In the last month of 2017, yet another corporate scandal hit the news: Steinhoff, the South African-German retailer selling furniture and mattresses in Europe and the US and the owner of the UK’s Poundland, admitted to “accounting irregularities”, meaning that more than €6 billion had disappeared into thin air.
Steinhoff’s shares in Frankfurt and Johannesburg dropped more than 90 per cent when it became apparent that banks had started to pull the plug. The European Central Bank, having bought the company’s bonds under its “quantitative easing” programme, cut its losses and sold immediately. Many retail investors did the same. Bankruptcy seemed a certainty.
Steinhoff is not an exceptional event. One of the more regular known unknowns of our short 21st century is corporations that cheat and lie, with dire consequences for its lenders and bondholders. It often involves not only executives and prominent shareholders but colluding bankers, analysts, government officials and accounting firms in equal measure. Cheaters build and destroy wealth over very short periods of time to then keep courts and lawyers busy for many years thereafter.
In many cases these cheaters will collapse, leaving employees, pensioners, suppliers, creditors and investors high and dry. Yet, in some cases a turnaround is possible and will pocket the shrewd – or foolish – investor a handsome profit.
The first publicly-listed company to ennoble outright cheating into its sole business model was the US energy company Enron, which collapsed so spectacularly in 2001 that it became proverbial. Many later swindles have been described as “Enron-like”.
CEO Kenneth Lay, COO Jeffrey Skilling and Enron’s chief financial officer Andrew Fastov had contrived a book keeping system which made the expression ‘creative accounting’ a pale understatement. Turnover was booked as a profit, the expected returns of long-term contracts showed up optimistically on the day of signing with such deals often brokered for accounting purposes alone; mushrooming debts were hidden in countless offshore vehicles which were beautified by intra-company deals and hidden guarantees, and even failed contracts were over the years kept firmly on the books.
When the internet bubble burst and the stock market slumped, this edifice of lies and fairy tales came crushing down. Executives went to prison and Arthur Anderson, Enron’s accountants who had for many years happily signed off the financial statements without looking too closely, went bust with a whimper. Enron’s share price, over many years the darling of the New York Stock Exchange with profits prodigiously multiplying year after year, collapsed in six months to zero.
Calisto Tanzi and his dairy giant Parmalat was Europe’s Enron-moment. A close friend of Italy’s Prime Minister Silvio Berlusconi, who had built a family-owned ham-business into the biggest dairy company in the world, Tanzi was found with a €14 billion hole in his books, eight times more than was stated.
His methods of cooking financial statements were far less ‘creative’, though: cash held in bank accounts was created with the help of a simple Xerox machine and by bribes paid to a Bank of America banker for confirming false account statements over the years. Parmalat’s accountants, Deloitte Touche and Grand Thornton, obligingly looked the other way.
In a very Italian fashion, executives were still smashing computers and shredding thousands of pages of evidence when the police came to handcuff them. Within a few weeks the stock was worthless, dropping 66 per cent on one day alone.
Cheaters build and destroy wealth over very short periods of time to then keep courts and lawyers busy for many years thereafter
Leaving ethical questions, the moral theory of capitalism or the corroding effects of cheating corporations on societal cohesion aside, I wish to point out the retail investor’s predicament. It is certainly abhorrent to hear that renowned companies like Kobe Steel and Mitsubishi Materials have over at least a decade falsified data of copper, aluminium and steel components for planes, trains and cars. Hundreds of companies are affected, including Japan’s bullet trains. Will transport be safe? Do expensive recalls loom and even more expensive class action lawsuits?
Will these companies go bust like Enron, Parmalat or Takata, the producer of faulty airbags? Or will they survive against all odds, like Tesco, which had, to the horror of investors, to admit to account ‘irregularities’ of £326 million in 2014, to only a few years later become yet again a stellar performer on the London Stock Exchange?
Fraud is difficult to detect but it is even more difficult to predict corporate survival.
When Germany’s engineering giant Siemens had to admit in 2006 to a worldwide, systematic bribery scheme to the tune of €1.3 billion paid in almost every country it had done business with, it suffered not only €1 billion in fines in the US and Germany alone, but legal costs and loss of business amounting to €2.5 billion.
Few would have thought that a company which had built its business acumen on graft would manage to turn around so quickly, to change corporate culture so entirely and to restructure so convincingly for years to come. The scandal had dented its share price when it broke but not as drastically as did the financial recession of 2008. Today, at 121.90 per share, Siemens stock stands at the same level as before the dot.com bubble (127.02) and 180 per cent higher than at the onset of the Great Recession (43.29).
Or take Volkswagen. When it became apparent in 2015 that the world’s biggest car manufacturer had systematically lied to authorities and customers alike about the harmfulness of its cars and the use of ‘defeat devices’ to falsify emissions data, it looked as if the hero of German manufacturing would go under in no time, taking with it employees, subcontractors and even whole countries dependent on VW-component industries. ‘Made in Germany’ looked blemished and harmed beyond repair.
VW’s share price has admittedly never fully recovered. Yet at the beginning of this year it had gained already more than 94 per cent since its low point in October 2015. The Qatari Investment Authority, usually not known for unfailing business acumen and holding a stake in VW of 17 per cent, has made a gain of almost 300 per cent since 2009.
Investors who picked up the broken Steinhoff shares in December 2017 were, on January 9, sitting on paper profits of 54 per cent – in less than two weeks!
As always, we small-scale investors will have to come up with our own decisions. Often we will be wrong; sometimes lucky. I don’t believe in Steinhoff with its outdated business model and its glaringly extravagant owners, and I think that Kobe Steel, which earns less than it spends in normal times, will be too weak to survive. But I may be wrong, mayn’t I?
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge. It should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
Please send in any suggestions for discussion in this column to: editor@timesofmalta.com – Subject: Sunday Times Personal Finance.