Wirecard and the Dangerous Allure of Lots of Cash

(Bloomberg Opinion) -- Like all good financial aphorisms, the notion that “profit is an opinion, while cash is a fact” contains a kernel of truth. It’s certainly a lot easier for companies to massage quarterly earnings than it is to lose track of how much cash they have in the bank. Ultimately, investors use projected cash flows to determine what a business is worth today, so it’s certainly worth paying attention to.

Yet the implosion of German electronic-payments processor Wirecard AG shows once again that it’s unwise to rely too much on a company’s cash position when evaluating an investment. Doing so can cause investors to overlook more troubling signs.

When Wirecard last published audited results in September, it boasted of 2.3 billion euros ($2.6 billion) of net cash and said free cash flow had jumped 60% to more than 410 million euros for the first nine months of 2019. That was doubtless of considerable to relief to the investors who’d read articles in the Financial Times accusing the company of fraudulently inflating its sales and profits. Wirecard’s financial results were backed by cash that auditors Ernst & Young had verified, so what was the problem?  

However, 1.9 billion euros of that cash has gone missing, according to the statement Wirecard provided on Thursday when its long-delayed annual report was supposed to be published. The shortfall could imperil the survival of a company that was worth 24 billion euros at its share-price peak in 2018. Until recently, Wirecard’s debt was investment-grade rated by Moody’s and most analysts had a buy rating. Since Thursday’s bombshell disclosure, however, the stock has lost three-quarters of its value.

To be clear, we don’t yet know whether Wirecard’s cash was stolen or whether some of it didn’t exist in the first place. The company’s chief executive officer, Markus Braun, said on Thursday that it may have been the victim of a massive fraud — you can watch the presentation here. He’d resigned with immediate effect by Friday lunchtime. One of the big questions is: Why did Bavaria-based Wirecard choose to park so much cash in the Philippines?

A special audit by KPMG, whose findings were published in April, had already raised doubts about how the company accounted for its cash. Among the disturbing findings — glossed over by Wirecard in its own flattering summary of the accounting firm’s report — was that about 1 billion euros of deposits processed by third parties, and held in trust or escrow accounts, were insufficiently documented during the 2016-2018 period. They couldn’t therefore be verified.

KPMG said this escrow cash (essentially, the money held by an impartial third party in a financial transaction between two other parties) should perhaps not have been presented as cash and equivalents in Wirecard’s own accounts, which Ernst & Young had signed off on. The FT, whose reporting on Wirecard prompted the special audit, highlighted the company’s odd cash accounting back in December. 

The recent scandals at FTSE 100-listed hospital operator NMC Health Plc and Aim-listed cakemaker Patisserie Valerie Holdings Ltd. also featured large reported cash balances that turned out not to be reliable. Almost two decades ago, Italian dairy group Parmalat appeared to have a healthy cash balance just before it collapsed under a mountain of hidden debt.

Investors in those companies were so enamored by the cash rolling in that they didn’t spend enough time questioning whether there were nasties lurking under the hood. Wirecard’s investors will wish too that they’d been a little more questioning.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

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