Oliver L Campbell : PDVSA: A new conglomerate

Oliver L Campbell writes: As a generality, a conglomerate is a grouping together of a number of diverse things but, in the commercial world, a conglomerate is a grouping together of companies with quite distinct activities. Years ago, there were many conglomerates and one thinking behind them was that they would have different economic cycles. It was argued that, at any point in time, some activities would be on the down slope but others would be on the up slope and this would even out earnings. However, conglomerates fell out of favour with the investing public which preferred companies to concentrate on just one or few activities. The disadvantages of conglomerates were said to be:

• a) The lack of any synergy between completely distinct activities.
  
• b) Little likelihood that top management would have all the specialist knowledge required to manage companies with distinct manufacturing processes, technology, distribution channels and markets.
  
• c) The risk that top management would spend too much time sorting out companies with problems, but little profit contribution, at the expense of other, more profitable companies.
  
• d) Top management is spread too thin to dedicate sufficient time to many distinct activities.

The key word in all this is “distinct” since a conglomerate embraces distinct activities and this is what has now happened with PDVSA. I do not know if top management has the expertise to plan, coordinate and control so many diverse activities. For instance, it is most doubtful a petroleum engineer, a refinery technician or an oil trader on the Board would also be a specialist in urban development, ship building, agriculture or food distribution. However, that is not the focus of this article -- I intend to cover only the accounting aspect because it gives cause for concern.

A colleague has recently complained that my explanations are not sufficiently clear for the “neophytes” who read my articles. I shall thus start with a brief description of consolidated accounts, or, as I prefer to call them, “Group Accounts” since they are a grouping of all the subsidiaries which PDVSA controls, and this control comes from owning more than 50 percent of the shares. The consolidation is done “line by line” and I wish PDVSA would use this description since it explains the process in just three words.

The individual items in the Profit and Loss account of all the companies are added together and the same thing is done with the Balance Sheet items. All intra-group transactions, i.e. those between the consolidated companies, are eliminated as the intention is that the figures should show transactions that PDVSA and its subsidiaries have with the outside world as if they were just one company. For that reason, the sales made by PDVSA to CITGO do not appear in the accounts, and are substituted by the sales CITGO makes to customers in the USA.
PDVSA follows the standards set by the International Accounting Standards Board (IASB) and International Accounting Standard 27 (IAS 27) contains the standards for the consolidation of subsidiaries. The pertinent stipulations are as follows:

The consolidated accounts should include all of the parent's subsidiaries, both domestic and foreign:

• a) There is no exemption for a subsidiary whose business is of a different nature from the parent's.
  
• b) There is an exemption for a subsidiary for which control is intended to be temporary because the subsidiary was acquired and is held exclusively with a view to its subsequent disposal in the near future. For such a subsidiary, if it is highly probable that the sale will be completed within 12 months then the parent should account for its investment in the subsidiary as an asset held for sale, rather than consolidate it under IAS 27.”

Thus it is quite clear under a) that PDVSA should consolidate subsidiaries that have nothing to do with the oil business such as PDVSA Urban Development, PDVSA Naval (including the ship building DIANCA), PDVSA Industrial, PDVSA Agriculture (including popular supermarkets PDVAL), and the cement companies just recently nationalized.

On the other hand, under b) the recently nationalized power companies, including La Electricidad de Caracas, will not be consolidated since, in Note 10 to the Financial Statements for 2007 about “Assets held for resale,” PDVSA stated that the shares “will be transferred shortly to the National Electric Corporation.” Several months have now passed and it is not known why this has not been done.

What is the problem with consolidating subsidiaries that have nothing to do with oil? It is simply that adding apples and pears together, line by line, makes it difficult to analyse the results of the oil part of the business. Up to 2007, there was no problem since the figures for subsidiaries with extraneous types of activities were insignificant. In 2008 the figures may not be material either, but the “contamination” in the Group Accounts of the oil business with other, distinct activities will have begun.

It is quite possible the new subsidiaries will make losses which will be absorbed by the oil part of the business. In that case, the public may not realise it has happened because it is hidden by the consolidation--other conglomerates have certainly done this is the past.
Suppose PDVSA were to report “Operating Expenses” in one figure that included expenses to produce petroleum, maize, sorghum, oilseeds, sugar cane, rice and dairy products--the figure for petroleum would swamp the others and nobody would know it had happened. I don’t believe PDVSA would do this, but the possibility is always there and this is a defect of the consolidation process.

I do not suggest you read IAS 27 since it is a document for accountants and likely to produce somnolence. However, PDVSA’S external auditors, Alcaraz Cabrera Vásquez, doubtless are studying it to see how the results of the oil business can be reported without being mixed up with extraneous activities having nothing to do with oil. One possibility would be to cover the latter under “Operating Segments” in the Notes to the accounts, but I believe the auditors will come up with a better solution.

PDVSA sold all the bonds it had issued in the USA so it no longer has to, and does not send reports to the Securities Exchange Commission. This means it can choose not to follow a particular standard of the IASB. A novel solution would be not to consolidate subsidiaries unrelated to the oil business, but account for them under the equity method.
This is the method normally used for associated companies where less than 50 percent of the shares are held.

In brief, Petróleos de Venezuela’s business is no longer confined to “petróleos” and it is a conglomerate with many distinct activities. Under the IASB rules, it should consolidate all companies where it exercises control, and this creates a presentational problem in the Group Accounts. It is important that PDVSA and its external auditors devise a way which allows the results of oil activities to be shown separately from those of non oil activities.

Oliver L Campbell, MBA, DipM, FCCA, ACMA, MCIM was born in El Callao in 1931 where his father worked in the gold mining industry. He spent the WWII years in England, returning to Venezuela in 1953 to work with Shell de Venezuela (CSV), later as Finance Coordinator at Petroleos de Venezuela (PDVSA). In 1982 he returned to the UK with his family and retired early in 2002.