Wirecard Bombs Again Following A Devastating KPMG Special Audit Report

Summary

• More than a year after the Financial Times had launched serious allegations at Wirecard, a highly-anticipated KPMG special audit report was finally released after multiple delays.
• The report is mostly a disaster as it failed to conclusively rule out any balance sheet manipulation at Wirecard and instead contained some crushing language regarding transparency and cooperation.
• As a result, Wirecard's stock dropped over 33% last week and is gearing up for even more selling given that the 2019 financial statements have been postponed again.
• Despite all the negativity in the report and Wirecard's behavior before, during and after the investigation, it also contains one silver lining for investors.

Germany's scandalous stock of 2019 is back with a bang. More than a year after the Financial Times brought forward a series of serious allegations in January 2019 and more than half a year after Wirecard (OTC:WRCDF) (OTCPK:WCAGY) contracted KPMG to conduct a special audit to thoroughly, forensically in some aspects, investigate these allegations, the KPMG special audit report has been released and Wirecard stock managed to punish me and fellow investors yet again.

Source: Wirecard

The report paints a very bleak picture on Wirecard in terms of accounting, reporting and transparency, and while it was not able to find evidence for the publicly raised allegations of balance sheet manipulation, it also was not sufficient to rule them out once and for all.

Wirecard's stock dropped over 33% over the next two days and is currently back where it was a year ago after the FT launched its initial allegations.

Source: Onvista.de

Given that the report so far has only been published in German but is of crucial importance to investors, I am going to paraphrase key messages, opine on them and also provide a much needed silver lining, although Wirecard remains a "black-or-white investment" for me personally.

Objective of the KPMG report

Released on April 27, 2020, once markets closed, the KPMG special audit report was released.

The investigation was triggered by the following allegations against Wirecard published in the press and on the internet:

• Alleged increase in sales revenues through fictitious customer relationships, especially in third-party acquiring (TPA) with a third-party acquiring partner.
• Incorrect presentation of the Merchant Cash Advance business.
• Irregularities in connection with the accounting of subsidiaries in Singapore.
• Allegations concerning business activities in India where an allegedly excessive purchase price was paid to the seller for the acquisition of the payment business and allegations concerning "roundtripping."

It is telling that even KPMG as a specialist in complex accounting practices had to experience some deep learning in order to understand Wirecard's business model in the TPA business since this is where the entire investigation was starting. The report is very comprehensive and goes into great detail regarding KPMG's approach to this investigation as well as its conclusions.

Findings of the KPMG report

Allegations surrounding the TPA business are the most serious, as if true, they would reveal potentially large-scale balance sheet manipulations. These allegations date back to October 2019 when the FT fired a devastating article titled "Wirecard's suspect accounting practices revealed" where it revealed that one of Wirecard's TPA partners, Al Alam Solutions, an intermediary company located in Dubai, is responsible for a substantial part of Wirecard's worldwide EBITDA in 2016 despite having relatively low payment volumes. Notable statements from these and earlier FT articles regarding the TPA business are as follows:

Source: KPMG special audit report

KPMG's findings on these allegations stand in stark contrast to how Wirecard interpreted them stating "no incriminating evidence was found for the publicly raised accusations of balance sheet manipulation". While that is literally true, it does not provide any relief, as according to KPMG, Wirecard and its partners have not been very transparent in providing documents and assisting the investigation and thus KPMG concluded the following:

With regard to the amount and existence of sales revenues from the TPA business relationships between Cardsystems Middle East, Wirecard UK & Ireland and Wirecard Technologies and the relevant TPA partners, KPMG cannot make a statement as a result of the forensic investigation activities carried out with regard to the investigation period 2016 to 2018 that the sales revenues exist and are correct in terms of amount, nor can it make a statement that the sales revenues do not exist and are not correct in terms of amount. This constitutes an obstacle to the investigation.

Source: KPMG special audit report

That's a rather polite way of putting it that KPMG was basically not equipped with what it needed to run the investigation. It is a devastating statement that not only KPMG did not receive that data, but also that apparently Wirecard itself is not able or willing to prove that these sales exist and were accounted for correctly. Wirecard is a multi-billion euro company with thousands of employees and the poster child of the European fintech sector and that such a large business is seemingly running its accounting as reporting as "the shop next door" (no offense here against small business owners where using simple spreadsheets is perfectly fine if your accounting complexity is very low) is in my view disgraceful and unheard of for a DAX company. Make no mistake, this is not just about a minor glitch in transparency, but instead it reveals massive failures in some of Wirecard's core processes and needs to be addressed with the highest priority before even doing more acquisitions further complicating the organizational setup and accounting infrastructure.

I have a strong financial and semi-strong accounting-related background (bachelor in business administration, master in finance and almost seven years as junior and senior controller) paired with technical acumen, so I was shell-shocked when I reviewed the documents the FT uploaded last year as part of its articles. Back then I concluded:

...if indeed those files are authentic and also used as final input for external reporting, then not only are these allegations serious and concerning but also the way Wirecard is technically generating these massive Excel files as they appear to be a huge manual collection of input as fixed values which is always difficult to maintain and validate.

Source: Wirecard vs. Financial Times - The Drama Continues

As bad as this conclusion sounds and appears, it is important to notice that this does not mean that KPMG couldn't find any evidence for any sales revenue, but rather that it was not able to come up with a holistic assessment.

KPMG stated that the Third Party Acquirers had not fully and transparently cooperated in the course of their special audit. According to KPMG's investigations, 13 percent of the revenues in the analyzed period (2016-2018) could not be validated with regard to contract compliance, while numerical calculation and contract compliance could be validated for 75 percent of the revenues of the TPA partners in the analyzed period and plausibility checks could be carried out for 12 percent of the revenues.

While that still leaves a potential black hole of 13% of Wirecard's revenues in the analyzed period representing high-profile accounting fraud if found true, it is much better than what the top-down conclusion actually implies.

Aside from a forensic assessment of Wirecard's TPA partners, KPMG also investigated Wirecard's Digital Lending Business with its Merchant Cash Advance (MCA) product:

Source: KPMG special audit report

In a letter sent to Wirecard's Supervisory Board in mid August 2019, the following allegations were raised:

Source: KPMG special audit report

While KPMG had not reported any irregularities in the presentation of Wirecard's MCA business in Turkey and Brazil (including the stated volumes), the report mentioned €150M and €100M credit lines for TPA partners 1 and 3 in 2018, respectively, which accounted for 88 percent of the stated MCA exposure of €285M at the end of 2018.

Against the background of the information provided on the structure of the MCA business of Wirecard's branches in Turkey and Brazil, no evidence of the legal inadmissibility of the corresponding business activities could be found on the basis of the results of the KPMG investigation

Source: Wirecard Investor Relations

What's going on in India?

Allegations also raised the topic of Wirecard's market entry into India where it allegedly paid an inflated acquisition price, almost 10x higher than what the business cost weeks ago:

Source: KPMG special audit report

As far as this is concerned, KPMG was neither able to identify the beneficial owner of Fund 1 (called "Unternehmen 1" in the chart below) from which Wirecard took over the payment business of the GI Retail Group in 2015 nor able to confirm or falsify that Fund 1 is simply an intermediary. Wirecard AG had declared to KPMG that it did not know the beneficial owner of Fund 1. KPMG, in turn, had declared that no further evidence had been found in the documents submitted or in the investigations conducted by KPMG.

Source: KPMG special audit report

I have no explanation why Wirecard is paying over €300M to make this strategically important market entry into India without really knowing who the beneficiary is. This exposes a total lack of oversight, governance and compliance at Wirecard, and the company needs to seriously improve its processes. While acquiring businesses is important for Wirecard to continue its rapid growth path, due diligence and comprehensive documentation and transparency are key for investors to trust management (ever again). On the positive side though, KPMG at least had found no evidence of roundtripping.

A Silver Lining for Wirecard

So despite a very shady picture the KPMG report is painting on Wirecard, it also provides a much needed silver lining. Given that Wirecard's large TPA business appears like a black hole at this stage due to a complex setup as well as missing documents, meeting minutes, contracts and cooperation from Wirecard's TPA partners and Wirecard itself, KPMG was not able to come up with a holistic assessment.

However, beginning 2019 Wirecard's new "elastic engine" platform was introduced which finally allows reliable end-to-end valuation of third-party transactions. Accordingly, the scope of the audit was extended, but due to the high transaction volumes of 200M rows of data just for December 2019, there was simply not enough time for KPMG to fully review this data set. The good news is that KPMG was still able to release a preliminary assessment which shows that transaction volumes were in line with the partner's accounts and were accurately reflected in the accounts.

So far this ongoing investigation only covers December 2019, but if it concludes that the allegations are unfounded, I am sure it will be extended for other periods in 2019 as well. This could be absolutely crucial to restore confidence and trust among investors and allow the dust to finally settle.

Investor Takeaway

Wirecard's roller-coaster ride continues with the KPMG special audit neither able to falsify nor confirm the serious allegations the company is facing. Actually, the auditors raise more questions than they answer and paint a very bleak picture on Wirecard's transparency and core accounting processes. Such a report does not help to instill trust, instead it will lead to further erosion. It also does not help that Wirecard itself considers it exonerated totally denying reality.

Source: Wallstreet-online.de

It's overdue for Wirecard to stop acting like the shop next door that can handle its accounting and reporting with simple spreadsheets and insufficient documentation and instead act like a DAX company with proper accounting and reporting processes, solid documentation, transparency, responsible governance, oversight and compliance. So far Wirecard is, to different degrees, lacking all of this and in my view needs large-scale external expertise and consulting in order to align its processes with its peers in the DAX family.

That said it is still important to notice two things: 1) these allegations (so far) have not touched Wirecard's fiscal 2019 but only earlier years and 2) a massive silver lining is looming on the horizon if the outcome of the extended audit on December 2019 transaction volumes is positive.

Wirecard remains a "black-or-white investment" with massive upside potential over the long term, but it needs to get its house in order before shareholders can see any relief. I am not sure how long Markus Braun as visionary and CEO can be retained at the top given how Wirecard behaved during the investigation. Right now, Wirecard's Supervisory Board continues to support him, but in big corporations, these things can change quickly. Investors are still waiting for Wirecard's audited financial statements for 2019 which after having been postponed twice will now be released on June 4, 2020. It will be very telling to see what sort of commentary Wirecard's auditor Ernst & Young puts into it.

On my birthday, I made myself a "pleasant" birthday gift and actually added two shares to my holdings at €110 (which was obviously too early given that it tanked into the mid €80s but still better than the €130 where I sold it a few weeks earlier). I continue to believe in Wirecard's strengths such as technological leadership, impressive regional diversification, high profitability and economies of scale, but I have become very skeptical about the over-reliance on its CEO, Markus Braun, who still hasn't managed to establish adequate transparency, compliance and governance communication at Wirecard.

In terms of rating, it would be easy to say I am very bearish given the news environment currently, but that would imply that I expect the stock to fall significantly more. I don't expect that to happen over a one-year horizon provided Wirecard gets its house in order or shows investors that it is humble, understanding the lack of trust investors currently have, learning from this and taking proper action. As long as that does happen in a convincing fashion, this stock is mostly for gamblers and traders and will only remain a small speculative position in my portfolio.

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Analyst’s Disclosure: I am/we are long WRCDF, WCAGY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.

Comments

[TreDrier]

I'm a buyer of Wirecard. I love losing money. LMAO!!!

[ISLAND INVESTOR]

#1 Short Sellers vs. Activist Investors
Activist Investor Christopher Hohn has called on Wirecard AG to remove Chief Executive Officer Markus Braun (bloomberg)

Short sellers’ have one single overriding goal which is maximize financial gains by driving down the price of a particular stock (of Corp 1) that they sold short (short equity). Consequently, they have no interest in any improved organizational structure, processes and business performance of Corp 1.

Activist investors are usually long equity with a single overriding goal of maximizing gains by forcing the board of the particular company to improve the organization, processes, cost structure, balance sheet etc. which should result in an increased share price and creates value for shareholders.

In case of Wirecard, Christopher Hohn is a Short Seller and NOT an Activist Investor! This means that he obviously values the CEO (Dr. Markus Braun) as a critical asset for Wirecard and expects that the CEO’s departure would have a negative impact on Wirecards business / stock price.

Unfortunately, most articles / headlines related to this have been misleading and don’t summarize the intention of short-seller Hohn’s request.

#2 From the huge list of accusations there is only one pending issue left which Wirecard should be able to address within the next couple of weeks.

#3 Communication & Processes need significant improvement. This should be addressed by the supervisory and mgmt. boards after the public response to the KMPG report.

#4 Cooperation between WDI & KPMG was clearly unacceptable. WDI should have assigned a dedicated senior manager to support the KPMG team on completing the report in a timely manner. However, KPMG’s wording does not reflect well on KPMG and might have a negative impact on their business. I would have expected a rational, facts-based report with the usual disclaimers on a single page (without any sugar coating). I have never read such an “emotional” audit report from a Big Four accounting firm which is simply unprofessional.

#5 The most recent pressure on the stock price seems to be primarily driven by an increase in short interest (source S3 Partners). Check the increase in short interest and trading volume during this period. This means that the majority of share holders are not selling at current levels.

#6 The compliance rules set by the FT for WDI should apply to all companies in the payments processing industry. Just looking into this, interesting findings, stay tuned…..

[PHOTIOS]

Behavior “Unheardfull for a DAX company”??

Well, just do some research about the “Deutsche Bank“- and the Penalty they had to pay for admitted fraud in the US Subprime years.

[ms0154]

Yeah this investigation really turned out to be a huge boomerang for Wirecard. I view the internal process and compliance failings as bad but nothing that cannot be solved. Whats worse is that the CEO touted for months how nothing had been found so far leaving investors to believe that they were going to be totally exonerated.

Only for KMPG to then state that they can neither prove or disprove half of the accusations because documents and data aren't available. That kind of communication is not worthy of a DAX company and destroyed a lot of investor trust.

Still positive for the business model of the company provided they get their house in order and KPMG finds that the Dec. 2019 numbers are without issue.

[Stefan Redlich]

@ms0154 Great comment which perfectly summarizes the article in my view, couldn't have said it better. Yeah, the behavior of the CEO is really disgraceful of a DAX company but then he build the whole company from the ground so Wirecard without Markus Braun would be like Tesla without Elon Musk. If you can't fire him, at least make sure he does act so foolishly and the statement from Wirecard today is also no improvement since they are basically saying that none of the allegation were confirmed but that also means none of them have been 100% rejected.

We need that December 2019 full review from KPMG. I think I am going to listen to their annual shareholders meeting if it is broadcast free for everyone ;)

[ms0154]

Well from what I understand, after having read the report, the allegations regarding the Merchant Cash Advance business as well as those centering on the Singapore Unit (Round-tripping) were in fact dis-proven.

The one centering on the Indian unit (again round-tripping) was inconclusive as the financial beneficiary of the PE fund "fund 1" whom they bought the company from isn't known. But they also found no evidence of it being connected to any Wirecard employees and officers so I'll go with innocent unless proven otherwise.

The big fish, however, was the TPA business and here investors were basically slapped hard in the face by all the documents missing, minutes of meetings only being kept since I think 2018?! and data not being available for testing as it wasn't kept in-house and the TPA's are unwilling to provide it. Data protection legislation might certainly be a valid part of the 'why' but it leaves a very very bitter aftertaste and room for even more allegations.

[Stefan Redlich]

@ms0154 Yes, it does. Pressure mounting on CEO Markus Braun to step down from institutional investors like Deka Bank now. He lost all trust and credibility with his entire handling of this crisis and his communication. Just does not live up to any standard in terms of communication, compliance and cooperation. The biggest risk is not that some numbers may be wrong but rather that Wirecard's operational business will get hurt if customers also lose trust.

[Kiril Kapital]

Thanks for the write-up. Why didn't you remove the bullish rating on the stock?

The tail risk lies IMO on outright fraud, and not that Wirecard is not capable of getting its books into order. As such, you can go and buy a lottery ticket, at least it saves you some transaction costs.

[Stefan Redlich]

Well, because I am more bullish than bearish on Wirecard's prospects but I highly dislike how management is still behaving. Supervisory Board needs to step up and they need external consulting and expertise how to manage accounting and reporting processes in such a large firm.

Well, if not even KPMG after an in-depth forensic evaluation can find any material fraud, who else could or should do it? It is a toxic stock and one that totally tortures investors right now for sure but I am not one of those people downgrading a stock when it has just collapsed without at least thinking about a potential brighter future.

What happened, happened, it is time look forward. The preliminary assessment of Dec 2019 is encouraging. Also, Wirecard has large institutional investors, they will make life very uncomfortable for executives, and deservingly so, until they get their house into order.

[F_BIO]

"who else could or should do it?"

maybe someone who can seize forcefully documents, instead of having to ask Wirecard to kindly provide them?

[Kiril Kapital]

So if I had you beliefs, I would pile heavily into Wirecard then.

I would love to own this business, no doubt about it. But not with the potential of it being a fraud.

[thorkild27]

www.wirecard.com/...

[Stefan Redlich]

@thorkild27 We posted at the same time ;) Nice one!

[Stefan Redlich]

Two new developments:
1) KPMG special audit report has been conveniently translated by Wirecard and can be found here: www.wirecard.com/...
2) Wirecard released a statement on that KPMG report here: www.wirecard.com/...

Both happened after I had submitted the article so I couldn't incorporate it anymore but Wirecard remains confident and understandably also stresses the silver lining I mentioned

[FadG]

Regardless the strong operational performance would continue and the mentioned sliver lining will eventually convince investors to be abit forgiving.

[Stefan Redlich]

@FadG Yes, we think alike

[South_of_no_north]

Thank you for this article. I haven’t seen that silver lining, but I agree. Even with that bad news the share price is unlikely to fall below 85€. There might have been wrong behavior but Wirecard is not Luckin Coffee. Greetings from Germany

[Stefan Redlich]

Yeah, everybody is just jumping right into the headline findings and this KPMG quote and that presents opportunity even though not for the faint-hearted ;)

[Dan100k]

Who cares. at worst i see them paying a small fine and business continues.

Cash flow is there, they have billions of money and 30+ per cent growth continues

[F_BIO]

The market does not price a company 50-30% of what its fundamentals would suggest, unless the risk is much bigger that a small fine.

The market is pricing the risk of an Enron-like outcome.

[Dan100k]

Business is very real and doing extremely well. Short sellers and headlines like this are creating exceptional buying opportunity.

[Value Investor90]

I don't see anything more negative come out of this. I'd rather like to read an article on the question: "What is Wirecard's moat?" Greetings from Germany.

[bluescorpion0]

Their moat:
Excellent customer service
Amazing transparency.
World renowned communication
LOL

[Stefan Redlich]

@Stephan Fischer
I continue to believe in Wirecard's strengths such as technological leadership, impressive regional diversification, high profitability and economies of scale, but I have become very skeptical about the over-reliance on its CEO, Markus Braun, who still hasn't managed to establish adequate transparency, compliance and governance communication at Wirecard

[Value Investor90]

What do you mean by "technological leadership"? Obviously this is not the only electronic payment company.

[pointblank]

no offence but all the cheerleaders didn t see the wood for the trees. Imho: Not investible without a complete management overhaul.

[Stefan Redlich]

speculative for sure but given that their business is firing this stock could shoot up as quickly as it dropped if for instance such management overhaul takes place or the extended audit will confirm the preliminary December 2019 results. By then a lot of upside is already gone

[pointblank]

Really amazing - despite of KPMG Forensics (imho) being exceptionally clear, most of the cheerleaders keep ignoring the real issues ...

[F_BIO]

@pointblank can you be more explicit about what Wirecard shareholders are risking in a worst-case scenario?

[bluescorpion0]

very bearish.

[Stefan Redlich]

@scorpion.north You or me?

[bluescorpion0]

Me. They are in over their heads. But their refusal to admit the frauds and or wrong behaviour is troubling. What are they afraid of? or do they really believe their own lies?

[Stefan Redlich]

Surely concerning but it is not as if the whole business was just thin air, KPMG could evaluate 87% of TPA sales and the Dec 2019 preliminary results also are plausible, cash flows exist. Their governance, transparency and maybe even arrogance though is troublesome at this stage but I am confident it will change. It is a toxic stock but once the cure has been found it will change I believe