Steinhoff update: Another debt downgrade as creditors edge closer to pulling the plug

By Alec Hogg.I received an email a couple weeks back from a Biznews community member who'd made big money trading Steinhoff shares after the December 6 collapse. He offered to enlighten us even promising to write a piece for publication explaining why the stock was worth a lot more than the price at which it had been trading. A couple days after his missive, the price collapsed again. Since then the comms have gone silent..___STEADY_PAYWALL___.Doubtless some fortunate souls piled into the shares at 600c on December 8th and offloaded above R20 on the 12th. But there will also be punters who will be feeling intense pain. For the moment, however, anyone trading the shares is gambling..An announcement from the group today noted that neither external auditors PWC nor the internal financial managers are able to provide a timeline of when they will be able to release their reports. Until they are able to provide some clarity, we're all guessing. But what they did say is the accounting irregularities stretch back further than expected with the financials statements for 2015 and even earlier likely to be restated..There is little cheer for Steinhoff bulls. In the usually dead week between Christmas and New Year, ratings agency Moody's downgraded Steinhoff debt a further three notches, taking the total to an astonishing seven. It's hard to believe that less than a month ago Steinhoff debt was given the "investment grade" stamp required by major global players..That puts the rating at just two notches above "imminent default". The risk of the banks pulling the plug and putting Steinhoff into liquidation is very real indeed...2 January 2018.There is still no certainty on when a report on the accounting irregularities will be completed. The audited 2017 financial statements for the group will be accompanied by restated figures for 2016 and 2015 – the previously published numbers "can no longer be relied upon". In addition, investigations into accounting irregularities already suggest published financial reports for all parts of the group barring Steinhoff Services Limited will require restating for previous financial years..COMMENT:.Good news and bad. First the good: the accounts published by Steinhoff Services, the vehicle which issued the JSE-listed debt, appear to be clean. That heartened South African investors, with Steinhoff shares bouncing by as much as 25% in the early morning before losing most of that to close 7.5% better on the day at 500c. That return to reality came on the dawning that numbers produced by the international operations are even more compromised than previously imagined, with accounting irregularities going back to 2015 and perhaps earlier. The future survival, or otherwise, of Steinhoff will depend on how its big global creditors respond..Thursday 28 September 2017.Ratings agency Moody's announced the further downgrade of Steinhoff debt to Caa1. The company said it is still in discussions with lenders to request their on-going support and the provision of further funding to meet short-term liquidity needs. .This is another hammer blow for the embattled group. Less than a month ago, Steinhoff's debt was rated at investment grade. Two days after the December 5 shock Moody's cut the rating four notches which as the table below shows, is described as "highly speculative". At the time Moody's said "given that allegations of accounting irregularities (now admitted) were raised and rebutted in August 2017 and November 2017 it calls into question the quality of oversight and governance at Steinhoff." This additional downgrade to the level of "substantial risks" puts the paper just two notches from imminent default – reflecting the significant possibility of the banks putting the group into liquidation. .Thursday 21 December 2017.The Enterprise Chamber of the Amsterdam Court of Appeal has postponed the date when it anticipates announcing its decision to "no later than" 22 January 2018..This in-camera hearing is at the core of Steinhoff's unravelling and the second postponement suggests the uncovering of new evidence – not surprising given the recent admissions by auditors Deloitte and PWC. This surfaced in mid-September when the court was petitioned by Andreas Seifert, Steinhoff's previous joint venture partner in POCO. Seifert maintains that Steinhoff falsified its accounts by not acknowledging his 50% shareholding in POCO Germany and Conforama France – acquired through the conversion of a loan. Seifert has also launched civil suits in Germany and Austria. He claimed the 2016 financial statements needed to be restated, something the auditors and the directorate now agree with. Until former CEO Markus Jooste's departure, Steinhoff issued numerous statements stating the claims were false and that is was confident the petition would be dismissed. .WARTS EXPOSED TO BANKERS OWED R160bn AS EXECS PETITION FOR SURVIVAL.After a fortnight of near silence, Steinhoff's communications machine has clicked back into gear with a spate of announcements ahead of the 130,000 employee group's critical meeting with bankers in London..Apart from the acting CEO Danie van der Merwe, other presentations will be given by the new STAR CEO Leon Lourens, Conforama CEO Alexandre Nodale; Pepkor Europe CEO Andy Bond; and from the US, Mattress Firm CEO Steve Stagner. The presentations provide an update on the operations of the major operational businesses..Of special interest to Steinhoff shareholders is the disclosure that total debt is only half of the widely quoted €21bn. Total outstanding debt owed by Steinhoff as at last Thursday is €10.7bn (R161bn). The lion's share, €8.5bn, is in Europe. There is €2bn owed in South Africa and €169m in the US..On the downside, the presentations also point to a severe weakness in management information systems with many of the operating companies reliant on the group treasury for working capital because of a structure where cash is centrally managed..UK law firm Linklaters has been co-opted alongside Moelis & Co to engage with funders and creditors. There has been some success on this front with €690m in debt facilities rolled over..The other US consultancy introduced last week, turnaround specialists AlixPartners, has put people on the ground in South Africa, Germany and the US. All non-critical expenditure has been frozen and all discretionary cash flow spending has been centralised. AlixPartners has introduced a number of critical management information processes including rolling cash flow forecasting at the operating companies.PWC has defined the full scope of its forensic audit; has conducted meetings with key individuals and has visited the relevant offices. It has ensured "data preservation" and started the information gathering process..PWC is unable to yet state the scale of the accounting irregularities or whether they began earlier than the 2016 financial year (which would require re-statement of accounts for 2015 or earlier). It is also unable to state when audited accounts for 2017 or the restated 2016 statements will be ready..The cash flow position at the operating companies is "evolving daily – credit facilities … increasingly being suspended or withdrawn by lenders.".It is rapidly emerging that Steinhoff's accounting irregularities were a direct result of its a highly centralised treasury function which put absolute power over the cash at the centre. The shock departure of CEO Markus Jooste suggests his unfettered access to these billions was at the root of the problem. AlixPartners has implemented systems to rectify this, but it has warned that creditors are pulling their facilities. Steinhoff needs its global bankers to come to the party today. Desperately. This heightened risk has been reflected in a distressed Steinhoff share price which fell 21% since late afternoon yesterday, from 935c to 735c..Tuesday 19 December 2017.In the wake of ex-chairman Christo Wiese's departure on Friday, Steinhoff's former chief operating officer Danie van der Merwe (59) has been appointed acting CEO. Conforama's young CEO Alexandre Nodale (39) has been appointed deputy CEO and Louis du Preez (48) is now commercial director. They have also been appointed to a strengthened Management Board, joining Van der Merwe and chief financial officer Ben la Grange (43)..The appointments, announced on the day Steinhoff's fate will be decided during its meeting in London with global banks, confirms the notion that former CEO Markus Jooste's accounting irregularities were done without the knowledge of his confidantes. Van der Merwe, who trained as a lawyer, has been Jooste's right hand virtually since he joined Steinhoff in 1998. He has been a director of the group since 1999 and chief operating officer since 2013 so was the obvious successor. The other new appointments to the Management Board provide further clues about what is now happening within the group – that the focus now is on the legal fight rather than the business itself. Du Preez is also a lawyer. He was previously Steinhoff's General Counsel and wasn't even a member of the 15 person Executive Committee. Nodale, regarded as one of the group's rising stars, was appointed to the Exco three years ago when he became Conforama's CEO. He joined Steinhoff's French retail subsidiary as deputy finance director in 2009..Christo Wiese and international banks are emerging as the biggest losers in the Steinhoff disaster..Wiese has taken an effective loss of just over €3bn. The banks look likely to be hit even harder, but have already had to swallow a €1,1bn knock on money lent to Wiese last September so that he could increase his bet on the now teetering furniture group..Christo Wiese, billionaire and former chairman of Steinhoff Holdings NV. Photographer: Waldo Swiegers/Bloomberg.When it raised capital from shareholders 14 months ago to help fund the Poundland (UK) and Mattress Firm (US) acquisitions, Wiese borrowed €1.6bn (R24bn) from a consortium of international banks to ensure he was able to buy another 314m Steinhoff shares at the strike price of €5.05 each. The shares are now trading at less than a tenth of that..To raise his total Steinhoff bet to €4.7bn (R71.5bn) Wiese pledged the shares he was buying together with 628m Steinhoff shares (then worth R48bn) he already owned. His initial stake was received as payment for the injection of his Pep Group into Steinhoff in 2015 – the JSE's biggest ever merger..With hindsight, the only smart thing Wiese did in that fateful September deal was insist his €1.6bn loan was "non-recourse"..That "no recourse" clause restricted the South African billionaire's loss to the Steinhoff shares he owned, stopping the banks from attacking his other assets. That means the banks are now responsible for the €1.1bn (R17.8bn) shortfall between what they lent Wiese and the current value of the 942m Steinhoff shares they hold as security..The names of those exposed reads like a who's who of international banking's most famous names. They include Bank of America (owed €400m according to the Financial Times of London), Citigroup (€200m), Goldman Sachs (€120m), HSBC (€120m), BNP Paribas (€100m) and another €200m spread between JPMorgan Chase, Nomura and UBS..From a broader perspective, that loss might end up being only part of what global banks will lose on this nightmare as it only covers Wiese's "double up" exposure made public last September..A far bigger millstone for global institutions is the estimated €21bn in debt on Steinhoff's books. This was accumulated over many years, supported by an Investment Grade rating from Big Three agency Moody's..Earlier this year €800m was raised through an eight year loan that paid interest of just 1.875% a year..Among those which supported this disastrous loan was the European Central Bank whose president Mario Draghi said last week the ECB's governing council is discussing whether to sell the Steinhoff bonds. The ECB holds an estimated €130m of paper now trading at around 50c in the euro..On Tuesday this week, creditor banks will meet Steinhoff management and its New York advisors Moelis & Co and AlixPartners in London. For Steinhoff's 120,000 employees, the best case scenario is the banks agree to a debt standstill that will rely on the underlying subsidiaries, many of which are strong cash generators, to repay the loans..But at least one of the banks, believed to be Goldman Sachs, appears to have broken ranks..Friday's SENS announcement from Steinhoff stated that Wiese's shareholding in the group had been "involuntarily" reduced by 98.4m shares. Also sold out was Steinhoff COO Danie van der Merwe, whose 1.6m shares (then worth R120m) have been sold to offset the debt he took on to increase his holding last September..The move by Goldman Sachs will put additional pressure on Steinhoff to come up with an attractive deal for the banks. Whatever extra the banks get to hold off calling in the €21bn will, by definition, be prejudicial to owners of the ordinary shares that are still trading on the Frankfurt and Johannesburg stock markets..Our table below shows how the cookie is crumbling..Friday 15 November 2017 from Steinhoff International.Christo Wiese and his son Jacob have resigned form the Steinhoff board with immediate effect. Heather Sonn has become acting chairperson. She will remain a member of the independent sub committee with Dr Johan van Zyl and Dr Steve Booysen.A total of 98.4m of the 942m Steinhoff shares owned by Wiese have been sold by the banks which held them as security. They realised a price of €0.4935 a share. As a result of the sale, the shareholding of the banks and Wiese has dropped below 30% and the voting pool arrangement between them has been terminated.Banks have also sold 1.6m Steinhoff shares owned by chief operating officer Danie van der Merwe, at a price of R9.38. Steinhoff has sold 20.6m shares in the PSG Group at R230 a share, raising €293m (R4.7bn), reducing the group's share in PSG from 25.5% to 16%. .COMMENT:.The unwinding has started, and it's now clear that apart from former chairman Wiese, in terms of scale the other confirmed losers in the Steinhoff disaster are international banks which took Steinhoff shares as security for loans made to directors in September 2016 (see story above). Wiese has resigned as CEO and chairman of Steinhoff, because he no longer has any exposure to the company and he told the other directors that his being out of the way would enhance the independence of the investigation. As part of the need to raise liquidity, Steinhoff has sold the first one third of the stake it owns in PSG at an average price of R230, a 22% discount to the price at which the stock traded immediately ahead of the Jooste resignation bombshell. The share price decline means the highly rated stock now trades at a discount of 18% to its "sum-of-the-parts" (SOTP) value of R279.59. For extended periods, PSG has traded at a premium to this SOTP number. Until Steinhoff has completed the sale of the 40m shares it still holds, PSG's shares are likely to remain under pressure..Thursday 14 December 2017 from Steinhoff International.The group has informed shareholders that accounting irregularities go back further than the 2017 financial statements. As a result, the audited results for the year to end September 2016 "will need to be restated and can no longer be relied upon." .A Steinhoff International Holdings NV logo sits on display outside the company's offices in Stellenbosch. Photographer: Waldo Swiegers/Bloomberg.The Steinhoff board's sincerity in wanting to get to the bottom of the scandal was evident in its appointment of its most respected non-executive directors – Dr Johan van Zyl (ex CEO Sanlam); Dr Steve Booysen (ex CEO Absa) and Heather Sonn – as the subcommittee which will oversee greater independence in the group. The trio have been investigating assets on the Steinhoff Europe balance sheet which appears to be where auditors Deloitte found problems. Van Zyl and co have found issues that stretch back at least into the previous financial year hence the rather blunt statement that the 2016 financials should be disregarded. This is confirmation of market suspicions that what appears to have been accounting fraud goes back some years, This is bad news for Deloitte, which only raised the alarm in 2017. Some observers say this may have been a result of the audit shifting from Deloitte SA to its European colleagues after Steinhoff took its primary listing to Frankfurt..Monday 11 December from Steinhoff International..Ahead of next Tuesday's (19th) meeting in London with its lenders (major international banks) the group has appointed Moelis & Company as its independent financial advisor; and AlixPartners to assist with "liquidity management and operational measures". Moelis is a NYSE-listed global investment bank headquartered in New York, with 17 offices worldwide and annual revenues of over $600m. AlixPartners is a New York-headquartered management consultancy which specialises in high profile corporate turnarounds and bankruptcies.The group is "asking for and requires" continued support from its funders. Its aim is to ensure existing lending facilities are not pulled so that the group can achieve an "immediate stabilisation" of its finances.Steinhoff's Supervisory Board has appointed a subcommittee of independent non executive directors Johan van Zyl (ex CEO Sanlam); Dr Steve Booysen (ex CEO Absa); and Heather Sonn (ex Merrill Lynch NY, Legae Securities) to "bolster independent governance of the group."The audit committee chaired by Booysen alongside Theunie Lategan (ex FirstRand) and Len Konar (ex-accounting Prof, professional director) is working with auditors Deloitte to finalise and release the audited financial statements.After being appointed as forensic investigators last week, PWC has started its investigations..This morning's announcements from the company tell us the next week will be critical. Executive chairman Christo Wiese has enlisted the strong support in two top rated US consultancies to help prepare for the critical meeting next Tuesday in London when Steinhoff's top team gets together with the international banks that have provided an estimated $21bn in funding. Steinhoff still has many cash-generative underlying businesses. As Futuregrowth's Andrew Canter unpacked for us last week, although doubtless furious at the misrepresentation, the bankers are unlikely to have the stomach to let it all collapse. But they will also need to buy into a credible turnaround plan. The fresh eyes of PWC, Moelis and AlixPartners are intended to help draft that will give the plan the credibility Steinhoff itself has lost. The company is also making efforts to re-establish credibility internally. The creation of the new board subcommittee to address governance is significant. Again, it is aimed at the funders. The members selected, three independent board members, all have international profiles. Also apparent from the statement is that the objections raised by Deloitte (and resisted by departed CEO Markus Jooste) appear to have been accepted by the board. Given the scale of the eruption, these "adjustments" will doubtless make a significant impact on the bottom line..Monday 11 December from Investec Limited..Investec Limited issued a comprehensive statement this morning outlining its exposures to the Steinhoff Group. This is summarised in the table republished below. Its exposure is primarily to subsidiaries of Steinhoff Africa (listed on the JSE as STAR) which operates through 18 brands with almost 5 000 stores, including Pep, Russells, Bradlows, HiFi Corp, Tekkie Town and Incredible Connection. Investec says it does not expect to experience any losses on this exposure. Investec also says its exposure to the troubled Steinhoff International is either immaterial or negligible. The bank does have two material exposures: in derivatives linked to the Steinhoff share price the loss might be zero but could reach a maximum of 3% of operating profit (R237m). Its holdings of Steinhoff convertible bonds have a carrying value of 0.3% of consolidated tier one capital (R200m). An associated company IEP, of which Steinhoff's former CEO Markus Jooste was a director, has no exposure to the Steinhoff Group. Jooste resigned as a director last week..COMMENT:In the wake of the Steinhoff shock it was always likely market talk would switch to the close relationship between Investec MD Bernard Kantor and former Steinhoff CEO Markus Jooste who are partners in numerous horseracing-related ventures. Investec this morning addressed the rumours, spurred on by a share price which dropped 12% in three days, falling from Tuesday's R94.20 to end the week at R83.11. The share regained its composure to R87 this morning but the company's market capitalisation is still R7bn down since before the scandal broke.What the Investec announcement points us towards, however, is the significant losses made by who bet on Steinhoff using derivatives. Investec says it could lose up to R237m on clients' exposure. Recent SENS reports reinforce the view that those closest to Jooste were unaware of issues which burst so spectacularly into the public arena on Wednesday morning. Most famous of the derivatives bets is the one made by chairman Wiese who, on 6 November, announced through SENS he had acquired 20,000 Steinhoff single stock futures, effectively an exposure to 2m shares, at a price of R61.46. In under a month that has cost him more than R100m. Also, a SENS notice on 4 November shows Steinhoff Group FD Ben la Grange, now working with Wiese to try right the ship, invested R4m in Steinhoff shares at a price of R60.70. Their investments came less than two weeks after the company itself spent R5bn buying back its own shares.

Steinhoff update: Another debt downgrade as creditors edge closer to pulling the plug

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