GLJ - Grenke AG

[changegonnacome]

Grenke:

 

Wonder if anyone here following or has opinion on Grenke? - small ticket SMB leasing / factoring company out of Germany.......nice compounder till Viceroy short seller report claimed it was a fraud ala Wirecard. Given nervousness around the ability of BaFin to regulate national champions you could certainly see why many jumped out of this as it started to look Wirecard v2.0-esque............. COVID took it from c.109 euro a share to 65e……then short report took it to 33 euro a share today where it sits.

 

Short version (forgive pun) is you have a business that in steady state returns probably ~15% on equity and has grown equity at a CAGR of 15% for the last 10 years………….if the short allegations are refuted by audit reports AND growth dynamics resume anywhere near 2019 levels (16% ROE with E growing 15% pa) this is a short term win and a long term compounder with 40% ownership sitting with the Grenke family (which prior to the report was seen as good thing with aligned inside ownership ensuring rational pricing/risk control given extended family wealth tied up in the business .) You can argue that their equipment leasing/factoring value proposition to businesses post-COVID has been enhanced as every business would be wise to run itself with a little more cash on hand than the text books traditionally say & Grenke at its core turns potentially large capex items into a opex (& increasingly accounts receivable into cash/working capital through its factoring business)

 

Summary of short report and my take on them below:

 

(1) Viceroy said its a fraud - cash balances are phony ala Wirecard

-  cash balances have all been independently verified by KPMG

(2) Lease are fraudulent too and in many cases dont even exist

- 1,000’s of lease and lease payments have been verified by the auditor with no issues identified

(3) Franchise system used by Grenke to expand to international markets had unreported related party transactions that favored Mr.Grenke and associates who were financing these enterprises with sidecar structures knowing that Grenke Inc. would ultimately buy the business possibly absorbing problems at the franchisee/investor level by overpaying to bring them into Grenke Inc. Either bailing out bad capital investment or paying excessive prices for what is in effect a risk less investment in a financing sidecar

- this to my mind is about the only legitimate area of the short report……it does appear that corporate governance / disclosures were lacking in this space and indeed Mr.Grenke (founder) via CTP entity had an economic interest in ‘independent’ franchises that would later likely be bought out by Grenke. Seems that prices paid for these franchisers was both above and below the OPTION value that Grenke agrees with franchisers in advance. Still think its not a good look and is now rightly being addressed where Grenke will be buying and consolidate all remaining franchisees.

(4)  Grenke bank & international franchises used in money laundering schemes aided and facilitated by Grenke

- Mazar’s have reported some poor AML/KYC controls at Grenke Bank….but as anyone who understands AML/KYC can tell you it is ultimately almost impossible for any institution to live up to the aspirations of the regulators short of hiring private investigators to shadow every customer. Any auditor worth its salt and audit fee would find and recommend changes and enhancements to AML/KYC protections. It seems to me that Viceroy is capitalizing on the Wirecard element again bringing in shady underworld type overtones.

(5) Viceroy showed a number of businesses in the UK who had been supposedly been defrauded by Grenke in concert supposedly with retail partners......$1,000’s for leases for TV’s that are only worth 500 etc.

- Grenke has nearly 1,000,000 active leases in force.......its key distribution model is point of sale partners & office/IT equipment distributors .............it appears Viceroy has found a number of businesses who have indeed been sold equipment married to Grenke lease contracts with strange related party side deals....for example flat screen TV’s sold to butcher shops, that were then to be subsequently rented by a different company to display advertising & thus being cost neutral even if the monthly lease fee was 350 pounds giving a TV asset value of 10,000..........under examination it appears that both Grenke & the businesses have been defrauded......when Grenke approves a lease you see it pays its retail partner in full for the equipment it’s delivering to the customer............the customer is asked to verify that the equipment they are being provided is indeed brand new and as described in the lease. It appears some enterprising con artists have spotted a gap here and are getting unwitting businesses to enter into leases for things they don’t receive, aren’t as described i.e not new or with 3rd party side deals riding sidecar. This is clearly a failure in Grenke’s distributor partnership model that should be addressed by greater due diligence on retail/distribution partners as well customers it runs through its risk model......but in reality Grenke is the victim of fraud here too having paid out cash for assets that don’t exist or have inflated values..................a few hundred cases in a total lease pool of 1m IMO does not impair the value of Grenke’s assets.

 

Grenke is currently selling for x1.2 book…….it traded as high as x4 in the past given growth characteristics.

 

Bear Case - Grenke cash in the bank is real, its lease are real……….BUT………Grenke’s corporate governance problems in conjunction with reputational damage shut it out of the capital markets at rates that its spread business needs to function properly (72% of its lease book is financed through ABS & senior secured bonds)…….it effectively goes into run-off………cash is returned to shareholders avg.lease term is 4 years it doesn’t take forever to achieve………30% downside

 

Bull Case - short thesis fully refuted by BaFin, Mazars, KPMG........company gets clean bill of health, corporate governance is beefed up and the new consolidated franchise model doesn’t hurt previous growth trends. Grenke in FY 2022 returns to growth & previous 100 euro share price………in the next 5 - 10 years it continues compounding book at 15% with RoE of 15%………five years time business is worth 5x where it is today

[Spekulatius]

FWIW, Bronte is short. Probably means nothing.

[changegonnacome]

I like Hempton - enjoy his interviews and style.............i think the franchise model, related party transactions and interesting locations like Brazil & Turkey......fit possibly in Bronte's fraud playbook screen (& maybe some side money in CTP comes from the list of 'bad guys' & 'crooks' that apparently Bronte keeps on file). Dont think I've seen him talk about Grenke yet - will keep an eye out.

[thowed]

I'm not very up on it, but my understanding that it's not fraudulent, but the governance could do with some improving.

 

Devon Equity had a position - sold on the day of the fraud accusation, and have now bought back in after doing extra due diligence - google their website and you should find their report.  They're generally an impressive house........ except - they had Wirecard as their top position for a while...!

 

And also Rob Vinall seems happy with it.

[changegonnacome]

I'm not very up on it, but my understanding that it's not fraudulent, but the governance could do with some improving.

 

Devon Equity had a position - sold on the day of the fraud accusation, and have now bought back in after doing extra due diligence - google their website and you should find their report.  They're generally an impressive house........ except - they had Wirecard as their top position for a while...!

 

And also Rob Vinall seems happy with it.

 

Interesting thanks must check out Devon - I had seen RV Capital’s long standing position in it.......its what makes these situations so interesting that you could have John Hampton & Rob Vinall on opposite sides. Both investors I respect.

 

What’s curious about Grenke too which leads me to believe that Viceroy has caught a company with idiosyncratic governance issues as opposed to an outright fraud is the level of inside ownership......Mr.Grenke owns 8% of the company himself which is inside of his families trust which owns 40% of Grenke!.......to take your families wealth and put it in jeopardy by enabling fraud at the margins of the company you founded would be particularly reckless act.

[lathinker]

I looked at Grenke but decided to pass. It is true, they they had a great run over the last decade or so. They might  have been the most succesful German  financial company with both outstanding growth and profitability.

 

Grenke is not a fraudulent company, but the Governance issues look real to me and even after the investigations and reports, doubts on certan aspects remai. I also doubt how useful their services really are to their customers and how they will be able to grow from here - growth requires more funding and in my view, their reputation clearly took a hit.

 

Valueandopportunity had a good write-up detailling some problems. For me, Grenke is on the "too hard" pile

 

https://valueandopportunity.com/2021/02/27/grenke-ag-update-all-clear-or-the-same-old-song-again/

[changegonnacome]

I've been doing more work on this over the past few days. I'm fairly convinced this is far from an outright fraud - the short report from Viceroy is predatory using the Wirecard debacle to make wild accusations.....the most wild of which are off the table now.....fake cash & fake leases................Viceroy HAS uncovered some poorly underwritten leases inside a leasebook of 1 million tickets......in those circumstances Grenke AND the end user are a victim of fraud. Grenke's automated underwriting & distribution model which is at the heart of the business model does leave it open to this. The question is whether its pervasive and I just dont see it given historical loss ratios, equity build overtime etc.

 

In terms of the franchise model that has been driver of Grenke's overseas growth and is now the focus of the governance issues. It seems that Mr.Grenke's founder/entrepreneurial beliefs led him to conclude that the best way to enter new markets was with 'skin in the game' founder/ franchisees........when these local market 'entrepreneurs' found it difficult to secure funding 'unrelated' parties stepped in to finance them ......Mr.Grenke himself but most certainly associates of Mr.Grenke were providing this funding with the explicit/implicit guidance & insights from Mr.Grenke. This was wrong and should have been disclosed. If Mr.Grenke was funneling cash from the company via these sidecar deals he was both defrauding Grenke AG but also his own family members who own 40% of the outstanding shares in Grenke.

 

My believe is that once convinced of the correctness of the international expansion strategy using franchisees. Mr.Grenke was not going to let financing problems stand in the way of the mini-me founder/entrepreneurs he had found in various markets and so using his rolodex gathered together high net worth individuals to support them.........these investors unsurprisingly sought Mr.Grenke's wisdom/guidance/insights before each investment and at various points I think its clear that those investors looked for their own 'skin in the game' from Mr.Grenke which he provided. What began as unrelated third party transactions morphed over time to be anything but and this is not be forgiven lightly. Shareholders we're misled but have the prospects of the business been mortally wounded? I think not. In fact SMB's post-COVID will seek out opportunities to conserve cash and given loss rates at traditional banks in the SMB space are spiking I can see a further pull back in this area post-COVID......Grenke's leasing business is ultimately sub-prime SMB lending secured on equipment and delivered at the point of sale. Cash starved and rejected by your local bank for loans numerous times an SMB owner/manager when presented with Grenke's value proposition at the moment of a large (for them) capital outlay will gladly take the opportunity to secure a loan with a minimum of paperwork/fuss and get back to running their business.

[changegonnacome]

I think I might be in the audience of one on this particular case.

KPMG issued an unqualified audit yesterday - GLJ rallied but not as much as you might expect......attention turns now to I guess Mazars & Bafin's audit of Grenke Bank.

I played this with Grenke bonds in the end + some equity - especially the ABS paper that I had reasonable confidence was money good.

Interested if anyone else has a view post-KPMG audit?