/ 8 December 2017

Steinhoff implosion staggers SA

Steinhoff chief executive Markus Jooste resigned because of accounting "irregularities".
Steinhoff chief executive Markus Jooste resigned because of accounting "irregularities".

The collapse of Steinhoff International’s share price this week, following allegations of accounting fraud, is being described as the biggest corporate failure on the JSE so far, but it may just be the tip of the iceberg.

On Thursday afternoon, Finance Minister Malusi Gigaba said he supported a decision by the Financial Services Board (FSB) to institute an independent probe into possible false and misleading reports under the terms of the financial markets Act. This was over and above an internal investigation by the Johannesburg Stock Exchange to probe the extent of the alleged irregularities.

Gigaba said he was gravely concerned and mindful that many retirement and savings funds may be adversely affected by the loss in the value of Steinhoff shares.

The international furniture and household goods retailer, with operations in the United States, Asia, Europe, Australia and New Zealand, saw its value plummet by two-thirds on Wednesday, wiping out an estimated R180-billion from the JSE.

Besides having major implications for private asset managers and investors, it also has serious implications for the Public Investment Corporation. It holds about 10% of the shares in issue and helped to fund Steinhoff’s recent empowerment deal with the Lancaster Group — a transaction that was valued at about R10-billion, according to PIC records. The Lancaster Group is a broad-based investment company founded by Jayendra Naidoo.

Naidoo said: “We are greatly concerned about where everything is now. Obviously we will look at all our options at all times as we understand the position more clearly.”

The group had various instruments in place to mitigate against the impact, Naidoo said, but he hoped that Steinhoff would be able to ringfence the problem.

Allegations of accounting irregularities exposing the company to criminal investigation was a serious concern, the PIC’s Deon Botha said. The PIC is awaiting further information from domestic and international regulators and law enforcement agencies before deciding on a course of action.

Gigaba has requested that the PIC, FSB and the Government Employees Investment Fund provide him with a report on the extent of exposure for retirement funds.

It is unclear what the PIC’s losses are, with estimates ranging from R2-billion to R12-billion.

Steinhoff, which has a primary listing in Frankfurt and a secondary listing on the JSE, has been battling to shake off allegations of accounting fraud after news broke that German authorities were investigating the company.

But the firm’s precipitous decline came after the group’s long-serving chief executive, Markus Jooste, resigned on Tuesday, and it cancelled the release of its financial results.

In a statement on Wednesday, the Steinhoff board said new information had come to light about accounting irregularities that had to be investigated, including determining whether any previous financial results had to be restated.

The scale of the alleged accounting irregularities is only beginning to be understood. A research report by Viceroy Research has painted a bleak picture of the extent of the potential problem. It claims that the company has been inflating earnings and obscuring losses with off-balance sheet entities.

According to the report, Steinhoff has been under scrutiny for several reasons, including the aggressive acquisition of “stagnating or deteriorating businesses whose performance seems to miraculously improve post-acquisition, even if only on paper”, and “rampant and dilutive equity raising”.

The report unpacks a web of complex transactions that centre on three off-balance sheet companies — Campion Capital, Southern View Finance and Genesis Investment Holdings — suggesting that these may just be “the tip of the iceberg”.

“Steinhoff’s confusing roll-up structure likely holds numerous other secrets which are yet to uncover,” Viceroy said, adding that incestuous managerial transactions, a lack of transparency and non-independent governance made Steinhoff borderline uninvestable.

Adrian Saville, the chief executive of Cannon Asset Managers, said it is evident, given the nature of these complex structures, there is “a potentially massive off-balance sheet liability”. This has major implications, including rendering the company’s financials “meaningless” for determining income.

He said there are material risks of legal action, both criminal and civil, as well as a risk of contagion to other companies through Steinhoff’s network of investments in companies such as AP International, PSG, Shoprite and Brait.

The company also recently unbundled its African retail assets into the JSE-listed Steinhoff African Retail (Star).

Steinhoff did not respond to questions about the alleged fraud. But in an announcement on Thursday, the board said it had “given further consideration to the issues subject to the investigation and to the validity and recoverability of certain non-South African assets” amounting to roughly R95-billion.

It noted that it seeks to sell “certain non-core assets” to release at least €1-billion to shore up the firm’s liquidity. It also said that the company’s subsidiary, Star, will today formally commit to the refinancing of its long-term liabilities due to the company, releasing a further €2-billion.

“The extent of this is astonishing,” said Wayne McCurrie of Ashburton Investments. The value destroyed would be more than enough to recapitalise power utility Eskom or provide free higher education for all, he added.

As of Thursday afternoon, the company’s market value had dropped R145-billion, and its shares were trading were trading at lows of about R11.

The crux of the problem is that profits may have been overstated, which presented Steinhoff’s financial position as being stronger than it actually was, said Jean Pierre Verster, a portfolio manager at Fairtree Capital. The banks then lent the company money based on this, which allowed Steinhoff to amass more than R100-billion in debt, he said.

Whether the banks will call these loans in is not yet known, Verster said. “It depends on the covenants [debt agreements], but the banks will likely need to wait for the next set of audited financials.”

In accordance with Frankfurt Stock Exchange rules, the audited financial statements must be released by January, Verster said. 

The writing was on the wall

Magda Wierzycka, the chief executive of asset manager Sygnia, said active asset managers should have seen the Steinhoff failure coming.

“Priding themselves on meticulous research, scrutiny of balance sheets and income statements, backed by interviews with management, they should have seen what was obvious from the beginning that this was as close to a corporate-structured Ponzi scheme as one can get.”

In looking at Steinhoff’s financials, it took Wierzycka 30 minutes to see “that the structure was obfuscated, that financial items made no sense, that the acquisition spree was not underpinned by any logic and too frenzied to be well thought out, and that debt levels were out of control”.

She said the right questions were not asked, the corporate structures were not analysed in detail, earnings versus debt calculations were not done, and management was taken at its word. — Lisa Steyn