Peter Varga provided TREND with his observations on the situation regarding Arca Investments

Only Arca Investments has applied for protection from creditors, does that mean that the other daughters and the mother can sell the property?

Temporary protection from creditors generally applies only to the company that has applied for protection. Other companies in the group can thus dispose of assets.

According to FinStat, several of their subsidiaries have long-term negative equity and are in the red. They are also increasing their liabilities to their mother and she is still lending to them. Is this a common practice in financing daughters?

Having negative equity is not uncommon in the business sphere. It is particularly typical for companies that are in the early stages of start-up and/or operate in a capital-intensive environment where the horizon for return on funds is distant. It is also generally the case that the parent company may invest in the subsidiary either in equity or by providing debt financing. The form of the investment then at the end of the day depends on a number of legal, tax, financial and commercial parameters. Either way, if a company has negative equity, it is in crisis and in that case, legally speaking, loans are considered to be equity substitutes that are not easy to get back to the parent company. If Arca Capital’s subsidiaries have had negative equity for a long time, although this may seem non-standard, it may not be the case at all. Without knowing more details about the Arca Capital group, individual projects or internal relationships, it may be premature to assess their performance.

Arca also uses this financial scheme: the mother lends her daughter 40 million, the daughter issues bonds because she has assets. Then she pays the money back to her mother. Aren’t these essentially fictitious assets?

I understand that by those assets you meant Arca Investments’ financial investments in its subsidiaries. Such assets are normally valued annually in the parent company’s accounts to reflect the fair value of such an investment. If a subsidiary has no assets other than funds after obtaining loan financing from the parent company, the fair value of such subsidiary is, in simplified accounting terms, equal only to the amount of its shareholders’ equity. And this should be reflected in the financial appearance of the parent company. That is to say, it does not have to be notional assets.

So can Arca pretend to have large debts and inflate the parent company’s assets? Is this a common practice of companies in a holding company? How are receivables from subsidiaries normally valued?

In general, it is possible to ‘inflate’ the value of receivables in situations where the fair value of the receivables is less than the nominal value, but this is not reflected in the accounting. This can occur if a parent company makes a loan to a subsidiary with a principal of 100 and the subsidiary misinvests the 100 and takes a loss. However, unless this loss is offset by new financing, the chance of satisfying the claim decreases and hence the fair value of such a claim decreases. The value of receivables on the parent company’s balance sheet is also affected by the amount of interest, which is charged to income by default even if unpaid, and increases both the equity and assets of the parent company. On the other hand, artificially inflated interest is contrary to transfer pricing regulations and in turn worsens the financial ratios of the debtor subsidiaries. Again, unless we know the economic profile of the parent company’s debtors, we cannot say whether the value of the receivables is artificially inflated.

According to the 2018 financial statements, Arca Investments had liabilities and equity of EUR 860 million. Liabilities due within a year amounted to €555.4 million, of which promissory notes amounted to €453.8 million. Interest expenses alone were worth 41.8 million. Bonds issued the year before last amounted to 103.9 million euros. Shareholders’ equity was only 66.4 million. Can it be said that the company is overextended?

An extension occurs if the entity has negative equity and at least two creditors. It appears from your figures that the company does not have negative equity and is therefore not extended.

The 2018 financial statements also state that Arca Investments had €540.6 million in investments that are illiquid. This means they can’t be sold quickly. Is this risky?

If we label an asset as illiquid, it means that it is not easy to exchange such an asset for funds. Of course, this can be especially risky if the cash-flow situation in the company is tight, and therefore even a possible subtle deviation from the planned path (e.g. due to shocks such as the coronary crisis) may not be handled by the company and thus pass the contagion on.

Arca Investments had an equity to liabilities ratio of only one percent at the end of 2018. Isn’t that a risky debt ratio? What is the normal ratio for such companies?

With such a ratio, according to the Commercial Code, the company is in crisis because it is at risk of bankruptcy. The mere fact that a company is in crisis may not indicate anything. As an example, a company with equity of 100 and debt financing of 10 000. Technically, this company is in crisis, but as long as its legal situation allows it to return the 1k1 funding back to the creditor, it will become a healthy company again. The problem arises, however, if such financing were to carry an interest rate of, say, 3 % per annum, and the company would not be able to invest these funds efficiently. At the end of the year, this would result in a financial balance sheet as follows: assets: 100 + 10 000, liabilities: 100 + 10 000 + 300 (interest payable) – 300 (loss). The company could easily end up with negative equity, which in this simple example means solvency problems. So that is why the legislator has reached for the crisis provisions in the Commercial Code, which are intended to adapt the next steps in cases where a company is threatened with bankruptcy so that it can get out of it quickly. That ratio should by default be higher than 8 to 100.

Source : https://www.trend.sk/trend-archiv/drava-arca-capital-narazila-mantinely-vlastneho-biznis-modelu