Steinhoff has been hung drawn and quartered, without any firm evidence of guilt.
There are many serious allegations flying around, all feeding off each other: fraud, tax evasion, emerging skeletons, accounting fraud, financial fraud, pyramid scheme, predatory consumer loan providers, even Stellenbosch Mafia. All in all, many detractors are also suffering from a heavy bout of Schadenfreude. The scene is one of tall poppies being chopped and trampled into the ground.
In August 2017 Manager Magazin reported on an investigation into possible accounting fraud by German prosecutors. In September, Fraudenwalt, a German online publication, published an explosive article titled “Always new fraudsters”. Fraudenwalt alleges that the group is built on quicksand “as vulnerable to collapse as cabinets and drawers made of cheap chipboard”. Referring to the “Stellenbosch Mafia”, the publication avers that “The Godfather and his executor are often on the verge of legality”.
The report further alleges that tax avoidance is being investigated in three different countries, and there are further speculations of alleged accounting fraud. Even though proven tax avoidance may lead to further taxes or penalties being paid, it is not illegal. Tax avoidance based on loopholes in the law, or arbitraging differences in domestic tax laws, will escape scot-free. Tax evasion on the other hand, is a criminal offence. I do therefore hope that the tax investigators get around to finalising their investigations – and then we can all opine on the outcome. Similarly with the alleged accounting fraud.
Steinhoff is involved in a dispute with a former joint venture partner, which is still subject to legal hearings in Amsterdam and Germany. Could the disgruntled former joint venture partner perhaps have sparked off Fraudanwalt’s article? Hell hath no fury like a partner scorned?
Another popular accusation is: “This is another Enron”. Not really. Enron was a trader, selling contracts in anything ranging from energy to weather. It was easy to cook the books, and to convert debt into sales via complex partnership arrangements. Apart from a few gas pipes, there was not much substance. Enron also created an online electronic trading platform to facilitate its online trades. It commenced building a high-speed broadband telecom network at the height of the dotcom bubble. Worst of all, it booked future profits before they were earned. Their liabilities dwarfed their assets. When Enron was close to bankruptcy, the directors started offloading shares. Various directors of Enron, including Jeffrey Skilling, Andrew Fastow and Michael Kopper, went to jail.
Steinhoff may have a lot of debt, and more liabilities may crawl out the woodwork, but it owns real businesses. Furthermore, the directors have the most to lose financially. Nevertheless, Steinhoff may have overextended itself, and it may have moved liabilities off balance sheet. Moving liabilities off balance sheet through ever more sophisticated techniques ahead of the clumsy accounting standards forever playing catch-up, is a game that many corporates are involved in. And they can usually manage to just squeeze this within the allowable boundaries of the applicable accounting standards. Or, by using some new-fangled financial instrument that no one comprehends. This would place us in the same moral dilemma as aggressive tax planning, technically a particular transaction may fall within the law, but it may not be in the spirit of the law or regulation.
There have also been allegations in regard to the relationship with JD Consumer Finance business (JDFS). Steinhoff sold JDFS to an independent third party during the 2016 financial year. This transaction was even approved by the Competition Tribunal in March 2016.
In growing its business to the second largest furniture empire behind Ikea, Steinhoff pursued an aggressive acquisition campaign in the US, UK and Australia. Acquisitions included Poundland in the UK, Mattress Firm in the US, Fantastic Holdings in Australia, and Tekkie Town in South Africa. Creating value through acquiring businesses is not uncommon, and it is not surprising if those businesses improve under new direction, centralised services, and greater purchasing power. But, it can also result in cash flow problems, and this may lead to innovative finance solutions. I remember the days when the acquisition cost of a trademark was tax deductible – this allowed the portion of the purchase price of a business attributable to the trade mark to be deductible. These transactions were challenged on various grounds, sometimes successfully, other times not. Even though some transactions were perceived to be tax aggressive, did they constitute fraud? Definitely not. When laws and regulations are subject to interpretation, and the exercise of judgement, one must expect a range of outcomes.
Is Steinhoff on the verge of bankruptcy? All is not lost. Steinhoff has received expressions of interest in certain non-core assets that will release a minimum of €1bn of liquidity. Furthermore, Steinhoff Africa Retail Limited (Star) has committed to the refinancing its long-term liabilities due to the company. Steinhoff will be meeting with its bankers on December 19.
Notwithstanding underlying fundamentals, a share is worth what buyers think it is worth. If buyers are clamouring to buy a share, the share price will rise. On the other hand, at the hint of a scandal, or a tax investigation, investors become nervous and start selling. Even in this market, there are those who want to make a profit out of the misfortune of some, and “short” the share. This means they sell a parcel of borrowed shares at the current price, hoping to purchase the shares at a lower price at a future date. This in itself places a downward pressure on the share. The contrary argument is that short transactions provide much needed liquidity to the market. The JSE may yet have its hands full in investigating trades around this time. Did a large investor, too impatient to wait for the share to recover, short the share?
The accounting world is forever changing, with accounting standards becoming more voluminous, tortuous and indecipherable. And countries follow various different accounting conventions.
South Africa, the United Kingdom and Europe follow International Financial Reporting Standards, previously International Accounting Standards, which are littered with subjective evaluations and judgments. For example, a fair value accounting adjustment of short-term securities, may result in an upward or downward adjustment to income. Income can also include other accounting adjustments, such as a deferred tax asset adjustment, whereby a tax loss is morphed into an asset at the current tax rate (with an equal increase in income). Ascertaining a related party relationship is a minefield, and the applicable statement advises that “attention is directed to the substance of the relationship and not merely the legal form”, and any “economic dependence” should be considered. The statement on investments in associations and joint ventures refers to “significant influence”, impossible to define. It is not surprising that tax investigators and prosecutors resort to bullying tactics and threats of prosecutions.
Perhaps this is the time for a rethink of how financial statements can be improved to protect investors. Current financial statements are not fool proof. An auditor cannot possibly be expected to detect a cleverly hidden complex fraudulent financial transaction, which may be routed through 50 entities that are tax residents in 50 different jurisdictions, and perhaps incorporated in other jurisdictions, in a split second. The auditors will only see one leg of the transaction. Only the relevant tax authority will be privy to the “real” taxable income, but many complex tax and financial arrangements are not identified. Perhaps it is time to introduce legislation that requires listed companies to obtain an all clear by a certified financial analyst.
Rotating auditors is on the cards, but a large group should use different auditors to audit subsidiaries, and perhaps two firms of auditors should sign off the consolidated financial statements. Details of any qualified report given to subsidiaries should also be disclosed. All of this will add to the costs of an audit, but this is outweighed by the losses suffered by investors.
Time will perhaps provide the answer as to whether Steinhoff is guilty of building up a shadow empire of off balance sheet companies, fraudulently overstating income, and hiding liabilities. Or, whether a gullible market has been fed misinformation? Neither outcome will assist investors who have lost a lot of money. The key lesson for investors remains that of diversification.
If Markus Jooste had been quietly offloading his shares, I too would be baying for his blood. But he is heavily invested in the group, as are the other directors. Jooste has decided to take it on the chin and step down. I don’t read anything else in that other than it is time for Die Ou Ballie with plenty of fight left in his veins to take charge. My money is on Christo Wiese. I therefore took a decision which I may in time either celebrate, or heavily regret. I purchased more shares in Steinhoff.
Disclosure: The author purchased further shares in Steinhoff on the December 8 2017.