Muddy Waters Capital LLC (“Muddy Waters”) is an investment advisor to a private fund. Muddy Waters has analyzed the German listed stock corporation Stroeer SE Co. & KGaA (together with its predecessor legal entities, “Stroeer”) and is hereby publishing the outcome and the conclusions of our analysis, which is based on publicly available information. The fund Muddy Waters manages is short in Stroeer and for this reason there might be a conflict of interest.

Stroeer – Blue Sky or Being Taken for a Ride

Muddy Waters Stroeer

Introduction

Stroeer went public in 2010 as a Germany-based operator of billboards, with the founders Dirk Stroeer and Udo Muller floating 47.8% of the company’s shares – they still hold about 42% of the shares today. The business was steadily growing, but perhaps a bit boring. The stock price languished. At the end of 2012, it was down 40% from its IPO, and trading at 7x EV / EBITDA. But something big changed in 2013. Stroeer unveiled a “digital” strategy based on three pillars – acquiring a group of online businesses in Turkey and Poland, buying a couple of online ad exchanges, and buying a few online advertising businesses from Dirk Stroeer and Udo Muller, who is still the CEO of Stroeer. This all seemed to make sense – old world advertising meeting the new, Stroeer striving to become number one in Germany in online and offline, a bold company that grasped what others weren’t yet seeing…

Most of the world seems to think Stroeer’s move into online has been a smashing success. Revenues, EBITDA, and net income are all up substantially since the end of 2012 – and not coincidentally – so is the stock price. At around Eur 54 per share, Stroeer now trades at 19.77x EV / EBITDA. The company promises an even more exciting future that includes neat things like beacons, and it gives us cool graphics like the one below to show us what’s coming – Stroeer has since acquired content companies, Deutsche Telekom’s online portal, an education software company, mobile advertising companies, a statistical analysis company, gaming companies, a company aiming to make the yellow pages obsolete, and a location-based advertising firm. Since 2012, Stroeer has bought stakes in at least 29 companies, spending what we calculate is Eur 142 million in cash, and increasing the share count by 32%.1 Stroeer says its digital businesses grew organically by 34.3% in 2014, and 23.5% in 2015. Why should anybody be skeptical?

Muddy Waters Stroeer

Well, it turns out that Stroeer’s claimed digital organic growth rates are way off from what we can calculate. We see Digital organic growth rates of only 2.2% in 2014, and 2.5% (using adjustments we believe are more reflective of the business) to 16.4% (using the company’s methodology) in 2015. Maybe Stroeer’s digital foray makes as much sense as wanting to be sucked into your computer in order to get physical media implants. The billboard business strikes us as a real estate business. It is our view that much of the business revolves around knowing commuting patterns and neighborhood demographics, dealing with planning departments, negotiating leases with property owners, schmoozing with government employees, managing construction, securing adequate insurance, detecting structural problems and managing maintenance, working with industrial printers, managing logistics, etc., etc. Billboards seem to us like a fairly old school, hard-nosed business.

Perhaps there’s a good reason why Stroeer seems unique among OOH advertising companies in aggressively pursuing online business. Why is it that large U.S. OOH companies with relatively easy access to Silicon Valley seemingly haven’t caught onto Stroeer’s opportunity set? Probably for the same reason Sergei Brin, Larry Page, Jerry Yang, and Mark Zuckerberg were not in commercial real estate before founding online marketing powerhouses – there seems to be little overlap.

When we scratch the surface at Stroeer, we see a company that to us appears far less successful in online than the market seems to think. Moreover, we see a company whose insiders have spun a great story, but with seemingly little substance; and, while telling the story, have engaged in more highly questionable self-dealing than we’ve ever seen outside of a Chinese company. That’s why we’re short Stroeer.

Summary

Stroeer SE Co. & KGaA (“Stroeer”) is not the company the market seems to think it is. We believe organic growth, EBITDA, operating cash flow, and free cash flow to be significantly lower than Stroeer reports. These items go right to the heart of the investment case for Stroeer. We have serious concerns about Stroeer’s governance, and these concerns are inextricably linked to our views on the company’s profitability and cash flows.

Stroeer’s governance reminds us of some of the companies we researched in China. In one instance, Stroeer agreed to buy a company from insiders before the insiders themselves even purchased it. Because of the way the transaction was structured, it is impossible to say how much profit the insiders made; however, we believe approximately Eur 22.4 million on a Eur 2 million cash investment made just six months earlier is a reasonable estimate. Insider-affiliated companies are both users and suppliers of Stroeer OOH advertising locations, which we think is inappropriate; and, further causes us to be concerned about whether sufficient internal controls exist.

We have identified an instance in which a once key digital acquisition went bad, and to our mind, the company and management seem to have avoided being held accountable. Perhaps it is then not surprising to read the remarks that a senior Stroeer executive made publicly about the company’s approach to buying digital businesses – in our opinion, his comments show a highly cavalier attitude toward capital allocation.

Insiders have sold hundreds of millions of euro worth of stock, and even failed to properly report some of their share transactions – possibly in violation of the law. We believe that since Stroeer embarked on its digital strategy in 2013, its board of supervisors has generally lacked sufficient independence, which has helped to create the conditions giving rise to the aforementioned issues, as well as other issues we discuss in this report.

We believe that Stroeer has substantially overstated its organic growth figures in 2014 and 2015. We do not know if what we believe to be the overstatements result from incompetence or are an attempt to mislead investors. In our view, the most accurate way of measuring Digital organic growth in 2015 would have yielded a rate of only 2.5%.

We adjust Stroeer’s 2015 free cash flow down by a) Eur 24.8 million due to our inability to reconcile certain balance sheet and cash flow statement accounts, which causes us concern about Stroeer’s accounts, and b) Eur 26.9 million of purchases of non-controlling interests. We adjust Stroeer’s 2015 operating cash flow downward because we suspect the company greatly stretched its payables (in terms of days sales) to 118 days, versus a three-year average of 95 days. We believe Stroeer artificially inflates EBITDA through other operating income, and certain capitalized items that we suspect are more conservatively expensed.

Stroeer’s year-end cash flow statements wrongly show that Stroeer had no borrowings during the year. However, Stroeer’s annual statement cash flow statement only shows borrowing activity net of repayments, rather than gross. This appears to violate IFRS, and gives the incorrect appearance Stroeer is able to fund itself through cash flow and cash on hand throughout the year. In our opinion, Stroeer’s auditor has committed a clear error in allowing for the misleading presentation in the annual cash flow statement.

Stroeer’s public video operation, Infoscreen, seems to be an outlier in the industry in terms of its profitability. Since its reclassification to the Digital segment in 2015, Infoscreen has been integral to the Stroeer growth story. We believe Infoscreen deserves greater scrutiny from investors.

As a result of the foregoing factors, we find the investment case for Stroeer hollow.

Organic Growth in Digital and Overall Appear to be Greatly Overstated

We believe that Stroeer has substantially overstated its organic growth figures in 2014 and 2015. We do not know if what we believe to be the overstatements result from incompetence or are an attempt to mislead investors. Below are the organic growth figures we calculated from the information the company released. We use the same formula Stroeer used in each year, and we made no adjustments to methodology. (We explain the misleading way Stroeer calculates the base year for its 2015 organic growth calculation. When we adjust Stroeer’s base year, 2015 organic growth is even lower.)

Muddy Waters Stroeer

Below is our reconciliation of 2014 and 2015 organic growth.

Muddy Waters Stroeer

The impossibility of Stroeer’s claimed 2014 overall organic growth rate of 11.4% is laid bare by the inconsistency in a single paragraph of its 2014 AR. In that paragraph, Stroeer reiterates that its organic growth in 2014 was 11.4%; however, it also states that its inorganic growth was Eur 42.2 million.2 As shown in the tables below, it would have been impossible in 2014 for Stroeer to have grown organically by 11.4%, and inorganically by Eur 42.2 million.

Taking 11.4% organic growth as a given, trying to reconcile to €Eur 42.2 million inorganic growth:

Muddy Waters Stroeer

Taking Eur 42.2 million inorganic growth as a given, trying to reconcile to 11.4% organic growth:

Muddy Waters Stroeer

Stroeer’s 2015 Organic Growth Should be Adjusted even Lower

In our view, the most accurate way of measuring Digital organic growth in 2015 would have yielded a rate of only 2.5%. First, Stroeer misleads regarding its 2015 organic growth rate by “cherry picking”. (“Cherry picking” is the practice of excluding poor individual results when calculating overall performance.) Without this selective exclusion, 2015 Digital organic growth would have been only 11.8%, and 2015 overall organic growth would have been only 7.6%. Second, Stroeer made its Digital segment appear to be growing 3.9 percentage points faster by reclassifying public video as digital in 2015. We argue this is disingenuous. Third, Stroeer changed its organic growth calculation methodology in 2015 to include organic growth of companies it acquired in 2015, which increased Digital organic growth by 2.6 percentage points and overall organic growth by 0.9 percentage points. We believe that including organic growth of acquisitions in the year of the acquisition is a perversion of what “organic growth” means.

In 2015, Stroeer disposed of a group of companies that, per the below slide, contributed revenue in 2014 of Eur 7.2 million.3 These companies were disposed of for near zero consideration – even though at least one of them had profits implying it was worth at least a few million euros.4 As shown in the below slide, when Stroeer calculated 2015 organic growth it adjusted downward the 2014 revenue base by the Eur 7.2 million revenue it disposed of in 2015.

Disposing of companies for zero consideration is effectively a management failure. If the purpose of organic growth is to gauge the effectiveness of management’s strategy, then organic growth should not benefit from such failures. That is even truer when Stroeer dubiously includes organic growth it acquires in its calculations (discussed infra).

Muddy Waters Stroeer

Second, Stroeer made its digital segment appear to be growing much faster by reclassifying public video as digital in 2015. We argue that move is disingenuous because, unlike the rest of the Digital segment, public video is not accessed over computers or mobile devices – it’s just another version of a billboard. Stroeer management is likely aware that the market puts a higher multiple on its Digital segment (especially if growing quickly) than on OOH. Changing nothing else about Stroeer’s methodology, reclassifying public video boosted the Digital organic growth rate from 11.7% to 15.6%.5 If we also disallow the “cherry picking” adjustment, then the reclassification increased Digital organic growth from 7.1% to 11.8%.

Third, Stroeer changed its organic growth calculation methodology in 2015 to include organic growth of companies it acquired in 2015. As we explain infra, we believe that including organic growth of acquisitions in the year of the acquisition is a perversion of what “organic growth” means. This change alone boosted Digital’s growth rate (all other aspects of Stroeer’s formula kept unchanged) from 9.2% to 11.8%. It boosted Stroeer’s overall organic growth rate from 6.7% to 7.6%.

If we adjust Stroeer’s 2015 organic growth formula to i) eliminate the cherry picking adjustment Stroeer made, ii) reverse the reclassification of public video as Digital, and iii) use the 2014 organic growth calculation methodology, which excludes acquired organic growth, then Stroeer’s 2015 Digital organic growth rate would have been only 2.5%.

See full report below.