Steinhoff International, a major global retail conglomerate, based in Stellenbosch, South Africa but with its main listing in Germany, is in trouble. On Wednesday 6th December, CEO and major shareholder, Markus Jooste, resigned amid accounting irregularities, ongoing litigation and possible criminal charges, replaced by his Afrikaaner friend and Steinhoff’s biggest shareholder Christo Wiese. Over the week the company has lost 90% of its previous €14bn market capitalisation with the share price falling from €3.5 to €0.44. There are fears that the company may now default on its liabilities, which are thought to include up to €10bn of gross debt.
We began shorting Steinhoff in March 2017 at €4.77 and continued building a meaningful position. The positive equity story spun by the sell-side  seemed to entirely rely on a blind belief that Jooste and Wiese could apply the secret sauce of Stellenbosch in turning around distinctly average newly acquired international retail assets. To us there appeared no obvious synergies, coherent strategy or attempts to integrate the acquired businesses. There were also numerous other red flags: breath-taking disregard for disclosure and corporate governance; little grasp from management of operational challenges in public communications; ongoing rumours and reports of aggressive accounting policies, tax investigations and litigation by former business partners and lastly a balance sheet bloated by significant debt financing, convertibles and unutilised large reported cash balances. Steinhoff stunk.
Over the past three years, it is estimated that Steinhoff has spent €10bn buying 14 companies, creating a retail empire spanning the globe with 49 different global brands and 25 different businesses, including Poundland (UK), Conforama (France), Pepkor (South Africa), Mattress Firm (US) and Kika-Leiner (Germany). These assets were often acquired in a whack-a-mole buying frenzy for staggeringly generous valuations or hefty premiums to previous share prices and often served to make disclosure increasingly opaque. Basic standards such as reporting like-for-like sales were too challenging whilst newly acquired assets often displayed miraculous reported improvements in profitability without logical explanation. The move to a September from June year accounting for 2017 resulted in a 15-month reporting period. Steinhoff took advantage of the extra three months to raise equity through the listing of its STAR South African subsidiary. This was done via private placement rather than a conventional IPO (which would have necessitated a full prospectus) and before the company attempted (without success) to persuade their auditors to sign off the full year accounts of the parent company.
Steinhoff’s last major acquisition was Mattress Firm (the largest bed retailer in the US in August 2016) for $3.8bn (including $1.4bn in debt). It was symbolic of the shambolic acquisition strategy which Steinhoff had come to embody. After failing to acquire Home Retail in the UK and Darty in France, at the same time it was attempting to complete the Poundland acquisition in the UK, Steinhoff paid a stiff 115% premium for Mattress Firm, a company whose dim prospects did not seem to justify such enthusiasm. After taking control, Jooste, who enjoyed his reputation as a tough negotiator, immediately fell-out with the company’s biggest supplier, Tempur Seeley. Mattress Firm announced that it would no longer be stocking its most popular mattress range that had accounted for up to a third of sales. Consequently, Tempur Seeley began discounting its product through other distribution channels, which when combined with Mattress Firm being short of stock, saw a collapse in current trading and profits at the newly acquired asset just weeks after Steinhoff took control. On the subsequent investor conference call, Steinhoff management played down the severity of the issue and announced that they would be visiting the US in due course to find out what was going on. Whilst near term catalysts to our short thesis centred around trading and earnings, we were also aware that there was either insufficient disclosure for the market to fully grasp the issues or that poor trading in one asset could be brushed off as just one among many assets in the Steinhoff global retail empire. There was no smoking gun.
Developments over the summer of 2017 would, however, refocus on corporate governance issues. An article in German Manager Magazin in August reported that Steinhoff executives including Markus Jooste had been the subject of accounting fraud investigations and police raids. This was dismissed by the company as relating to a dispute with a former joint venture party controlled by Andreas Seifert, which they had already publicly disclosed and made adequate provision for potential compensation. The court ruling on this dispute is thought to be imminent and there is thought to be a risk that Steinhoff may be liable not only for compensation exceeding the existing provision but also potentially equity in the disputed assets Poco and Conforama. It is also not clear whether the German investigation relates to this litigation or Steinhoff’s alleged use of an intellectual property company in Switzerland as a tax shield on its European retail profits. This is thought to be one explanation for why Steinhoff has consistently paid a much lower corporate tax rate (14% in 2016 and 8% in 2015) than any of the companies it has acquired and much lower than the statutory tax rates of 28% in South Africa and over 30% in the company’s main operating jurisdictions (Germany, US, France).
Additional articles in the German press also raised questions about Steinhoff’s use of off-balance sheet vehicles such as Genesis Investment Management (reportedly owned by Jooste) which Steinhoff had funded and used to purchase German furniture retailer Kika-Leiner for €322m, from which Steinhoff then bought its property portfolio for €452m just six months later: a higher price than that which Genesis paid for the whole of Kika-Leiner. Last month, it was reported on Reuters that two years earlier Steinhoff had made a significant acquisition of a minority interest in Swiss holding company GT Branding (alleged to be owned by Steinhoff management beneficiaries) and subsequently also lent it CHF 810m. Steinhoff responded that it was under no obligation to report the transaction despite its meaningful size. In a note published on December 6th, the day of Markus Jooste’s resignation, Viceroy Research Group alleged that Jooste and Wiese habitually used off-balance sheet companies (notably Campion, Southern View and Genesis) of which they were the ultimate beneficiary to siphon off Steinhoff assets. It alleged that most of Steinhoff’s €1bn of investments and loans “are used to fund an off-balance sheet entity’s purchase of loss-making Steinhoff subsidiaries. These off-balance sheet entities are used to obscure losses, inflate earnings and on one occasion, round-trip a predatory loan issuer.” We have no opinion on the validity of these claims.
The obvious critique of Steinhoff’s over-enthusiastic acquisition policy was as a way for Markus Jooste and Christo Wiese to diversify their wealth away from South African political risk. This might explain the motivation behind moving the main listing to Frankfurt in December 2015 through a reverse take-over of a shell company, the recent separate listing of the South African assets, and Wiese’s ongoing attempts to merge his Shoprite African supermarket chain into Steinhoff or more recently the STAR subsidiary. However, the allegations contained in the Viceroy report will likely increase speculation on an alternative explanation: that the regular acquisitions were designed to obfuscate accounting and used as an excuse to raise additional external funding; the €2.5bn raised in September 2016 coinciding with the Mattress Firm and Poundland deals, and the convertible bonds issued in January 2014 for €465m, July 2015 for €1.1bn, April 2016 for €1.1bn. Until the current investigations are completed we can offer no opinion on this matter or what the funds raised were ultimately used for. What is now clear, however, is that if it was Jooste and Wiese’s intention to monetize South African assets via the Steinhoff parent company then this strategy has spectacularly backfired with any recoverable equity value in the Steinhoff parent company now seemingly dependent on the monetisation of its subsidiaries.
Finally, we still do not understand the need for Steinhoff to operate with such a bloated balance sheet. Although Steinhoff last reported €3.8bn of cash on its balance sheet, it is not clear why it recently took a bridging loan of €750m from its own Hemisphere International Properties subsidiary and issued an €800m bond in July 2017 for general purposes given the large cash buffer. We are reminded of the Parmalat scandal of 2003, whereby CEO and major shareholder Calisto Tanzi defaulted on a bond repayment despite reporting more than €4bn of net cash on its balance sheet in an accounting fraud that had been perpetrated for over a decade. At best, Steinhoff’s cash balances look like inefficient balance sheet management but debt investors will now be relieved when the auditors confirm that such cash balances exist. Whilst there are multiple red flags on accounting, corporate governance and capital allocation at Steinhoff we cannot profess to know at this stage the full scale of the wrongdoing. However, we suspect that further details will likely emerge with the investigation, which will then illuminate the motivations of the two main protagonists, Jooste and Wiese. Whether Steinhoff is another Parmalat is unproven but what is clear is that there was never any secret sauce of Stellenbosch.
Barry Norris and Greg Bennett
 Source: Bloomberg Dec 8th 2017. Credit Suisse Dec 6, 2017
 Source: Argonaut. We have this afternoon (December 8th) now completely closed our position.
 Today, of the 18 sell-side analysts who follow the stock, there are, at least officially, 11 buys and no sells.
 Deutsche Bank, November 17, 2016
 Bloomberg, January 30th 2017
 Steinhoff Q1 2017 Conf Call. 28th Feb 2017. Bloomberg Transcript
 Credit Suisse Dec 6, 2017
 Source Bloomberg
 Bloomberg 3rd August 2017 SHFSJ BRIDGE-TL
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