4 questions Steinhoff must answer

Jan 11 2018 11:37
Marcia Klein

Time is running out for Steinhoff International to produce results for the year to end September if it wants to avoid being suspended from the Frankfurt and JSE exchanges.   

Management and the board have not done much to set the record straight in the more than a month since they admitted “accounting irregularities” and got rid of CEO and chief culprit Markus Jooste as the share plunge lost investors nearly all of their money.   

They have until 31 January to give investors, authorities and lenders some idea of Steinhoff’s actual financial position and its plan to put things right. 

Until then, apart from announcing total group debt of €10.7bn and a positive outlook for Steinhoff’s operating companies at mid-December, they have done little to calm investor despair. 

They have shuffled the very same management team that oversaw the disaster and launched an investigation into what no one in the group seems ready to admit they may already have known. 

A 4 January update said only that talks with funders were ongoing, that operating profit had stabilised to a degree and that some business units needed funding.   

Management changes have done little to appease investors given the unlikelihood of management, or the board for that matter, having been unaware of or not involved in what was going on. 

One analyst, speaking off the record, said the group was keeping existing management around as they are able to point out “where the bodies are buried” and help with the investigation and retrieval of financial information.   

A number of announcements in 2017 outright denied allegations made by the German publication Manager Magazin, as well as legal issues in the Netherlands, where it is registered, and Germany, where it has its primary listing.  

Turning these denials around into an admission that things were not as they seemed while avoiding criminal implication is what they are no doubt scrambling to achieve as they prepare to reinvent Steinhoff’s history, going back at least three financial years.   

The management changes are curious. Ben la Grange stepped down as chief financial officer (CFO) “to focus on the preservation and procurement of liquidity” and to finalise financials. 

He was replaced by Philip Dieperink while Johan Geldenhuys is now head of treasury – both men fulfilling the roles that La Grange is supposedly redirected to oversee.   

Danie van der Merwe is now acting CEO, Alexandre Nodale deputy CEO and Louis du Preez commercial director.   

They are all tasked with preserving and “procuring” liquidity, completing financial statements for 2017 and restating at least two prior years, and finalising an investigation into “irregularities” currently pinned on the previously lauded and feared Jooste alone.   

To date, the most comprehensive analysis comes from a relatively obscure US outfit which was short-selling Steinhoff, Viceroy Research Group, which said management had used off-balance-sheet entities to obscure losses and enrich themselves.  

Among a slew of allegations is that Steinhoff bought bad businesses which, at least on paper, miraculously improved post-acquisition. 

The report highlighted alleged tax evasion, document forgery and fraud, and pointed to off-balance-sheet vehicles Campion Capital, Southern View Finance and Genesis Investment Holding, as well as JD Consumer Finance and Capfin, which were allegedly used to artificially inflate earnings.  

With investigations and legal action mounting in Germany, the Netherlands and South Africa, Steinhoff is left having to answer a number of questions.  

Can it survive?   

Not in its current format or under its current name, says Wayne McCurrie, portfolio manager at Ashburton Investments. “That does not mean there is no value for shareholders, and it doesn’t mean the company is worth nothing,” he says. 

“They need liquidity and they will want to try and get some value for shareholders by essentially splitting the good assets from bad assets – like African Bank.”  

The problem is now that what it published in the past cannot be trusted, it is difficult to know what the good and bad assets are.   

McCurrie says companies unaffected by the accounting scandal can be sold or listed separately. 

The 80%-owned Steinhoff Africa Retail (Star), which was separately listed in September and owns numerous retail brands including Pep, Ackermans, JD Group, HiFi Corp and Incredible Connection, would more than likely be up for sale, or it might have to be split or Pepkor sold to someone else, says McCurrie. 

“As far as we know now it is a good asset and not implicated in accounting frauds and problems. We are reasonably confident Star is clean.   

“We also know with some degree of accuracy that the Pepkor asset is a good asset. Poundland (UK) and Mattress Firm (US) are not tainted because Steinhoff only just bought them – they may only be worth half of what it paid for them, but they weren’t around [in the Steinhoff stable] in 2016 and 2015 so there may be some value in them.”   

McCurrie says the rot is likely to be found in companies like French furniture retailer Conforama, bought in 2011, and furniture and household goods chain Poco, with operations in SA, Australia and Germany.
Once split into good and bad, the “bad” company will be subject to all kinds of legal implications but will be bankrupt, giving those affected little recourse.   

“Every single investor can sue them for loss in the share price, with shares purchased based on the financial statements. This can go on forever,” says McCurrie. 

Vestact portfolio manager Byron Lotter says: “It is important to note – and what the market has recently been reminded of – that Poundland managed to raise capital as a separate subsidiary in its own right and had a record festive season. Steinhoff is definitely not a business worth zero.”   

The current share price indicates investors are expecting the worst.   

“I have a feeling the business will survive and the share price should revalue reflecting the value of the underlying businesses, but there might be a few more shocks on the way,” Lotter says.   

While Steinhoff could sell operating businesses, Lotter points out that it was the one buying distressed businesses, and selling could be difficult.   

What will it restate?  

Analysts say there is no point in guessing at this stage. Steinhoff last reported – for the nine months to end June – that revenue increased by 48%, largely reflecting the acquisitions of Mattress Firm, Poundland and Fantastic Furniture, while organic revenue grew 8%. 

In the six months to March 2017, debt was €9.5bn and cash €3bn.   

All of this is now fictional, and analysts are wary to hazard a guess.   

It is likely that everything is restated, says McCurrie. “When you encounter this kind of corruption and fraud, there are generally two possibilities – they can overstate profits or overstate assets. They have more than likely done both.”   

Tax evasion or avoidance will also surely be an issue, but with restated results the tax implications are unclear.    

Bradley Preston, head of listed investments at Mergence Investment Managers, comments: “Unfortunately, there are potentially a wide range of possible outcomes and it is difficult to know anything concrete. 

"They are either unsure or hesitant to release information, and there is uncertainty around the net cash and debt position.  

“We can value some underlying entities, but until we understand the liquidity position, the overall group gross debt position is difficult to tell.”  

Were crimes committed?   

Yes, says McCurrie. “Maybe this did not start as an economic crime,” he says. Often, someone looks at their financial statements which show the company did not make as much profit as promised, and massage the numbers that year and hope to trade out of it in the next year. 

“These never start with a criminal intent; it starts by effectively starting to hide the truth until you end up in a criminal position.”   

This may not be a case of money being physically stolen, but crimes perpetrated to make financial statements look better so the share price does not fall.   

McCurrie points out that this cannot be executed by one person. “This was a massive company – one person doesn’t sit at his computer late at night and commits this [type of] fraud. 

Who is involved? Every single senior person, board member or member of the tax, audit or ethics committee is going to be embroiled in this for years. 

If a senior person didn’t know about it, why didn’t they know?  

“If the financial director, chairman, and independent directors didn’t know, they should have known, as should the auditors.”   

That Jooste was the only culprit seems unlikely and points to “negligence or complicity” of other executives and the board, not to mention the biggest investor, Christo Wiese, who ploughed his money into Steinhoff and was the architect of various deals, including injecting Pepkor into it and mooting (twice) its takeover of Shoprite.   

Analysts are split on Wiese’s role. “It seems unlikely he was complicit as he actively moved a huge amount of wealth into this entity in the last few years, so it is difficult to imagine he had known this was a Ponzi scheme,” the analyst speaking off the record says. 

“But he may have been complicit in things that were either illegal or ethically questionable. Did he know the extent? It seems unlikely.”  

“If he didn’t know, why didn’t he know?” asks McCurrie, adding that Wiese has been chairman, has known key role players like Jooste “forever”, and has put a vast amount of his wealth into Steinhoff. 

Jooste and his team built Steinhoff, but Wiese was the architect of putting Pepkor into Steinhoff and putting Shoprite into Star, a deal which has now fallen through.   

His reputation is now in tatters. “You don’t recover from this,” says McCurrie. “You may not be implicated, you may have been misled or did not do your homework, but your reputation will never recover.”   

Lotter says Wiese has done “a huge amount for this country”.  

“I still have lots of respect for him,” he says. “No one would put that amount of wealth in – he was duped. He made a very bad investment decision, but he will come out of this.”   

Whichever way it pans out, Wiese’s big plan to build a massive retail conglomerate is on hold. “Now it is about saving face for Steinhoff.”   

What can investors and corporate South Africa learn from this?
“The fact is that minority shareholders were coming second and customers were coming second,” says the analyst. 

“People have known that, but to be an investor alongside someone who up to recently created immense wealth seemed like such a good idea.” Investors tend to follow wealthy investors blindly, but Steinhoff has been cause for some reflection.   

McCurrie says: “Don’t think for a moment you are going to sniff out a fraud like this before it happens. All investors can do is to go back to Investments 101 – don’t put all your eggs in one basket and you will not be destroyed by things like this.”   

He adds that companies could learn not to put too much power in a single person’s hands. 

“There will be a lot more focus going forward on the ethics of a company,” McCurrie says, and if it is involved in something suspicious there will be far more of a reaction by the market after Steinhoff than before.

This article originally appeared in the 18 january edition of finweek. Buy and download the magazine here