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SoftBank Invests in an Opaque $100 Billion Industry

Chris Bryant

(Bloomberg Opinion) -- About $1 billion of shareholder wealth went up in smoke last week when GMT Research – a Hong Kong firm that tries to hunt down anomalies in financial reports – accused the Australian construction group Cimic Group Ltd. of using creative accounting to inflate its profits.

Cimic is controlled by Germany’s Hochtief AG and contributes most of its earnings, while Hochtief is majority-owned by Spanish construction giant ACS.

Responding to GMT, the Australian company said its accounts were “fully audited and in compliance with the accounting standards.” The statement didn’t appear to entirely alleviate the market’s concerns, though, and perhaps that’s no surprise. In one respect at least, those accounting standards aren’t really comprehensive enough.

I’m referring here to how the rules apply to a practice known as supply chain finance. Also called reverse factoring, this is an increasingly popular way for companies to free up more cash by getting a financial intermediary to pay their suppliers. (It’s so popular, in fact, that even the $100 billion SoftBank Vision Fund is investing in the reverse-factoring sector, spending $800 million on a stake in one of those intermediaries, Greensill Capital(5)).

GMT claims that Cimic improved its cash flow by using supply chain finance, and that this was one way in which the Australian company could obscure the alleged poor quality of its earnings.

In reverse factoring, a financial intermediary – historically a bank, but increasingly new specialist firms like Greensill – pays a company’s suppliers quickly, in return for the supplier agreeing a small discount. The company then repays the intermediary at a later date, sometimes on more extended terms than the ones it had with its suppliers. Both sides end up feeling like they’re winning: The company keeps hold of its cash for longer, while the supplier gets its money quickly – something they aren’t generally accustomed to.

The size of the supply chain finance market is difficult to measure because of the lack of disclosure by the companies that use it. However, Greensill, whose advisers include the former British prime minister David Cameron, estimates that outstanding supply chain finance assets have swelled to about $100 billion.(4) That’s still just a fraction of the $2 trillion in payables (or supplier obligations) that the consultancy McKinsey & Co. thinks could be financed in this way in future.

Accounting issues can arise, though, because instead of a liability to its supplier, the company using the reverse-factoring service now has a liability to a financial firm. Some credit rating agencies and analysts are inclined – correctly, in my view - to see this liability to the intermediary as borrowing, which should be labelled as such and would thereby change the company’s leverage ratios. Often though, it isn’t. That’s because neither of the current sets of IFRS and GAAP accounting rules provide much guidance on how reverse-factoring obligations should be treated, leaving much to a company auditor’s judgment.

“It is relatively easy to cloak the existence of a reverse-factoring arrangement within a set of financial statements,” according to UBS analyst Geoff Robinson.

When the U.K. building contractor Carillion Plc collapsed in 2018, its decision to classify ballooning reverse-factoring liabilities as “other creditors” – a footnote in the accounts ignored by most analysts – became a focus of the subsequent inquiry. Moody’s estimated that as much as 500 million pounds ($646 million) was owed under this reverse-factoring arrangement, a figure that dwarfed Carillion’s reported net debt. (I’ve written before about how short-sellers spotted this).

Many companies, including Cimic, provide even less disclosure than Carillion and simply lump supply chain finance liabilities in with trade payables (the amount owed to all suppliers) without providing a separate figure. That leaves investors mostly in the dark.(1)

Of course, there’s an argument that it doesn’t matter whether a company owes money to a supplier or to a bank; the total liability is the same and that number isn’t “hidden.” Lex Greensill, the billionaire chief executive of the eponymous supply chain finance firm, told me the problem lay with the credit rating agencies. “In my view it’s extremely odd that if you owe money to a bank or bondholder, that’s classified as debt, whereas if you owe money to a supplier it is not. In future, the rating agencies will have to consider credit provided by suppliers to be a financial liability of the firm.”

Still, the credit rating agency Fitch says there’s a danger that a bank might limit or withdraw a reverse-factoring facility if a company gets into financial distress, worsening the pressure on its cash. This appears to have been a problem for the indebted Spanish renewable energy group Abengoa SA, which almost collapsed in 2015.

After Carillion’s liquidation, the U.K’s Financial Reporting Council acknowledged that the growth and complexity of supply chain finance arrangements may have reached a point where accounting standards “should explicitly and more comprehensively address them.” Standard & Poor’s agrees, saying last year that: “A great deal more needs to be done by audit committees, auditors, and regulators to ensure that companies clearly disclose their use of supply chain finance.” 

There’s nothing wrong with big companies using financial intermediaries to help their smaller, weaker suppliers get paid more quickly. But investors have a right to know how a company is generating cash and to whom it owes money. Absent better disclosure, there’s a danger that even the very mention of reverse factoring in a company’s accounts will unsettle investors and provide fodder for short-sellers.

Cimic isn’t alone in drawing scrutiny for its use of supply chain finance recently, with the French retailer Casino Guichard-Perrachon SA and the U.K. building contractor Kier Group Plc also coming under the spotlight. But, unlike those two companies, Cimic does not provide numerical detail on reverse factoring in its financial reports. The accounting rule-setters should require it and other businesses to be more transparent.

(1) Greensill has said in the past that it has done work for Cimic, but both companies declined to comment on that when I asked them.

(2) These financial obligations are increasingly repackaged into tradeable supply chain finance notes for sale to pension funds, insurance companies or companies with spare cash.

(3) Cimic's annual report explains that the supply chain finance arrangements “mirror normal credit terms and do not modify the original liability," and hence are classified within trade and other payables. These payables jumped 20 percent to A$ 5.7 billion ($4 billion) last year. Suppliers that use the Cimic early payment facility are promised their money within 10 days.

To contact the author of this story: Chris Bryant at cbryant32@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

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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