When Bottom-Up Research Helps Top-Down Understanding
In our search for new ideas, we often come across companies we would never invest in. Steinhoff International (OTCPK:SNHFY) is one of them. It’s a company we’ve encountered on a few occasions over the last year or two, and in each case, it triggered an immediate negative assessment. Nevertheless, there’s a story worth sharing here.
Steinhoff demonstrates some of today’s peculiar business practices that lead to huge wealth creation followed by even quicker wealth destruction. It’s also a textbook example of what an important role monetary policy has played helping such phenomena to continue.
You may have never heard of Steinhoff International – a retailer that took 50 years to build but only two days to collapse, wiping out $10 billion of market value in 48 hours. It’s a South African retail holding company dual-listed in Germany. It has about 6,500 retail outlets in 30 countries covering the globe from Africa, Europe, the United States to Australia and New Zealand. It handles 40 different brands, has 90,000 employees, and brings - or brought - in revenue of almost 20 billion euro.
Bruno Steinhoff started the company in Germany in 1964. It initially sourced furniture from communist Europe to sell in Western Europe. In the late 1990s, the company acquired and then merged with South African retailer Gomma Gomma. It continued acquisitions in Europe – UK’s Homestyle Group, and Conforma – Europe’s second largest retailer of home furnishings.
Two years ago, the company moved its primary listing to the Frankfurt Stock Exchange. It became a German-listed Dutch holding company with management in South Africa.
It kept up its M&A spree and acquired more retailers: Pepkor in South Africa and Poundland in the UK. The deals became bigger and more ambitious. Steinhoff’s acquisition of US-based Mattress Firm for $3.8 billion got our attention. Mattress Firm was an unimpressive roll-up of US mattress retailers. Steinhoff decided to pay a whopping 115% premium to acquire it.
Steinhoff’s market capitalization went from 2.7 billion euro to 22 billion euro in the last seven years with revenue climbing from 4 billion euro to almost 20 billion. The debt increased from under 2 billion euro to 10 billion euro with major payments due in the next few years. As of March 2017, the total exposure to lenders and creditors was estimated at $21 billion (18 billion euro).
When Steinhoff did its US acquisition, we assumed it was betting big with someone else’s money. We had doubts about the strategy which featured the irresponsible use of leverage enabling with very aggressive acquisitions.
On top of obvious questionable managerial decisions, it’s impossible to ignore the role of the ECB’s (European Central Bank) monetary policy in enabling this buying spree.
In the last two years, the ECB’s balance sheet grew from 20% of Europe’s GDP to 40%. Part of the program has been buying investment grade corporate bonds since mid-2016. By becoming a 15%-plus holder of the investment grade market, the ECB not only dramatically depressed yields and compressed spreads - making borrowing even cheaper - but also became a not-so-proud holder of Steinhoff’s bonds.
In early December, the CEO left after an accounting scandal brought the company down. The chief auditor chose not to sign off on the financials, and the company has apparently limited visibility as to profits and cash flows. And now, the Steinhoff debacle is being called the biggest corporate scandal in South African history.
The stock dropped from 6.00 euro to 0.30 euro, bonds are down 50%, credit lines are being cut off, and the ECB has a major dilemma. Should it 1) dump the bonds and speed up the company’s demise, 2) hold on to them, or 3) possibly buy more?
Is the ECB about to bring back to life the Ancient Roman tradition of pollice verso – a thumbs up/thumbs down signal used to pass judgment on a defeated gladiator?
As much as Steinhoff’s accounting may raise questions, what should be said about the ECB’s accounting? How does a central bank account for a drastic loss on an asset acquired with freshly printed money that wasn’t there to begin with? Who will bear the loss? Or maybe if ECB bought worthless assets with imaginary money, nothing really happened after all?
The bonds the ECB holds used to be investment grade, and are about to be downgraded to junk. ECB bond buying policy only covers buying. There is no selling policy in place, least of all for holdings that get downgraded to junk as they hold them.
We can only wonder how many more stories like this have happened because of easy money policies. Steinhoff might just be a sign of the times, and a great lesson for investors: If something looks too good to be true and the story just doesn’t add up - it’s better to pass.
Maybe there's a lesson for policymakers, too. Excessively cheap, easy-money policies that were supposed to stimulate growth and employment can have alarming unforeseen consequences.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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