Grenke Leasing Short Attack – First analysis
Long time readers of my blog know that I covered Grenke a while back and unfortunately invested instead in what I thought was the “Australian Grenke” with a pretty bad outcome.
Now Viceroy Research came out with a blazing short attack on Grenke. Viceroy seems to be the same guy that released the now famous “Zatarra Report” on Wirecard in 2016.
This post is a first attempt to look at the allegations in order to find out if they are true and how severe they potentially could be. At the time of writing, Grenke is down more ~ -20% and close to the lows from March.
1. Non disclosed related party transactions
This looks indeed strange. The allegation is that Grenke is buying “franchisees” in foreign jurisdictions from companies that are ultimately controlled by Mr. Grenke himself. If this is the case, then this would be a pretty serious issue despite the fact that the total volume is “only” 100 mn EUR.
In general I think it is also questionable not to consolidate these entities from day one if the sole purpose of these structures is to acquire the company at some point in time. Not sure how this works under IFRS, but this clearly opens up some very creative P&L “opportunities” to put it mildly. Every newly established subsidiary will not be profitable from day one. Instead of showing these losses in the consolidated P&L of Grenke Group, this mechanism allows a “recycling” of losses outside the P&L into Goodwill which is nice but maybe not in the spirit of generally accepted accounting rules.
There is an interesting (German) Video where Grenke among other things explains the “Franchise system” (Minutes 32:00, 36:00):
To me it is pretty clear that the Franchises should be treated as Group companies, independent from the question if Mr. Grenke himself benefits from the sale or not. He even mentiones that the Gorup has “2000 employees including the franchises”.
So it will be very interesting to see how Grenke’s answer will be to those allegations and if they will start consolidating the entities.
2. Grenke Bank support of fraudulent trading operations
Grenke Bank has been processing payments for fraudulent trading operations well after the BAFIN warned against doing so. This could be sloppiness but overall does not shine a very bright light on Grenke Bank controls.
3. Grenkes underlying assets are “dying”
A large percentage of Grenkes assets are items like software licenses, Printers, copy machines etc. which the authors think are “dying assets”. This is clearly a judgement call, however the stated numbers (8k avg price per printer) look indeed strange and the percentage of photocopier assets is indeed high.
4. Low default rates
Claim: 3% default rates are too low, should be more like 10% that are normal for US subprime auto loans.
The default rates are indeed surprisingly low, but the “proof” is weak in my opinion. Bancruptcy laws are very different across countries and making a comparison to US auto loans is a little bit to easy from the authors.
5. Dependence on resellers
85% of Grenke’s business volume is done via resellers, only 15% direct.
Indeed, indirect financing via resellers can become a big issue. My “Australian Grenke” Silver Chef actually got killed by fraudulent resellers. Grenke has been operating more and more in jurisdictions where fraud in general is a bigger issue (Turkey, Brazil) so the risks are clearly increasing.
The report also mentions the specific structure: A Customer has 2 seperate contracts with reseller and Grenke. I am not sure if this is standard or if only Grenke is doing this, but it clearly benefits fraudsters at the expense of customers when something goes wrong.
6. Financing of Ponzi schemes
Claim: Rhino, Viewble and Rebl are schemes where small businesses were sold subscriptions to a TV set that should generate advertisement revenue. However the revenue never came and the hugely expensive Grenke leasing loans (20x the price of the TV set) remained. A similar scheme was operated with charities and schools in UK.
As mentioned above, the dependence on resellers makes fraud clearly more easy. It is mentioned that Grenke was not the only lender in these cases but the fact that they subsequently collaborated with the successor of one busted scheme doesn’t look good. The UK can be quite problematic if they zoom into predatory lending, a fact that UK Banks and subprime lender Provident Financial can clearly testify on.
7. Cash flow statement
Here, the report claims that issuing of Hybrid debt despite having cash is a warning signal.
In my opinion, this is a pretty weak argument as a hybrid is issued to support the capital ratio and not because of cash requirements. This is rather sloppy research from the Shorty.
However, the “Free Cash Flow” reporting of Grenke is clearly misleading as I already mentioned in a post in 2016. This is what I wrote back then:
In Grenke’s case we can read from the balance sheet, that financial liabilities have increased overall by around 400 mn EUR, however financing cashflow is only +13 mn. How can that be ?
The solution is found in the Operating cashflow part: Grenke actually reports the increase in borrowing as operating cash flow. Just out of interest I checked different leasing companies such as Sixt Leasing, Aercap and a few others and Grenke is the only one doing so.
What are the implications of this ?
The implidation of this is very easy: Grenke’s reported cashflows are absolutely meaningless. If you include borrowing into operating cashflow, you can create any free cash flow number you like just by borrowing some more money. This is not the meaning of Free Cash flow.
The fact that they report as such is not a crime, but it clearly means that they show at least some “creativity” when it comes to financial reporting.
As I mentioned back then, a growing asset heavy leasing company always has negative free cash flow, so I never understood how some investors took these numbers seriously,
The report mentions that they have no dedicated CFO and that the “acting CFO” is not registered as public accountant. I don’t think that such a rgeistration is required in Germany, at least I have never heard about it. It is indeed somehow starnge that they don’t have a formal CFO role.
9. High amount of short term refinancing
The report claims that the high amount of annual refinancing is a proof that the business is not profitable. To be honest, I didn’t understand the resoning:
This effectively means Grenke is not making any money from the receivables in its asset book, as the tail end of lease income is assigned to its creditors.
There is clearly operational risk from short term refinancing and I think that is why Grenke has increased cash at HY 2020 so much, but it doesn’t lead to the conclusion of the shortie.
Many of the allegations in my opinion are rather superficial or sloppy, such as mixing up capital requirements and cash requirements.
However the related party / consolidation issue is really critical. If this is true, this alone would make the company uninvestable for me and/or require a much higher discount rate for future profits than the market currently assumes.
To be honest, I don’t find Grenke super transparent anyway, that’s why I never invested in them despite their stellar growth. And yes, the valuation was always an issue, especially branching out into high risk jurisdictions.
On the other hand, the shorties chose a vulnerable target: Everyone knows that Grenke will suffer defaults and their business model relies on the ability to refinance. So false allegations could really hurt the company. From what I have heard, there was unusual activity in short dated, out of the money put options last week. So Viceroy doesn’t only do this because they are Mother Theresa. On top of that, BAFIN will think twice on acting against the short seller, especially with the Wirecard story still unfolding. This “attack” oin Grenke was well thought out and well timed.
However, especially financial businesses need to be run in a way that they can withstand such attacks when they are not true. You can’t just blame the shorties if things go south.
So let’s see how this turns out. Current score: Viceroy: 2 , German Financial growth companies: 0