Company / Analytics

Analytics, 25 June 2020

Wirecard scandals: What it means for investors?

Wirecard has come under intense scrutiny this week following accounting discrepancies. Before it filed for insolvency on Thursday, the company’s scandals came to light last week when it failed – for the fourth time - to report its full-year results for 2019. The stock has since fallen more than 90% in just under a week; on Thursday it was trading at 2,92 EUR, and analysts forecast it could drop to zero. We provide a brief outline of the situation and what investors should consider going forward.

The Situation

Wirecard rose from being a minor player to one of Germany’s biggest companies. The German payments processor scrapped its final results for the fourth time in mid-June, declaring last week that its auditor couldn’t locate €1.9 billion ($2.1 billion), roughly a quarter of the cash on its balance sheet, before later claiming that the missing euros may not actually exist.

Wirecard on Monday pulled its previously-reported preliminary earnings results for the entire financial year 2019/20 as well as forecasts. Its CEO Markus Braun has since resigned was arrested and later released on bail by authorities in Munich.

A brief regulatory statement released by the company on Thursday said: “The management board of Wirecard AG has decided today to file an application for the opening of insolvency proceedings for Wirecard AG with the competent district court of Munich (Amtsgericht München) due to impending insolvency and over-indebtedness.”

It is the first insolvency of a member of Germany’s Dax index of blue-chip companies in its 32-year history.

Wirecard’s auditor EY reported that they were shown documents purporting to show that the €1.9bn was held at two leading Philippine banks on behalf of Wirecard by a local trustee. However, authorities in the Philippines contested the claims, stated the paperwork was bogus and that the money did not enter the country.

The Significance

Wirecard has long been the subject of “repeated allegations from whistleblowers, journalists, and speculators that its revenue and profits had been pumped up through fake transactions with obscure partners,” according to Reuters.

In 2019, Financial Times investigated the company for alleged improper accounting conduct in Asia and the Middle East, claims which Wirecard denied and accused the paper of fake reporting. However, in April this year, an external audit by KPMG could not verify cash balances, questioned Wirecard’s acquisition accounting, and was unable to trace millions in reported cash advances to merchants.

Following the scandal, Germany’s financial regulator has filed a fresh complaint against Wirecard with the prosecutor, saying the company’s belated admission that billions were missing showed it had mis-stated its financial position between 2016 and 2018.

While shares have since collapsed, investors have been blindsided by the accounting scandals, and short-sellers have made a killing. Analysts note that Wirecard is the most heavily shorted stock in the German stock market at the moment, with more than $3.22 billion in short interest and 27.4 million shares shorted last week.

How the Stock Moved?

Wirecard’s shares have since shed more than 90% and it’s only listed bond is trading at 26 cents on the euro, indicating that investors expect to lose most of their money. Wirecard shares closed trading at 12,30 EUR on Wednesday 24 June. Analysts, including the Bank of America, forecast the stock is likely to fall to one Euro.

After it filed for insolvency on Thursday, June 25, the stock dropped more than 76% to 2,92 EUR. The company’s shares have since been suspended from trading in Frankfurt.

Bottom Line

Despite its accounting irregularities, Wirecard won a brief reprieve from creditors after banks postponed by a few days a decision on whether to terminate €2bn in loans. Before it filed for insolvency, some of the lenders had signaled that they do not, for now, favor canceling their loans and sending Wirecard into insolvency but demanded full transparency as they seek to recover their money.

The lenders have mandated FTI Consulting to assess whether the company can be rescued. Wirecard already missed a crucial deadline to publish its audited results and the loans could be terminated, a decision which itself could declare the company insolvent.

On the other hand, Wirecard has already hired restructuring experts Houlihan Lokey (HLI) to “develop a plan for the sustainable financing strategy of the company” while concurrently “examining a broad range of possible further measures to ensure the continuation of its business operations, including cost reductions as well as restructuring, disposal or termination of business units and products segments.”

If the widely reported allegations are proven, Wirecard will likely be remembered as the largest German accounting fraud ever. The Financial Times reported that the company itself warned investors that it previously misrepresented large parts of business activities and accounts for prior years may be inaccurate. According to the Financial Times, Wirecard’s 40-plus businesses have collectively been lossmaking since 2018, based on its disclosure of each unit’s performance.

It remains difficult to envision any kind of recovery for current equity holders. Wirecard has customer deposits and at least EUR 2.5 billion of debt ranking, which is well ahead of equity holders in the company’s capital structure. Even after the sell-off following the scandal (more than 90%), Wirecard’s market capitalization still calculates to a whopping EUR 2.1 billion and leaves ample room for further losses. Moody’s last week downgraded Wirecard to junk and on Monday withdrew its credit rating altogether.

The company’s real business will likely take a meaningful hit. Most investors have likely not been satisfied by its history of accounting irregularities. For instance, Bank of China is reportedly against an extension of the revolving credit facility and considers writing off most of the EUR 80 million it is owed by Wirecard.

With a key lender ranking ahead of bond- and particularly equity holders not expecting a meaningful recovery, the outlook for junior stakeholders appears bleak, to say the very least. Investors should not bet on the company becoming an acquisition target either as it will likely take years to clean up the current mess, which will include among others, a host of anticipated lawsuits.

Given these issues, investors should not touch Wirecard’s stock with a ten-foot pole. Expect the shares to remain a playground for day traders and highly speculative investors for the time being. Once investor interest starts to wane, trading volume will come down significantly with the share price likely moving closer to zero as time progresses, as we are already seeing.

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