This week we would like to take a look at Greensill Capital and its spectacular fall from grace. Its fall, preceded by another yet bigger collapse in the form of German payment processor Wirecard, has raised many questions around the ability of regulators to keep up with changes in modern finance and left the German regulator in a shambolic situation.
A Bit of Background
So, how does a company that just two years ago had raised $961m at a lofty valuation of $6bn AUD from SoftBank and was talking up an IPO at a humble valuation of $7bn AUD (according to industry insiders) just a month ago, collapse almost overnight? What that might suggest about valuations and the IPO market in its current form may be an article in its own right but for now let's look at what happened.
Firstly, let's begin with what Greensill actually does. Simply put, the business, despite its later diversified revenue streams including conventional banking services and bonds (on debt it has purchased) to outside investors, operates in the world of supply-chain finance as its bread and butter. Think about it as BNPL for a supply chain. Essentially it is factoring in reverse, whereby a buyer uses a bank or financial institution to finance a suppliers invoice. Because the invoice gets immediately sold, the supplier gets immediate cash whilst the buyer has more time to pay off the cash. In this entire transaction there are three parties involved, the buyer, the supplier and the mediating financial institution (cue Greensill).
Simple, right? However, for the financial institution, there are even more hurdles. A company like Greensill needs two further things, access to immediate capital (a line of credit) to pay the suppliers on behalf of the buyers and, from a risk perspective, an ability to adequately insure the possibility of non-payment by the buyers. On face value this seems simple enough. However, problems can arise when any one of these pieces fails to work.
So, what happened?
The problem began around eight months ago, when Greensill found itself in a situation whereby the insurers, IAG (IAG.ASX) in this case, were unwilling to insure or renew around $4.6bn AUD in policies. With that first major problem, the dominos began to fall. Without insurance, there was no way that banks or financial institutions, in this instance Credit Suisse and GAM Holdings, were going to extend liquidity in order for them to make the requisite payments to their suppliers. The business model effectively falling to pieces as soon as this occurred.
There was some last minute flurry when Greensill sought an injunction in order to stop IAG from ceasing coverage. Unfortunately for Greensill, it was not until the last minute (they had found out about IAG looking to cease coverage in September 2020) that they sought to do so and the Justice cited this issue as the reason for denying the firm. Shortly following this Credit Suisse froze close to $10bn AUD in funds.
What went wrong?
This begs the question, why did IAG actually suspend coverage? What went so wrong? The answer lies not in the Greensill business model itself but around how it handled its risk and we’re quite sure that this is what IAG realised rather slowly. The big red flag for investors, including Softbank, should have come from the fact that when the firm sought a change in auditors due to increased complexity, two of the Big Four accounting firms (and the smaller BDO) all declined the business.
But let's look at the risk and Greensill's management of it or lack thereof, a somewhat understandable scenario given the founder and CEO’s propensity for risk-taking and making bold moves. So bold in fact that, despite the firm's claim of over $163bn in financing and north of 10m customers, by far the biggest and most lucrative client was a single entity, GFG Alliance (the group owned by Sanjeev Gupta). This group owes close to $7.3bn AUD. Not only had the firm engaged in traditional supply-chain finance but they had made loans which were then repackaged, securitised and sold back to GAM Greensill Supply Chain Finance Fund (which has now been closed for subscriptions and redemptions).
Mr Gupta, of course, has conveniently indicated that repayments would be frozen and had previously indicated that GFG itself would file for bankruptcy should Greensill stop providing it with working capital loans. A relationship that had turned particularly toxic and was predicated much upon the personal relationship between the heads of both groups.
As if the concentration and reliance on one client wasn’t enough, it seems that, on the other end of the spectrum, IAG through its subsidiary BCC was the only substantial insurer. So, the firm in its entirety relied on one client and one insurer to make or break its business. A situation that helped it when it grew rapidly. The GFG and Greensill alliance, though now seemingly toxic, was mutually reinforcing (on the way down too it seems). On the positive for GFG, the loans from Greensill were unsecured.
For the shareholders of IAG? Despite the beating it took at the time of writing, the company has apparently managed to sell off its exposure. The subsidiary, BCC (the entity writing contracts to cover Greensill bonds), actually sold a chunk to Tokio Marine Management, itself owned by three companies all linked to the Mitsubishi UFJ Financial Group (MUFJ) keiretsu. IAG sold its 50% of BCC to Tokio on 9 April 2019 and the deal effectively wiped out any exposure to trade credit insurance. The timing was coincidental, of course. This author would like to know how Mitsubishi feels about this particular coincidence.
Where to Next?
Call me a cynic, but I for one have a feeling that it wasn’t an accident that the working capital issue was left to the last minute. Much of the recent mess may have been avoided with a timely IPO at a requisite valuation and enough of a liquidity injection. No one would have been the wiser. But for now, Apollo Global Management, the private equity firm with enough brains to see a good deal, are probably going to come out on top. They are likely to buy out the business for a tidy $127m, minus the headache of the Gupta loans of course. Remember, this is a business that still made close to $35m AUD in 2019 (that’s net profit) and, if you take out the biggest headache (GFG) and reinsure it with some capital on top, that may just be a decent deal (if done well, one might say, the deal of a lifetime).
As for the Honourable Lex Greensill CBE (oh yes, he’s that too)? The golden boy from Bundaberg might’ve fallen from grace along with his eponymous firm but, somehow, I doubt this will be the last we will see of him. For the moment, the now former rich lister might file for insolvency and be protected under safe harbour laws for whatever is left of his business (after Apollo is finished with its cannibalisation).
For us mere mortals though, it shows us some useful lessons when assessing a business. Always look to the downside, after all, it only took IAG pulling its support and a $7bn business went to 0 almost overnight.
Markets & Commentary
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