment. For example, consider an investment with a pre-tax return of 10 percent and an after-tax return of 7.5 percent, meaning the tax wedge is equal to 25 percent of the pre-tax return. If investors decide they require an 8 percent after-tax return in order to cover the opportunity cost of the investment, taxes will stop the otherwise profitable project from being undertaken. By lowering the effective tax rate on investment, the pre-tax return is unaffected but the after-tax return will rise.
In Malaysia the income taxation rules are applied fully to the financial reporting standards, overruling any other reporting objectives (An important consequence of government bureaucrats setting standards is a much higher probability of un ambiguous standards, with precise and invariant formats and measurement rules). Bureaucracies are more likely to want certainty to make assessment of taxes, adherence to regulatory rules, etc., easier to specify and enforce. Inland Revenue Board in Malaysia plays their role strictly for tax enforcement purposes.
f) Accounting profession
In United States, the power of the accounting profession to determine or influence standards is also relevant. Accountants' self-interest lies in creating complex, ambiguous standards that will provide and maintain the demand for their professional services. A market-regulated economy may let the accountants set standards, or let the market itself decide who will set standards. This is also likely to lead to the accountants getting the job.
In Malaysia, accounting profession is purely supported by accounting bodies like Malaysian Institute of Accountant (MIA) to maintain the professionalism.
g) Accounting education and research
In United States, a high value in placed on the university education of student, and firms that recruit at universities are familiar with the background of students when they graduate. The educational system might be also influenced by the role an accountant is expected to play (e.g., managerial accountant, tax accountant). Like many of the learned professions, preparation to become a practicing accountant includes the timeless elements of formal education, experience and examination. The university based model for certification is applied in United States and Malaysia.
h) Legal system
The legal system is also important in determining the extent to which company law governs the regulation of accounting. In United States, the company law is supplemented by professional regulations like accounting regulation. Regulations often differ in the case of investment in different telecommunications sectors and activities. However, due to strong trends in the convergence of technology and services, the delineation of sectors is becoming more and more blurred. Moreover, due to the rapid development of the telecommunication industry, many observers suggest that regulatory reviews are now necessary and should be relatively frequent. The United States, for example, has such reviews done on a biennial basis.
Apparently, there are compliance with the Communications and Multimedia Act 1998 (“CMA”), and its subsidiary legislations, which regulate the Group’s core business in the communications and multimedia sector in Malaysia. As a licensee under the CMA, the Group adheres to its licensing conditions, as well as economic, technical, social and consumer protection regulations embedded in the CMA and its subsidiary legislations. The Group actively participates in new regulatory and industry development consultations initiated by the regulator, the Malaysian Communications and Multimedia Commission (“MCMC”). The Regulatory function also frequently engages the MCMC and the Ministry of Energy, Water and Communications in discussions on pertinent industry issues.
i) Inflation
In reality, The United States has experienced the fastest acceleration of productivity growth among major industrialized countries since the early 1990s. The inflation rate has been reduced from 2.08% from January 2007 t0 1.97% in August 2007. This situation shows a good indicator on investment market for investors and emerging economies. Thus the effect of inflation on the financial position and performance of a corporation will measure the effectiveness of the accounting treatment is covered towards economic changes.
j) Political system
Clinton has established a clear lead over her Democratic competitors in the early U.S. primary states, while the race for the Republican presidential nomination remains open
Few frontrunners in recent American politics have displayed such steady strength, although a couple -- Democrat Walter Mondale in 1983-84 and Republican George W. Bush in 1999-2000. They are strong leaders and the best able to deal with national security and terrorism issues. The political system in U.S have been changed with different leadership style and political objectives.
A majority of Republicans in the three states want tax cuts to stimulate U.S. economic growth, which is expected to slow later in 2007 while at the same time even larger margins of Democrats would prefer education and health spending. By looking at the objective of the politic system in U.S, more or less it will effect the law and regulation of the country whereby affected with the potential economic growth. When comparing with Malaysia’s political system, there’s a big gap from U.S system due to different objective of the nation.
Political system in Malaysia applied democrat system. The strength bonding comes from the union of political bodies represent as intermediary bodies on behalf of nation needs. The leadership style is also more on human relationship and economic objective which benefits the country. The nature of the political system will impact the authorities bodies into statutized and made into rules and regulation processes.
k) Social climate
In the United States, social climate driven by the political system and rapid technology will change. The level of satisfaction of the quality of life depends on the reaction how people react with the current situation. As environmental changes move faster, the communication system also becomes competencies. Nowadays, telecommunications become a major rapid change. Thus, The leadership style influenced the nation. Equal opportunity in the name of social justice, racial tolerance is committed to maintaining a climate of social relationship to build a strong nation.
In Malaysia, multiracial nation given some advantages to build the society. From the very beginning, national unity was a preoccupation for Malaysia's leaders. Any new technological changes relatively can reflect the social climate in society also.
l) Economic Growth and Development
Economic growth and development in a corporation can have a significant impact on the complexity of accounting transactions and thus influence the accounting principles or disclosures. One of the normal practices for the corporation to expand its operations for economic growth is via acquisition of another potential company. When such acquisition takes place, accounting for goodwill for example must be accounted by the investor in its recording book. The goodwill must be disclosed in details as required by the standards.
Under US GAAP and Malaysia Financial Reporting Standard (FRS), the goodwill for both Citizens and Maxis is not amortized and the impairment test must be reviewed at least annually.
FINANCIAL ANALYSIS
The financial analysis was evaluated using financial reports ended 31st December 2006 and the applicable financial extracts of the preceding year’s annual reports. Both companies have the same financial year ending 31 December. The comparative financial analysis of the two companies is summarized in Appendix 3 . The Income Statements and Balance Sheets of the two companies are tabulated in Appendix 4 .
Our financial analysis applies both the “time series” and “cross-sectional” basis on each company and among the two companies respectively. The analyses focus on the following management performance ratios:
1. Profitability Ratios
2. Liquidity Ratios
3. Gearing Ratios
4. Investment Ratios
MAXIS
PROFITABILITY AND EFFICIENCY
According to our 3-year analysis, Financial Year 2006 recorded the highest revenue for the Group of RM 7,706 million compared with the previous 2 years (Figure 8-Appendix Graphs). This achievement was due to the combination of positive market outlook and also the increase in sales of international getaway services. Riding on the back of higher operating revenue, the Group maintained its incremental trend over the last 3 consecutive years registering a consolidated pre-tax profit of RM2337 million in 2004, RM2450 million in 2005 and RM 2790 million in 2006. Overall, the company did well to strengthen its leadership in the market in all key performance. The company’s subscriber base has increased almost 18% from 7.9 to 9.3 million. Its revenue grew 9% to RM7706 million in 2006 from RM6370 million in 2005. With this strong subscriber and revenue growth, the group has achieved the increase in profit after tax of RM2007 million mark for the first time from RM1613 million in 2005.
By measuring profitability ratio of the Group, gross margin ratio within 3 years analysis shows that the ratio of 39% is maintained in the year 2006 and 2005 whereby in the 2004, it recorded the highest ratio of 41.34 %. Continuously, it also reflects the net profit margin in year 2006 of 39.97% due to the reduction in prices as well as termination fees. Moreover, the Group also shows that its assets were not utilized productively to generate revenue when its return on asset of 13.02% in 2006 was low compared to 15.89% and 18.42% in 2005 and 2004 respectively. In order to increase the subscriber base in the market, Maxis tried to strengthen its market position with improved coverage, new product offerings and more targeted marketing. In 2006, it managed to increase the subscriber of market share from 40.3% in 2005 to 41.4%.
Another profitability and efficiency benchmark for the Group’s performance is Return On Capital Employed (ROCE). The combination of issuing ordinary shares every year, exercise option of The Employee Share Option Scheme (ESOS) commencing from 1st July 2002, movements in reserves and long term loan borrowing, resulted ROCE from 61.66% in 2004 to transform into 38.04.89% and 36.68% in 2005 and 2006 respectively. This positive influence assessing the effectiveness with which funds have been deployed promptly. Ultimately, Return on Ordinary Shareholder’s Funds (ROSF) achieved the higher ratio of 56.65% and 27.37% respectively in both years. These positive achievements are due to the issuance of the highest new ordinary shares of RM 39,354 billion under the “ESOS”.
LIQUIDITY AND SOLVENCY
Benefiting from an improving economy grew over 5.0% in 2005 and 5.9% in 2006, the Group was able to meet its short-term financial obligation in terms of liquidity. As liquidity is vital to the survival of a business, in 2006, Group’s quick ratio of 0.58 times and current ratio of 1.52 times were the highest over the 3 years comparisons. By the reason, the advantage of deposits of the Group has maturity periods ranging between overnight and one month. Accordingly, it’s reflecting cash turnover recorded of 1.27 times in 2005. Despite of this, the Group’s credit policy provided trade receivables with 15 days to 120 days credit period. The Group has no significant exposure to any individual customer, geographical location or industry category. Significant credit and recovery risks associated with receivables have been provided for in the financial statements. Other receivables and deposits of the Company are shown high of allowance for doubtful debts. Thus, short term investment in unquoted money market instruments stated at cost with higher interest rate of 7.75% which will cover the risk through higher profit.
GEARING AND INVESTMENT
In measuring current liabilities and capital fund for the Group, it was found that the solvency has been reduced from 16.7% in 2005 to 15.8% in 2004. However it has increased to 19.9% in 2006. The larger ratio means that there’s a less security of creditors especially the amount due to holding company and other related companies were unsecured, interest free and repayable on demand. Included in current trade payables were payables under deferred payment schemes repayable within the next 12 months and the non-current trade payables are payables under deferred payment schemes, repayable between 13 to 16 months. The weighted average of interest rate of these balances as at the balance sheet date was 9.16%. Trade payables and other payables of the Group had a credit period up to 90 days. Likewise, long-term debt and capital bear higher interest ranging from 8.75% to 12.50% per annum.
The Group continued their increasing trend of dividend payment for their shareholders over the last 3 years and recommended a final dividend of 46 cents less 28% income tax per ordinary share of 10 cents each for the year ended 31st December 2004, 58.35 cents less 28% income tax per ordinary share of 10 cents each for the year ended 31st December 2005 and 71.68 cents less 28% income tax per ordinary share of 10 cents each for the year ended 31st December 2006. In spite of this, 2006 recorded the lowest dividend payout ratio of 52.5% over the 3 years. Absolutely, availability of earnings to cover the actual dividend is more. Thus, Earning Per Share (EPS) continuously rose to 83.92 cent in 2006 compared with 64.83 and 66.29 from 2004 and 2005 respectively. In line with this, the Group remains upbeat of the long term potential and production cost efficiency that it would generate creditable returns to shareholders.
CITIZENS COMMUNICATIONS CO
PROFITABILITY AND EFFICIENCY
According to our 3-year analysis, year 2006 recorded the highest revenue for the Group of RM 2025 million compared with the previous 2 years (Figure 8-Appendix Graphs). The only slightly low achievement is due to combination of change in the number of the group access line and increased competition. Riding on the back of higher operating revenue, the Group maintaining its incremental trend over the last 3 consecutive years registered a consolidated pre-tax profit of RM390 million in 2006 and RM263 million and RM61 million in 2005 and 2004 respectively.
The group intended to continue to increase the penetration of enhanced services. They believed that increased sales of such services would produce revenue costs necessary to offer such services. The group also believed that its ability to integrate these services with other services would provide opportunity to capture an increased percentage of our customers’ communication’s expenditures.
By measuring profitability ratio of the Group, gross margin ratio within 3 years analysis showed that the ratio slightly change every year whereby 2005 recorded the highest ratio of 92.23%. On the other hand, year 2006 recorded as 91.54%. Continuously, it also reflected the net profit margin increased in year 2006 to 31.35% from 20.12% in 2004.. Moreover, Group also manages their assets more productively to generate revenue when again in 2006, Group recorded highest return on asset of 5.07% compared to the last two years of only 1.08%.
Another profitability and efficiency benchmark for the Group’s performance is Return On Capital Employed (ROCE). Combination of reducing ordinary share from year 2005 to 2006 and movements in reserves and long term loan borrowing and increase in income before interest and tax from 2004 to 2006 showed a resulted ROCE from 6.76% in 2004 transform into 10.77% and 11.18% in 2005 and 2006 respectively. This positive influence assessing the effectiveness with which funds have been deployed promptly. Ultimately, Return on Ordinary Shareholder’s Funds (ROSF) achieved the higher ratio of 19.43% and 32.57% respectively in both years. These achievements are due to the issuance of ordinary shares under Management Equity Incentive Plan (MEIP), and Equity Incentive Plan ( EIP).
LIQUIDITY AND SOLVENCY
Benefiting from an improving economy grew over 6.37% in 2006 compared to 3.9% in 2005, the Group was able to meet its short-term financial obligation in terms of liquidity. As liquidity is vital to the survival of a business, in 2006, Group’s quick ratio of 2.99 times and the same current ratio of 2.99 times are the highest over the 3 years comparisons. By the reason, the advantage of deposits of the Group has maturity periods ranging between overnight and one month. Accordingly, it’s cash turnover recorded of 2.45 times on 2006. The group used cash flow from continuing operations, proceeds from the Rural Telephone Bank (RTB), proceeds from the sale of ELI and cash and cash equivalents to fund capital expenditures, dividends, interest payments, debt repayments and stock repurchases. Short-term investment in unquoted money market instruments stated at cost with higher interest rate of 7.94%, which would cover the risk through higher profit.
GEARING AND INVESTMENT
By measuring current liabilities and capital fund for the Group, almost every year the solvency averaged ranging from 0.736 to 0.765 except for year 2006 was 0.804. The larger ratio meant that there’s a less security of creditors especially the amount due to holding company and other related companies are unsecured, interest free and repayable on demand. Likewise, long-term debt versus capital fund in 2006 was the weakness due to the amount represents an unsecured loan obtained in December 2006. The group borrowed $150.0 million under a senior unsecured term loan agreement. The loan matures in 2012 and bears interest based on an average prime rate or London Interbank Offered Rate or LIBOR. The group intends to use the proceeds to repurchase a portion of its outstanding debt or to partially finance their acquisition of Commonwealth.
The Group continued their increasing trend of dividend payment for their shareholders over the last 3 years. In spite of this, in 2004, the company recorded the lowest dividend payout ratio of 22% over the 3 years and year 2006 recorded the highest of 29.9%. Absolutely, availability of earnings to cover the actual dividend is more. However, Earning Per Share (EPS) was continuously up by 0.47 cent from .60 cent in 2005 to $1.07 in 2006 (Figure 1-Appendix Graphs). In line with this, the Group remains upbeat of the long term potential and production cost efficiency that it would generate creditable returns to shareholders.
CONCLUSIONS AND RECOMMENDATIONS
At current price of $14.30 as at october 8, 2007, we recommend investments in Citizens Communications Co. for capital growth potential. We have adopted a PE valuation methodology as our primary valuation benchmark.
We believe that Citizens has the potential to be a key player in the global telecommunication industry in the near future. Its price of $14.37 at PE of 13 (Figure 3-Appendix Graphs) is still attractive compared to market leader in Malaysia, Maxis RM12.30 at PE 14 (Figure 3-Appendix Graphs). Citizens is one of the profitable telecommunication companies in the United States with annual profit of more than USD 150 million in the year 2006.
The consistency of generating profits from 2004 to 2006 and distributing higher dividend payment to shareholders than other reputable company like Verizon Communications Inc. can really attract new investors in future. And once the consolidation of Commonwealth Inc. acquisition by Citizens is taken into consideration for the year ended 2007, we believe that overall net profit and cash generated from the operations can even increase further given that the total revenue is expected to be up by $300 million more from the preceding year (analyst, Business week). Cash flushed, investors can expect higher dividends in future.
Despite Citizens’s share price being almost consistent over the last twelve months, there is still some upside. At 13x forward earnings, Citizens should trade closer to US17.10, a 20% upside. Therefore, we recommend a “BUY” for Citizens to our Malaysian investors.
LIMITATIONS OF THE ANNUAL REPORTS
The main limitation of the annual reports is to have the exact data for both Citizens and Maxis. In the case of operations for example, not all activities in Citizens as of 2005 are relevant to the telecommunication industry as classified on the New York Stock Exchange. The basic reason is that some material operations of Citizens’ subsidiaries are applicable more towards real estate or insurance industry. As Citizens is a parent company, the consolidated figures must be inclusive of all the subsidiaries’ data and the segregation of the data would be impossible. Therefore, the net income or revenue of Citizens if taken into account for the basis of telecommunication sector alone could be understated or overstated depending on the transactions. In summary, it is difficult to compare apple with apple in terms of operations.
Another limitation is in the aspect of the disclosure of some information in the income statement. Different disclosures of income statement information will be presented for different parties. In other words, a detailed breakdown of income statement information will be only provided to insider or for management purposes. The normal investors or users therefore are difficult to make a reasonable judgement as to the “actual” performance of the company.
REFERENCES
(Bureau of Economic Analysis, USA)
(Central Bank of Malaysia)
(Citizens Communications Co)
(Rating Firm-USA)
(Maxis Communication Bhd)
(First Reseach)
(US Securities Commission and Exchange)
(Malaysia)
FINANCIAL REPORTING STANDARDS (FRA)-MALAYSIA AND US GAAP
The following is the accounting standards practiced by both Maxis and Citizens.
( 1 ) INCOME TAX
FRS
Current tax expenses are determined based upon the taxable profits (including withholding taxes payable by a foreign subsidiary or associate on distribution of retained earnings to companies in the Group), and real property gains taxes payable on disposal of properties. Deferred tax is recognised in full, using the liability method, on temporary differences arising between the amounts attributed to assets and liabilities for tax purposes and their carrying amounts in the financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax assets are recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary differences or unused tax losses can be utilised. Deferred tax is recognised on temporary differences arising on investments in subsidiaries and associates except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax is determined using tax rates (and tax laws) that have been enacted or substantially enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
US GAAP
Citizens utilized the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recorded for the tax effect of temporary differences between the financial statement basis and the tax basis of assets and liabilities using tax rates expected to be in effect when the temporary differences are expected to reverse.
( 2 ) PROPERTY, PLANT AND EQUIPMENT
FRS
Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses. All property, plant and equipment are depreciated on the straight-line method to write off the cost of each category of assets to its residual value over its estimated useful life. Residual values and useful lives are reassessed and adjusted, if appropriate at each balance sheet date. At each balance sheet date, the Group assesses whether there is any impairment. Where an indication of impairment exists, the carrying amount of the asset is assessed and written down immediately to its recoverable amount Gains and losses on disposals are determined by comparing proceeds with carrying amounts and are included in profit/(loss) from operations.
US GAAP
Property, plant and equipment are stated at original cost or fair market value for our acquired properties, including capitalized interest. Maintenance and repairs are charged to operating expenses as incurred. The gross book value of routine property, plant and equipment retired is charged against accumulated depreciation.
Example:
The components of property, plant and equipment at December 31, 2006 and 2005 for Citizens are as follows:
($ in thousands)
Estimated
Useful Lives 2006 2005
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A $ 17,944 $ 17,921
Buildings and leasehold improvements 41 years 324,230 320,789
General support . . . . . . . . . . . . . . . . . . . . 5 to 17 years 425,952 411,191
Central office/electronic circuit equipment 5 to 11 years 2,602,168 2,509,769
Cable and wire . . . . . . . . . . . . . . . . . . . . . 15 to 60 years 3,171,421 3,052,560
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 to 30 years 11,800 22,307
Construction work in progress . . . . . 131,951 98,582
6,685,466 6,433,119
Less: accumulated depreciation . . . . . . . . . . . . . . . . . . (3,701,962) (3,374,807)
Property, plant and equipment, net . . . . . . . . . . . . . . . . $ 2,983,504 $ 3,058,312
( 3 ) PRINCIPLES OF CONSOLIDATION AND USE OF ESTIMATES
FRS
The financial statements of the Group and of the Company have been prepared in accordance with the provisions of the Companies Act, 1965 and Financial Reporting Standards (“FRS”), the Malaysian Accounting Standards Board (“MASB”) Approved Accounting Standards in Malaysia for Entities Other than Private Entities.
The financial statements have been prepared under the historical cost convention. The preparation of financial statements in conformity with FRS requires the use of critical accounting estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported financial year. In particular, areas involving a high degree of judgement or complexity or areas where assumptions and estimates are significant to the financial statements are disclosed to the financial statements.
US GAAP
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP). Certain reclassifications of balances previously reported have been made to conform to the current presentation. All significant inter company balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions which affect the amounts of assets, liabilities, revenue and expenses reported and the disclosure of contingent assets and liabilities at the date of the financial statements.
( 4 ) BASIS OF CONSOLIDATION
FRS
The Group financial statements disclose the financial statements of the Company and its consolidation of company, subsidiaries and its associates for the entire financial year.
US GAAP
Citizens only disclose the financial statements of the consolidation of company, subsidiaries and associates only. No disclosure of the company financial statement in the annual report.
( 5 ) GOODWILL
FRS
Goodwill arises on the acquisitions of subsidiaries and it represents the excess of the cost of the acquisition over the Group’s interest in the fair value of the net identifiable assets, liabilities and contingent liabilities of the acquirer at the date of acquisition. Goodwill is measured at cost less any accumulated impairment losses. When the excess is negative (negative goodwill), it is recognised immediately in the income statement. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. Goodwill is allocated to cash-generating units for the purpose of impairment testing and is tested annually for impairment or more frequently if events or changes in circumstances indicate that it might be impaired.
US GAAP
Intangibles represent the excess of purchase price over the fair value of identifiable tangible assets acquired. The company undertakes studies to determine the fair values of assets and liabilities acquired and allocate purchase prices to assets and liabilities, including property, plant and equipment, goodwill and other identifiable intangibles. The company annually (during the fourth quarter) examine the carrying value of our goodwill and trade name to determine whether there are any impairment losses.
Example:
During 2002, Citizens estimated and booked impairment charges (pre-tax) of $1.07 billion. The group subsequently discovered that the impairment charge recorded was overstated as it exceeded the underlying book value by approximately $8.1 million. The result was an understatement of goodwill. The error was adjusted by reversing the negative goodwill balance of $8.1 million with an offset to increase retained earnings.
( 6 ) CONTINGENT LIABILITY
FRS
The Group does not recognise a contingent liability but discloses its existence in the financial statements. A contingent liability is a possible obligation that arises from past events whose existence will be confirmed by uncertain future events beyond the control of the Group or a present obligation that is not recognised because it is not probable that an outflow of resources will be required to settle the obligation. A contingent liability also arises in the extremely rare circumstance where there is a liability that cannot be recognised because it cannot be measured reliably. In the acquisition of subsidiaries by the Group under a business combination, the contingent liabilities assumed are measured initially at their fair value at the acquisition date, irrespective of the extent of any minority interest. The Group recognises separately the contingent liabilities of the acquirer as part of allocating the cost of a business combination where their fair values can be measured reliably. Where the fair values cannot be measured reliably, the resulting effect will be reflected in the goodwill arising from the acquisition. Subsequent to the initial recognition, the Group measures the contingent liabilities that are recognised separately at the date of acquisition at the higher of the amount that would be recognised in accordance with the provisions of FRS 137 and the amount initially recognised less, when appropriate, cumulative amortisation recognized in accordance with FRS 118.
US GAAP
Determination of the treatment of contingent liabilities in the financial statements is based on the management’s view of the expected outcome of the applicable contingency.
The Group consults with legal counsel on matters related to litigation and other experts both within and outside the Group with respect to matters in the ordinary course of business.
( 7) REVENUE RECOGNITION
FRS
Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services in the ordinary course of the Group’s activities. Revenue is shown net of sales and service taxes, returns, rebates and discounts and after eliminating sales within the Group. The Group recognises revenue when the amount of revenue can be reliably measured, it is probable that future economic benefits will flow to the entity and specific criteria have been met for each of the Group’s activities. The amount of revenue is not considered to be reliably measurable until all contingencies relating to the sale have been resolved. The Group bases its estimates on historical results, taking into consideration the type of customer, the type of transaction and the specifics of each arrangement.
US GAAP
Revenue is recognized when services are provided or when products are delivered to customers. Revenue that is billed in advance includes: monthly recurring network access services, special access services and monthly recurring local line charges. The unearned portion of this revenue is initially deferred as a component of other liabilities on the consolidated balance sheet and recognized in revenue over the period that the services are
provided. Revenue that is billed in arrears includes: non-recurring network access services, switched access services, non-recurring local services and long-distance services. The earned but unbilled portion of this revenue is recognized in revenue in our statement of operations and accrued in accounts receivable in the period that the services are provided. Excise taxes are recognized as a liability when billed. Installation fees and their related direct and incremental costs are initially deferred and recognized as revenue and expense over the average term of a customer relationship. We recognize as current period expense the portion of installation costs that exceeds installation fee revenue.
GRAPHS
Figure 1: Earnings Per Share (EPS)
Figure 2: Share Prices
Figure 3: PE Ratio
Figure 4: Dividend Payment
Figure 5: Maxis’ Earnings, Cash From Operations and Liquidity Ratios
Figure 6: Citizens’ Earnings, Cash From Operations and Liquidity Ratios
.
Figure 7: Current Share Price Performance of Citizens
Figure 8: Turnover
