Wirecard's Fair Value Must Be Reduced After It Lost The Trust Of Its Investors

Summary

• After a long waiting period, KPMG published the final report on the review of Wirecard's balance sheets.
• The company and the market have reacted differently to the report.
• After a long period of waiting, Wirecard published KPMG's final report on the review of Wirecard's balance sheets.
• Wirecard has at least not acted transparently. Wirecard's statement that KPMG has refuted all accusations is also highly euphemistic.
• It will be a long time before Wirecard regains credibility here.

Introduction

After a long period of waiting, Wirecard published KPMG's final report on the review of Wirecard's (OTC:WRCDF; OTCPK:WCAGY) balance sheets. Wirecard commissioned the investigation after the allegations of the Financial Times ("FT"). After the publication, something interesting happened. Wirecard has published on its webpage the report with the following words:

No incriminating evidence was found for the publicly raised accusations of balance sheet manipulation.

So, this is one perspective. Let's take a look at how the market perceived the KPMG report:

Wirecard has lost almost a third of its market value within a short time. This is a clear sign that the market takes a substantially different view of the report than of the company. And this is precisely where the company's major problem lies. So, it is time for an analysis of the different points of view.

The findings on the individual allegations

So, let us first look at the results of the specific allegations. As a reminder, the FT's allegations concerned three areas. Firstly, the handling of the Third-Party Acquiring Partner ("TPA") businesses had been criticized. At the same time, more and more inconsistencies have come to light in the India and Singapore business.

Third-Party Acquiring Partner ("TPA")

In particular, the FT raised the allegation that Wirecard had increased its sales revenues through fictitious customer relations with TPAs. Thus, Wirecard is said to have reported higher consolidated sales revenues and hence an increased consolidated net income due to false customer sales. To proof these allegations, FT contacted 34 customers and found implausibilities indeed. This mainly related to TPAs operating in Ireland and Dubai.

And what did KPMG find out? KPMG was simply unable to make any statement on the amount and existence of revenues from the criticized third-party business in the years 2016 to 2018. KPGM could neither find out that these exist and are correct, nor that they do not exist and are not accurate. This is unsatisfactory because investors had hoped that these practices could be clarified.

But what is much worse are the following circumstances, which KPMG reports. The reason for the lack of clarification was that the necessary documents were in the possession of the third parties. These partners were not prepared to cooperate in the audit. There are still more than 200 million data records to be analyzed in this context. KPMG refers to this as an "obstacle to the investigation".

To speak here of a kind of absolution as Wirecard does is, therefore, really adventurous.

Singapore business

The FT also reported on irregularities in the accounts of subsidiaries in Singapore. The allegations have the following content:

• The subsidiaries are said to have reported revenues too high.
• Contracts and bookings are also said to have been backdated.

KMPG has indeed become aware of at least questionable practices. Software contracts were concluded, "without economic substance". Furthermore, incorrect postings were made, which were corrected by KPMG. KPMG sees no further need for an audit of the Singapore subsidiary. However, the transactions are still subject to official investigations. Documents confiscated in this context could, therefore, bring further inconsistencies to light.

India business

In the course of the KPGM investigations, allegations about business activities in India have also become public. The allegations concerned the acquisition of a company in India. The main allegations are as follows:

• An excessive purchase price was allegedly paid.
• The so-called round-tripping is said to have taken place. "Round-tripping" is a chain of transactions between companies. It is also often used in connection with illegal or undeclared money. Round-tripping might increase the turnover of the companies involved. However, these turnovers are without any real financial benefit.

Again, the results of the report were rather disappointing. The seller simply could not be identified. After all, KPMG found no evidence that members of Wirecard's management were involved on the seller side.

Analysis

The report was definitely a disappointment for investors. They reveal that there were at least severe carelessness and possibly even criminal acts (see the ongoing official investigations in Singapore). KPMG also criticized deficiencies in documentation and organization. However, Wirecard has called on external help to remedy these problems. In my first Wirecard analysis here at Seeking Alpha, I had presented my investment thesis. The background was that I had invested a small position in the company. One argument was that the allegations were not aimed at the very foundation of the company:

...that's not the accusation, it's just individual cases of misconduct. These should of course be eliminated and communication (investor relations) with the public should also be significantly improved. On the other hand, Wirecard also fulfills enough conditions to put such accusations on fertile ground: rapid growth, a complicated network of subsidiaries with a complicated business model. With such a combination, even small inconsistencies in the balance sheet are sufficient [to shake up the stock price]. So that's the bet and the risky part every investor needs to know. A bet on the fact that in the end there were some mistakes which do not affect the fundamental position of the company.

I think that these considerations are still valid. In addition, the KPMG report shows that beyond the known allegations, no other major corpses in Wirecard's basement could probably be discovered. With KPMG and E&Y, two of the best consulting firms are now looking through Wirecard's numbers.

Wirecard has at least not acted transparently. Wirecard's statement that KPMG has refuted all accusations is also highly euphemistic. One might doubt that the company has understood the scope of the report.

Do fundamental metrics still count?

Currently, Wirecard is traded below its fair value P/E ratio. With a fair value P/E ratio of 28 based on 10 years P/E ratio, the stock price should be around USD 170. With an actual price of about USD 98, this indicates an upside potential of almost 85 percent.

(Source: Fair value of Wirecard)

And there are also many indications that the company will continue to achieve a good operating performance.

(Source: Annual results/table by author/taken from previous analysis)

Nor do I believe that the whole company and its foundations are affected by the accusations. KPMG or other audits by E&Y would probably already have brought this to light. But as I stated in my initial analysis: Wirecard remains a risky bet. The risk/return ratio is good, but this does not mean that the risk does not materialize.

Conclusion

An upside potential of 85 percent that is based on the P/E ratio of the last ten years is tempting. However, investors should make a substantial discount for a longer period. The actual fair value is likely to be far below the fair value based on the EPS of the last ten years. Wirecard continuously loses the trust of its investors. It will be a long time before the company regains credibility here. For long-term investors, however, there could be a good risk/opportunity ratio. But as always: The risk increases with the level of opportunities.

Wirecard is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, click "Follow" next to my name at the top of this article or discuss this analysis with me on the TEV blog.

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.