Viceroy’s Grenke-Cash Accusations – rather unlikely that they are true!

Matthias MeitnerManaging Partner, VALUESQUE

Yesterday, short-seller Viceroy attacked MDax-listed leasing company Grenke AG (HERE). Today it raised some more allegations (HERE). One important point relates to the accusations of accounting misstatement of the franchise business and consequences for the cash account. We would like to shortly comment on this below.

The franchise model is Grenke’s way of entering new markets. The rollout is in most cases done via franchise businesses that are operated under the Grenke brand. But Grenke provides even more to these businesses: Expertise, infrastructure, different services and even refinancing of operations. For this Grenke retains the right to buy the franchise firm within a time frame of 3-6 years at pre-fixed terms.

  1. Consolidation

The first point touches the question whether Grenke has to consolidate these businesses. In this context, IFRS 10 mainly says that an entity has to consolidate another entity if it “controls” it. So the question of consolidation goes down to the question of control. In simple cases the majority (50+%) of voting rights is a clear indication of control, but in some cases this could also be misleading and in other cases control can be exerted also without the voting majority. The rules for control under IFRS 10 are (IFRS 10.7):

“An investor controls an investee if and only if the investor has all of the following three elements:

power over the investee, i.e. the investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee’s returns)

exposure, or rights, to variable returns from its involvement with the investee

ability to use its power over the investee to affect the amount of the investor’s returns.”

From the explanations regarding the nature of Grenke’s franchise business one might get the impression that there is a clear liaison between Grenke and the franchise companies. The acquisition option at pre-arranged terms is a strong indication of power and exposure, and the general setting of the relationship also indicates that Grenke has the ability to use its power over the franchise company.

However, for me this is not a clear case. I do not know enough of the relationships to clearly judge whether this is a situation of “control” according to IFRS 10. And additionally, these relationships are clearly one of the focus points of auditors. And I think that it is not super-complicated to make an auditor judgement here that this structure is off-consolidation. In many cases companies that do not want to consolidate set the terms of the relationship to partner companies according to the auditors’ guidelines, they do not go beyond. Hence, I think the consolidation issue is not an accounting fraud (as I believe in auditors’ ability to understand the structures).

However, the economic consequences of Grenke’s franchise strategy are worth a deeper look here. In particular two aspects might be of relevance for readers of financial statements. The first one has already been highlighted by memyselfandi007 HERE

As long as Grenke can create businesses outside of its consolidation sphere (case 2 below), it can step in at a later point in time and does not have to record any losses from starting up businesses in its P&L. According to IAS 38.69 companies cannot bring start-up costs and initial losses as an asset onto the balance sheet. So, if the businesses were developed internally at Grenke (case 1 below) then the P&L and the equity account would have suffered more over the first years. Over the whole period this leads to higher total earnings of Grenke (as compared to the internal generation case). The counter-entry is (depending on the way of structuring such deals) either a lower debt position at the balance sheet, a higher receivables position or some goodwill.