Profit E-Magazine Issue 217

How shareholder activism made the billion-dollar Lakson Group listen

By Muhammad Raafay Khan

InOctober 2020, one man decided to lock horns with one of the largest business groups in Pakistan. Tired of what he thought was consistent mismanagement and a complete lack of disregard for minority shareholders, Ahmed Manaf banded together with his fellow shareholders to try and force Merit Packaging, owned by the Lakson Group, to listen to them.

It worked. The shakeup in management that had followed the shareholder activism resulted in belt-tightening and a push to fully utilize the company’s resources. In its recently published financial results for the year, Merit had a turnover of PKR 4.1 billion and turned a positive gross profit of PKR 252 million for the first time in almost three years. This is a yearon-year sales growth of 44%. And even though the company shows a negative profit after tax of 168 million, it is only due to the financial charges that it owes to the sponsor because its core operating profit has already become positive again for the first time in three years.

Back when Manaf made his first putsch, many were skeptical about whether or not it would work. In a country like Pakistan where big companies are often kept and controlled within the family, minority shareholder activ ism is not usually successful. This is even more starkly true when the big fish are involved. Take the Lakson Group for example. It is one of the leading business groups in Pakistan with total assets exceeding $1 billion and employing over 17,000 people. It owns and runs companies in sectors such as agri-business, call centers, consumer non-durables, fast food, financial services, media, paper and board, printing and packaging, surgical instruments, technology (data-networking, BPO and software) and travel. Some of the well-known companies Lak son owns include Express News, Colgate-Palmolive, McDonald’s Pakistan, and StormFiber.

Merit Packaging is only one of the four publicly listed companies the Lakson group owns. It was incorporated in 1982 as a publicly listed company in the Pakistan stock exchange.

Its clientele includes names such as Unilever, Nestlé, Tapal, National Food Ltd., Vital, EBM, Continental Biscuits, Philip Morris, Colgate Palmolive, etc. With a market capitalization of around $9 million, Merit Packaging owns a paltry position in the billion-dollar Lakson group of companies. That the sponsors would pay heed to the demands of the minority shareholders’ of Merit is telling of how Lakson conducts its business. But how did it all play out?

The play-by-play

As Profit previously reported, in October 2020, Mr. Ahmed Munaf, on behalf of a group of minority shareholders owning in excess of 17% shares of Merit Packaging (PSX symbol: MERIT), wrote to the board of directors asking them to explain their poor performance in the years prior, which included financial losses, lack of sales growth despite expansion, role of independent directors, and even the possibility of a merger with Century Paper & Board Mills Limited (another Lakson Group company). Since the minority shareholders owned in ex cess of 10% of shares, they were able to move a special resolution and force the board to discuss their grievances in the next AGM. Sure enough, the minority shareholders had their first success when the board removed the then CEO Mr. Shahid Ahmed Khan by year end.

This is where the turn-around started. The most important change in Merit was made when the board appointed Mr. Amir Ahmed Chapra as the new CEO in March of 2021. Com ing in with nearly three decades of experience in the packaging industry, Chapra brought with him experience and knowledge of the packaging business not just in Pakistan but also in Africa, Middle East, Southeast Asia, and Turkey. His own company, Metatex, was at one time the largest packaging production company in Pakistan. When Chapra came in, the first thing he had to do was stabilize the bleeding company which had generated a combined loss of over PKR 1.5 billion in the last two years alone. According to his own assessment, the company was not doing well when he came in. The basics

of the business were wrong because the compa ny was selling below the cost of goods sold (as can be seen from the graph above).

Since Merit had been in the market for over three decades, it had all the big customers but was not the primary supplier to any one of them. And the volume it was getting did not matter because it was selling below margins. The new CEO took the company by the horns and micromanaged everything: he got rid of the customers who were buying below margins, increased the prices, removed the inefficient management without hiring any new senior people, and tried to improve the operational efficiency of the machines.

In Chapra’s own words, “Our volumes didn’t go up until the end of the first quarter. And only after stabilizing the company we made a strategy for marketing and added value. Then our volumes grew based on reliability and price. For example, when I came in, we were doing only 25 tonnes of business with Philip Morris, which is a premium customer for any printer. Now we are doing 250 tonnes with them, and we provide 80% of Phillip Morris’s supply.”

Merit Packaging also had two factories, one in Lahore and the other major in Karachi. Under the new management’s leadership, a feasibility study of the Lahore operations was made after which it was decided to shift from Lahore to Karachi in September 2021. This also affected the company’s performance because of under-utilization of machinery during the shifting process. But this move made sense from a financial point of view because aside from PepsiCo and Nestle (who were based in Lahore), all the major customers of Merit had their operations in Karachi.

According to Mr. Suleman Maniya, Head of Advisory at Vector Securities, “The company has improved margins and it is getting all the big clients now. This is all due to the shareholder activism at the company. And since the company has accumulated losses, it means that there will be no tax on the company for the next 2-3 years which will give it space to become a strong company.”

A unique case of minority shareholder activism being successful, Merit Packaging has seen an impressive turn around

A hostile takeover on the cards?

Shortlyafter Chapra became the new CEO, Ahmed Munaf, the shareholder activist whose letters prompted this change, saw a vacancy on the board of Merit Packaging and went for it. As the representative of the minority shareholders holding over 17% shares at the time, this was the natural next step for Munaf. In the EGM on May 04, 2021, there were 7 openings on the board of MERIT and 9 candidates were running for the election. Each candidate needed at least 14% of the votes to get elected. Ahmed Munaf, Hossain Aga, and Raziuddin Monem, three candidates, had votes as such that either two of them could get together and beat the third. Unfortunately, this was going to be Mr. Monem, who lost by a small margin because Munaf and Aga got together and pooled their votes.

For some background, Ahmed Munaf is an importer of polyester yarn, a philanthropist, and an activist investor, among other things. After getting on the board, one would expect that the next step for Munaf would be to force a hostile takeover of Merit Packaging. But when Profit approached Munaf previously, he said he had no such plans. He said he was only trying to become a voice for the minority shareholders who felt that the company could be run better.

In December 2021, the company issued 119,330,029 right shares at PKR 12.50 per share to raise PKR 1.4 billion. This brought the total tally of issued shares of the company to 199,958,427, whereas the total authorized shares of the company are 200,000,000. There are two implications for this.

First, even if Munaf was intending a takeover of the company initially, that option has now ceased to exist. At the time of his election to the board in May 2021, the free float shares of Merit Packaging were 40%. As of June 2022, after the December rights shares, the percentage of free float shares has come down to 17%. This means that the sponsors have not simply shaken up the company to appease the minority shareholders, they have also solidified their own control of the company as well, and if ever Merit Packaging was going to be a case study of shareholder activism leading to a hostile takeover in Pakistan, that is no longer the case.

Secondly, although Merit has shown growth in its last financial year ending June 2022, its accumulated losses are still PKR 1.8 billion. If the company needs to raise more cap ital in the future, the board will have to increase the limit of the authorized shares. When Profit talked to Amir Chapra about this, he said that the company will not be looking to expand in the next 2 years because the board first needs to be shown that their last annual performance can be replicated. However, given the high

rates of bank borrowing in Pakistan currently, if Merit does have to raise capital, issuing new shares remains a likely possibility.

Packaging Industry and the Future Outlook of Merit

InFY 2021, the company had exports of PKR 9 million but in FY 2022, exports were zero. It looks bad at first glance but when Profit talked to Chapra about this, he pointed out that the government needs to make an export policy for the packaging industry. He says, “Pakistan primarily does textile exports and when we go to the FBR or Customs, they don’t understand the makeup of our product, and making them understand can take years. The government also needs to give incentive on power costs and other inputs without which we cannot compete against countries in the Middle East, Africa, and China. And then comes the part of trying to convince the world to buy Pakistani packaging, which will predicate on developing trust, and this can take 2-3 years. We will target these beyond 2023-24 because at the moment we need to build capacity and bring in good people.”

According to Chapra, the packaging in dustry which covers cartons, boxes, plastic, and bottles, etc. will be a $ trillion industry in three years with a cumulative average growth of 3.5% per year. At the moment, packaging is $300 bn and Merit Packaging is nothing in it. For Chapra, exports are necessary for growth in the future because while volumes are always guaranteed in Pakistan due to the huge population, margins cannot be as easily increased because consumption of packaging material is directly linked to the buying power of the consumers, which is not much.

The Packaging industry is not for ev eryone. It is curious to note that there is not a single multinational in the packaging industry and about 55% of the packaging industry is unorganized and saturated with small players. While barriers to entry are low in this industry, sustainability is the real challenge. It requires high initial capital investment, a know-how of the packaging business model, and technically skilled human resource to operate the Euro pean machinery where one machine can cost upwards of 1 million euros.

“During COVID when there was a dip in the economy, many small players entered the packaging industry who charged low prices and took loans on credit,” says Sulaiman Manya. “They drove price competition and brought the margins down for everyone. Eventually, these small businesses went bankrupt. When such price competition ends, margins increase. And the big FMCGs who were previously benefit ing from the low prices are now giving their

business to reliable companies in packaging like Merit because they want good quality.”

Chapra agrees with this but says that such small players have always been there and a lot of them entered the market 10 years ago as well when they were supported by multi nationals like Unilever who wanted to gain an advantage from lower pricing. This mushroom growth of smaller players was created by the big companies who later suffered themselves because they were not getting quality packaging from these smaller players.

For a shareholder, it seems to be a good time to invest in Merit Packaging because all the stakeholders of the company are on the same page on taking the company forward. In 2007, the company’s share price was trading at its highest around PKR 115. At the moment in 2022, it is only around PKR 11-12 per share. If the company keeps on improving linearly as it has in the past year, it can provide good returns to the shareholders.

Starting November, the company will start providing packaging to McDonald’s Pakistan. It already has the machines to produce the packaging for Happy Meals and french fries, which comprise the largest sales revenue for the fast food giant. Then in 2023, they also aim to invest in more machinery to cover the packaging for the rest of McDonald’s products. Merit also aims to increase its offset packaging production capacity by another 200 tons which will give over PKR 100 million sales revenue by the third quarter of FY23.

The financial performance of the company in the most recent results of the first quarter for FY23 prove that the company is finally giving a return. Net sales posted a growth of 60% at 1.39 billion PKR compared to the same quarter last year and gross profit posted a growth of 173% to PKR 136 million. Similarly, operating profit posted a growth of 473% from PKR 16 million to PKR 93 million. Finally, net profit after financial charges and taxation for the quarter turned a positive PKR 3 million against a loss of PKR 57 million in the same quarter of last year. This is the first time in over 20 quarters that the company has turned a positive profit after tax. If this isn’t a sign of the company’s reversal of fortunes, we don’t know what is.

Chapra credits the turnaround of the company to the sponsors who are fully backing it. “It’s a great time for companies like Merit because this is the first time in the last 10 years that it’s being run properly. The sponsors and the management are on the same page and at the right time. Despite the economic and political instability of the country, I think we are doing good because we are well backed by the Lakson group, we do have the facility to produce goods, and we have good machines and good people. Our aim is to make the best out of this situation.” n

By Daniyal Ahmad

Thereis no vehicle more used, no mode-of-transport more common, and no sawari quite so quintessentially South and South-East Asian as the humble motorcycle. Two wheels, a seat, and small motor that turn those wheels through a chain. That is all you need for a motorcycle, particularly in a country like Pakistan where it is a low-cost, high-utility invention meant for everyday intra-city travel.

In the rest of the world, the story is a little different. Motorcycles are either a passion or an indulgence meant to be taken out for long roadtrips and pleasure rides. After all, a motorbike is one hell of a ride on a cool summer evening or a sunny winter afternoon, but for everyday travel it is less than comfortable — particularly compared to cars and buses. In Pakistan, however, motorcycles are the most prevalent form of transportation.

Data from the Pakistan Automotive Manufacturers Association’s (PAMA) statistics from FY 2007/8 to FY 2021/22 show that they not only dwarf every other category of vehicle, but they also sell in excess of all other vehicles combined. Multiple times over. And when you think motorcycles in Pakistan, you don’t have to look much farther than Honda of “mai te Honda hi le san” fame.

Yet the road to this point has not been a simple one. The history of motorcycles in Paki stan and how Honda came to rule them all is a long, winding road that takes us down decades of colonial and post-colonial history. At the core of the current scenario is a simple issue. Pakistan’s cities are horrendously designed and no real attention to public transport of walkability has ever been given. As life has grown faster and the population has grown, the requirement for cheap transport has burgeoned and cheap motorcycles have long been the solution. It is a story not very different from other South and East Asian countries. But to get to the bottom of it we must go back more than a hundred years. Back to a time before bikes and cars. Back to when the first petrol-engine motor car was brought to India, changing how life was lived forever.

British beginnings

Ithappened in 1897. A Parsi gentleman from Calcutta bought a motorcar and brought it back to India. Fascinated by this new mode of transportation, three more Parsi businessmen brought cars to India by the next year, one of them being Jamshedji Tata. That same year, the first pneumatic tyres arrived in Bombay, with Dunlop opening an office in the city. Suddenly there was no looking back. It is hard to imagine now, but back then

there were no carpeted roads the way there are now. Traffic in the Indian subcontinent had been limited to horse-drawn carriages and trams, the railways, tongas, and bicycles. It is remarkable how quickly traffic and everyday life changed and developed in the next few decades.

The motorization of transport was swift all over the world and India was not too far behind. As early as 1908 Bombay had 276 cars and 1,088 bicycles and Madras 250 and 3,146 respectively. With the introduction of motor vehicles came a major shift in life.

Bicycles moved rapidly from being used by well-to-do Britons and Indians to being, even before 1914, a means by which postmen, tele gram boys, government clerks, and municipal servants conducted their business or commuted to and from work. By the 1920s the perceived ‘indignity’ of the bicycle had begun to restrict its use among both white and Indian elites.

This, of course, is the first instance that we get a

distinction along class-lines appearing between two-wheeler and four-wheeler vehicles.

After the first world war, motorcars became much more common, even though motorbikes were still a comparatively rare sight. But even as the bicycle became a lower middle class, or even working class vehicle, an increas ingly subaltern mode of transport for those who could not afford a motorbike, there was sudden ly an influx of two-wheeler motorbikes coming into the subcontinent. The amount of bikes particularly saw an increase after World War Two, where they were used extensively resulting in the blossoming of an entire industry.

These motorcycles were either Amer ican or British. The most notable companies between the two included the Indian Motocy cle Manufacturing Company, Harley Davidson, Triumph Motorcycles, Birmingham Small Arms (BSA), Matchless Motorcycles, and Ariel Motorcycles.

Crude Oil Prices - 70 Year Historical Chart. Source - Macrotrends

The British companies had a more solid footing in the subcontinent due to British suzerainty whilst American companies did not prioritise the subcontinent. “American bikes were brought over by merchants and priests who would sell them here if they got a good price.” Sheikh Abdul Wahid, Lead Cyclist of the British Motorcycle Club Pakistan, told Profit.

British manufacturers had also become cash rich because of their lucrative wartime contracts leading to the British government implementing mandatory export quotas. The absence of competition, due to quite literally bombing the competition, and the surplus pro ductive capacity led to their global hegemony.

Enter partition

Atthe time of partition, motorcycles were a largely accepted means of transport. And this was not a cheap means of transport. “A bike in those days cost Rs 2,600-2,700 whereas a tola of gold cost Rs 100,” explains Wahid. A tola of gold cur rently retails for Rs 136,582. By those standards, simply scaling the cost of the motorcycles similar to the price of gold, these British motorcy cles would have cost Rs 3.5 million today — in which you could get the Suzuki Swift today.

There were two reasons for these bikes

being this expensive. The first was that back then bikes were not considered a cheap mode of transportation. The second was that they were all imported. Cities like Lahore and Karachi had less motor-traffic than Bombay or Calcutta, but there was a steady demand for motorcycles.

As a result, the new state started importing motorcycles. These bikes came semi-assem bled, and are what we now know as “semiknocked down” (SKD) units, which meant the two-wheelers came partially assembled and some of the fitting and assembling would be done in Pakistan.

“They were brought in wooden crates and were then assembled here,” said Wahid.

As a result, a small industry began to emerge surrounding the assembly of these SKD unit motorcycles. Polad, Universal, and Lotia were local companies that set-up shop in Karachi to assemble the British motorcycles by engaging in partnerships with their British counterparts. Universal began assembling Triumph and BSA motorcycles, Polad assembled Matchless motorcycles, and Lotia assembled Ariel motorcycles. These companies then built up their own networks of mechanics whom they taught how to assemble the motorcycles, and subse quently incorporated them as dealers to sell the motorcycles.

Now the thing with SKDs is that it is a good trade-off for when you want to manufacture something locally without possessing the requisite industrial base. However, it is a temporary solution at best. Ideally, you want to be importing any vehicle as a com pletely-knocked-down (CKD) unit and then assemble the whole thing yourself. This would give you the lowest cost of production in the long-run but also requires immediate capital injection to set-up assembly lines capable of efficiently putting together CKD units.

So here was the situation. If you wanted to convert your industry from SKD to CKD, you had to have more volume in demand. To do that, the bikes had to be cheaper. And that would have meant producing lighter quality more practical motorcycles designed specifically to be cost-effective. For decades after partition, the SKD model continued as was. Some tried to import bikes from Japan and China as well, but British and American motorcycle manufacturers like Triumph continued to dominate the streets of Lahore and Karachi. But as the population grew and cities began to sprawl, the demand for cheap vehicles grew. And that is where Honda comes in.

The big-three (wheels): Vespa

we do not mean Toyota, Honda, and Suzuki. Because before these three companies entered the market and took over there was another important big-three that made an impact on Pakistan’s motor-history: the three-wheeler Vespa.

No,

Perception is an amazing tool. Up until the 1960s, motorcycles were considered an upwardly mobile means of transportation. They were driven by government officers, bankers, and other professionals and considered a sign of doing well in life. That is why, perhaps, few could have imagined that cheap versions could be successful on a larger scale.

A local company called Khawaja Autos

For a newcomer it was not easy to achieve 70% localisation. You would need a very large investment. We lobbied for concessions with General Pervez Musharraf. The 70% deletion requirement prevented Chinese based manufacturers from entering the market, and so the Government relaxed the requirements for us in 2002

Muhammad Sabir Shaikh, Chairman of the Association of Pakistan Motorcycle Assemblers (APMA)

of Statistics

Muhammad Salman, Director of Sales and Marketing at Road Prince

brought the Italian scooter brand Vespa to Pakistan. Cheap, slow, and decidedly un-sexy, the Vespa was the every-man vehicle. The sheer sales volume achieved by Khawaja Autos through this move proved to be a game changer. One of the unexpected results was that mobility suddenly increased, and it became apparent that there was room in the market for more cheap transport accommodation. The problem became, however, that Khawaja Autos doubled down on three-wheeler scooters. The envi ronment was all but ripe for someone to take advantage of. And that is when Honda came in and began the Japanese domination of Paki stan’s automobile industry.

Yusuf Sherazi, the chairman of the Atlas Group, realised this. He became the first Paki stani to gain licensing for the manufacture of motorcycles in partnership with Honda Motors of Japan, along with Syed Wajid Ali, the brother of Syed Babar Ali. Together, the two families set up the motorcycle industry in Pakistan, and the At las Group saw a meteoric rise. Honda itself was formed in 1948, but by 1955 had become the leading Japanese manufacturer of motorcycles. So,

in 1962, when Atlas Autos signed an agreement with Honda, the Japanese company was only 15 years old. Pakistan at the time was the fifth largest country in the world behind China, India, the Soviet Union and the United States. Honda came to India in 1995, and brought motorcycles there in 1999. In Pakistan, Honda brought motorcycles in 1962, and cars in 1992, entirely due to the efforts of Shirazi. The first two factories that Yusuf Shirazi set up were in Lahore and Dhaka. The project was an instant success, and Honda was followed into the market by Yamaha, which commenced operations in 1968 with an assembly plant in Balochistan. However, they could not replicate the same success as Honda and had two failed local ventures.

Then, in 1971, disaster struck on a national level. The independence of Bangladesh meant that half the country was now another nation, but it also meant that all the private industry set up in erstwhile East Pakistan was now no longer available to them, including one of the motorbike plants. However, there was also a silver-lining. By this point, Honda motorcycles had become common-place in Pakistan.

The independence of Bangladesh meant significantly reduced purchasing power and the overall market for high-end British motorcycles. Globally, British motorcycle manufacturers had lost significant ground to their Japanese counterparts. The Japanese initially built mostly small motorcycles with an engine capacity of less than 250cc, but had gradually moved ‘up’ the market with larger and larger motorcy cles. In contrast, by 1975 the British industry produced nothing smaller than machines in the 500cc engine displacement class, with the majority of production in the 750cc and 850cc classes, and had nowhere left to retreat.

Smaller bikes, bigger money: How the market shaped up

WithBritish motorcycles down in the dumps, Honda once again saw a spike in demand.

Yamaha also launched again in 1974 which proved to be more successful than their last couple of efforts. In 1976, the exact results of this shift became apparent. In that same year, Honda Atlas launched the now iconic CD-70, and CG-125. Yamaha launched their YBR-100 Royale, and Sindh Engineering Limited introduced Suzuki to the Pakistani motorcycle market. Suddenly, there was an influx of cheap and easily available motorcycles in Pakistan and the industry saw healthy competition too. In fact, the main event of 1976 was not the now classic CD-70, but the YBR-100, which propelled Yamaha to immediate stardom whereas Honda would only catch-up later.

“The British companies were lost. They began to close because of their unprofitability. The Japanese bikes were more affordable and they started setting up their plants.” said Wahid. “The Japanese bikes were more affordable to make, the Triumph’s frame occupied the same size and space as the frames of five Japa-

We were focused on affordability from the onset. The emphasis on the CD-70’s shape was because of localisation and the cost of parts. The parts were exactly the same, there was just a difference in quality due to the difference in prices being charged. Parts’ vendors existed for the CD-70, it was easier to utilise parts made by Honda’s vendors because they operated at scale, and thus had lower costs of production. Having vendors develop new parts would have been expensive

nese equivalents,” Wahid explains to Profit.

Localisation was also a problem. Remem ber, how we said SKDs were a short-term fix? Well, the British companies just continued to utilise the jugar on the assumption that the economy would remain stable and the good times would continue. “They never considered localisation. Royal Enfield was smart, they set up a plant in India and have continued producing bikes there. Ours completely shutdown. In the end their parts were still available till 1988-89, after which the assemblers auctioned off everything and closed shop.” said Wahid.

Localisation, scale, and cost would all be words that would come to categorise the industry for decades to come. And it would be off those concepts that Yamaha would be able to dominate the market for the years to come. Even though Honda had a first-mover advan tage, losing their factory in Dhaka proved to be a significant blow. On top of this, Yamaha used a combination of clever tactics and good marketing to become King of the Ring. “The North (Punjab) was Yamaha’s market and the South (Sindh) was Suzuki’s market.” said, Affaq Ahmad - Vice President Marketing, at Honda Atlas. “There was a time when people said mai Suzuki lena aya hun like it was a fridge. It was like Xerox with printing. And in the North, you’d have people say Yamaha gaddi kadani ha.

“Suzuki outsold Honda in Punjab. Customers would go to Honda showrooms and demand to buy a Suzuki because the bikes were so similar and Suzuki had such a strong footing” Muhammad Sabir Shaikh, Chairman of the Association of Pakistan Motorcycle Assemblers (APMA), told Profit.

Honda’s misery was largely a result of their choice of engines for their motorcycles. “Our bikes were not two-stroke. Two stroke engines produced more torque and the acceleration was immediate. This fascinated

people” continues Honda’s head of marketing Affaq Ahmad. “The two-stroke engine also enabled Yamaha’s domination of rural Punjab. In Punjab people would even transport their crops on bikes and sometimes 5-6 people would be on one bike. For these purposes, two-stroke engines were ideal.”

Two stroke engines apart from being more powerful in the specific aforementioned manner, were also simpler mechanically which provided Yamaha and Suzuki with an intrinsic advantage. These engines have fewer moving parts, and are thus cheaper and easier to service which reduced the cost of ownership for buyers whilst also making them the darling of mechanics. Is this last bit important? Well, yes. “Every product has an influencer and the influencers for motorcycles are the mechanics. They are the opinion makers.” Ahmad told Profit. “Suzuki and Yamaha’s product was easy to disassemble, assemble, and fix. This allowed them to quickly build a network of mechanics.”

The legend of Kawasaki

By the 1980s, three Japanese companies had a hold on the motorcycle industry.

At this same time, Honda and Suzuki were both also trying to expand into cars with the introduction of Toyota to Pakistan. But in the field of bikes, the Big Three were Yamaha, Suzuki, and then Honda — all in that order. Until that trinity became a quartet.

The introduction of Saif Nadeem Kawasaki Motors Limited in 1982 changed the game. Back in the early days before Vespa and Honda, motorcycles were cool. They had an overreaching sex appeal. After they became cheaply available and the Japanese iterations took over the British ones, things changed a little. For sure, bikes were still designed to be

good-looking but with the cheaper ones you could only do so much. And most people were buying the smaller ones such as Yamaha’s 100cc. Kawasaki changed this entire scenario by introducing cheaper bikes made to look longer, sleeker, more American (very much like the motorbikes that the famous detective novel series the ‘Hardy Boys’ had made popular).

Kawasaki became the bad-boy motorbike. They had established an assembling plant in 1977 but with the introduction of this new venture, it doubled down on the Pakistani market. Kawasaki jumped on the two-stroke bandwagon. It was a no brainer for the time. The dealer network existed and that’s what the customer wanted. To differentiate themselves from everyone, Kawasaki went straight for the upper end of the price spectrum.

“The Kawasaki 70 was very popular. It’s still a vintage bike here.” said Ahmad. “It’s GTO 125 was matchless.” Kawasaki was such a phenomena and so loved by its customers for its performance that its bikes were dubbed widow makers. The Japanese quartet could be broken down into the two-stroke trinity of Yamaha, Kawasaki, and Suzuzki, and then Honda separately with its four-stroke alternative. Honda did try to enter the two-stroke market by introducing its two-stroke MB-100 in 1980 and the H-100S in 1982. However, both models were largely unsuccessful

Honda’s limited initial success and the imperious run by the quartet was not just a Pa kistani phenomenon though. This 1960’s to the 1980’s is what many argue was the golden age of two stroke motorcycles with the aforemen tioned trinity dominating globally. Until 1984 happened. But then came the crash. In 1984, the sale of two-stroke cars and motorcycles was banned in the USA. The ban was implemented to tighten emissions regulations on vehicles. Two-strokes couldn’t be modified to reduce their emissions to an acceptable standard, therefore they were no longer road legal. This was a major reset for motorcycle manufacturers which prompted the shift to four-stroke motor cycles lest they continue to stay frozen out of the, then, largest motorcycle market.

Now, this did not translate directly to Pa kistan. In fact, to this day there is no regulation

The North (Punjab) was Yamaha’s market and the South (Sindh) was Suzuki’s market. In Punjab people loaded their bikes with crops and 5-6 people as well. Two-stroke engines suited them, and we didn’t have two-stroke engines

Affaq Ahmad - Vice President Marketing, at Honda Atlas

in the country against two-stroke motorcycles. However, it was more convenient for the Japa nese parent companies to have their domestic portfolio running in Pakistan as well, which saw an end to the two-stroke phenomenon. On top of this, two-stroke bikes also ate more petrol and were more expensive to maintain.

Honda’s era T

he four-stroke engine was considered the better alternative, both in Pakistan and globally. And this is when Honda lucked out. It was

cognisant of how the industry was on the precipice of a shift in the 1990s, and it sought to capitalise on the opportunity by making a few smart marketing decisions. In 1992, Honda released what Ahmad referred to as the “Big CD-70”. This was Honda borrowing from Yamaha’s and Suzuki’s playbook whereby they abandoned their smaller frame for a more domineering one.

“Our CD-70 looked very small in com parison to the competition, which did not appeal in particular to customers in Punjab. Yamaha’s bigger fuel tanks made them look

bigger as well” told Ahmed. “To survive in Punjab, we decided to enlarge the frame. We increased the wheel-base, the fuel tank, and the seats so that we could reposition our selves against Yamaha” continued Ahmed. It was also around this time that Honda sought to capitalise on the rising fuel costs and high light the four-stroke engines fuel efficiency relative to its two-stroke counterparts with their “aik bhi bohat hai” ad set. At a time of increasing fuel prices again, this just worked.

The onset of the 1990s was perhaps the first time that the term ‘and the rest is history’ could have been used for Pakistan’s most iconic motorcycle. This transition from the two-stroke to four-stroke is also what laid the groundwork for the shift from the Big 3 to the Big 1 in the motorcycle industry.

There are no publicly available sales figures for this time period, however, Profit was able to acquire Atlas Honda’s Communication Plan for 1993 to identify the sales throughout between 1987-1992. Looking at the figures, Honda’s dominance is evident with the company having a 56% national market share at its lowest. The numbers also corroborate Ahmad’s statements whereby despite Honda’s imperious figures, Yamaha retained brand equity in Punjab unlike its other former twostroke contemporaries.

The most notable change was Suzuki’s capitulation to Honda in the Southern region where it lost key markets such as Hyderabad and Karachi. Suzuki’s losses were so concern ing that In 1991, Suzuki Corporation of Japan started taking a more active interest in Suzuki operations in Pakistan. In late 1991, there was a major management change in Suzuki of Pakistan whereby Mr Danishmand, previously the CEO of Atlas Honda, was made head of Suzuki.

Not only would the aforementioned trinity have to play on Honda’s playing field, but they would also run into their own struggles, and in particular rely on Honda’s mechanics. Setting four-stroke as the stan dard and its mechanics as the default, Honda had made the rules of the game very clear.

The British companies began to close because of their unprofitability. The Japanese bikes were more affordable and they started setting up their plants. The Japanese bikes were more affordable to make, the Triumph’s frame occupied the same size and space as the frames of five Japanese equivalents

Sheikh Abdul Wahid, Lead Cyclist of the British Motorcycle Club Pakistan

However, whilst everyone was fixated on how the two-stroke trinity would transition, the groundwork had been laid for newer entrants who want to leverage this established infra structure to launch themselves.

The Chinese make a splash

If there is one thing that this entire long-winding history of motorcycles in Pakistan teaches us, it is that the most important part of getting a motorcycle business up and running has been localisation. Failing to localise is why the British motorcycle industry collapsed abroad. It is also why others failed, and how in recent years a number of Chinese manufacturers have been able to enter the market.

“For a newcomer it was not easy to achieve 70% localisation. You would need a very large investment” said Shaikh, Chairman of the Association of Pakistan Motorcycle Assemblers. However, 1994 proved to provide an opportunity that was too good for the taking. Why do we say this? Well, this was the last year of production for Kawasaki. “Kawasaki had financial issues and it failed to meet the localisation requirements.”

Kawasaki’s woes were common knowledge and subsequently Sohrab Cycles rose to the occasion with its JS70.“It was the first Chinese motorcycle.” Ahmad told Profit. “Sohrab made a good machine and undertook localisation. It’s bicycle background helped it with electroplating. Their rims are still better than most of the market to this day.” continued Ahmad. Sohrab’s entry and Kawasaki’s exit prompted other companies to jump the gun as well, most notably Plum Qingqi Mo tors in 1995 and United Autos in 1999. These companies were then followed by Hero and Pak Hero in 2000.

Chinese motorcycles are ubiquitous now, but in reality they came through the continuous efforts of multiple manufacturers to establish themselves through trial and error. Breaking into the motorcycle industry was initially a very painful task. The Gov ernment initiated a localisation program in 1987. In 1995, it launched the Product Specific

Deletion Programme (PSDP) to nurture the industry in its infancy and support its growth by requiring OEMs to achieve local content levels of at least 70%.

However, many in the automotive mar ket began to realise that there was potential for additional sales volume particularly due to the increased motorcycle production capacity across the border in China. “You could find Chinese replicas of the CD-70 for $250 where as it was sold for $1,000 here.” And where there’s a will, there’s a way. The breakthrough for the Chinese manufacturers came first in 2002, and then in 2004.

“We lobbied for concessions with General Pervez Musharraf. The 70% deletion requirement prevented Chinese based manufacturers from entering the market, and so the Government relaxed the requirements for us in 2002” said Shaikh. Shaikh’s comments are in reference to the reduction in import duties by, then, Finance Minister Shaukat Aziz in 2002. This led to seven new companies entering the market. These new Chinese entrants setup shop in Hyderabad and Karachi. Most notable of them, that still commands a sizable market share today, would be Super Star. The real breakthrough, however, was in 2004.

To put it into context, if 2002 was a crack in the wall, then 2004 was the wall coming down entirely. So, what happened? Pakistan scrapped its localisation program entirely. Albeit, not of its own free will.

Local players reached out to prospective partners in China and began importing vehicles in droves. How many companies sought to establish themselves as players in the motorcycle space? “A lot of brands came.

I think there were more than 100 applicants” Muhammad Salman, Director of Sales and Marketing at Road Prince, told Profit. Shaikh puts the exact number of applicants at 125. However, there is no official count as to how many applicants proliferated the market throughout the 2000s. The floodgates were open and it was essentially the wild west.

For the sake of brevity, Profit will iden tify the major players that entered the fray and continue to operate at a reasonable scale. These firms can be divided into the Hyder abad and Lahore based ones as a secondary filter. The former included Unique in 2004, Super Power in 2004, and Hi-Speed in 2004. The latter included Road Prince in 2004, and Ravi in 2007. From 2002-7, sales increased year-on-year peaking at 195,688 in 2007. What led to the ascent of these companies? Deferred payments. Lots of them.

“Honda originally used to lease its mo torcycles to its dealers so we, along with our contemporaries adopted the measure as well. We gave credit terms of 8-9 months. The de ferred payments gave us a boost in sales” said Salman. Moreover, Chinese brands focused on affordability. Doubling down on the CD-70 provided them the opportunity to initiate a race to the bottom in terms of prices due to the infrastructure of dealers and vendors that the Japanese, Honda in particular, had established.

“We were focused on affordability from the onset. The emphasis on the CD-70’s shape was because of localisation and the cost of parts. The parts were exactly the same, there was just a difference in quality due to the dif ference in prices being charged. Parts’ vendors existed for the CD-70, it was easier to utilise parts made by Honda’s vendors because they operated at scale, and thus had lower costs of production. Having vendors develop new parts would have been expensive.” continued Salman.

So how did the Japanese incumbents respond? Well, it was in 2004 that Honda introduced its iconic “Mein te honda ee lay saan” as a response. While the Japanese bikes had originally entered as the cheaper option to the British bikes, they now presented themselves as the quality, legacy, product. Su zuki consolidated its presence in Pakistan by incorporating its motorcycle division (Suzuki Motorcycle Pakistan Limited) into its main

car business (Pak Suzuki Motor Company) in January 2007. Finally, Yamaha suffered from a divorce between the Japanese parent company and its local partner in Pakistan in 2008. The local partner, the Dawood Group, retained the infrastructure and production facilities, and relaunched Yamaha as DYL. A spin on the original Dawood Yamaha Limited (DYL) name.In hindsight, it’s not hard to tell which of the three made the better decision.

The state of the industry

Moving beyond the late 2000s till now, there are perhaps just three major highlights. Honda’s absolute domination of the industry, the Chinese entrants entrench themselves, Yamaha returns to the market and repositions itself in the Pakistani market alongside Suzuki.

Let’s start with Honda’s domination. What do we mean by that? Put simply, there was a Big 3, and there was the Chinese, but at the end of the day, there’s really just one company in the sector. Profit looked at sales figures provided by PAMA from FY 2007/8 till FY 2021/22. Honda was the single largest player every year. Every year, it was also greater than the sum of all other players combined. On average, it produced 455,911 more motorcycles than all its competitors combined. This reached a peak in FY 2021/22 where it produced 940,056 more units than all other competitors combined whilst at its lowest in FY 2008/9, it still produced 221,592 more units.

The remaining six entrants have solidified themselves in the Pakistani market as the last ones standing. Not only have they been able to create their own brands and personas, but just the sheer amount of time that they have spent operating in the industry have reduced the moral hazard that many customers associated previously with the Chinese market due to how permeable it was. The Karachi and Hyderabad based companies are not members of PAMA, and therefore their sales figures are not available. However, based on

Profit’s interactions with the aforementioned sources, alongside others, we have a solid idea as to where they stand. The Sindh centred competitors would roughly lay between Road Prince and Ravi in terms of sales volume. As to the particular hierarchy amongst themselves, well, Profit was unable to ascertain that due to the negligible difference in volume between all of them.

Finally, the relationship between Honda and its Japanese counterparts. Yamaha Motors had split with the Dawood Group due to Dawood’s reluctance to move beyond the affordable segments. Yamaha, on the other hand, realised that a race towards the bottom in terms of pricing may not be the most profitable strategy for them to employ. Thus, when they relaunched the brand in 2015, the aim was to cater to a new target market. Similarly, Suzuki sought fit to compete in the more premium segment. This was largely due to Suzuki’s car segment being the company’s bread and butter. Suzuki could therefore afford to compete on the more premium segment on account of the scarce competition there and because it largely did think of the segment as ancillary to its core car operations.

So how different were Yamaha and Suzuki in terms of market positioning this time around? Well, they completely extricated themselves from the 70cc segment. Once, the main battleground for all three was now served solely by Honda. Yamaha and Suzuki do not compete with each other in any seg ment but do compete with Honda. The former competes with Honda in the 125cc segment, whereas the latter competes with Honda in the 150cc. In both segments Yamaha and Suzuki offering is appreciably more expensive than Honda’s.

Now that we’re all caught up now, the lurking question that might pop in anyone’s, anyone at least into motorcycles or who read the introduction to the CD-70 and CG-125, mind at this point is why is that still the dominant motorcycle in Pakistan? By that we do not mean just Honda’s offering but also as to why the design is the darling of the Chinese manufactures?

The simple answer is cost and scale. It’s cheap to make, which leads to customers buying it, which in turn allows companies to make it en-masse and incur lower per unit costs. Simple economies of scales really. Are we likely to have more modern and better motorcycles become as ubiquitous as the CD-70 and CG-125? Maybe.

It’s not impossible for either Honda or the Chinese to do this. It’s just very hard. What do we mean? Let’s start with the Chinese reason for sticking with the tried and trusted bike designs. “We’re a local brand, not an international one. The Japanese are

backed by their foreign parents whereas we have had to navigate the market on our own. We’ve only begun exploring the premium market recently as our footfall has improved. If we were to partner with a foreign company for the premium segment then we would be able to easily capture market share as well.” Salman told Profit. However, Salman didn’t tell Profit as to why Road Prince hasn’t done exactly that. The answer to that Profit found with Honda.

“We have a very large lineup but only two of our models are successful. Companies cannot bring new models because they are stillborn because of how expensive they be come due to the duties. The government will not only need to align localisation to protect existing investment but also provide space to import new parts not found in Pakistan needed for the newer models.” Ahmad told Profit. What does he mean here? The aforementioned three SROs that are attached to the TBS mechanism.

As a reminder as to what they are. They are the duties that are levied on imported parts. Their aim is to discourage imported inputs and encourage companies either using local inputs or making the requisite inputs here themselves. “Localisation cannot happen without scale. The SROs need to be revised for higher engine displacement models whereby grace periods are given to allow companies to build the volume needed to localise the parts.”

We’ll likely have to add a new section entirely to this piece in case the Government does act on the recommendations. Until then, we can just add FY 2022/23’s data to the graph as the trend looks stable going forward. Unless of course, we have a new country emerge as a juggernaut with its motorcycle industrial complex to dislodge the Chinese. n

Pakistan Police Centenary Stamp (1961) - Triumph Motorcycle

OPINION

Omer bin Ahsan

With Raast, context is key

Raast by the State Bank of Pakistan (SBP) has received a lot of excite ment and interest from the financial payments industry, particularly from the young-guns over on the fintech side of things. The SBP backed gateway is a savior in providing confirmation of instant payments and access to debit accounts and low cost of transaction. However, one distinctive feature of Raast has been overlooked and going forward will set Raast apart from all the contemporary payment rails available in Pakistan. That distinctive feature is Raast’s ability to capture the context of the payment.

To make things simple, payment rails such as Local Fund Transfer (within same bank), Credit/Debit Card Transaction, IBFT, ePay Gateway (NIFT/APPS) or BPS are different vehicles to transmit payment information and authorizations between two Financial Institutions using a technology intermediary. This trans mission has always been restricted to the flow of payment information. To make it simpler; imagine if the railway line between Karachi and Lahore was only used for moving passengers and not containerized or liquid cargo. That means the other transportation infrastructure would be required to move the cargo and that creates further inefficiencies and wastage of resources.

Getting two nodes connected, whether cities by means of road, rail or airways or banks by means of technology intermediation is a great infrastructure piece for the financial efficiency in any economy. But restricting it to just the movement of payment flows is sheer underutilization. Unfortunately, such design elements were either not foreseen or restricted to the optionality of narration or purpose in an IBFT transaction (which was never used or enforced effectively).

In 2016, I penned an article “The Context is Missing” and wrote a whitepaper for the industry and SBP on “Accelerating Corporate Digital Payments in Pakistan” where I explained my personal realization that the payment infrastructure does not support the movement of non-payment data i.e. context of the payment, between two financial intermediaries and the sender/receiver. The key question that needs to be addressed before diving into the importance of the marriage between context and payments, is what Contextual Payments is.

Payment is not the end, but the means to an end, the end being a business transaction or exchange of goods/services. The trade or exchange is what the con text captures. The context may include multiple data elements or documents such as the contract elements, invoice, sender profile, history, credit score, credit limits, SKU/Service information, tax incident(s), transactional reference(s) and any other corresponding data that is either a prelude to the payments, has to accompany it or

The writer is CEO of fintech company Haball and Head of Regulatory Affairs, Pakistan Fintech Association

has to come after it for audit/reconciliation.

A practical issue that occurs in most business transactions. Reconciling bank statements against invoices in a way that the bank statement narration points to the under lying invoice/ trade. Things get trickier in case of advance payment (no invoice), partial payments, multiple payments for a single invoice and single payments for multiple invoices. In these scenarios the correlation between invoice, payment and banking statement requires an army of receivable managers to institute audit controls and then update their financial ledgers. Bank systems are not designed to capture these complex scenarios and have too much inertia to innovate in this direction. Payment infrastructure such as cheque and digital payment infrastructure such as IBFT also do not address these issues effectively and throw the burden of managing contextual synchronization to the business users themselves.

Nowhere does this issue get further exasperated than in the handling of taxation. In 2016, FBR and SBP embarked on a program to digitize Duties and Tax collections. A single goods-declaration submitted to Pakistan Customs Clearance System carries as many as 16 various tax heads that have to be settled in multiple Trea sury accounts held by SBP. Federal Treasury Rules required SBP Treasury systems to issue CPR (Computerized Payment Receipt) separately for each Tax Head. The taxpayer had to pay a single amount through check over the counter or digital payment, but it had to be split into multiple tax heads based on the Customs Tariff. This means that once the payment is initiated, SBP has to know that this single payment carries multiple tax heads that have to be settled in different accounts and their respective CPR to be issued and com municated back to the sender for the finalization of his tax returns. Through the brilliant effort of the Payment System Department (SBP) and 1link a solution was designed that was then followed through by GoPB and other P2G use cases by SBP/1link. The same determination and agility that the Payment System Department (SBP) exhibited in this case cannot be matched by the new age private sector processors in handling contextual payments.

Since 2017, the whitepaper has been studied by SBP Payment System Department and in my deliberations with them I was told that Raast will provide the infrastructure where context can be captured and moved between Banks/Merchants. In the recent industry engagements on Raast, it is very clear that the SBP Payment System Department, now a cluster within SBP called Digital Financial Services Group has delivered on its promise to make sure the pay ment rails can capture the context of the payments and then move it across the ecosystem. This opens a world of opportunities for Banks and Fintechs who can use the easy access of Raast to move credit related data, analytical insights, reconciliation, tax treatment and vanilla invoice data. Fintechs are eagerly waiting for the disruptive power of Raast and are excited about how Raast brings about inclusion, efficiency, quicker time to market and reduction in cost. But what everyone is missing is the impact that Contextual Payments will make in the digitization of the economy and effectiveness of payment use cases by moving context within the payment flow. The latest phase of RAAST incorporates Request to Pay (RTP) functionality through which a business/merchant can initiate a Request for Payment and in doing so pass on structured and unstructured contextual data which will be delivered to the paying customer’s financial institution. Financial institutions can use the rich data to perform data analytics and build further insights about their customer’s profile to offer them other products and services. n

Ammar H. Khan

Can Pakistan ever be on a path of sustainable economic growth?

If education continues to be an afterthought, and remains on the backburner, then we shall never be able to get on a path of sustainable economic growth. Education and development of intellectual capacity is a prerequisite. Without universal literacy, no country ever has been able to graduate to a middle-income or upper-income country on the path of development.

Yes.

The path to sustainable economic growth exists. Dozens of countries around the world have success fully improved living standards, and prosperity of its citizens by adopting one path or another. The path to becoming a middle-income country, or even an upper-income country exists, but it's one that does not align with the path predominantly chosen by politicians, and rentier policy makers.

We have one of the fastest growing populations in the world, a potential demographic dividend, that can become a demographic liability if the status quo continues. A human capital de elionebt plan which covers both immediate needs, as well as long-term capacity development is critical. There are more than 23 million children out of school in Pakistan, and the number is only increasing over the last few years. A population that is not educat ed, or skilled, cannot differentiate itself, or even demand a premium in the global marketplace for talent. An unskilled workforce acts as a drag on economic growth, as the country cannot embark on activities that are heavily reliant on intellectual capital.

An unskilled and uneducated workforce effectively acts as a drag on the productivity of an economy. Productivity can only be increased once an economy can generate more output from similar levels of input, the same can only be achieved through acquisition of scale, and technology. We cannot have either scale, or tech nology with an unskilled workforce. Educating the children of today and imparting skills such that the workforce is equipped to deal with the technological and economic demands of the future remains critical.

Before a population can educate itself, it needs to feed itself first. Pakistan has one of the highest rates of malnour ishment amongst it's children. Despite being an agrarian economy, food insecurity is high. A distorted market structure has led to a scenario where the country has to import even basic staples like wheat. The absence of a supply-chain infrastructure results in colossal wastage of agricultural produce; despite there being food insecurity.a country that cannot feed itself, cannot educate itself, and consequently cannot attain sustainable growth, or improve livelihoods of its population base.

Agricultural yields continue to be among the lowest as compared to peers, and other economies in similar stages of economic growth. With the exception of a few products, yields have largely remained stagnant over the last decade even though population continues to grow. The country imports more than US$ 4 billion of basic food staples on an annual basis: An amount which will continue to grow as the population, and overall income levels grow. Absence of a robust supply chain infrastructure, low yields, and a distorted market often results in shortages which drives up food inflation, making it increasingly difficult for households to afford food.

As food affordability reduces, so does calorie and micronutrient intake, which directly has an impact on the ability of a population to learn and educate itself, as stunting kicks in. It is estimated that almost 40% of children under five years in Pakistan are stunted. In the presence of political brouhaha and an elite that dominates all discourse, very little, or nothing is being done to solve these structural issues.

A well-fed and educated workforce is critical for any transition towards a middle-income economy. A sovereign that isn't able to feed it's population, or educate its children cannot ever attain broad based sustainable growth. There may be boom-bust cycles driven by injection of external capital, or yet another round of subsidies, and amnesties. But the duration of these cycles continue to shorten.

The writer is an independent macroeconomist and energy analyst.

The economy has been sustaining itself on borrowed capital, and even borrowed time. Inability to address structural issues has led us to a scenario where it's already too late. We can either fix these structural issues and ensure broad-based growth for everyone, or we can continue operating an elite focused economy that continues to survive courtesy of one bailout, or another.

If the status quo continues, the answer to the question is a very clear no. n

The road to IFRS 9: A bumpy ride towards global standardisation

By Ahtasam Ahmad

In a statement that reverberated within the world of accounting and finance, Warren Buffet once claimed that the “application and improve ment of some modern accounting and financial techniques are fun damentally changing companies’ ability to make a profit.” For those unaware of the intricacies of the accounting world, this will mean very little. To those with some basic understanding, it may seem absurd that accounting practices could be impact ing the profit of major companies. However, those aware of the nuances of accounting can truly appreciate the depth of this state ment and the problem it refers to.

Accounting has become the language of the modern corporate world yet at times it is difficult for even some of the most well-versed individuals to apply modern

financial reporting standards. One such ac counting development has been the International Financial Reporting Standard (IFRS) 9. The Security Exchange Commission of Pakistan (SECP) and State Bank of Pakistan (SBP) have tried their hand at expediting the implementation of the accounting standard, but the lukewarm response from the industry and underlying economic factors have kept that from happening.

What is IFRS 9 and what does it mean?

IFRS 9, like its predecessor IAS 39, helps in laying out recognition and measurement criteria for financial instruments. Financial instruments can be placed into two broad categories; financial assets and financial liabilities. The financial assets consist of primarily two instruments, Equity-based or Debt-based e.g. shares of a

The Pakistani regulator is prepping the industry for the inevitable adoption of the new accounting standard

company and an investment bond. On the other hand, financial liabilities are obligations that would be settled through the payment of a financial asset. If a company owes its creditors money, basically, that’s a financial liability.

IFRS 9 was developed in the aftermath of the global financial crisis as regulators realised that the existing standard (IAS 39) doesn’t provide for the deteriorating quality of financial assets over a period of time. Therefore, it resulted in a “cliff effect” where a sudden shock of accumulated losses was realised in a certain financial reporting period which distorted investors’ decision-making. This was the case in the 2008 subprime mort gage crisis.

Therefore, the new standard presented an “Expected Loss” (Forward Looking) model to replace the existing “Incurred Loss” model under the IAS 39. Further, IFRS 9 has also laid out the criteria for the classifica tion of different types of financial assets and liabilities.

The classification of the financial assets

is dependent on the nature of contractual cash flows and the business model of the entity that owns these assets. If the cash flows essentially represent two components, Principal and Interest, then the asset should be classified as a debt instrument. For instance, Market Treasury Bills (MTB) are highly liquid short-term, zero-coupon Government Debt Instruments which are sold at discount to face value and have tenors of up to 1 Year. MTBs offer a risk-free return on investment as these securities are issued by the Government of Pakistan. Although there is no interest payment on MTBs, these securities meet the Principal and Interest test because the principal amount (i.e. the fair value at initial recognition) would be accreted back to par using the effective interest rate method.

Based on the above, the MTB holder is being compensated by a margin; which in substance constitutes interest mainly to compensate for the time value of money and is not subject to any other risks or volatility unrelated to a basic lending arrangement.

However, once the type of the instru

ment is ascertained, the reporting standard makes it compulsory to assess the intended use by the entity to determine the measurement of the financial asset based on the intended purpose of owning the asset. The subsequent measurement can be one of the three; amortised cost which is equivalent to the asset’s cost of acquisition less their principal repayments and adjusted for any discounts, premiums impairment losses and exchange differences.

While the other two methods are based on fair value, one is routed through the profit and loss statement and the other one is routed through the other comprehensive income (OCI).

The Pakistani context

The Pakistani corporate circles are still apprehensive about the effects of the implementation of IFRS 9 on their bottom line. Specially, financial institutions are reluctant about the increased non-performing loan provisioning as the expected loss approach is adopted. Further, strict classification criteria won’t al low commercial banks to manoeuvre around any accumulated losses on investments to maintain profitability.

In addition to much more stringent criteria of providing for possible future credit losses in case of lending, Financial institutions will also need significantly more disclosures. (Read more about it in Profit’s article: IFRS-9 likely to revamp loan provisioning)

However, the new standard isn’t only a hard pill to swallow for lending institutions. More conventional businesses like those in the energy sector are also wary of its effect. HUBCO’s external auditor’s report for 2022 stated, “The company has applied to the SECP for further extension in the period of the exemption (from IFRS-9). In case such

The application of IFRS 9 would lead to complicated outcomes as far as tax matters are concerned. The reason for it is the fact that tax profits are calculated differently from accounting profits. Certain items are deducted and added to accounting profits to reach the taxable profits. FBR, being a very litigious body, can challenge the treatment of IFRS 9 in individual company’s financial statements which would add to the inconvenience of those operating in the industry

Talha Ahmed Shah, Chartered Accountant and Ex-Senior Associate at PwC

Havaris Arshad, a Senior Chartered Accountant and Quality Assurance Inspector at the Audit Oversight Board

exemption is not extended, the Expected Credit Loss (ECL) model will be applicable on Company’s receivable from CPPA-G w.e.f July 1, 2022, resulting in recognition of an impairment charge of the Rs. 9,482 million against receivable from CPPA-G, based on the assessment carried out by the manage ment of the Company.”

“In view of the significant delays in settlement of receivables, the materiality

of these trade receivables and the potential impairment charge and the consequential impact on the liquidity and operations of the Company, we have considered this to be an area of higher assessed risk and a key audit matter.” The audit report further added.

Recently, the SECP has also extended the deadline for the adoption of IFRS 9 by Non-Banking Finance Companies (NBFCs). The official statement read, “SECP has ex

tended the effective date for applicability of IFRS-9 for NBFCs and Modarabas till June 30, 2024. This extension has been granted in the wake of economic hardships and capacity issues being faced by the respective sectors in the post-COVID times.”

The largest player in the aforementioned sector are the mutual funds that have a significant portfolio placed with financial institutions and invested in debt securities.

For these entities, IFRS 9 would mean an immediate impact on profitability if the quality of debt instruments falls below a certain point. For instance, if investments fall below the investment grade rating (BBB- or equivalent) from an external rating agency at the reporting date the funds would need to take a haircut in the form of impairment loss.

Alignment of IAS 39 categories for debt investments with IFRS 9 classifications

Further, another class of NBFCs, Private equity firms might face high variability in the portfolio value once the new standard is adopted.

Havaris Arshad, a Senior Chartered Accountant and Quality Assurance Inspector at the Audit Oversight Board explained to Profit, “IFRS 9 significantly reduces the ability of companies to measure equity investments at cost. In the case of private equity and venture capital, this would result in a shift to fair value measurement for many unquoted equity investments. This would lead to a need for detailed analysis at the end of each reporting period and subsequently, a possible downward revision in investments, particularly for those investing in startups and early-stage ventures.”

IFRS 9 significantly reduces the ability of companies to measure equity investments at cost. In the case of private equity and venture capital, this would result in a shift to fair value measurement for many unquoted equity investments

Challenges in Implementation

As per the World Bank’s survey, IFRS 9 in Emerging Markets and Developing Economies, “the main challenges highlighted by the survey are (a) data availability and low data quality that make it difficult to set up and apply expected credit loss models; (b) modelling risk and overreliance on managerial judgement; and (c) burden due to the involvement of several business areas, such as budgeting, information technology, risk, finance, governance, and processes. Super visors indicated that banks, and especially small banks, faced challenges with using forward-looking information for modelling the probability of default (PD), the significant increase of credit risk (SICR), and other parameters used for calculation of the expected credit losses (ECL).”

Further, as per Talha Ahmed Shah, Chartered Accountant and Ex Senior Associ ate at PwC, “The application of IFRS 9 would lead to complicated outcomes as far as tax matters are concerned. The reason for it is the fact that tax profits are calculated differently from accounting profits. Certain items are deducted and added to accounting profits to reach the taxable profits. FBR, being a very litigious body, can challenge the treatment

of IFRS 9 in individual company’s financial statements which would add to the inconve nience of those operating in the industry.”

However, the major concern remains the initial impact of implementing the stan dard. The framework of the standards has raised concerns about its financial impact being procyclical in cases of events like the pandemic or more recently, the floods. This defeats the purpose of introducing the stan dard in the first place.

Hence, regulators across the globe in cluding Pakistan have provided some buffer to mitigate the impacts at transition and one-

off events like the pandemic. For instance, the SBP has allowed Financial Institutions (FI) to add back the transitional adjustment amount in CET1 capital starting at 90%, falling to 10% in the final year throughout the transition period by recalculating it periodically to reflect the evolution of an FI’s ECL provisions within the transition period.

Yet, the most important cog in the regulatory machine remains the external auditors. The smooth implementation and adherence to the principles of IFRS-9 are heavily dependent on the competence of external auditors.

As stated in the aforementioned World Bank report, “In the wake of the IFRS 9 implementation, the Prudential Authority (PA) within the South African Reserve Bank (SARB) met with all the auditing firms that performed the audits of banks. The objective was for the PA to communicate its expecta tions, understand the challenges the firms faced, ascertain their readiness to audit banks and their application of IFRS 9, and encourage them to develop a “firm view” on the macroeconomic scenarios that banks would use in their ECL models.”

“Firm view refers to the audit firms’ internally developed, independent deter mination of the macroeconomic and other related forward-looking factors used in the computation of ECL. It was envisaged that this be a firmwide view, across its South African operations, to facilitate consistent application of the macroeconomic outlook across the firm’s audit engagements.” The report further added.

Transition to new accounting stan dards and the cost associated with it might seem unnecessary to some. However, it is a fact that adopting globally applicable reporting standards makes the financial statements of local companies more comparable to their foreign counterparts and also helps derive international investors’ confidence. n

The Legend of Moola Jatt

Pakistan. The movie is being shown on more screens abroad than in Pakistan – but more on that later. Huge amounts of money were put into making Maula Jatt, and into advertising it.

Ammara Hikmat, producer of Maula Jatt also mentioned how much time and mon ey went into pulling off this feat. “So many expenses that normal Pakistani productions don’t incur, caused this huge budget. From foreign crew to production spread over two and a half years in outdoors and legal battles, everything was quite costly.“

Hikmat also added that both she and Bilal made a conscious decision to not spend on fancy premiers, promos and road shows. Instead, they decided to take the digital route. “We advertised in the last two weeks. We used the trailer to generate hype, and abroad we advertised on buses, metros and tube stations.” All this paid off, she added. So while their release in Pakistan may have been a little disappointing, the response overseas was both mind-blowing and gratifying.

By Sabina Qazi

TheLegend of Maula Jatt has done a lot of unprecedented things: an ambitious concept, a massive budget, record-shattering revenues, and gripping execution. But perhaps its most iconic battle will not be Maula Jatt vs Noori Nuth on screen. It will be the off-screen faceoff between the producers and exhibitors – a power play that has sought to upend a jealously guarded formula governing the business of movies.

Put simply, the producers believed they had an unprecedented product, and they wanted an unprecedented payday. So they proposed to rewrite a settled financial sharing formula with exhibitors. They did this by proposing two new formulas, which, in short, sought higher ticket prices for the first 11 days, and a bigger share of the receipts. The non-financial demands in these formulas also mirrored swashbuckling action sequences of a reborn Maula Jatt.

Here is how it all went down.

The beginning

of a return of Pakistan’s most well known action fran chise first came into the open back in 2013, when another action-epic film Waar was released. Waar was also a first of its kind production back then. The director of that movie was Bilal Lashari, who spoke about his next project: a film that would bring the Punjabi gandasa genre back onto the screens in the modern age. And so the return of the brooding son of Sardar Jatt was conceived.

Maula Jatt, just for background, is a uber-masculine, testosterone-driven Punjabi action hero/anti-hero who first appeared on screen in 1979. The movie and its characters were based loosely on a novelette by Ahmed Nadeem Qasimi called “Gandaasa”, says critic and journalist Rafay Mahmood.

Jatt’s oft-exaggerated machismo has since been beloved by the masses, so much so that it inspired spin-offs and derivatives and deeply impacted the Pakistani cinema industry. Jatt was most famously and iconically played by the unmatched Sultan Rahi, who delivered one-liners that found place in Pakistani lore.

“Maula nu Maula na maare, te Maula nai marda.” Wow.

So when word came out that Lashari was taking this on, expectations began to rise. It took 10 years for Jatt’s re-invention (it’s not a “remake” Lashari insists) to be completed and for the project to see the light of day, producers say.

It’s here and it’s huge

“We have used the best of everything despite all obstacles,” she said. “We opened on fewer screens as per our overseas distributor’s suggestion, allowing demand to determine profits.” With every passing day, screens had to be added in Pakistan and abroad. “People were travelling all the way from Murree to Lahore to watch the movie.” It worked for us because the process of word of mouth was great and people loved the content. According to Hikmat, Lashari had the foresight to know that his product was nothing anyone has experienced in Pakistan. Echoing Mandviwala’s words she said, “he knew that his work would speak for itself, people just had to see it.”

Mahmood agrees. “It is the first time in history that the exhibitors’ share doesn’t matter.”

The face off

so much money spent on making the film, a strategy had to be put in place that would benefit the producers while not hurting anyone else in the business chain. So they proposed two new financial formulas.

With

to the completion, it was clear that it was going to be big. Lashari says in interviews that he did nothing else during the shooting or production of the movie. Sources say it ended up costing between Rs 400 to 500 million and this doesn’t include the marketing budget.

Closer

Nadeem Mandviwala, owner of Karachi’s Atrium cinema and also distributor of the movie, says he has seen nothing like it in all his years in Pakistan. According to him, nobody could have believed that such a movie could be made locally. In a press conference held in Ka rachi on October 21 he said the issue was how to maximise returns with such few cinemas in

According to details given in a press conference, the first formula proposed said the distributor share for the first eight days – October 13 to October 21 – would be 60%. That was the highest ever demanded from exhibitors. This would move back to 50% in the second week of the film. To make up for this, they proposed that the ticket price be Rs 200 higher for the first 11 days, so the exhibitor’s absolute share would not be hurt, and would, in fact, increase – or so Mandviwalla believed.

Along with this, there were a number of other demands, such as strict receipt reconciliation timelines, curbing discounted rates and no new local film being released in the first 11 days.

The record shattering film created a stir by demanding new financial sharing formulas with cinema houses, creating a stand-off with cinema owners. The verdict is out on who won

The second formula saw a 50-50 share but demanded no allowance for “FOC” or free of charge seats – which make up a sizeable chunk of cinema footfall.

Mandviwala said that the unusual financial formula was necessary because there was no other option. Abroad, for example in the US, the number of a larger film could be shown on would just be increased and those numbers would be in the thousands. Pakistan, however,

does not have this privilege; there are only 60 cinemas and a total of 144 screens, which means there is no economies of scale.

“Our biggest concern usually is that here you don’t recover money,” said Hikmat, justifying their need to recover costs. “You have to have a strategy to make sure you earn but how it works here is that cinema owners give you a fixed share of what they make. They dictate the terms and producers succumb to the pressure

The two formulas

SHARE %

a. 1ST WEEK (8 DAYS, Thursday 13 October to Thursday. 21 October.): 60%

2ND WEEK ONWARDS: 50%

FOC SEATS ALLOWANCE IN EACH SHOWING**

2) Increase in admission price for 11 days (K-L-I & R) (Rs 200)

Distributor payment to be done on each Monday.

Reconciliation of accounts to be done each week.

20% discounted tickets for the film sponsor applicable after 11 days.

50% of the amount collected from Advance Booking in the first 7 days (30th September to 6th October 2022) to be paid as advance to the Distributor. Paid amount to be adjusted from the 1st week Dist. Share.

7) No regular discounted rates to be allowed for first 11 days.

8) 500 FOC seats to be given to the Distributor from each cinema site.

9) Special arrangements will be done by the cinema to curb recording of the film.

10) No new local film will be released in first 11 days

OPTION 2:

1) DISTRIBUTOR SHARE %

a. ALL WEEKS: 50%

b. NO FOC SEATS ALLOWANCE

2) Increase in admission price for 11 days (K-L-I & R) (Rs. 200)

3) Distributor payment to be done on each Monday.

4) Reconciliation of accounts to be done each week.

5) 20% discounted tickets for the film sponsor applicable after 11 days.

6) 50% of the amount collected from Advance Booking in the first seven days (30th September to 6th October 2022) to be paid as advance to the Distributor. To be reimbursed to Exhibitor from the 1st week Dist. Share.

7) No regular discounted rates to be allowed for first 11 days

8) Special arrangements will be done by the cinema to curb recording of the film.

9) No new local film will be released in first 11 days

because they want their movies to be shown.” For the first time now, producers took the reins. “You have to let them recoup their investments,” she explained, “it is a business after all.”

“For the first time in history, content is dictating the terms,” added Mahmood. But of course, it wasn’t received well by many exhib itors. Listed below are the two options that were given to cinema owners to choose from.

Some exhibitors grudgingly chose option one, while others opted for the second. Some 38 cinema owners agreed, and four did not, Mandviwalla said. Importantly, of the four who walked away, three are considered the ‘big cinema’ owners.

Mandviwala remained unfazed. He said that it is a business at the end of the day. With a slight shrug of his shoulders and sideways tilt of the head he said, every businessman has the right to run his business the way he wants to... “But it was my duty to explain to them why this (new formula of ticket pricing) was important for the producers, for their recovery and their advertising budget.”

This has been a big blow to the business of the exhibitors who walked away, sources within the industry say. But obviously, it would also mean less receipts for the producers given the size of the cinemas. When ques tioned about this Mandviwala agreed and said he wasn’t worried. “People will continue going to see the movie days and weeks from now, cinema owners have only hurt themselves.”

When asked about who has lost most in terms of business by not showing Maula Jatt in the first 11 days of its release, Hikmat paused. “I would say the exhibitors mostly,” she then an swers, almost reluctantly. “I never spoke to cinema owners directly. We partnered with Geo films and later on got Nadeem Mandviwalla on board as the distributor. Nobody knows cinema as good as him in Pakistan and nobody can match Geo’s strategic partnerships. Pre-covid, Mr. Mir Ibrahim had already taken ownership of the project and Geo gave us support not only on air but at the back end as well.

Cinema owners were not easy to interview. “Pakistani cinemas work like a

Our biggest concern usually is that here you don’t recover money…You have to have a strategy to make sure you earn but how it works here is that cinema owners give you a fixed share of what they make. They dictate the terms and producers succumb to the pressure because they want their movies to be shown

Amara Hikmat, Producer The Legend of Maula Jatt

cartel,” said Mahmood. The owner of Nueplex Cinema in Karachi, Mirza Jamil Baig, despite several attempts by Profit was unable to co ordinate a time for an interview while others seemed unwilling to answer any questions. One CEO of a cinema in Lahore, wanting to remain anonymous, said the rules put forward by the distributor were “ridiculous”. “If it is a business for them, it is a business for us, too. Why should we not have a say in the matter?”

This is disheartening for some like Hik mat who was hoping the industry would come together for a movie of this scale and scope.

On the other hand, Waqas Sheikh, Gen eral Manager of Cue Cinema in Lahore said: “We have always been willing to show it.” Ru bishing claims that they were selling tickets in black for Rs 5,000, he said, “I believe the team who made Maula Jatt put in such a big effort, so if they were willing to give it on their terms we should respect their process. We should support the movie.” With such a small cinema industry, Pakistan has no formal association but owners are closely connected and do dis cuss important issues that bind them. Despite this, they were unable to convince those who decided against agreeing to the terms of the distributors.

Sajid Ilyas, deputy chief executive at Bahria Town, which also has cinemas, says business dynamics have changed post-Covid, and that everyone should keep that in mind

when trying to put new formulas in place. Moreover, while he understands that everyone wants to make the most of this big-budget and much-awaited film, it should not and cannot force anyone to compromise on the “fundamen tal principles” of doing business.

“This is destroying business norms, what will happen when the next Lollywood movie is released?” Ilyas said, adding that not every upcoming film has the size and scale of Maula Jatt but with a new precedent in place they will most likely also try to dictate terms. “Refusing them will be unfair because if we could make an exception for one, why can we not do the same for the other. These new rules can’t apply to all films. Who will pay Rs 1,200 for a Pakistani movie?”

Ilyas eventually agreed to the new formulas but called it a “compromise on business ethics” and said he was concerned about the future of the industry. He said he had nothing against Mandviwalla, and added that it is pos sible for both of them to be right in their own ways. Which is why he said they “swallowed a hard pill and conceded.” Maula Jatt was aired at cinemas in Bahria Town by day five.

How it ends…

Don’tworry, this isn’t a spoiler. Now that the 11-day period during which the distributors wanted the new formula applied is over, the movie is

showing in the cinemas that rejected the de mands. They are doing booming business. But it could have been more.

The verdict is still out on who will come out victorious. But there are some initial impressions.

“It will change the future for the better in two ways,” says Mahmood. “First of all, now international distributors and exhibitors have an example of a bankable Pakistani film so our upcoming films are more likely to open in newer markets.” The Legend of Maula Jatt showed in over 300 screens abroad – a record by most accounts.

Mahmood continued: “Secondly, purely in terms of a Pakistani market, a precedent has been set that a good film is bound to draw crowds in regards of where and how it opens for exhibition. The local exhibitors will now think twice before acting like a cartel, and strong-arm ing Pakistani producers into deals that only favour the cinema owners. Pakistani producers now also have some cards in their deck.”

“Every movie makes money differently depending on variables that are unique for each project, said Hikmat. “That’s why movie production is not an ideal investment choice any investor would like to explore in a nascent market like Pakistan. That’s why even my own family insisted one should invest in real estate and not a film. Actually my hus band, Asad Khan, who is also the executive producer, decided to finance this project in less than 15 mins after meeting Bilal. We made an unachievable financial projection with Bilal which solely relied on his creative vision. The market was not favourable. Covid made it worse.”

She also said she really wanted people to believe in this, to restore people’s confidence in Lollywood so that the industry could get investors. “In that sense, I feel like we have suc ceeded,” Hikmat said simply. And she is right, Maula Jatt has increased the box office size. Who will ultimately benefit more, the produc ers or the exhibitors? That remains to be seen.

In conclusion, to quote a line in the film: “One pride cannot be led by two lions.”

Or can it? n

This is destroying business norms, what will happen when the next Lollywood movie is released?...Refusing them will be unfair because if we could make an exception for one, why can we not do the same for the other. These new rules can’t apply to all films. Who will pay Rs 1,200 for a Pakistani movie?

Sajid Ilyas, deputy chief executive at Bahria Town

We have always been willing to show it...I believe the team who made Maula Jatt put in such a big effort, so if they were willing to give it on their terms we should respect their process. We should support the movie

Waqas Sheikh, General Manager of Cue Cinema in Lahore