would require far more scrutiny from auditors.
Steinhoff would then charge interest on that loan, which it would recognise in the income statement as revenue. But for all intents and purposes, it was a fictitious debtor: that main debt would never be repaid. Ingeniously, through some fancy footwork using “guarantees” in Europe, that debt would then be classified as “cash and cash equivalents” in Steinhoff’s books.
This is important, since one obvious red flag for accounting fraud is when a company’s operating cash flow doesn’t match the profit it reports in its books. Masked as “cash equivalents”, these loans didn’t arouse suspicions. So in 2016, for example, there was no major discrepancy between Steinhoff’s operating profit of €1.8bn and its operating cash flow that year of €2.03bn.
But that growing balance of fictitious “cash and cash equivalents” needed to be hidden somewhere. So, Steinhoff would then typically do another deal that would effectively allow it to reclassify that debt into an “intangible asset” on its balance sheet.
The bottom line: Steinhoff’s revenue was artificially inflated, and so were its assets.
One insider says that at this point, it doesn’t seem the main goal was for the fraudsters to steal money personally. “Primarily, it was about manufacturing a false picture of Steinhoff’s performance and earnings to perpetuate this story about the phenomenal growth. Of course, some of those may have made some money personally in the process, but it seems the goal was to inflate Steinhoff’s numbers.”
Other insiders doubt this, believing the perpetrators must have made money along the way. The PWC investigation, which is only likely to be finished by the end of the year, will provide the final verdict.
In December, an independent committee was set up consisting of Sonn, audit committee chair Steve Booysen and Sanlam chair Johan van Zyl (who resigned before the AGM). They spoke daily, often working 20-hour days to determine how deep the cancer went.
For context, consider that the board had met only four times the previous year; yet between December and February, Sonn’s committee had 20 formal meetings. In those three months, Steinhoff’s board committees met no less than 63 times.
“It really has required everything I have — all my skill, all my preparation, everything I have learnt,” says Sonn today. “But it has been a peak experience too, as there hasn’t been much time to reflect on what was happening. It was just about fighting this fire, then moving to the next one.”
It wasn’t that Sonn didn’t have the experience. Besides Merrill Lynch, she’d had stints at Sanlam Investments, been CEO of Legae Securities, and been on numerous other boards, including financial services firm Prescient, construction firm Esor and the Nelson Mandela Foundation.
It’s just that it was uncharted territory: nobody in SA had chaired a company of comparable size at the centre of the country’s largest corporate fraud.
While she’d joined Steinhoff in 2013, her father, academic and anti-apartheid activist, Franklin Sonn, had been on the board for years. He’d been the SA ambassador to the US but when he retired, Jooste asked him to be a nonexecutive director. When Franklin Sonn retired, one of the names he proposed to take his place was that of his daughter. “I was keen, really interested in how large SA corporates worked,” she says.
She could never have foreseen the burning building that would be Steinhoff five years later.
“There’s so much going on that we’re all just batting every day. I know that, as chair, eventually all decisions will come past my desk. But it’s a hectic environment, where the simple matter of trust between colleagues is broken. A lot of work must be done to fix that,” she says.
Of course, there had been plenty of warning signs prior to December’s crash.
As Allan Gray portfolio manager Leonard Krüger wrote last week: “Numerous warning signs and inexplicable actions flagged Steinhoff as a high-risk and below-average prospective investment” before its crash.
This included a sharp rise in the number of shares issued by Steinhoff to buy companies, which was accompanied by a spike in debt and intangible assets.
“Important shareholder metrics, like return on equity [ROE] and growth in earnings per share were uninspiring. ROE declined from 20% in 2007 to only 9% in 2017 and earnings grew by only 17% in euros, or 1.6% per year.”
In 2007, Jpmorgan analyst Sean Holmes published a 56-page report, advising investors to steer clear. He spoke of Steinhoff’s “pattern of aggressive accounting treatment”, its “unnervingly” poor disclosure, a “disturbing” spate of acquisitions to “paper over the cracks” and an “unusual emphasis” on minimising its taxes.
Then in 2009, Craig Butters, who comanages Prudential’s Dividend Maximiser and Core Value funds, met with Wiese to warn him that Steinhoff’s success story was not all it was cracked up to be. Up to 40% of its earnings were of poor quality, he said.
The problem is that Steinhoff’s survival, at this point, is not guaranteed.
At the moment, it has €10.4bn (R156bn) in debt, and a market value of just R8.4bn. Bankers who were relaxed a year ago when Steinhoff’s value was around R300bn are biting their nails over a debt-to-equity ratio that would break a thousand covenants.
For the year to September 2016 (its last audited numbers), Steinhoff paid €215m in interest and other finance charges, at a time when it reported aftertax profit of €2.1bn. But those financials now all carry a stamp saying “information can no longer be relied upon”.
But this equation will change radically in the next set of financial results, partly