Laying bare the ransacking at Steinhoff
For pundits in arcane accounting high jinks, Steinhoff’s 2017 financial statements were always going to be a precedent-setting treat, stretching the boundaries of what is possible.
Late last Tuesday, before a public holiday, Steinhoff finally revealed its audited financials for the year to September 2017 — the very set of financials that pulled the rug out from under former CEO Markus Jooste.
The 327-page annual report was something to behold. It lay bare a web of shadowy related-party transactions, vast personal enrichment at the expense of shareholders, and, at R246bn, one of the most audacious frauds ever committed.
In a note sent to clients the day after the results, Peter Armitage, the founder and CEO of Anchor Capital, wrote: "The financials give further details of the extent of irregular transactions, false profits and manipulated accounts. It is hard to believe it is so big. Remember the world’s biggest fraud, Enron, was R650bn."
Armitage added that when Steinhoff releases its results to September 2018 in a few weeks, "the position is likely to look worse".Compare the new 2017 figures to the original 2016 accounts (before they were restated), and it lays out in unambiguous, cold numbers the sheer gravity of what happened.Of course, the market knew that immense write-downs were on the way, but still: just among the noncurrent assets, €11bn evaporated primarily from three items — goodwill, intangible assets and property.
All three of those items had the signature mark of Jooste’s self-dealing and manipulation. Goodwill is typically generated when a company pays more than NAV for an acquisition. But in Steinhoff’s case, Jooste and his cronies would sell an asset to Steinhoff at an inflated value using a third-party proxy that hid his personal interest, then include the extra amount above NAV as "goodwill". This made Steinhoff’s accounts look better than they were.
The category of "intangible assets" mostly consists of brand names in the group that were sold to undisclosed related parties and leased back to the group. Only, these were often later bought back at higher values, inflating Steinhoff’s balance sheet.
Take, for example, a property company called Alvaglen, which the FM wrote about last year in an article headlined "Steinhoff’s secret history". There, Jooste, with the help of cronies, developed the property company, leased it to Steinhoff and later got Steinhoff to buy it at a rich premium.
Now, last week’s annual report shows that when you strip down Steinhoff’s assets to what they were really worth, the balance sheet almost halves. For example, the amount of its loans and investments considered current assets plunged 89% to €107m.
The problem here is that unbeknown to shareholders, most of the loans issued to third parties had only a small chance of being repaid, while many of the so-called "investments" had an awful smell about them.
Take the JD Group consumer finance book. In 2014, that loan book, which was meant to finance customers from Joshua Doore and Morkels buying furniture, was riddled with bad debt. But Steinhoff managed to shift it off its books in 2014, citing an "imminent" sale of this unit to French bank BNP Paribas, which then fell through. But desperate to get these bad debts off its books, Steinhoff secretly lent money to a "third party" in Switzerland, Campion Capital, to "buy" JD Consumer Finance.
But Campion wasn’t an arm’s-length company, as it was run by Steinhoff’s former European CEO, Siegmar Schmidt. The auditors have now determined that Steinhoff was still really on the hook for JD Consumer Finance, and have brought that finance book back into its accounts. The bottom line: JD Consumer Finance is back in Steinhoff’s books, but it has been impaired by €150m for the restated 2016 year.
It’s just one brazen example of what happened, and the unravelling job Jooste’s successor, Louis du Preez, has had to do in light of the dozens of "fictitious" transactions exposed by PwC’s forensic investigators.In another twist, Steinhoff had to create a new item on the balance sheet for the 2017 accounts: "investment property".This can be considered a little doff of the cap to Jooste’s curious penchant for developing high-end residential apartment blocks in places like Green Point and selling them to Steinhoff, as revealed by Moneyweb last year.Investors who read the full annual report will wonder how it is they inhabited a different universe for so long.To assist these investors in deciphering Steinhoff’s true earning power, Steinhoff created a new line called "sustainable ebitda", or earnings before interest, tax, depreciation and amortisation, which measures the pretax and deduction profit, once you exclude all the adjustments for past sins.The gap is huge. Between the false and restated published numbers for 2016, ebitda fell by over €1bn to €753m. In other words, Steinhoff’s true earnings had been handsomely inflated, from a loss to a profit. For 2017, Steinhoff’s "sustainable ebitda" was €765m despite the inclusion of several acquisitions that bolstered the bottom line. These included Tekkie Town (bought for €226m), Fantastic in Australia (€247m), SRP (€79m) and the US-based Mattress Firm that was bought for a staggering $3.8bn in August 2016.So here’s the conclusion: Jooste’s capital-raising and deal-making in the months leading up to his resignation in December 2017 barely moved the needle of Steinhoff’s profit.Perhaps Jooste’s worst deal, done months before the fall, was the purchase of Mattress Firm in the US for a 115% premium to its share price at the time. Worse: Steinhoff now says it has "lost control" of Mattress Firm, following its exit from bankruptcy proceedings (the equivalent of business rescue) in the US.
Effectively, the deal the company had to reach with creditors means that Steinhoff’s shareholding in Mattress Firm is likely to slip below 50%. Mattress Firm must be a prime candidate for the worst international acquisition by an SA firm ever, eclipsing even such dogs as New Look (Brait), Gourmet Burger Kitchen (Famous Brands) and David Jones (Woolworths). Quite how bad a deal it was will only become clear in the 2019 accounts.
Unlike fluffy items like goodwill, intangibles and investments, debt doesn’t go away. In its two indebted finance companies Steinhoff still owes creditors €8.5bn. And because the discovery of accounting irregularities only occurred after the end of the financial year, no provision has been made for the billions and billions of claims filed by a range of current and former shareholders. Former chair Christo Wiese, for one, is suing Steinhoff for R59bn.
By one account, there is little hope left that shareholders will see a cent as the company undertakes a "restructuring" to repay creditors.
Armitage says: "The maths don’t look pretty, and it’s hard to see any value whatsoever."
On his estimates, Steinhoff’s ebitda for 2018 could amount to just R6bn — equal to just 5% of the company’s nearly R140bn in net debt.
In other words, the company’s earnings simply cannot sustain the level of debt, and even if all the businesses are sold off there will not be enough money to pay creditors.
"The current market cap is R6.55bn, or R1.52 per share. This is effectively a bet that there will be a [sliver] of value left after the businesses are sold off. I would certainly not be taking that bet. Sadly, in my opinion, there is no value left," Armitage says.
Surprisingly, the company, now chaired by former investment banker Heather Sonn, makes no bones about how brittle the ground is for its continued survival.But there are some rays of hope. First, Steinhoff has no material legal claims awarded against it which are payable in the next year; second, there are no material or unexpected tax assessments; and third, the agreements struck with creditors which allow the company time to reorganise its assets without being declared bankrupt continue for now.Sure, it’s not much to hang your hat on, but there is a perverse incentive to keep Steinhoff alive, if only to pay creditors and litigants. Mutually assured destruction is to no-one’s benefit.But back to the house of horrors. In the economical and precise language of the auditors (who clearly authored the report), all sorts of obscene details are disclosed in footnotes strung across the 200 pages of the financial statements.The extent of executive largesse was gobsmacking.Besides a Gulfstream G550 corporate jet, which was bought in January 2017 and sold a year later at a substantial loss, Steinhoff quietly notes that "two smaller jets" were also disposed of during the year. Read this alongside the "related party" disclosures, and you’ll find that Jooste and another executive, Danie van der Merwe, supplied "aviation services" to the company, as did Wiese. Wiese, it turns out, leased one of his aircraft to Steinhoff for €800,000 during the year.This suggests that Steinhoff had a veritable fleet of jets at its disposal.And while the disclosure of Jooste’s €8.2m payday for the 2017 financial year has been revealed (see page 6), we also learn that he exercised share rights that pocketed him a further €8.4m during the year. Perversely, this means the man identified as one of the prime suspects in this epic fraud earned more than R250m in the year of the company’s demise.Related-party disclosures also show how the company’s founder, Bruno Steinhoff, and Wiese tapped it for money apart from their directors’ fees. Bruno Steinhoff provided business management consultancy services for €350,000 during the 2017 financial year. This has since been terminated.
Wiese supplied secretarial, administrative and office management services to Steinhoff at a cost of €150,000, as well as management services, which came at a price tag of €497,000. Taken together with his director’s fees and the aircraft, it means Wiese and his entities earned €1.76bn from Steinhoff in 2017.
Of course, this pales in comparison to what Wiese still owes Steinhoff. In October 2017, shortly before the company hit the wall, Wiese received a "pre-payment" of €325m to sell his shares in Shoprite to Steinhoff. The deal was apparently struck between Wiese and Jooste, and it wasn’t disclosed to the full board.
Wiese argues that under Dutch company law (Steinhoff has its headquarters in the Netherlands), he had no duty to disclose the deal to the main board.
In the end, though, the Shoprite transaction was cancelled, which meant Wiese is supposed to repay this amount. Steinhoff says he has only repaid €125m of the €325m, though arrangements have been made to repay the rest.Readers might also recall Pepkor’s (previously Steinhoff Africa Retail) controversial executive ownership scheme that allowed its executives to buy shares in Steinhoff through a company called Business Ventures Investments (BVI).Last year, Pepkor shareholders were asked to bail out BVI (and Pepkor’s executives) at a cost of R550m, as Steinhoff’s stock plummeted. Steinhoff’s annual report now says that BVI should be "consolidated" as at March 2015, meaning its entire debt now sits on Steinhoff’s balance sheet with shares that have since turned out to be worth virtually nothing.Rarely have shareholders, already deceived by a fraud, had to endure such a torrid ransacking of trust. But then, Steinhoff’s 2017 annual report is, let’s hope, one of a kind. As a line-by-line, figure-by-figure account of the most incredible financial mirage ever constructed in SA, it will be picked apart in the months ahead to sketch the true picture of a global retail conglomerate built on lies...