Disclosure: I am not exposed to Grenke, nor do I plan to expose for the foreseeable future.

Grenke is a company that I’ve written about quite a bit on this blog. My only investment was buying Grenke Bonds after the short attack in September 2020. I sold them relatively soon after the initial recovery at a decent profit.

A few things have happened since then: The COO suddenly resigned on February 8, with an understandable explanation given just a day later. The story, which was also communicated via some return channels, was that everything was fine and the main problem was that the German regulatory authority BAFIN was overwhelmed after the Wirecard fiasco and there was nothing to worry about. Another story is that Grenke is still an “innocent” inexperienced company and therefore communication is not as professional, but the company as such is a great company with a great future.

Personally, I’ve always had problems with Grenke. Yes, the numbers always looked good, but I found the reporting very intransparent, for example their definition of “free cash flow”, which included the issuance of debt, which at least in my “old school” way of thinking was not even free cash Flow comes close.

Last week, Grenke released an update that initially sounded like what we would say in Germany was a “clean bill of health” or proof that everything is great. It starts like this:

  • The Mazars interim report commissioned by BaFin shows no doubt about the existence of the lease receivables. Money laundering allegation not confirmed
  • Criticisms of Mazars relate in particular to the accounting of the franchise companies, the lack of disclosure of related parties and deficiencies in preventing money laundering and parts of the customer lending business at GRENKE Bank
  • Franchise companies are fully consolidated for the first time
  • Earnings after taxes for the 2020 financial year are expected to be in the upper double-digit million range
  • Net liquidity of EUR 1,290 million as of February 22, 2021

Investors seem to have enjoyed this, and the stock price rose ~ + 15% after the release:

chart_year_Grenke

Personally, in my opinion, the first paragraph came as no surprise. I think it was pretty easy to see that Grenke isn’t the next Wirecard.

However, once you have read the text more closely, Some really ugly details crop up.

CTP returns

My biggest problem has always been the “related party transaction” with CTP and the franchises. W. grenke has still not disclosed who the owner of the mysterious CTP company was. What we now know, however, is that they made some really serious money by funding a sale of the franchise to Grenke (focus on mine):

In this context, Mazars has retrospectively criticized the returns from CTP and the other financial investors as excessive. Mazars concludes this from an analysis of the top 10 acquisitions by goodwill. Mazars advises that for the franchise investment between 2003 and 2018 There was amortization of EUR 62.6 million compared to investments of EUR 7.2 million.

So CTP (whoever it was) made an average of 9x their money with a pretty negligible risk. In my opinion, this is clearly “too good to be true”. In the PE business, a 3-fold return (over 7-10 years) is considered to be absolutely first class. The combination of these returns and W. Grenke’s refusal to disclose, in my opinion, the beneficiaries, are really very close to my embezzlement. Maybe not in a legal sense, but economically.

Consolidation / Goodwill:

You can find that in the Adhoc:

A major criticism from Mazars concerns the accounting of the franchise companies. Mazars believes that these should have been consolidated in the consolidated financial statements as soon as they were prepared.

Despite everything that has been communicated so far, The entire franchise structure has clearly been used to hide losses from subsidiaries, which is confirmed here::

After considering all available information, the company believes that there is greater evidence that, due to their actual control under IFRS, regardless of the ownership structure, the franchises should have been consolidated in the consolidated financial statements as soon as they were formed 10

No problem, says Grenke:

The retrospective full consolidation leads to a change in the presentation of company acquisitions, in particular exclusively in the consolidated financial statements according to IFRS. This has no impact on the Group’s cash flow. In the consolidated group’s balance sheet, no goodwill is shown for the franchise companies acquired after December 31, 2012, and thus since IFRS 10 came into force. The acquisitions are recorded directly in equity. The equity is reduced by around EUR 90 million compared to the previous result.

No impact on money, Only EUR 90 million equity is gone. This 90 million reduction is, in my opinion, a combination of the money paid to CTP and the losses incurred. The cash flow effect has clearly already occurred but has been disguised as a goodwill payment.

It’s clear that Grenke found a way to post this directly to equity instead of posting it as a loss through the income statement, but make no mistake: economically, those $ 90million are past losses that Grenke has hidden.

W. Grenke’s friend:

Mazars has criticized Corina Stingaciu for not being identified as a related party in the consolidated financial statements, although the relationship with Wolfgang Grenke appeared to be known within the GRENKE Group.

My speculations from back then were actually known in Grenke, which I find interesting as a friend. This means that a lot of people knew and played along, which in turn tells me something about the corporate culture.

Lending in the Grenke Bank

The Mazars report lists several deficiencies in the subsidiary GRENKE Bank. This includes violations of the Minimum Requirements for Risk Management (MaRisk), which relate to complaints in the customer lending business. In particular, a number of loans granted were mentioned where either no or insufficient collateral was provided or the borrower’s ability to service the loan was not adequately verified.

Yes, the amount is relatively small, but Metro Bank actually almost killed something very similar. Underestimating venture capital sounds harmless, but it has all the ingredients for a complete blast when the going gets tough. The general problems of “sloppy process and sloppy methods” seem to be really present at Grenke Bank as well

Risk management

Another finding by Mazars concerns the method for calculating risk provisioning in accordance with the IFRS 9 accounting standard. Model and documentation weaknesses are identified. Regarding the model, Mazars finds among other things: that GRENKE has not yet taken macroeconomic factors into account. GRENKE AG continues to use its model-based approaches, which were derived from statistical methods, but has expanded them in line with the standard without significantly changing the estimates of the amount of risk provisioning.

Another item that would make my hair stand up. Again, they seem to have found a way to smooth the numbers, but ignoring macro factors when calculating provisions is “naive” if I want to be very friendly. It will be really interesting what kind of creative delivery they have developed in the financial statements.

Internal controls / compliance

The Mazars report also contains findings on missing or ineffective process-dependent controls in the internal control system as well as serious findings on internal auditing and compliance organization. The latter two largely agree with the criticism of BaFin, about which GRENKE provided detailed information in the letter from the Chairman of the Supervisory Board dated February 8, 2021 and which led to the resignation of Board member Mark Kindermann. The Board of Directors has started to significantly improve the internal control system on the basis of these findings.

This clearly exposes the background story that only BAFIN was oversensitive, and also contradicts Grenke’s statements about the dismissal of the CFO. There are real problems and they don’t just go away with a new CFO.

Outlook:

In particular, the time-consuming reviews were the main cause of significant delays and the reason why it was not yet possible to set a corporate calendar for 2021.

The audit opinion on the consolidated financial statements is expected in the second quarter of 2021. KPMG will publish the final results of the audit as of December 31, 2020 in the audit report and in the auditor’s report.

It will be interesting to see when Grenke can actually make verified statements, but to me this sounds like the problems are far from over.

Summary:

The things I have pointed out here clearly show, in my opinion, that Grenke has had major problems in the past. They seemed to have cut corners at every opportunity, and the related party issue is still not resolved in my opinion, particularly with regard to Grenke’s significant transfer of funds to some mysterious third parties.

I can’t judge how much Grenke has changed in the meantime, but in my opinion the character of a financial institution doesn’t change so easily just if you remove the CFO. To me it looks like everyone knew about these things and, due to the presence of W. Grenke, didn’t dare to comment, even when he was already on the board of directors and for a financial services company. This is a very problematic culture. The message from Grenke to me looks like you want to say, “Please leave us alone and let’s just get on with what has worked so well in the past.”

Another point to mention is that, especially for financial institutions, the following rules almost always apply:

As long as you grow, you can “paint over” many problems with a growing balance sheet. However, as soon as you stop growing, the “real sxxx hits the fan” almost always. However, once the cost of refinancing rises and reputations are broken, growth becomes very difficult and financial services companies can enter a “vicious circle”. This can be seen in many cases, such as Provident Financial in the UK or Wells Fargo, once Buffett’s favorite in the US.

So Grenke has to find a way to grow again with much more stringent governance, which will not be easy

If I look at all the points from above, I cannot invest Grenke in its current form. The company’s message to me shows that they don’t really want to change the way they run the business, despite some changes on the company’s board of directors. Be clear: To me, Grenke doesn’t look like a “quality company”, on the contrary.

Before anyone asks: I wouldn’t short-circuit the company either, as anything can happen in today’s markets. There is so much money going around that even Grenke could go up like crazy despite the underlying issues.

Personally, though, I think if you want to get exposure to (difficult) financial companies, there are plenty of ways that you can get better upside at much lower valuations.

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