We invested in Steinhoff based on consistently improving margins, supported by strong divisional management.

We first invested in Steinhoff in 2010. Over the years, our investment case in Steinhoff was built on improving margins in the European furniture business.  The business achieved these margins with a change in their mix of products, an improvement in their supply chain and logistics, and an expansion of the store base. We also had a high regard for their divisional management, many of whom have proven track records in running independent retail operations, including some large listed entities. Their reported numbers showed a consistent improvement in their core margin over the last number of years as management executed their stated strategy.

The announcement of financial irregularities cast doubts on the reported margins.

We revisited our investment case after the resignation of CEO Markus Jooste and the announcement of financial irregularities. These announcements put a question mark over the reliability of the numbers Steinhoff has reported on in the past. The numbers published by a company are not only the primary indication of the financial health of a company, they also give us the information we need to measure financial performance. Because we couldn’t rely on the numbers, we had to re-consider the validity of the reported margins over time, which were central to our original investment case. The value and existence of all the assets on the balance sheet and the extent of the debt was impossible for us to verify.

All the uncertainty made a reasonable valuation impossible.

Although the value of the listed assets in South Africa (which account only for a portion of Steinhoff’s asset base) could be verified independently, it became impossible to know how much debt these assets would have to service in time. In addition, the group had raised equity and debt in Europe and South Africa over the last few years. If this debt was raised based on unreliable numbers, claims for compensation would add substantially to the significant but unquantifiable, debt. This made an accurate valuation impossible – and investing in a company where a reasonable valuation is impossible is contrary to our investment process and philosophy. Without knowing what a balance sheet really looks like, we can’t be confident of having a reasonable margin of safety to protect our clients’ capital. We therefore sold our investment in Steinhoff at an average net price of R18.70 a share early December.

While the scope of the irregularities is unknown, we will not reinvest in Steinhoff.

Steinhoff has subsequently confirmed that investors can’t rely on the 2015 and 2016 audited financial results. This means that the extent and the impact of the accounting irregularities remain unknown. Only time will tell how material they are and what the scale of any potential compensation claims may be. Until this is clear we will not reinvest in Steinhoff.

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