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If you missed the warnings signs on Steinhoff - don't miss them on this company

by , 19 February 2020
If you missed the warnings signs on Steinhoff - don't miss them on this company
Since 2018 I've been telling investors that this company is in trouble.

When I wrote about it in 2019, calling it Steinhoff 2.0, the share price was 862c. This week it was 59% lower at 352c.

But instead of fixing its problems this company has kicked up its ‘dodgy' dealings by a BIG notch…

Let's have a look.

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Trustco’s got a history of questionable dealings
 
Trustco (JSE: TTO) used to be a property developer in Namibia. The company then later on bought Trustco Bank through which it loaned money to people buying its properties.
 
But once the Namibian economy and property market turned negative this business started struggling badly.
 
And that’s where the company started with its accounting tricks and questionable dealings…
 
In 2017, instead of auctioning properties with non-performing loans on the market the company bought them back. Trustco bought back properties, by effectively writing off loans they extended to the buyers. This kept the property values ‘high’ on its books, and ensured the bank didn’t report losses on loans.
 
But then things got really ‘dodgy’…
 
In its 2017 financial statements, Trustco moved properties from ‘level 2 non-financial assets’ to ‘level 3 non-financial assets’.
 
Now, this is strictly legal. But it's definitely not completely honest.
 
Look at the effect this had on Trustco’s books:
 
 
As you can see here, doing this change Trustco revalued properties worth R816 million to R1.01 billion.
 
 
Basically, this allowed Trustco’s management leeway in valuing these properties.
  
But here’s the thing – how can properties that are already not in demand, in a declining market increase by 23.77% in value in a single year?
 
So why would management want to overvalue properties on its books by R194 million?
 
Well it’s simple…
 
Trustco’s MD, Quinton van Rooyen gets paid based on performance of the company:
 
 
 
Now here’s where things get crazy!
 
In its March 2017 final results Trustco reported 39% of its increase in profits was thanks to the ‘revaluation’ of investment properties amounting to R194 million.
 
While the company ‘improved’ revenue and profits in this year it’s cash generated by operations decreased and its net cash flow from operating activities went negative by R72 million. At the same time the company’s borrowings show up from R1.1 billion to R1.5 billion.
 
And that brings us to 2018 and the ‘ground breaking’ deal that Trustco pulled off…
 
Trustco sold a 20% shareholding in its company Legal Shield Holdings to one of its main shareholders, Riskowits Fund (Conduit Capital’s largest shareholder). Riskowitz fund manager is also the CEO of Conduit Capital…
 
The sale transaction was for R1.2 billion for 20%, so it put a value of R6 billion on Legal Shield.
 
But Legal Shield was valued at R2.1 billion on Trustco’s books in the same year.
 
Now why would Riskowits buy this business from Trustco at such a huge premium? Well, it immediately makes things at Trustco look a lot rosier. Trustco suddenly has a lot of extra cash, and it can show a huge profit on the sale of this share in the business.
 
This saw Trustco’s share price rise from around 400c in 2017 to a high of R13.49 in August 2019.
 
And obviously this in turn showed an improvement in Riskowitz funds as well…
 
Now back to ‘revaluing’ property for another R693 million in profit
  
In June 2019 I showed investors how Trustco booked R693 million in extra profits by revaluing property – yet again.
 
In short, here’s what happened:
 
In 2014 Trustco bought a property development arm. The properties it owned were worth R247 million on Trustco’s books in 2018.
 
But, in Trustco’s own words from its financial report: “Due to the decline in the property market, as evidenced by relatively low demand and a decline in property prices, caused by the slowdown of the Namibian economy, management decided to review its plan and developed a new strategy as regards the extraction of value from these property assets.
 
The revised strategy is to hold the properties for longer term capital appreciation and not for short term development and sale.
 
As a consequence, the board decided that the planned imminent development of the affected property assets be cancelled immediately. The strategy adopted for the affected property assets is now aligned with that adopted for other similar property assets within the property portfolio of the group which have been accounted for as investment properties.”
 
What Trustco’s saying here is that:
 
1. The property market in Namibia declined and it is struggling to sell the properties
 
2. Due to low demand there has been a “decline in property prices”
 
3. Trustco will no longer sell these properties but hold on to them and hope they appreciate in value
 
Now, here’s where the accounting trick comes in…
 
Development property is held on the books as inventory. Investment property is held on the books as a long-term asset.
 
By making the change from development inventory Trustco effectively “sells” the development property to itself. It claims the value of the transaction as “revenue”.
 
But wait, that’s not all!
 
Trustco ‘revalued’ the properties, and it now tells investors the properties that were on its books for R247 million (and couldn’t sell) are now worth R984 million.
 
That’s right – in a market where Trustco itself admits property prices are dropping it claims a 298% increase in the value of its properties…
 
But it’s even more shocking than that.
 
This move allows Trustco to book R984 million as “Revenue” and book a R693 million profit. But there were no cash inflows, and no real value created for shareholders.
 
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How Trustco and Conduit Capital creates R950 million out of thin air
 
So, by now Trustco’s share price has started to drop due to the market recognising there’s something wrong there…
 
And with Conduit Capital being a massive shareholder in Trustco it’s reflected negatively on Conduit. The problem is, Conduit needs a certain amount of assets on its books for its Insurance business to remain operational… So, this time Trustco ‘helps’ Conduit out with R950 million…
 
Conduit’s subsidiary buys a property valued for R138 million on Trustco’s books from Trustco. It pays R50 million in cash – and issues R950 million in shares to Trustco. So suddenly Conduit’s net assets increases by R950 million, even though it only had R50 million in cash. What’s more, Conduit is a shareholder in Trustco, but through this transaction Trustco is now also a shareholder in Conduit’s subsidiary Constantia.
 
This now means Trustco books a R862 million profit on the sale of this property (even though it only received shares in a nearly bankrupt insurer). What’s more, through its 20% holding in Legal Shield Holdings (a subsidiary of Trustco that owned these properties) Riskowitz fund can now declare 20% of the R862 million profit as theirs.
  
But wait folks – there’s more…
  
After all of this, Conduit Capital now announces that it has entered into a deal with Trustco’s subsidiary Legal Shield Holdings (LSH), to sell all of Constantia insurance to LSH in exchange for more shares in LSH.
 
The deal is being done, placing a R2 billion value on Constantia – but all of the purchase is being done via shares in LSH and not cash. But Constantia’s net assets were valued at only R700 million in 2019. So again, this deal will  put a big ‘profit’ on Conduit Capital’s books (also meaning massive gains for Riskowitz fund management), and it allows Trustco to gain an asset using ‘over valued’ shares in LSH.
 
The deal again places a value of R2 billion on 16% of LSH – whilst when Riskowitz bought 20% of LSH it valued that 20% at R2 billion. So LSH is only growing in value more and more. But the value is all on paper…
 
So why is this transaction not above board? Well Riskowitz is one of the largest shareholders in BOTH Trustco and Conduit Capital. Riskowitz's fund manager is also the CEO of Conduit Capital.s
 
If you’re still holding shares in either of these two companies you should be asking questions by now… These accounting tricks are even more audacious than those pulled at Steinhoff – but because these are smaller JSE listed companies nobody is paying the due attention they should…
   
Here’s to unleashing real value,
Francois Joubert,
Editor, Red Hot Penny Shares 
 
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If you missed the warnings signs on Steinhoff - don't miss them on this company
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