Last December, former investment banker Heather Sonn parachuted into what must be a shoo-in for the worst job in SA today: chair of teetering furniture retailer Steinhoff International.
It was at the height of the hurricane, 10 days after CEO Markus Jooste quit and the company admitted to unspecified "accounting irregularities", which sparked an 82% slide in its value.
It was the most rapid destruction in value at a JSE-listed company in recent memory, as more than R160bn was erased within days — much of it from pension funds.
"Basically, it was your worst nightmare," Sonn told the Financial Mail this week. "To walk into a situation like that, and realise what had happened, is not something I’d wish on anyone. To have that sense of betrayal of trust from senior members of management is just horrible."
To describe it as a baptism of fire for the 46-year-old, who began her career working in the cauldron that was Merrill Lynch in New York in 1997, doesn’t reflect the full immensity of the challenge she took on when Christo Wiese quit as Steinhoff’s chair.
Only a few weeks before, Sonn had been lecturing accounting students at the University of Cape Town (she earned a master’s degree in international affairs at Georgetown University in the 1990s) and one student asked to what extent a board of directors should place unqualified trust in a company’s management.
Sonn answered that the last mile between the CEO and the board was entirely about trust: at some point, a director won’t know everything — he or she has to trust the CEO.
Steinhoff today is the ultimate cautionary tale of what can go wrong with that theory.
Jooste, according to those close to the forensic investigation, is seen as the pivotal figure in systemic fraud that dates back years.
At last week’s AGM in Amsterdam, Steinhoff confirmed the worst fears of many investors: the deception was far more extensive than anyone realised.
Investigators from PwC have "confirmed a pattern of transactions undertaken over a number of years, across a variety of asset classes that led to the material overstatement of income and asset values of the group".
Initially, in December, Steinhoff said the size of the "hole" in its accounts was about €6bn. But insiders close to the forensic investigators who’re picking through the mess tell the Financial Mail that they have since discovered numerous other frauds.
The upshot: the "hole" is now likely to be billions deeper than that initial €6bn.
The comparison between Steinhoff and Enron, the Houston-based energy company that went bankrupt in 2001 after systemic accounting fraud was discovered, seems irresistible.
"At Steinhoff, I believe there was purposeful deceit where certain people went to great lengths to misrepresent the financial statements, in collusion with others," Sonn says. "If that’s how you characterise what happened at Enron, then it’s comparable."
While Enron lost US$67bn in value in a year (R693bn at the time), there are other similarities — not least the fact that both companies were among the top 40 listed stocks in the US and SA, respectively, at the time of their collapse.
Enron created a series of companies that weren’t included on its balance sheet (as Enron held less than 51%) yet which held huge amounts of its liabilities. The point was to make Enron seem far more profitable than it actually was.
Right now, Steinhoff has disclosed little about what the 60 PwC investigators have found, largely because lawyers have advised them not to expose themselves.
However, the Financial Mail has spoken to a number of people close to the investigation, who sketch a picture of alarming, systemic fraud that dates back more than a decade. At the centre of it, allegedly, appear to be Jooste, Siegmar Schmidt, who was chief financial officer of Steinhoff Europe until 2013 and his successor, Dirk Schreiber.
Says one source: "There was a pattern of forged documents, contracts designed for a specific purpose, and misrepresentations, originating in Europe. A few trusted individuals close to Markus were used to perform these transactions, without exposing that they were ‘related’ parties."
Another insider says new details are emerging almost every week.
"It’s been going on for years, and it seems there were about three or so basic recipes used often to paint a misleading picture of the accounts – it was repeated when it came to property transactions, branding transactions, and a few others."
The recipe would be a variation on a theme. To use a simple example, Jooste would allegedly lend money to a company domiciled in Europe. However, it was never disclosed that the European company was run by a related party close to Jooste, which would require far more scrutiny from auditors.
Steinhoff would then charge interest on that loan, which it would recognise in the income statement as revenue. But for all intents and purposes, it was a fictitious debtor: that main debt would never be repaid. Ingeniously, through some fancy footwork using "guarantees" in Europe, that debt would then be classified as "cash and cash equivalents" in Steinhoff’s books.
This is important, since one obvious red flag for accounting fraud is when a company’s operating cash flow doesn’t match the profit it reports in its books. Masked as "cash equivalents", these loans didn’t arouse suspicions. So in 2016, for example, there was no major discrepancy between Steinhoff’s operating profit of €1.8bn and its operating cash flow that year of €2.03bn.
But that growing balance of fictitious "cash and cash equivalents" needed to be hidden somewhere. So, Steinhoff would then typically do another deal that would effectively allow it to reclassify that debt into an "intangible asset" on its balance sheet.
The bottom line: Steinhoff’s revenue was artificially inflated, and so were its assets.
One insider says that at this point, it doesn’t seem the main goal was for the fraudsters to steal money personally. "Primarily, it was about manufacturing a false picture of Steinhoff’s performance and earnings to perpetuate this story about the phenomenal growth. Of course, some of those may have made some money personally in the process, but it seems the goal was to inflate Steinhoff’s numbers."
Other insiders doubt this, believing the perpetrators must have made money along the way. The PwC investigation, which is only likely to be finished by the end of the year, will provide the final verdict.
In December, an independent committee was set up consisting of Sonn, audit committee chair Steve Booysen and Sanlam chair Johan van Zyl (who resigned before the AGM). They spoke daily, often working 20-hour days to determine how deep the cancer went.
For context, consider that the board had met only four times the previous year; yet between December and February, Sonn’s committee had 20 formal meetings. In those three months, Steinhoff’s board committees met no less than 63 times.
"It really has required everything I have — all my skill, all my preparation, everything I have learnt," says Sonn today. "But it has been a peak experience too, as there hasn’t been much time to reflect on what was happening. It was just about fighting this fire, then moving to the next one."
It wasn’t that Sonn didn’t have the experience. Besides Merrill Lynch, she’d had stints at Sanlam Investments, been CEO of Legae Securities, and been on numerous other boards, including financial services firm Prescient, construction firm Esor and the Nelson Mandela Foundation.
It’s just that it was uncharted territory: nobody in SA had chaired a company of comparable size at the centre of the country’s largest corporate fraud.
While she’d joined Steinhoff in 2013, her father, academic and anti-apartheid activist, Franklin Sonn, had been on the board for years. He’d been the SA ambassador to the US but when he retired, Jooste asked him to be a nonexecutive director. When Franklin Sonn retired, one of the names he proposed to take his place was that of his daughter. "I was keen, really interested in how large SA corporates worked," she says.
She could never have foreseen the burning building that would be Steinhoff five years later.
"There’s so much going on that we’re all just batting every day. I know that, as chair, eventually all decisions will come past my desk. But it’s a hectic environment, where the simple matter of trust between colleagues is broken. A lot of work must be done to fix that," she says.
Of course, there had been plenty of warning signs prior to December’s crash.
As Allan Gray portfolio manager Leonard Krüger wrote last week: "Numerous warning signs and inexplicable actions flagged Steinhoff as a high-risk and below-average prospective investment" before its crash.
This included a sharp rise in the number of shares issued by Steinhoff to buy companies, which was accompanied by a spike in debt and intangible assets.
"Important shareholder metrics, like return on equity [ROE] and growth in earnings per share were uninspiring. ROE declined from 20% in 2007 to only 9% in 2017 and earnings grew by only 17% in euros, or 1.6% per year."
In 2007, JPMorgan analyst Sean Holmes published a 56-page report, advising investors to steer clear. He spoke of Steinhoff’s "pattern of aggressive accounting treatment", its "unnervingly" poor disclosure, a "disturbing" spate of acquisitions to "paper over the cracks" and an "unusual emphasis" on minimising its taxes.
Then in 2009, Craig Butters, who co-manages Prudential’s Dividend Maximiser and Core Value funds, met with Wiese to warn him that Steinhoff’s success story was not all it was cracked up to be. Up to 40% of its earnings were of poor quality, he said.
The problem is that Steinhoff’s survival, at this point, is not guaranteed.
At the moment, it has €10.4bn (R156bn) in debt, and a market value of just R8.4bn. Bankers who were relaxed a year ago when Steinhoff’s value was around R300bn are biting their nails over a debt-to-equity ratio that would break a thousand covenants.
For the year to September 2016 (its last audited numbers), Steinhoff paid €215m in interest and other finance charges, at a time when it reported aftertax profit of €2.1bn. But those financials now all carry a stamp saying "information can no longer be relied upon".
But this equation will change radically in the next set of financial results, partly because the low debt charges will have risen sharply, as Steinhoff has had to scramble to convince lenders to give it more money. Its revenue for its next set of financials is also likely to be sharply lower than 2016, as it unwinds the fraudulently inflated numbers, and there is likely to be a big impairment for all the intangible assets that will have to be written off.
In this context, it’s no wonder that at last week’s AGM, Steinhoff finance director Philip Dieperink said the company was speaking to its lenders on a daily basis, and it was "both delicate and challenging" to ensure all Steinhoff’s tentacles had enough cash.
But if Sonn’s team thought they’d figured out a balancing act for that tightrope, their task suddenly became more difficult last week — thanks to a curve ball last week from her predecessor, Wiese.
On the eve of the 24th anniversary of SA’s first democratic election, Wiese served a summons on Steinhoff for R59bn — the largest claim yet from a single shareholder in SA corporate history.
It was a stunning act considering that Wiese, until he was replaced by Sonn, chaired Steinhoff and had been its largest shareholder, holding 23%. Until December, Wiese had backed Jooste to the hilt, famously describing the claims against him in Germany as "drivel".
Speaking to the Financial Mail, Wiese says it isn’t about extracting R59bn from Steinhoff (which it couldn’t afford to pay now anyway), but rather about staking a claim so he gets a seat at the table when it comes to the restructuring.
"That’s absolutely what it is about: so that I am part of the discussions around the restructuring process," he says.
But the revelation of his claim has been greeted with some raised eyebrows — another investor describes it as "chutzpah on steroids" — given his role as chair and how close he was to Jooste.
Says independent analyst Syd Vianello: "It’ll be tricky for Wiese to prove this. If I were the board, I’d say to Wiese, go to court and prove this claim, because you were the chair — it could be in court for years."
But Wiese says any suggestion that he knew about shenanigans with the accounts is rubbish. "It’s just obvious stupidity, really. How could anyone seriously suggest I knew the books were cooked, yet still decided to invest R59bn? I would have to be certifiable."
However, the suggestion is really more nuanced: should Wiese, as the chair, not have known what was going on? Should the entire board, for that matter, not have known?
On this point, Wiese points out he wasn’t the only one duped. "If I should have known, then what about all the other people who looked at it? What about the auditors, the bankers and the analysts — how come they didn’t know? Look, I have sympathy for people who feel hurt and betrayed, but really, how could I have known?"
Intriguingly, asked if there was anything he’d do differently today at Steinhoff, in hindsight, Wiese can’t highlight anything.
"It sounds horrific to say this, but I have to say I don’t know what I’d do differently. All the right structures were in place, the right reporting structures, and the auditors signed everything off. It was the only board I know of where all three members of the audit committee had doctorates in accounting."
While Wiese concedes some similarities to Enron, he says there are differences too.
"It’s similar in that both companies had audit problems that slipped past the auditors for year after year. But it’s also different in that Steinhoff does actually have good businesses. In Enron, there weren’t real assets. As with Bernie Madoff.
"It was all just smoke and mirrors."
Steinhoff’s debt:equity ratio breaks a number of covenants and its survival is by no means guaranteed
— What it means
Enron did, however, have a few real assets, like its natural gas pipelines. Its subsidiary, Northern Natural Gas, was eventually bought from the Enron ashes and today forms part of Warren Buffett’s Berkshire Hathaway group.
Wiese is right that Steinhoff does have some solid assets. The best of them are located in the Pepkor group, sold to Steinhoff in 2014 for R68bn — a transaction that was the springboard for the bulk of Wiese’s investment in Jooste’s company.
Those assets, including Pep and Ackermans, are now in Steinhoff Africa Retail (Star), of which Steinhoff now owns 71%.
"Obviously, had I known what was happening at Steinhoff, I would never have done that deal. But there was no way to know," says Wiese.
This is the central point of his legal claim: effectively, he swapped his Pep stake into Steinhoff based on a misrepresentation that Steinhoff’s financials painted an accurate picture of how the company was doing. As we know now, that wasn’t so.
It’s been a huge blow to Wiese, both in monetary terms (he lost half his wealth), and from a confidence perspective.
"Of course in a business sense, it’s the worst thing that’s happened to me," he says.
"But also it makes you doubt yourself. People have often told me that I’ve chosen good colleagues over 50 years, and I felt it was justified. But now when this happens, it makes you ask, how did I get it so wrong?"
Like Sonn, he believes there’s really no alternative to trusting management.
"Look, I’ve built businesses that operated in 25 countries and employ 200,000 people. You just can’t build a business unless you trust the people running them. It may carry huge risks to trust your management team, but actually, to distrust them carries even more risk," he says.
If Wiese’s legal gambit is to secure a seat at the restructuring table, he will be only one of the people whose view will be important. Those who lent Steinhoff €10.4bn will also be at the table. And intriguingly, about half of Steinhoff’s current lenders are "hedge funds".
Dealing with hedge funds has, acting CEO Danie van der Merwe acknowledged at the AGM, introduced a new dynamic. But at the moment it’s working, he says.
This month Steinhoff will sit down with the lenders to present its restructuring plan, and hear their thoughts. If Sonn’s team succeeds, stability will be restored.
One of the more likely options is that the lenders will convert their debt into shares in the "new Steinhoff".
But it’s no easy task. Sonn says it can’t just be a plan to save the company — the restructuring plan must provide a raison d’être for Steinhoff’s existence, illustrating a compelling vision for the future.
"Anyone can read a textbook and say, you need to sell enough assets to repay some debt, and get to a situation where you have enough cash-generating assets to service the rest of that debt. But that doesn’t tell you what the Steinhoff of the future will be."
Until now, its goal was to be the "number one retailer of choice by households, for quality and value".
We’re not just selling everything we can and winding up. That isn’t on the cards
— Heather Sonn
Analysts say the most likely options include:
Potentially reducing its 71% stake in Star, which owns the Southern African retailers Pep and Ackermans, to 51%, or selling it entirely;
• In Europe, selling its property portfolio (worth €5.4bn) as well as shedding some of the poorly performing brands;
• Getting rid of Steinhoff’s 26% of KAP and its 2.5% of PSG; and
• Selling off Mattress Firm, the US company which Steinhoff bought only two years ago for the sky-high price of $2.4bn. Analysts believe it will have to sell Mattress Firm for about half what it paid.
The problem is that Star would be the easiest to offload, but it’s one of the better assets. For the three months to February, its revenue actually grew 8%, while Mattress Firm’s revenue plunged 16% to €638m.
French chain Conforama’s revenue dropped 1% to €1bn, while the revenue of the UK business, which includes Poundland, fell 6% to €172m.
Says Sonn: "Everything is up for discussion. Do we keep a dual listing? How do we leverage our global repository of skills in retail and manufacturing to create new opportunities, and what is possible on the continent?"
The focus will be on considering which businesses have the best options for growth, while considering what "new opportunities" there may be.
The good news for investors, however, is that Steinhoff won’t be throwing in the towel and filing for bankruptcy until there’s absolutely no option. "We’re not just selling everything we can and winding up. That isn’t on the cards," she says. "That’s why we’re putting together a new restructuring proposal to present to our creditors in May, and this must include a plan on what the new Steinhoff will look like."
But there are numerous sceptics.
Analyst Vianello has an answer for what Steinhoff is worth: exactly zero.
"And that was my estimate before Christo Wiese’s claim last week. I think the debt holders will convert their debt into equity and ordinary shareholders will end up with close to nothing," he says.
After that, Vianello reckons, Steinhoff will remain listed, but it will be run in a much-reduced format after selling off Mattress Firm for half of what it paid, while part of its 71% of Star will, in all likelihood, be unbundled to the debt holders as a part settlement for what they’re owed.
"They need to create an incentive for management to stay. Conforama has potential in Europe, so it will probably be the rump of the new Steinhoff, [along with] the UK business, which includes Poundland and Pep Europe, with some of the leftover manufacturing assets," he says.
Another alternative is for Star to buy Poundland and Pep Europe by allowing the debt holders in Steinhoff to convert their debt into shares in Star as part-payment.
Either way, there’ll be big changes at Steinhoff. Which will be something of a change for a company that looked largely homogenous for years, run by people who all looked the same and thought the same.
"You talk about diversity, but no matter what job you performed at Steinhoff in the past, you were a chartered accountant. Which meant problems were looked at entirely from a figures perspective. One of the things I admired about Merrill Lynch is that it went into universities and plucked people from different disciplines: history, literature, the sciences," says Sonn.
What’s clear is that to build the new Steinhoff, a new energy will be needed. It’ll be a refreshing change from simply mopping up the mess created by Jooste.
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