Stroeer: The Pile Gets Bigger by Muddy Waters

Disclaimer: 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. The fund Muddy Waters manages is short in Stroeer and for this reason there might be a conflict of interest. For brevity purposes, the below response is to selected portions of Stroeer’s responses to our initial 21 April 2016 report, and is based on publicly available information. We do not concede to Stroeer any of the points we made in the initial report.

We are unimpressed with Stroeer’s response to our initial report. There seems to be a cottage industry that has grown up around responding to criticism from short activists. Accordingly, Stroeer leaves major issues unaddressed, which we presume is because it has no good answers. Further, certain of its response were highly misleading.

This response to Stroeer is 10 pages long, plus a 14-page appendix. It covers the following topics:

  1. Historic Organic Growth Remains Overstated
  2. Whether Stroeer Reports Q1 Organic Growth that Exceeds Guidance is Irrelevant
  3. Muller Misleads in Response to a Question on Self Dealing
  4. Stroeer’s Operational EBITDA Justification Does Not Hold Water
  5. Stroeer’s Response Strengthens Our Conviction that the Cash Flow Statement is Prepared Erroneously (and Misleadingly)
  6. StroeerAppears to Contradict Itself on freeXmedia, and Strengthened Our Conviction this was an Improper Transaction
  7. Muller Appears to have told an Untruth
  8. “Project Zero” and Alleged Ballroom Material Misstatements
  9. Stroeer Confirmed that Public Video is Unusually Profitable; Yet it Offered No Explanation as to Why
  10. Muller and Stroeer’s Moaning is Disingenuous
  11. Dirk Stroeer’s Relationship to Sambara Stiftung / Muller’s Failure to Address His Irregular Series of Share Transactions
  12. Dirk Stroeer’s Bizarre “Temporary Retirement”
  13. Former CIA Behavioral Analyst and Polygrapher Found Numerous Indicia of Deception in Stroeer’s Call and Written Response

1. Historic Organic Growth Remains Greatly Overstated

Stroeer’s attempt to rebut our organic growth calculations is nonsensical. The company appears to have no counter argument. We assume that if we erred, Stroeer would have published an organic growth reconciliation. Instead, management seems to want to gloss over the problem of its lack of organic growth by providing details that might be too technical for the average investor (even professional) to follow. We call upon Stroeer to publish 2014 and 2015 reconciliations for organic growth for both its Digital Segment and overall.

Stroeer wrongly claims that we didn’t give credit to the company for ~€12 million in FX movements in 2014. In fact, we gave the company credit for a total of €15.1 million in FX movements. This is shown in our reconciliation on Page 7 of the report.

Stroeer’s comment about our not giving credit for the JVs is irrelevant and misleading. The consolidated JVs contributed revenue of €12.5 million in 2014, and €14.0 million in 2015. The €1.5 million revenue growth in the consolidated JVs equals 0.21% of reported 2014 revenue. This obviously does not come close to bridging the gap between Stroeer’s declared organic growth and our calculation.1

We have seen a sell side report that erroneously claims to reconcile to Stroeer’s organic growth calculations. We show the reconciliation from this report in Appendix B, and we explain the material errors in it. We therefore remain unaware of anybody who can reconcile Stroeer’s organic growth claims.

In addition to the forgoing issues, we continue to firmly believe that the adjustments to Stroeer’s calculation methodology we discussed in pp. 7 – 11 of our report are prudent and warranted.

2. Whether Stroeer Reports Q1 Organic Growth that Exceeds Guidance is Irrelevant

It now seems absurd to discuss the company’s expectations for organic growth, given that it seems wholly incapable of (or uninterested in) calculating organic growth accurately. Stroeer  might as well report Q1 organic growth of 1,000%.

3. Muller Misleads in Response to a Question on Self Dealing

As shown in the following exchange, Udo Muller was asked a straight forward question about whether Stroeer had bought other assets from Media Ventures. His answer seems straight forward as well. However, as seems typical with Stroeer management, this was a misleading answer. In February 2015, Stroeer acquired 65% of a company called Evidero GmbH. Media Ventures had invested in Evidero in March 2014.

Below is an excerpt from the transcript:2

Marcus Diebel JP Morgan Chase & Co, Research Division

Yes. Given the allegations regarding freeXmedia and maybe to avoid allegations in the future, is there a scenario that Stroeer Media buys further assets potentially from Media Ventures going forward? And has there been another potential issue in the past with Stroeer Media buying assets from Media Ventures?

Udo Muller Co-Founder, Chairman of Management Board and Chief Executive Officer

No. This was the only assets literally that’s acquired from Media Ventures…

Muller’s response was technically correct, although in our opinion it veered far from being forthright. Media Ventures transferred its stake in Evidero to one of the co-founders, Thimo Wittich, in November 2014. Stroeer bought its stake from Mr. Wittich in February 2015. We would expect Mr. Muller to deny that the price Media Ventures received from Wittich was influenced by the price Wittich expected to receive from Stroeer. We just don’t think we would believe him.

Below is a screenshot from the Media Ventures website showing its past investment in Evidero:3,4

Stroeer Muddy Waters

4. Stroeer’s Operational EBITDA Justification Does Not Hold Water

The company did not discuss the fact that its Operational EBITDA has benefitted each year from increasing amounts of non-segment expenses, and from purportedly exceptional expenses. The company stated that the ~€7 million in concession refunds that it booked into Operational EBITDA in 2014 is rightly classified because “As this kind of compensation payment arises regularly and in a planned fashion given the structure of our advertising concessions, we do not classify them as extraordinary items.”5 Where are examples of other significant concession refunds? We haven’t seen any in recent years. We therefore think this statement is disingenuous.

5. Stroeer’s Response Strengthens Our Conviction that the Cash Flow Statement is Prepared Erroneously (and Misleadingly)

The company’s response here is jaw-dropping. The company states that its borrowings are short-term, and therefore net presentation is appropriate. While the company correctly states the accounting standard for short-term borrowings, it fails to acknowledge that a) the bulk of its borrowings are shown as non-current borrowings on its balance sheet, and these appear to be borrowings from its revolver, b) revolvers, unless extremely short-term in nature, are classified as long-term (so the company’s classification on its balance sheet is correct), and c) the reference to the three-month Euribor is a refence to the interest rate it pays – not to the tenor. (This is a very, very misleading statement.)

Stroeer classifies the bulk of its borrowings as non-current borrowings. For example, in Q2 2015, non-current financial liabilities increased by €37 million, while current financial liabilities increased by only €18 million.6 The cash received from borrowings according to the cash flow statement was €46 million.7 If we generously assume that the entire €18 million increase in current financial liabilities were borrowings, then at least €28 million of the €46 million in cash flow from borrowings was non-current. Therefore, Stroeer’s response that its year end cash flow statement presentation of borrowings on a net basis is proper because the borrowings are shortterm is contradicted by its own quarterly accounts. We maintain our view that Stroeer’s auditor erred in not apparently identifying this issue.

6. Stroeer Appears to Contradict Itself on freeXmedia, and Strengthened Our Conviction this was an Improper Transaction

The company’s response on the conference call “The company executed the acquisition of Stroeer Interactive Group, including freeXmedia and businessAD, with diligence in every respect. The board of management and supervisory board were fully aware of the special aspects of the transaction in terms of the related party position of the seller and took these into account in a particularly sensitive manner. All legal and valuation issues were examined step by step by legal firms of international repute, and their legality and correctness were documented in expert opinions. The supervisory board was informed of every step taken by the board of management and received detailed written and oral reports from the advisers. The company filed special valuation reports with the commercial register in connection with the capital increase performed during the transaction and made this publicly available at an Extraordinary Shareholder Meeting of the company in March 2013.”

Stroeer Muddy Waters

See full PDF below.