Investing – it’s not all about the numbers

June 27, 2020

German payment processor Wirecard was one of the hottest technology firms in Europe. In 2018, the company was valued at over €20 billion, more valuable than Deutsche Bank. The company entered the DAX index, a club of 30 major German companies. However, the share price has plummeted in one week by 96% from EUR 103 to EUR 3.5. What can we learn from this episode as Australian small cap investors?

 

 

 

Background

 

In early June 2020, Wirecard delayed the lodgement of its FY19 accounts. EY refused to sign the audit report because €1.9 billion of cash stored in banks operating in Philippines was missing. The two banks in the Philippines then denied having Wirecard as a client, adding that the claimed billions never even entered their country’s financial system.

 

At the same time, €1.3 billion of loans were due within the week. Wirecard was unable to refinance these loans and hence filed for insolvency. The ex-CEO was arrested on suspicion of using fake transactions to inflate the company’s sales.

 

The likes of the Financial Time has targeted Wirecard for suspicious activities for many years Red flags had existed long before this month. As an investor, what can we learn from this incident?

 

Lesson 1: Never trust companies with corporate governance issues

 

This is not the first time Wirecard cooked its books. In 2018, it was accused of accounting fraud in Singapore and other Asian countries. Singapore prosecutors commented that eight Wirecard subsidiaries were under investigation for suspected "forgeries, falsified documents, money laundering, and the round-tripping of funds to support false transactions between 2014 and 2018".

 

The company hired law firm Rajah & Tann to investigate, where it subsequently acknowledged accounting oversights and potential criminal liability among some Singapore staff. However, it didn't find evidence of criminal activity at Wirecard's German headquarters.

 

In response, Wirecard outlined a dozen measures to improve compliance, including the appointment of a new chairman of the supervisory board in 2020. Wirecard’s stock price, which initially fell 40% to €97, recovered to €140 in two months. Investors quickly forgave Wirecard – to their detriment.

 

Lesson 2: Be aware of highly acquisitive firms

 

Wirecard inflated their sales and profits by creating transactions in acquired subsidiaries. The company spent about €1.4 billion acquiring more than 20 companies from 2007 to 2017.

 

Complex cross-border transactions running through multiple subsidiaries were impossible for auditors and regulators to monitor and trace. This problem may be even greater in tech firms where transactions are done digitally.

 

Lesson 3: It’s not all about the numbers

 

Wirecard’s numbers looked fantastic – it posted very fast revenue growth and very strong free cash flow generation. But the numbers were fake.

 

It must have taken Wirecard a lot of brains and effort to hide a fraud of this scale for so long. But as Warren Buffett once said:

 

“When hiring, I look for intelligence, energy and integrity. But if you do ever hire someone without integrity, you’d prefer them to be dumb and lazy!”

 

Happy Investing

Michael

 

 

 

 

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