Friday, 23 January 2009

What is the Church's Business in the Dauis Renaissance Program?


Introduction

This paper presents an analysis, in financial perspective, of the details of the agreement entered into by parties 1) The Bishop of Tagbilaran, 2) Beatriz Susanna Zobel de Ayala, 3) Dauis Renaissance Company, Inc. and signed on June 24, 2008 in Dauis, Bohol, Philippines. As the agreement is vague in some respects, figure computations were interpreted on the basis of its implications to financial statements of the “Dauis Renaissance Company”, both currently and prospectively.

The paper is structured in three parts. The first section analyses the facts of the agreement and its implication on assets, equities, and net income projections. The relevant provisions of the agreement are cited side by side with the analysis. The second section represents the general independent appraisal of the author on the “Dauis Renaissance Company”, taking collectively all the facts mentioned in the first section. The annex section presents a list of important financial terms which are defined within the context of how these terms are used in the analysis.


Section 1. Who Stands to Benefit in the Dauis Renaissance Program?

AGREEMENT on ASSETS:

(Sec. 2.2) The redevelopment of the Dauis rectory is a major component of the Program. The first phase was completed with the construction of the Decks, the Museum (partial) and the Souvenir and Coffee Shop and installation of lighting fixtures for the Dauis Rectory Courtyard (the “First Redevelopment Phase”).These developments helped the Parish to host St. Therese of the Child Jesus….

(Sec.2.3) Bea paid the expenses for the First Redevelopment Phase amounting to P8,104,631. Of this amount, she donated to the parish P2,129,966……. She hereby assigns to the Organization the balance of P5,974,665 (the “Pre-incorporation Expenses”…

(Sec. 5.1)… Bea shall subscribe to P3,750,00 of redeemable shares at an issue price of P1.00per share and pay P1,250,000

ANALYSIS:

Pre-incorporation expenses are "assetized", as the agreement provides the application of the P2,500,000 for the full payment of the balance of her subscription and the P3,474,665 as redeemable preferred shares. The accounting entry for this is as follows:

Pre-incorporation Expenses (Assets) 5,974,665
Redeemable Preferred Shares (by application to subscription) 2,500,000
Redeemable Preferred Shares (by direct issuance) 3,474,565

Pre-incorporation expenses are costs necessary in forming a corporation and should be recognized as expense. The amount stated, however, are costs borne and paid by Bea at the time when there has been no indication of an intention to organize a corporation. The costs were incurred and paid in February 2008, without the necessary agreement to incorporate, and thus can be construed as a personal gesture of Bea, absent a written formal agreement between her and the bishop or the parish. The agreement was signed in June 24, 2008, without reference to previous agreements on the intention to incorporate, or a written contract to the effect that costs prior to incorporation are to be considered as initial capital for a corporation to be created. Without this priori agreement, the provision on application seems to be misplaced.

Pre-incorporation expenses, if indeed this was the intention (contrary to what has been commented in the preceding point) needs substantiation. If these were necessary expenses to "incorporate", the accounting standards require that these needs to be expensed as incurred. But the nature of the expenses incurred (as this was development of fixed assets) prevents this classification. However, if indeed these are to be taken as is, these assets, acquired before incorporation, need to be valued at fair value of assets received than book values of assets transferred. Undoubtedly, as the costs were incurred in February 2008, these are book values, and not fair values.

The new corporation to be created will start off its operations with non-cash assets. To date and based on the values contained on the agreements, the following are the assets of the corporation:
Pre-incorporation Expense (assumed as fixed assets) 5,974,665
Receivable from Bishop as subscribed capital contribution 1,250,000
Receivable from Bishop as subscribed capital contribution 1,250,000
TOTAL ASSETS 8,474,665

As such, it is important to ascertain if both Bishop and Bea have already paid cash their subscriptions, and documents substantiating this need to be examined. We assume here that this is already paid as the project is currently up and running. (Recent evidence, however shows, that the Bishop only has P1 subscription in the organized corporation, the "Dauis Renaissance Company". Also, Bea only has P1 subscription in the authorized capital stock. It is Reinosa Holdings, a company said to be owned by Bea who acquires majority shares).
What is disturbing however, is the fact that the pre-incorporation expenses are “capitalized” even when these are fully expensed or depreciated. It is important to determine what part of the pre-incorporation expenses are productive assets and those which no longer provide future benefits to the corporation.

AGREEMENT ON EQUITIES

(Sec 5.1) The organization shall have an authorized capital stock of P15 million divided into ten million Redeemable Shares, with par value of P1.00 per share, and five million Common Shares with par value of P1.00 per share.

(Sec 5.2) The Redeemable Shares shall have the following features: full voting rights, preferred cumulative dividend of 6% per annum, non-participating, redeemable…….in the case of liquidation to the extent of issue price plus accrued dividends.

(Sec 5.6) Bea deploys her capital contribution……..with the objective of effecting the redemption of all Redeemable Shares within five years from the incorporation of the organization.

(Sec 5.2) The Redeemable Shares shall have the following features………preferred right to assets of the organization in case of liquidation to the extent of the issue price plus accrued dividends.

(Sec.5.1) The Organization shall have an authorized capital stock of P15 million………
(Sec. 5.3) Bea shall subscribe to 3,750,000 of Redeemable Shares….the Bishop shall subscribe to 1,250,000 of the common shares .(Sec 5.4) ….the Organization shall apply P2,500,000 of Pre-incorporation expenses…….shall also issue Bea 3,474,665 of Redeemable Preferred Shares.

ANALYSIS:

The agreement seems not to indicate the existence of creditor's equity, and made mention only of residual equity (capital stock). However, a closer scrutiny of the stockholder's equity of the corporation would indicate that the new corporation has a total liability of P7.2 million, indicated to be paid with a 6% interest per annum (as this is the rate of preferred dividend), and payable over a five-year period (as this is the stated period of redemption). Consequently, this will result to a total cash outflow of:

Total Liability at redemption
For principal 7,224,665
For Interest ( at 6% for 5 years) 2,167,400

Total 9,392,065
Assumed Liability per year (to be recovered from income) 1,878,413
Total monthly net income (net of all charges) requirement to pay-off liability 156,534

This is highly contentious and reflects the poor business planning skills of parties. At the current state of things, it is impossible to generate a net-of-all income of P1.8 million per year.

The contract does not indicate the obligation of the corporation when the corporation will not be able to redeem the shares in 5 years, whether or not the corporation is liable to pay interests. However, the agreement provides for the payment of the investors in case of liquidation of the corporation. As the board membership is 3 is to 2, in favor of Bea, the corporation can be easily declared by the board as insolvent when unable to settle its liabilities. In the case of dissolution, the Corporation Code provides that payment of redeemable preferred shares is superior to common shares. Thus, Bea benefits from liquidation procedures.

In view of the last item mentioned above, what is critical here is to designate what are the assets of the corporation. If the improvements of land and building are the investments of Bea and the primary assets of the corporation, then these are correspondingly subject to distribution.

What is troubling here, however, is the fact that while Bea's improvements on building and land are factored as investments of the new corporation, the land and building (convent) themselves, are not. Had they been considered part of the investment in the corporation, then the capital of the Bishop, and thus, the preference, especially when these investments are treated as redeemable preferred shares, and not as common shares, are protected. Consequently, the assets of the Parish are protected in case of dissolution procedures. (Though at present, what Bea can only acquire is the building improvements and consequently the building when costs are factored). A greater amount of redeemable preferred shares would have accorded the Bishop greater voting rights, and thus, greater control.

Thus, the case of non-payment of the redeemable shares at the end of five years will give Bea the full right over the parish convent, as this will be the payment for the unpaid redeemable equity. The Bishop will lose its control of the asset, though he retains ownership of the land.

The equity structure is highly favorable to Bea in the current set-up. Bea already owns 72% of the preferred shares. Because preferred shares are voting shares, she already controls the total corporation given the current number of issued and outstanding shares. Also, because Bea also has a committed capital of P6.1M, she basically is saying she will purchase both unissued and unsubscribed preferred shares. Thus Bea is in control of this corporation.

The other equity-related obligations of the corporation are as follows:

Monthly payment to the Bishop 15,000
Annual payment to the Bishop 180,000
Share of the bishop 90,000
Share of the Dauis Heritage Program 90,000

The share of the people of Dauis, assuming the heritage program is intended for the people of Dauis, is miniscule as compared to the share of Bea which is P433,479.90 and even to the share of the Bishop. More than 5,000 parishioners share 90,000 while the single person, the Bishop also has P90,000.

The phrase which says "she desires to improve the lives of Dauis people" is contentious, given the way the earnings of the corporation is distributed. Also, the manner by which the share of the Bishop is to be used is not covered by the agreement, and thus, are within the rules of the Church. The challenge of the clergy of the Diocese of Tagbilaran is to ensure that this is accounted properly.

AGREEMENT ON INCOME PROJECTIONS

(Sec 2.2) ….the construction of …..the souvenir and coffee shop..
(Sec 2.3) The final phase……the construction of a function room, the and fit out of Kitchen and Bakery, completion of the Museum,…..the acquisition of implements for dining and banquet services
(Sec 3.2.b) …..the private rooms in the second floor…...
ANALYSIS:

The following are considered income-earning assets of the corporation, as indicated in the agreement:

Revenue Centers
Museum - entrance fees, donations
Souvenir - Shop sales
Coffee - Shop sales
Function Room - rent / service income
Bakery - sales
Dining and Banquet - Sales / service income

The aggregated total net income requirement out of these revenue centers are as follows (without considering the recovery of liability at the end of 5 years):

Interest Expense to Bea 433,480
Love Offering to Bishop 180,000
Total Annual Net Income Requirement 613,480
Total Monthly Net Income Requirement 51,123

It is to be noted here that there is no feasibility study conducted to ascertain feasibility of the projections. But if there are documents to prove feasibility of the different businesses identified above, these should be subjected to further scrutiny in order to determine validity of financial projections.

The author learned of a fine-dining restaurant feasibility study done by Holy Name University Research Center and commissioned by Fr. Valentino Pinlac but this only included one aspect of the “Dauis Renaissance Company” business. A scrutiny of this research output needs to be done as well.

The foregoing discussion has indicated that to a large extent, Bea, and not the Bishop, nor the people of Dauis will largely benefit from the Dauis Renaissance Program. The structure of assets, equity, and net income distribution is highly favourable to her and her company, at formation, operation, and even corporate liquidation. This is however expected, as she is the corporation’s largest investor, and thus, has the preferred right over the corporation’s earnings and assets.

The implication however of this is the fact that the Bishop and the people of Dauis loses control over its own heritage assets. The convent itself, will no longer be theirs, if the Dauis Renaissance Company will not be able to pay Bea’s redeemable preferred shares plus accrued interest in five years.


Section 2. The Dauis Renaissance Program: Whose Interest?

Given the facts mentioned above, the following can be deduced:

a. The Bishop has an immaterial financial control in the Dauis Renaissance Company. He currently holds 8% of the total company capitalization, and 14% of the total subscribed capital. As his investment is on common shares, he receives only the residual assets after payment to Bea upon liquidation.

b. The Faithful, the Laity of Dauis do not have a financial control over the Dauis Renaissance Company. They do not have an investment in the enterprise. They do not have a voting right. Only 60% of the 1,250,000 shares accrue to them, but still through a cooperative to be organized. Converted to percentage, their ownership is only 5% of the total company.

c. Bea is not an investor, but is “constructively” a creditor to the company, with a loan term of 5 years at 6% interest per annum. The “substance” of her investment is that of a loan, though the “form” is equity shares. She is assured of 6% interest per annum, cumulative, over five years. Her investment is also to be redeemed by the company after five years.

d. The Dauis Renaissance Company has high income projections without sufficient basis. To be able to pay Bea (both principal and interest) the company needs to earn 1.8 million pesos of net income per year. Net income means that all expenses for the operation of the business including salaries, light and water, among others are already deducted from sales or revenues. Furthermore, considering the fact that the company still needs to pay the Bishop P180,000 per year, the company needs to earn P2 million in net income per year to be able to pay all its committed obligations. There is no feasibility study available regarding how these projections are to be achieved.

e. To say that the Dauis Renaissance Company is created to “contribute to the betterment of the lives and people of Dauis” and to “strengthen the spiritual, moral, and religious foundation, cultural identity, and pride and community solidarity of the Dauis people” (Sec1.b and Sec 1.c) is objectionable. The income of the corporation in the next five years will all go to debt servicing (at P433,480 per year) and payment to the Bishop (at P180,000 per year). There is no clear provision of the agreement that says how the betterment of the lives of the people of Dauis will be achieved through the renaissance program. Also, there is not an indication that the income of the company will be used for spiritual, moral, and cultural purposes.

f. If the Dauis Renaissance Company can not achieve the income projections stated in item d above, it can not pay its obligations. If the corporation desires to liquidate, the Bishop and the Laity of Dauis will lose control of its heritage assets. Bea can decide on a corporate liquidation as she has the controlling power over the corporation. The consequent effect on this is the distribution of assets of the corporation. Because Bea owns majority interest, and preferred shares as well, she receives most of the assets of the corporation, including the building and land improvements on the Dauis convent and its environment. Unless, the Bishop has the sufficient money to pay Bea her investment plus accrued interest.

Thus, the answer to the question posed in the title of this section seems obvious. It is not of the interest to the Bishop, nor the Laity of Dauis to enter into a cooperation agreement for the Dauis Renaissance Program, unless there is evidence to suggest that the Dauis Renaissance Program is the collective will of the Faithful of Dauis, or the personal desire of the Bishop. But if the Bishop and the Faithful of Dauis desired for this program or company, then they entered into an agreement where they are most disadvantaged.