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Chris Haffenden

Once again Adler Group dominated news flow and our attention this week. After the release of KPMG Forensics’ special report and its aftermath, we were intrigued to see what the auditors at KPMG Lux would make of their colleagues work in Frankfurt. The deadline for the FY 21 accounts for the under-pressure German Real Estate group was 30 April, and when they didn’t arrive after last Friday’s close, we spent most of Saturday morning hitting F5 on our keyboards.

The accounts eventually landed late am. But were they audited? That depends on your point of view — and spoiler alert it will lead you deep down into the rabbit hole of auditing qualifications.

KPMG put out a press release immediately afterwards, in which it confirmed that it had issued a disclaimer of opinion in its audits of the consolidated financial statements and annual report.

But Adler said that it had met its obligations to file audited accounts by the 30 April deadline and therefore was in compliance under their bond docs.

“There was an audit, and we have audited results,” Chairman Stefan Kirsten told reporters in a press conference on Monday.

Not so fast, said Viceroy Research in a release in which it provided a list of questions for those listening into Adler’s conference call at 9am on Tuesday. The short seller said citing ISA 705 accounting standards (bolding and underlining is their own emphasis):

“…that a disclaimer of opinion, within the framework of IFRS and ISA, is specifically NOT AN AUDIT. The auditor is required specifically to remove from their report that the company has been audited, and state only that they were engaged for an audit. ISA 705 states a disclaimer of opinion is equivalent to an auditor resignation, and provided only where a resignation is not practicable:”

For those wanting to look at the definitions, IFAC gives helpful advice on their website

On Tuesday’s investor call with over 700 attendees, Dr Kirsten said he disagreed with Viceroy’s interpretation. The former finance director of Vonovia (now a significant shareholder after seizing Adler share collateral for a loan to Aggregate) told the audience that he had a background in accounting and had taught accounting standards for over 20-years. He said the board had received a legal opinion from White & Case stating that the covenants conditions [to produce audited accounts] had been fulfilled. When pushed under questioning whether this opinion would be disclosed to bondholders, he said it would be made public “as long as W&C agrees.”

Kirsten added that KPMG’s initial statement regarding its disclaimer of opinion was an “obvious mistake because it’s not in line with the standards”. KPMG updated its statement during the earnings call, clarifying that it did issue an audit report, including disclaimers of opinion:

As our piece last week noted, the previous conference call with investors following the release of the KPMG Forensic Report had more responses than answers. A number of documents were withheld due to legal privilege, which may suggest an ongoing or potential legal action. In total 3.1m emails and documents were disclosed with 800,000 held back.

The company now says it is looking for a clean audit for 2022, but Dr Kirsten was very clear on the call that the Forensics investigation is “definitely closed”. With simultaneous suggestions that the company wants to remove the reasons for the disclaimer of opinion as quickly as possible, it is unclear what this means for the auditing process and parties involved, says 9fin’s Emmet Mc Nally in his review of the conference call. Certain withheld emails may be handed over to the auditors, Kirsten suggested, as there is an ongoing process to determine what is not covered under legal privilege.

But whether KPMG will remain auditors remains to be seen.

Kirsten said they will now sit down and talk seeking to rebuild trust. Both sides will need to decide, but ultimately the appointment is down to shareholders, he noted.

Last weekend the entire board had submitted their resignations, but only three were accepted. 

Thierry Beaudemoulin (co-CEO, now CEO), Thilo Schmid and Thomas Zinnöcker were asked to retain their positions alongside Kirsten, who said the rationale for his decision was not to “cut off every single piece of know-how and information”. He was responding to a questioner who asked why Schmid as former audit committee member was promoted to its chair and wasn’t replaced instead by an independent. This would have sent a more positive signal, the analyst said.

A new CFO is being sought, with an interim CFO appointment likely shortly, with two shortlisted. “Board members are de facto on probation,” Kirsten said. The shareholder AGM is on 29 June.

The call provided some support to the bonds, which nosedived over 20-points on Bank Holiday Monday, but have since pared around half of their losses, trading close to double-digit yields.

Adler Real Estate bonds, Source: ICE Data

Following the termination of the RCF, Adler’s financial flexibility is limited, notes S&P. The cancellation was at the behest of Adler, Kirsten said under questioning, and not a cross-default — “we just didn’t need it anymore.” Yesterday the agency downgraded Adler’s bonds to CCC+ citing refinancing concerns, saying it was less certain that it can repay its Adler Real Estate €500m 1.875% April 2023 SUNs from organic cash generation.

Adler is therefore heavily reliant on LEG Immoblien exercising its call option to buy a remaining 63% stake in Brack Capital Partners, which it expects to generate €850m, and the successful execution of further asset sales. LEG’s option expires at the end of September, with no official communication thus far. Adler claims that €428m of deals have been signed in 2022 and estimates another €542m of further project disposals.

Most of the development portfolio is now redesignated as build-to-sell, with just six projects left as build-to-hold with an estimated Gross Asset Value of €891m. Adler says on its slides there has been an acceleration of construction. Bloomberg and Viceroy previously alleged that little work has been done on the majority of its development portfolio, with many projects’ years behind schedule. Helpfully, Adler provides slides in its presentation (pages 44-46) with tick boxes for zoning, building permits, and whether construction has started.

After a €1.1bn goodwill impairment and a ‘correction’ of €227m towards development projects value, there is a breach of the unencumbered assets ratio incurrence covenants (must be greater than 125%). This prohibits further debt issuance, however it can refinance existing debt, but as Kirsten admits Adler is shut out from capital markets. The LEG option exercise, however, would raise the ratio to a more comfortable 136%, with Adler stressing there are other options available to increase the ratio.

But after all this, how do you assess value, and what is the right entry point for either the equity and/or the bonds?

Kirsten says that Adler has to listen, learn, and lead. But trust is difficult to rebuild once lost.

When appointed in February he said that Adler was suffering from a “pervasive loss of confidence” but insisted that it wasn’t a hopeless case and that investors shouldn’t use the W-word (Wirecard).

Questions over connections with Cedvet Caner and transactions with related parties remain outstanding, as do the potential effects if the previous sales are reversed. What is the business plan for 2023 and beyond, given that it is seeking to offload a large portion of its assets?

If Adler is right, there might be enough proceeds to cover its debt — after all the reported LTV is 50.9% (Viceroy says this number is depressed by assets designated as held for sale and the use of overdue receivables). Their stated net asset value per share of €33.6 is well above the €6.55 current Adler Group share price. Perhaps a de facto wind down would be best for all.

After a series of accounting scandals and frauds, auditors are increasingly under pressure, which may explain some of the recent delays in producing audited accounts.

Adler’s German Real Estate peer Corestate recently saw its accounts delayed by auditors, eventually taking a big goodwill impairment after advice from auditor EY which might scupper attempts to refinance its 2023 bonds this summer. S4 Capital shares tanked last month, after it delayed its results due to audit issues. It today released unaudited results, saying that audited numbers are likely by 14 May.

Following EY’s experience at Wirecard and NMC Healthcare, regulators and auditors alike are taking more notice of short seller and whistleblower reports.

Grenke, the German equipment leasing business, took the best part of a year to address allegations made by Viceroy, with Mazars (hired by BaFin) being critical of compliance and internal processes which led to the removal of the COO and CFO.

This makes us wonder how do we audit the performance of the auditors?

Many audit firms will be sweating after the disclosure late last week, that EY is being sued by the administrators of NMC Healthcare for $2.5bn in damages for negligence in its audit of accounts between 2012 and 2018. Profit-participation notes resulting from the UAE-based hospital group’s $5bn restructuring are trading around 97, the litigation may provide some potential upside. However, it might take years to secure damages, and the settlement could be a lot less.

On Wednesday, we saw the Financial Reporting Council launch an investigation into the accounting by King & King for GFG Alliance companies including Liberty Steel owned by Sanjeev Gupta, a key customer of Greensill Capital.

Accountants have long cautioned about the expectation gap. They will not be able to spot every fraud, and documents and invoices can be falsified. But in hindsight, there were plenty of red flags at names such as Carillion and Patisserie Valerie in the UK and Wirecard in Germany. Making directors responsible of the accuracy of their accounts would be another step forward.

Raffinerie Heide’s letter to bondholders and investor presentation this week reminded me to revisit our Blessed to be Stressed list — our followed companies with near term maturities — which might undergo stressed refinancing or secure amend-and-extend transactions.

To recount, our list published last July included:

Lowen Play — a failed refi, the restructuring set to complete by mid-May after its Scheme was sanctioned yesterday; Haya Real Estate is yet another restructuring, with its Scheme convening hearing set to start on Monday; Raffinerie Heide (still outstanding, more info below); and Matalan — a failed refi sounding in February, still outstanding with the clock ticking down.

Takko — following a failed refi sounding in October; Olympic Entertainment which secured an A&E after bondholders called a default; Corestate Capital — increasing looking like a restructuring; as well as revisiting the options for Raffinerie Heide.

Taking a look at our 9fin bond screener, looking at businesses with a spread-to-worst of over 800bps and with maturities under two years, we can add Lycra, Norican, Adler Pelzer, Atalian and our old friend Aggregate Holdings to the list. With 7x leverage, Mauser Packaging could sneak in too, and while it had a standout quarter, time is running short for LimaCorporate.

Moving into loans, we add PGS, Vue, Hunkermoeller, Flakt Woods and Kalle to our list. Following its recent failure to refinance in January, Keter is on many advisor watchlists too.

I would caution that this list is not exhaustive. Given the mood within the EHY market, many issuers with less stressed metrics might struggle to refinance or decide that A&E is best.

So far, none of our previous list have managed to refinance, a sobering statistic.

But this week, Raffinerie Heide talked up its prospects, citing a strong recovery in refining margins in the past quarter. Despite long-standing sponsor Klesch contributing its newly acquired Kalundborg Danish refinery into the restricted group, the non-deal investor update in March failed to see the existing €250m 6.375% December 2022 bonds trade much above 90.

The sponsor had previously outlined that proceeds from a €330m bond at Klesch level would fund a shareholder loan to Heide to repay the notes.

But in a letter to holders, it said that it would postpone its refinancing plans, citing “extraordinary high” crack margins, “to allow [Heide] to re-assess the optimal structure, scope, type and appropriate size of any refinancing transaction”. The principal, expected to be “significantly smaller” than the €330m — wasn’t confirmed on the conference call, reports 9fin’s Ben Hoskin, but management signalled that the size of the current outstanding bond (€250m) is a good yardstick.

Rapidly evolving forward curves (despite their downward slope) have allowed Heide to lock-in 24% of throughput from May to December 2022, at $16.49/bbl versus an average of $7.59/bbl for 2019-2021.

A good set of Q1 22 numbers, plus the future benefit from locked-in hedges could allow for a more favourable set of metrics to refinance. Extending its inventory facility from Macquarie last year to 2024 was conditional on a bond refinancing by H1 22, but management said this week that lenders understand the postponement and the facilities remain available without constraint.

The 2022 bonds have since ticked up by around four-points to 94. Part of the move might be due to management comments they are keeping an eye on possible discounted purchases (Heide can purchase up to 10% under the indenture). Management said the expected coupon on the new bond would be “moderately higher” than the existing 6.375% SSNs.

Lowen Play’s scheme of arrangement was sanctioned by Justice Andrew Johnson in a short hearing yesterday morning. There were no challenges to the Scheme for the German coin gaming arcade operator. The restructuring is expected to become effective by the 13 May long stop date. The final hurdle is approval from the German tax authorities, expected shortly. If you are not a client but would like a copy of our Restructuring QuickTake please complete your details here. 

Under the restructuring plan there is no deleveraging, with the debt split into a Opco/Holdco structure, to ‘materially deleverage the Opco balance sheet’, with Opco net debt projected at 3.5x on projected FY 22 adjusted EBITDA. The €40m SSRCF will be repaid from cash on the balance sheet at completion. Debt maturities are extended until December 2025 and September 2026, with higher interest payable on the reinstated Opco debt, but overall interest costs will reduce slightly on an annual basis. Bondholders will take ownership and control.

Haya Real Estate is next up, with its Scheme convening hearing on Monday. The proposed restructuring offers a small principal paydown, with quarterly cash flow sweeps, a hefty interest margin bump, and a minority equity stake to sweeten a maturity extension to 2025. It is projected €46.4m of the 2022 bonds will be repaid with the remainder exchanged into €377.5m of new notes sitting at a new HoldCo paying E+900 bps and due in November 2025.

Noteholders will also receive 27.5% of the equity, which is not stapled to the new notes, with no portability. The existing RCF will not be renewed after its 2022 maturity. The intention is for an exit by the end 2023. For more, see our Restructuring QuickTake

Pro-Gest, the Italian container board, cardboard and packaging manufacturer has posted a surprisingly upbeat outlook for 2022. Its bonds tanked in early March to the high 60’s after a spike in European Natural Gas prices to over €300/Mwh saw it temporarily close some of its mills, saying it was uneconomic to produce. The lost production cost is around €6-7m it has disclosed.

Pro-Gest is budgeting gas prices of €90/Mwh in 2022, compared to €110 currently. It is not hedging, citing the costs of doing so as too prohibitive, with “no possibility/offer to hedge the future gas consumptions.” The €250m 3.25% December 24 SSNs are indicated in the mid-70s.

Keter, the BC-Partners-backed maker of resin-based outdoor furniture and storage released mixed earnings this Friday, according to buysiders. After a pulled €1.175bn refinancing in mid-February and a stalled IPO, there are concerns that rising costs and depressed consumer spending will not be conducive for its return, with its existing TLB going current in October.

Keter’s EBITDA declined 10.2% to €68.4m in Q1 despite a 22% increase in net sales to €501.1m as cost inflation reared its ugly head. One of Keter’s key materials, resin (polypropylene), is ultimately oil-derived and therefore sensitive to price fluctuations. The EBITDA margin also fell from 18.6% to 13.6%, while gross margins declined from 36.3% to 32.6%. Look out for more in our earnings write-up later today.

A shorter-list this week, most of my reading was taken up by Adler and Viceroy, and a break to Sheffield and the Peak District (I highly recommend the Sheffield Tap — on platform 1B at the railway station — a reason to celebrate a train delay)

Zoltan Poznar from Credit Suisse was talking about going long shipping due to a shortage of VLCC oil tankers, to transport rerouted Russian Oil to China. So its a little ironic, that Russian shipping company Sovcomflot is being forced to offload at least 40 of its 121 vessels ahead of EU/UK wind-down orders which kick-in on 15 May. Most buyers are from Dubai or China.

No upLyft yet for the ride-hailers. The idea was to scale-up as quickly as possible, take out the competition and then raise prices. Uber tried to do so in London, but was hit by court rulings on the legal status of its drivers, and a proposed ban, eventually overturned. US-based peer, Lyft reported another steep loss -$197m during the first quarter, making it -$7.1bn over the past five years. Worst still, driver retention is poor, despite relying heavily on cash incentives.

Uber isn't immune. The next day it posted a $5.93bn loss of its own, which included $5.5bn in losses from equity stakes in companies it received when selling operations.

As rates continue to rise, and inflation prints continue to surprise to the upside, it is worth looking at worst case scenarios. After all, the consensus remains that inflation will come down relatively quickly next year, and that rates hikes will end in the first half of 2023.

The excellent Bond Vigliantes from M&G give five reasons why US inflation will remain elevated.

Nouriel Roubini (aka Dr Doom) details The Gathering Stagflationary Storm. To be fair, it’s coming to the UK, the BoE projects UK CPI >10% by Oct'22,  and cut '23 GDP f'cast 150bps to -0.25%.

Finally, a long read. A great FT piece on how to serve papers on Oligarchs and other rich individuals who are skilled at avoiding them.

Friday Workout - Auditing the Auditors; Recounting our Blessings

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