Is Steinhoff back from the dead?

In early January 2018, Steinhoff’s commercial director Louis du Preez was on a charm offensive in London, trying to convince the retailer’s bankers not to pull the plug.

It was a desperate time. Weeks before, Steinhoff had admitted to "accounting irregularities" on the same day that its CEO, Markus Jooste, had offered his resignation to the board (remotely, of course, while sitting a few kilometres away on the Lanzerac wine farm).

It sparked a bloodletting. The share price tanked, wiping out R200bn in value within days, since nobody had any clue how deep the rot went. Asset-strippers began totting up what they could salvage from what they assumed would be a mercy kill.

Steinhoff’s funders were even more sceptical. At one point in that January meeting, one of the bankers, clearly believing the retailer was set for the knacker’s yard, looked at Du Preez and said: "I give your company till the end of February."

Du Preez, as steely a person as you’d expect from someone who cut his teeth as a corporate lawyer at Werksmans, wasn’t about to flinch.

A few weeks later, in February, he dialled into a creditors’ call, and that banker was mildly surprised. "You’re still here? I thought you guys would have folded," she told him.

Fast-forward to May 2018, and another creditors’ meeting. By now, the banker was incredulous. "This is ridiculous — you should have been out of here a long time ago," she told Du Preez.

The scepticism was, of course entirely valid. Nearly a year later, in March 2019, forensic auditors from PwC would conclude that Steinhoff’s accounts were about as trustworthy as an ANC anticorruption pledge.

As it turned out, Steinhoff had reported R106bn in "fictitious and/or irregular transactions" over nearly a decade. Its assets were overvalued by more than $12bn, and it had brazenly diddled so many investors that it would have made Bernie Madoff seem like a blushing amateur.

That was just the fraud. There was also the small matter of crippling debt (now €9.8bn) it had to repay with cash flows that were suddenly radically smaller than anyone suspected. And because Steinhoff was a pariah, that money attracted interest at a crushing 10% a year.

Soon enough, R136bn in legal claims flooded in from just about anyone who’d ever had the misfortune to borrow a teaspoon from Jooste — from pension fund managers whose clients had lost billions, to deal-makers who’d sold assets to Steinhoff in exchange for shares.

In January 2019, with the prospects at their bleakest, Du Preez stepped into the role of Steinhoff CEO — perhaps one of the hardest jobs going, with the possible exception of Gwede Mantashe’s PR manager.

Weren’t there times he wanted to throw in the towel?

"My wife will say I’m too hardegat to be a quitter," he tells the FM.

"Look, I’ll be the first to admit it was difficult. My moods would go up and down and there were moments when I’d ask: ‘Is this really worth it?’; ‘What are we trying to protect here?’ But we had to stay the course, to try to fix this."

Perhaps now, after three years of "very little sleep", Du Preez will finally consider that it has been worth it after all.

Last week, he achieved something few other CEOs of fraud-ridden firms had ever done: he orchestrated a "settlement" of all the legal claims against Steinhoff for its fictional accounting, paying out about 20c for every rand claimed. In other words, the R136bn of legal claims are now done and dusted, settled for R31.5bn.

This gives the retailer — perhaps for the first time since December 6 2017 — some kind of a shot at a future.

Says Du Preez: "Why did this thing survive? Why did the funders agree to roll over our debt many times, even though they didn’t have to? I think the answer is there’s still real value in this business. It would have been an absolute shame if we’d been liquidated, and the excellent businesses we had here were to go into free fall."

He is correct that while Steinhoff’s accounts had more holes than the EFF’s economic policy, the company does still own a number of high-class businesses that ultimately pump out enough cash to save the retailer from the grave.

The glittering jewel in the crown is Pepkor Holdings, which Steinhoff bought in 2014, when Pepkor’s largest shareholder Christo Wiese (unluckily for him) inserted it into Steinhoff in exchange for shares in Jooste’s company. It was, as Wiese points out, a R59bn mistake.

Pepkor today is a cash-printing machine. Its 5,470 stores in 10 African countries include Pep, Ackermans, Tekkie Town, Russells, HiFi Corp, Incredible Connection and Timbercity. And this month, it bought 70% of Brazilian clothing retailer Avenida.

Steinhoff still owns 58.9% of Pepkor, a stake valued at about R47bn.

In Europe, Steinhoff owns 78.8% of the Pepco Group — which pretty much replicates the Pep model, selling discounted clothing and merchandise in 3,500 stores in 17 countries. Pepco listed on the Warsaw Stock Exchange last year, and Steinhoff’s stake is worth around R70bn.

Also in the stable is Greenlit Brands in Australia, but perhaps the unlikeliest winner is Mattress Firm. In 2016, shortly before the crash, Steinhoff paid way over the bar for the US company, at a time when mattress stores were a dime a dozen.

For a while, it looked as if Mattress Firm would be the straw to break Steinhoff’s back, when it filed for chapter 11 bankruptcy in 2018. But it has since roared back — so much so, in fact, that for the year to September, it made a €237m profit, from a loss the previous year.

Make no mistake, Steinhoff remains brittle. At last count, the group’s total liabilities stood at €18.3bn — exceeding its total assets by €3.2bn.

Which is hardly the epitome of rude corporate health.

And yet, counter to almost every expectation — and certainly that of the bankers who first encountered Du Preez after the crash — Steinhoff may just survive.

Jean Pierre Verster, CEO of Protea Capital Management, says it’s almost unprecedented for a company to have navigated its way through a fraud of this magnitude. But, he says, this was only possible because a number of chips fell the right way for Du Preez.

"First, we’re in an abnormally low interest rate environment. So even though Steinhoff may be rated as junk, it ‘only’ has to pay interest of 10%. Of course that’s high — but if you’ve got great businesses like Pepco and Pepkor that are able to produce profit growth of more than 10%, your funders may be inclined to give you more time," he says.

So Du Preez got lucky to some extent. But any company faced with an existential fraud needs a little luck to go its way.

Defying the grave

The fact is, historically, companies just don’t survive frauds of this scope.

Steinhoff’s former chair Heather Sonn once described this as "SA’s Enron". But the Houston energy company went bankrupt on December 2 2001 — six weeks after it "restated" earnings and the US Securities & Exchange Commission (SEC) opened an investigation. Enron, as the gold standard of corporate fraud, died a quick death.

Equally, payments company Wirecard filed for bankruptcy on June 25 2020, just days after CEO Markus Braun quit amid a scandal over a "missing" €1.9bn. And blood analyser Theranos survived just six months after the SEC charged founder Elizabeth Holmes with fraud.

Even locally, the gravestones of fraud-addled firms are many: Masterbond, Fidentia, LeisureNet, Regal Treasury Bank, Macmed and Mirror Trading International are all examples.

Yet Steinhoff is now entering its fifth year after the crash, and its odds of survival have never looked better. It’s as if its plane crashed in the Andes, and years later, all the passengers have been found thriving in a cave, where they’ve all mastered Wordle.

"I’m quite proud of what our team has done here," says Du Preez. "From what I hear from the people in the Netherlands, the Steinhoff example is being used elsewhere in the world in other restructurings. There was a lot that was unique about this."

One of the few other instances of a company surviving after a crippling fraud was the Italian long-life milk producer Parmalat which, by 2003, had 214 subsidiaries in 48 countries.

Parmalat has eerie similarities with Steinhoff. In that case, the egotistical CEO Calisto Tanzi began covering up holes in the finances from 1990 to 2003, going so far as to forge a letter from a bank "confirming" the existence of a Cayman Islands account containing €3.95bn.

But after auditor Deloitte & Touche refused to sign Parmalat’s financials, and it defaulted on a €150m bond payment despite supposedly having €4bn in cash, the game was up.

Parmalat was declared insolvent, but thanks to help from the Italian government it remained on life support, and was ultimately relisted on the Milan Stock Exchange.

Says Du Preez: "Unlike Parmalat, we had no state support with Steinhoff. And our situation was unique because we were dealing with different legal systems; we did this in the midst of Brexit, which affected many of the retail operations; and we also had Covid to deal with."

What is interesting, however, is that two other SA companies have, like Steinhoff, managed to keep going despite equally existential fraud: Tongaat Hulett, where R12bn in equity was, essentially, fictional; and EOH, where hundreds of millions were looted.

True, the share prices of all three companies have plunged no less than 90% in less than five years — Steinhoff has lost 93%, Tongaat 96.6% and EOH 96.4% — but they have all survived, during a once-in-a-century pandemic.

This grit, and an unwillingness to concede defeat, has put Steinhoff on the global map.

Says Du Preez: "It’s quite amazing how a small retailer that started in SA could have such an impact on world markets. If you walk around London’s financial community, or that of New York, Amsterdam or Frankfort, there is no-one who has not heard of Steinhoff."

Of course, this isn’t just because of the success of the restructuring plan. Banks across the globe took a $1bn hit after Steinhoff collapsed in 2017.

JPMorgan, for example, took a $273m knock in its 2018 financial results due to Steinhoff — something which its then CFO, Marianne Lake, said was "far and away the largest loss in this business we’ve seen since the [2008 financial] crisis".

Elsewhere in Wall Street, Bank of America took a $292m hit too, while Citigroup lost $130m in its equities division, and sustained a $267m credit loss. And Goldman Sachs also took a $130m hit.

So everyone knows Steinhoff — just not in a good way.

Jac Marais, a partner at Adams & Adams who represented some of the shareholder claimants, says you can’t overstate how historic this settlement is.

"There’s never been a case like this in SA. Section 155 of the Companies Act has never been used in this way, and on this scale, to achieve a legal settlement. So this must be lauded as a victory from an outcome perspective," he says.

The Steinhoff settlement also has wide-ranging implications for the corporate sector — and for companies like EOH and Tongaat which end up ensnared in a fraud.

For a start, it will fuel expectations that where there has been fraud, shareholders can claim back some of their losses. It’s a critical philosophical point, since the notion of free market capitalism is that when it comes to investments, immense reward is possible only because there is risk involved. If there is now some sort of legal backstop, it changes this equation.

Is there an investment case?

Of course, it’s one thing for Steinhoff to have survived and settled the legal claims. But what is the next step? What is its raison d’être, if the operating companies like Pepkor, Pepco and Mattress Firm can all survive by themselves? What’s the purpose of keeping Steinhoff?

"If I’m brutally honest, and in two or three years we see that there’s no business reason for Steinhoff to exist, then we’ll reassess it," says Du Preez. "But at the moment, we do believe we can really provide a return to those shareholders who’ve stuck with us over the past three years. We believe we can unlock some value for them."

What’s clear is that those traders with either the good luck (or death wish) to have bought Steinhoff shares at its low of 68c in October 2020 have made a killing, as the price has since soared to R4.64. It’s nowhere near its pre-crash peak of R96, but it’s an epic recovery nonetheless.

Put another way, if you’d bought R100,000 worth of Steinhoff shares at its low ebb, you’d now have stock worth R682,000. That may look like a visionary decision now, but the company could easily have collapsed too, leaving traders with nothing.

So is there still value in Steinhoff? Would any investor piling in now only be setting themselves up for another morale-crushing tale of Steinhoff woe?

Chantal Marx, head of investment research at FNB Wealth & Investments, says that while there now "seems to be a way forward", the vulnerability in the balance sheet means "we still regard Steinhoff as a purely speculative play".

Verster says there may very well still be value in Steinhoff shares.

"Steinhoff does have expensive debt, but there’s a debt standstill which means it doesn’t have to repay this for many years with a cash outflow. So while it’s true that the €9.8bn debt does push Steinhoff’s net asset value right down, the share price isn’t anchored by this. If anything, the stock could keep rising in the short term," he says.

As a result, says Verster, what investors are really getting when they buy a Steinhoff share today is a long-term call option on the underlying assets such as Pepco and Pepkor which, he says, "are fantastic companies".

In practice, it means the downside is limited by the fact the debt won’t have to be repaid for years, while the upside for the stock will be determined by how well Pepco, Pepkor, Mattress Firm and the Australian businesses do.

"As an investor, you need to make a call on whether you think the value of Pepkor, Pepco and Mattress Firm will increase by more than 10% a year, which is the interest rate on the Steinhoff debt. If you believe it will, there’s value in the share," he says.

Famously, Verster’s company had taken a short position in Steinhoff shares years ago, betting that the price would fall.

In December, he says, he finally closed this short position.

"We aren’t short on Steinhoff any more, but at the same time, it’s quite speculative to have a long position. At the right price, you could make a case for holding Steinhoff stock right now — but I would put that price at about half its current value," he says.

The optimists may not need such a cushion. And they’ll have been heartened by Steinhoff’s financial results for the year to September 2021, released two weeks ago.

Critically, Steinhoff was able to report a 14% increase in revenue — to €9.19bn from €8.03bn. The European operations in Pepco expanded their revenue by 18% and Mattress Firm, which once looked like an unsalvageable delinquent, saw revenue climb 24%.

Operationally, it’s solid as rock. But the problem remains that as fast as Steinhoff is hoovering up cash, the money is flooding out even faster to repay its debt. So, while it generated an operating cash flow of €1.42bn in the year, the interest on its debt last year grew by €1.08bn.

Mercifully, Steinhoff got a €1bn windfall when Pepco listed in Warsaw, and a €520m repayment from Mattress Firm, which it used to pay down €2bn of its debt. But there still no getting around the fact that when you owe this much money, your back is firmly against the wall.

In the end, Steinhoff was able to narrow its bottom-line loss to €639m — a radical improvement from the €2.8bn loss the year before. Which is at least the right trajectory.

But, as Du Preez freely admits, the debt is the big headache.

"How many companies do you know that have got €9.8bn in debt on their balance sheet? It’s a massive amount of debt — but at least, now that we’ve settled the legal claims, we can engage with the funders to restructure it," he says.

The end of the Steinhoff name?

So what are these options? For one thing, Steinhoff could sell down its stake in both Pepkor and Pepco to just more than 50%. This would allow it to keep control, while giving it extra cash of nearly €2bn.

A few weeks ago, Mattress Firm filed to list its shares on the New York Stock Exchange, and a sale of anything up to 49% will bring in more cash for Steinhoff. (It’s hard to say how much though, since Steinhoff values Mattress Firm at zero in its accounts.)

FNB’s Marx calculates that by selling stakes in Pepco and Mattress Firm (while still keeping control), Steinhoff could raise €2.5bn to pay down debt. "The strategy of listing and selling down, but not divesting fully from strong assets — and letting the market do its thing — could work," she says.

Another option, which Du Preez moots, is for Steinhoff to approach its funders — mostly hedge funds at this point — and suggest they switch part or all of their debt into shares in the company.

"Pepkor is now expanding … and there are some really exciting things on the horizon. So if you factor that in, you could be looking at a very different business. You can see how this could be a compelling prospect," he says.

Du Preez is keeping all his options open.

This shouldn’t be a surprise: speak to his colleagues, and they’ll tell you he always has a back-up plan. "Louis always has a plan A, plan B, plan C and plan D," says one.

Depending on which option is chosen, incredibly, it seems there may be some kind of a pathway for Steinhoff to keep going. It may even actually make money again.

Du Preez certainly believes it will. "I do believe there’s a solid investment thesis for Steinhoff. For one thing, from an SA perspective, investors get an entry point into a wider variety of underlying assets," he says.

This rosy future of starry-eyed unicorns dancing on Tempur Sealy mattresses does hinge, however, on whether Steinhoff can pay down the debt without flogging the crown jewels.

But suppose it does survive, will it keep the name Steinhoff, with all the baggage that entails?

The name itself came from the founder Bruno Steinhoff, who first created the business in 1964 in Germany’s northern town of Westerstede. It was premised on the idea of buying furniture constructed behind the Iron Curtain in East Germany, and selling it to the wealthier West.

Bruno Steinhoff, now 84, no longer has any shares in the company that bears his name. Is it time to kill the association?

"We’re considering it," says Du Preez. "We’re already creating new corporate identities for several parts of the business. Strangely enough, Steinhoff is such a well-known entity that there may actually be some benefit in retaining the name. But we’ll look to see if there’s value in changing it."

As it is, Steinhoff is slowly switching the company’s trademark burgundy colours — famously emblazoned across rugby teams and Stellenbosch University in Jooste’s time — for a more demure, no-nonsense blue.

It’s an incremental move to ditch the past, and draw a line under that day in December 2017. But it would also mean ditching history: at this point, Steinhoff is more than just a name — it’s a testament to SA’s greatest corporate fraud, as well as what may be an epic escape from the precipice.

"It would have been an absolute shame if we’d been liquidated, and the excellent businesses we had here were to go into free fall" — Louis du Preez

At one time Steinhoff was a byword for failure and fraud. Now, amazingly, it may actually have a future

—  What it means: