Last summer, Marc Rubinstein and I collaborated on a blog about Greensill Capital. At the time, Greensill was valued at $3.5 billion, flying high alongside the likes of Revolut and Klarna among the most valuable financial technology companies in Europe. In truth, as we pointed out then, it wasn’t really a fintech, but the company wasn’t shy to promote itself as one and, armed with Softbank investment and a sky-high multiple on sales, it looked like it may have been getting away with it.
Its website cites $143bn of financing in 2020 with 10m+ customers and suppliers in 175 countries. Our look under the surface revealed that all was not right. Founded in 2011 by Lex Greensill, the company was a pioneer in a new field of supply chain finance. I am something of an expert in forensic accounting and Marc has seen a fair few financial companies in his time and we agreed – this was a wrong ‘un. We concluded:
The result is an institution drawn to scandal which itself raises several red flags. No-one comes out of this looking good – not the pioneer, nor its main investor, nor the companies it services.
The incoming correspondence each of us received after publishing was very high. Clearly, Greensill was raising eyebrows far and wide.
This week, Greensill collapsed. On Monday, an important insurance contract underpinning some of the company’s assets didn’t renew; later that day Credit Suisse suspended redemptions on funds linked to Greensill assets; in Australia, the company was refused insolvency protection; in Germany, regulators closed down its bank; and at headquarters in the UK, Greensill began the process of filing for bankruptcy.
In this follow-up blog (yes, for the second time in a week, I have followed up a previous blog), we examine the broader implications of the Greensill saga unwinding.
First, we look at what we can learn as generalist analysts and examine the accounting angle. We then examine this through the lens of a financial analyst.
THE ACCOUNTING ANGLE
One of the reservations we have expressed about Greensill (and supply chain finance in general) is that the practice helps companies disguise their true cash generation capacity and levels of working capital from investors and lenders. One of the elements of the second blog we had been working on was which companies were engaged in this practice, so we thought it might be interesting to name and shame them now.
Really, we should not have to worry about this. US GAAP is slightly better than IFRS in this respect, as certain disclosures are required but it’s beyond comprehension that the accounting authorities are expending massive effort (and companies are spending huge amounts of money) on nonsense like IFRS 16 (blog upcoming) when simple and obvious issues like the disclosure of the use of supply chain finance is not required.
Companies can factor or sell forward their receivables or engage in reverse factoring of payables and make no mention of it in their accounts – this seems crazy. In the US, the cash generated from the sale of receivables is generally disclosed separately as a cash flow from financing. Elsewhere, this is (inaccurately) treated as an element of operating cash flow, and as it’s not disclosed, investors have no clue as to its significance.
CREDIT SUISSE FUNDS – LATEST POSITION
We looked at the summary sheet for a Credit Suisse fund which invests in Greensill originated supply chain finance receivables. It had had net assets of $6.8bn as at January, 2021, and its top 10 positions were disclosed as:
Shipping company MSC is private and unquoted with limited financial data available. Shop Direct is part of Very which had over £2bn of debtors for its (former catalogue and now online) credit business. Tradeshift appears to be some form of trade network, Guazi is a Chinese e-commerce company, while Primevere Limited is a UK fulfilment centre with £4m of sales. BCC Bingera and BCC Fairymead were hard to find via Google although both appear to be villages in Bundaberg in Australia, Lex Greensill’s home town. It looks like these are probably some form of Greensill SPV – but 2 in the top 10 list, really?
Many regular readers will recognise Oyo, the Indian hotelier backed by Softbank, which we expect will be the next shoe to drop, landing its founder, who borrowed $2bn to increase his stake, in some hot water. Oyo Hospitality UK Ltd had sales in the last filed accounts covering the 7 month period to March, 2019 of £20k and £2k of trade debtors, but the share capital has since increased to £350m. Glass manufacturer View Inc is also Softbank backed, according to the Wall Street Journal which listed Oyo, View, auto finance company Fair Financial and Chinese online car trading platform Chehaoduo as former Softbank-related top 10 recipients of Greensill financing.
Most will know Deutsche Boerse, and the WSJ article explains that Greensill used the CS funds to make a loan to its investor General Atlantic, which “ used the loan to fund the acquisition of shares in a joint venture with German exchange operator Deutsche Börse AG”. This may help to explain why Deutsche Boerse, which only had $447m of trade receivables at end-19, would be a top 10 position in the fund with nearly $100m of supply chain finance.
We only recognised 4 of the top 10 customers; 2 might be a decent credit risk (if we understood the Deutsche Boerse rationale for borrowing in this way), one would require some due diligence, and one would be a high risk credit. We had not heard of 6 of the companies and 2 appear to be odd vehicles with a potential connection to Greensill’s founder. Many advisers and private investors would look at that top 10 list of credits and would rule this uninvestible – 10 minutes’ work. This raises two questions:
To whom was Credit Suisse selling this potentially toxic cocktail?
What was Credit Suisse thinking?
Given that the credits are sourced by Greensill, the precise role of the Credit Suisse portfolio managers is not clear to us. The senior fund manager according to the marketing documentation is an experienced manager and is a CFA charterholder (as is one of the other two managers). For those of you unfamiliar, CFA stands for Chartered Financial Analyst………hmmm.
(Full disclosure: I have a product which “competes” with the CFA, the Analyst Academy. In my jaundiced opinion, mine is the better product if you are interested in acquiring real analytical skills, but the CFA gives you letters after your name).
POSITIONS AT LAST MAIN REPORT
In order to look more closely at the sort of quoted companies which have been using the Greensill facility to move working capital off their balance sheet, we used the October 2019 report for the funds which has granular lists of every position held at the year-end. This gave us some interesting clues. We found a number of quoted company subsdiaries listed in the last published detailed statement of assets. This is slightly trickier to analyse as there are around 1500 entries, but there were a few interesting highlights:
First to catch our eye was Astra Zeneca. There were only around $25m of receivables securitised vs $3.6bn for the group. But this is a company whose lack of cash generation has been a notable characteristic for many years – see the report in the Behind the Balance Sheet Club library.
More significant were Kellogg, Vodafone, General Mills, Newell Brands and NMC Healthcare. Like Astra Zeneca, the numbers for Kellogg are tiny (0.5% of debtors) but Kellogg is another company whose working capital trends have been adverse:
The securitisation for Kellogg is not material either to working capital or cash from operations, being less than 1%. But it demonstrates intent, and we believe that is an important indicator of whether you should feel comfortable about the stock.
At the other extreme is failed hospital operator NMC Health – it appears to have had two subsidiaries securitising obligations, NMC Healthcare and Emirates Hospital Group – between them, the fund had over $100m of exposure, or 18% of the last reported accounts receivable and 26% of cash from operations. Care is required in the comparison of cash from operations, as the securitisation may have occurred over a period of more than one year so it would be better to look at cumulative cash generation, but if this occurred over 2-3 years, the ratio would be 13% or 9% – still highly significant.
NMC has already failed but using this data would have been a helpful indicator. The charts show some other groups which have been involved – Vodafone, General Mills and Newell Brands – with the significance to the accounts receivable balance (a more standardised scalar than payables) and to operating cash flow. We have used the closest year end and would again emphasise the cumulative cash flow would be a better tool, but we would need more data.
Vodafone is a separate story – as we explained last time, “The Vodafone controversy. Bloomberg reported last year that as well as throwing its invoices into a Greensill-sponsored supply chain finance fund, Vodafone also participated as an investor. In this way it acted as both a lender and a borrower in the transactions. It has been reported that at the end of 2018 Vodafone had a €1 billion investment in the fund. Vodafone’s treasurer later went to work as Greensill’s CFO.”
We were quite surprised by General Mills, however, as this is a high level of securitisation relative to the other quoted companies we examined. At General Mills, debt is 25% of the EV, so not extreme. Given that the end investor receives LIBOR + 175bps, and there are layers of fees (Credit Suisse, Greensill, the credit insurer, and perhaps others) on top to the borrower, this would presumably a strategy to employ primarily if you have difficulty borrowing by conventional means; the alternative explanation would be if you were trying to flatter your reported numbers. To be clear, we don’t mean to imply that any of the companies mentioned here would be engaged in such activities (perish the thought!) – we reserve such reservations for our Forensic Accounting Course where we list live examples.
Looking at the General Mills accounting policies, the Revenue Recognition Note says “Receivables from customers generally do not bear interest. Payment terms and collection patterns are short-term, and vary around the world and by channel, and as such, we do not have any significant financing components”. On the payables side, the MD&A notes the change in working capital “… driven by a $413 million change in the timing of accounts payable, including the impact of longer payment terms…” They also note that they use an online service for suppliers that allows them to view scheduled payments and have access to financing arrangements, but that the accounts payable is unchanged. Hence, the group looks to be using supply chain financing to improve operating cash flow and reduce capital employed.
Newell Brands and Henkel are at a lower level but again we would question why they were employing this financing strategy and ask what else they are doing – this is exactly the type of situation where at a hedge fund, I would have expended some effort in looking at the potential short case.
The numbers are less significant to cash generated and as this is a cumulative effect it’s hard to conclude that, with the clear exception of NMC, there has been a distortion of cash generation.
CONCLUSION ON THE ACCOUNTING ANGLE
As noted, both Marc and I received a considerable amount of inbound comment following the last Greensill blog, enough to make us feel like investigative journalists. Some of the stories involved made us sit up in wonder and our conviction that there were serious issues at Greensill was confirmed.
But Greensill was not quoted and did not attract the interest of short sellers. They should have been looking as the customers were risky, but there was no obvious way to make money via a direct short of Greensill.
We have three main takeaways:
What was Softbank doing? A 10 minute scan was enough due diligence to indicate that Greensill was not worth $1bn, let alone $3.5bn.
Why are the accounting authorities vascillating? Factoring needs to be disclosed in accounts immediately.
Fewer companies are listing than ever before. A hidden consequence is that unquoted companies are not subject to market scrutiny and therefore we should expect more events like the demise of Greensill. Let’s see what happens with the Gupta empire.
There are many other questions, like who was investing in this toxic fund? We believe that it was a high ticket entry and professional investors should have been asking these obvious questions. We also wonder what made the credit insurers withdraw cover, but then why did they extend it in the first place? Interestingly, Steve starts a Forensic Accounting Course next week for his second credit insurance client, probably more will be in the queue. Every cloud etc………
We now turn to Greensill through the lens of a financial analyst:
GREENSILL THROUGH A FINANCIAL ANALYST’S LENS
Financial companies go bust surprisingly often. In the past six months, two banks in America have failed – one in Florida and one in Kansas. In the past five years, over twenty have gone down. In some respects, these are more interesting failures than the ones that get caught in the downdraught of a financial crisis. The environment looks fine, there’s plenty of liquidity sloshing around and yet, in spite of that supportive backdrop … plop.
The demise of Greensill provides a case study of what can go wrong for a financial company when all around it is going right.
TWO SIDED PLATFORM
Most financial companies operate two-sided platforms. They take money in on the one side and invest it out on the other. This can create imbalances – it’s very difficult keeping both sides spinning in sync. Marketplace lenders failed to find the equilibrium. When they came to market, firms like Lending Club and Funding Circle saw plenty of demand from people wanting to borrow money but not enough money coming in to fund it. They recruited institutional capital, but that tipped the scales too far the other way, so they loosened lending standards to create more demand.
Banks get around this problem by inserting themselves between the two sides. Depositors don’t even have to worry what is happening on the other side of the balance sheet because deposit insurance creates a firewall. The bank can ratchet up or down its lending standards all it likes, and the depositor is guaranteed their first $250,000 / €100,000 / £85,000 back. Deposit insurance makes owning a bank quite attractive, a point not lost on Greensill, who bought one in 2014.
But Lex Greensill’s ambitions went beyond the perimeter of his bank’s balance sheet, so he still needed to address the challenge of growing his funding sources and growing his pools of demand – and doing them at the same time. His solution was to operate on both sides of the book:
· He won over Vodafone as a customer of his core supply-chain finance product but also got Vodafone to participate as an investor. (And to cement the bond further, he hired Vodafone’s treasurer as his CFO.)
· He funded Softbank portfolio companies with money provided by … Softbank. (All while Softbank was also an investor in Greensill.)
In each case, funding was withdrawn once it had been exposed by the press. But not before it had represented the market as bigger than it was and flattered Greensill’s position within it. And if these seem like conflicts of interest, they are just the tip of the iceberg.
CONFLICTS OF INTEREST
There’s a saying in financial services, “one man’s synergies are another man’s conflicts of interest.”
In Greensill’s case, there is little confusion:
💥 Between September 2016 and May 2018, Swiss asset manager GAM became a very large investor in Greensill-sponsored assets. But it also channeled funds into Greensill itself. In fact, the relationship between GAM and Greensill was very cosy: Greensill invested in GAM funds, it lavished the GAM portfolio manager with gifts and GAM’s former CEO was a senior advisor, prior to the investing relationship.
💥 Even after the GAM scandal blew up, causing enormous collateral damage for GAM, Credit Suisse doesn’t seem to have been put off from doing business with Greensill. Lex Greensill is a private banking customer of Credit Suisse and the bank was happy to structure funds around Greensill-sponsored assets which it marketed to clients. It was the suspension of these funds earlier in the week that triggered the group’s downfall. Credit Suisse had also been involved in Greensill’s IPO plans, and lent the company $140 million as a bridge to IPO.
💥 Pull on any thread in the Greensill story and you eventually get to Sanjeev Gupta and his company, GFG Alliance. No other company has been as big a user of Greensill’s financing solutions as GFG Alliance. The Financial Times has reported that as much as half the assets on the €3.5 billion balance sheet of Greensill’s German bank might be Gupta-related; the Australian Financial Review reported that at one point around a third of the financing for a local Gupta business came from Greensill. In the UK, Greensill channeled government-guaranteed coronavirus business interruption loans to Gupta.And guess what? Sanjeev Gupta used to be a shareholder of Greensill.
In some countries, a legal separation is imposed between commerce and banking to eliminate conflicts that can arise if an industrialist has access to his own bank. In the US, the separation was introduced in the National Bank Act of 1863. The board of Greensill recognised the conflict in 2016 and Gupta agreed to sell his shares back to the founders. But the ‘synergy’ remained: Gupta was hungry for financing and Greensill was hungry to give it.
After he’d sold his shares in Greensill back to the founders, Gupta bought his own bank which he named Wyelands, after his Welsh country estate. “It is part of his vision to support industrial business growth in the UK and around the world, where there is so much untapped potential for growth,” says the website. Yet a lot of Wyelands’ lending found its way into Gupta-controlled companies. UK regulators started looking around, and this week ordered the bank to repay all of its depositors.
The Gupta part of the story is still unravelling, but in his capture of Greensill and Wyelands, it shares many similarities with banking scandals across the world. In 2019, the Punjab and Maharashtra Cooperative Bank in India collapsed after allocating almost three quarters of its loan book to one client – Housing Development and Infrastructure Ltd (HDIL), owned by the Wadhawan family. These banks breach a golden rule of risk management: concentration risk.
Diversification is one of the most basic principles of finance. The European Banking Authority is not underplaying it when it states, “concentration is one of the main possible causes of major losses in a credit institution.”
In order to shield investors from potential losses, Credit Suisse, as a manager of Greensill-sponsored assets, took out credit insurance. Like any good risk manager, Credit Suisse knew to spread even that risk among multiple insurance carriers. It imposed a 20% exposure limit to a single insurer. Unfortunately, it didn’t stick to its own guidelines. Its biggest insurer supplied coverage over 40% of its portfolio, a figure that rose to 75% by July 2020.
It turns out that the insurer breached its own limits. An employee, who has been named in court documents, was fired last summer for signing off on numerous unauthorised policies. When this came to light and the insurer refused to renew, Greensill was left scrabbling around looking for cover.
The demise of Greensill reflects excessive concentration around a few credit exposures like the Gupta group of companies as well as excessive concentration on a few insurance carriers. Why Greensill needed the insurance at all is the next question to ask.
Underwriting credit risk is hard work and like any work that’s hard, people sometimes take short cuts. Last week we discussed Citigroup. In the late 1980s, the bank lent heavily to less-developed countries. When Fed chairman Paul Volcker expressed concerns, Citi’s CEO, Walter Wriston replied: “They’re the best loans I have. Sovereign nations don’t go bankrupt.” (Spoiler: they do, and they did.)
Greensill may have felt less pressure to do the work because of its recourse to insurance.
Yet its underlying credit record is pretty poor. In the past couple of years, at least three Greensill clients have gone bust. These include hospital operator NMC Health, retailer BrightHouse and Singaporean commodities trader Agitrade. Credit insurance placed a veneer over the portfolio and allowed funds managed by Credit Suisse to post stable returns. But as the Governor of the Reserve Bank of India once said, “You can put lipstick on a pig but it doesn’t become a princess.”
Just as monopolists won’t admit it while non-monopolists envy it, a similar dynamic plays out among financial companies. Those too-big-to-fail will do what they can to minimise the look; everyone else puffs themselves up. When Greensill was in court earlier this week arguing for its life, it suggested that its failure could “trigger further adverse consequences” leading to the loss of 50,000 jobs worldwide.
That seems like a bit of an exaggeration, but there will be spillovers, as we discussed earlier when looking at the customer base.
Lord Myners probably put it best when he said last year, “I have taken an interest in Greensill for more than a year. The explosive growth of Greensill in a competitive sector is intriguing.”
When it comes to financial companies, growth is not necessarily good and when it comes quickly, it’s time to ask questions.
Growth can be particularly dangerous in the financial sector, but it brings risk whatever the sector – the most dangerous companies are often the fastest growers whose growth falters – that’s a key signal for a fraud to start as we explain in our Forensic Accounting Course.
And investors should always question what they are investing in. The more novel the fund, the more you should ask, why, who, and who gets the money? As the Economist notes, “Creative forms of financing work best when they rely on conservative accounting”.
Thanks to Marc for another fun collaboration – I find writing the blog quite hard work, and don’t like exposing myself to the world for criticism – it feels a little like running around naked sometimes! But collaboration is quite another matter. So if you have an idea for Marc and I to work on, or if you would like to work on a blog with me, it’s half the work and twice the fun, so get in touch! (E: firstname.lastname@example.org or use button below)