Whitney Tilson’s email to investors discussing Greensill Capital, Softbank and cooking the books.
Greensill Capital Blows Up And Files For Insolvency Protection
1) U.K.-based supply chain finance company Greensill Capital blew up last week and filed for insolvency protection on Monday. Here's a Bloomberg article about it: Greensill, Gupta and the Fragile Tower of Money and Metal.
Historically, the Chinese market has been relatively isolated from international investors, but much is changing there now, making China virtually impossible for the diversified investor to ignore. Earlier this year, CNBC pointed to signs that Chinese regulators may start easing up on their scrutiny of companies after months of clamping down on tech firms. That Read More
Most American investors haven't paid much attention, as it hasn't affected them (though JPMorgan Chase (JPM) and Apollo Global Management (APO) are competing to buy Greensill Capital's core business). But I think wise investors will study what happened here because there are many lessons – in particular, how to spot the warning flags, so you don't become ensnared in a similar situation. Believe me, complex financial schemes like this are a dime a dozen!
To start, I suggest reading what forensic accountant (and my former student) Stephen Clapham of Behind the Balance Sheet posted last summer, when Greensill Capital was valued at $3.5 billion – he nailed it: Greensill, Softbank & Cooking the Books. Excerpt:
These conflicts shine a light deep into the business model of Greensill Capital. They reflect a firm trying to jumpstart a market whose core growth just isn't there. This gets us back to the idea of what it takes for a new asset class to take root. The SG Warburg chaps didn't have to rely on Autostrade to buy its bonds. And the KKR trio didn't have to rely on RJR Nabisco management to buy their leveraged loans (and not because they thought they were "funny money," "play dough," or "wampum" – to quote Barbarians at the Gate). Net out the assets that feature on the supply side and the demand side of the ledger, and the underlying growth in Greensill Capital's supply chain finance market shrivels up.
When it comes to asset class innovation, Lex Greensill ticks the first box. He is an outsider. But he doesn't tick the second – the growth in supply and the growth in demand are not in balance.
And that's not all. Dig deeper still and more red flags emerge...
Pioneering new asset classes is hard. The authors of The New Financial Capitalists write, "The essential populism of American culture is uncomfortable with financial schemes, which have so often been associated with venal fraud and scandal, or worse, unfruitful labour."
In the case of supply chain finance, it is not clear there is natural demand and so pioneers need to shimmy it along. The result is an institution drawn to scandal which itself raises several red flags. No one comes out of this looking good – not the pioneer, nor its main investor, nor the companies it services (indeed, with several of them having gone bust, stock pickers could do worse than to screen the rest for ideas). Perhaps it takes more than a zero interest rate environment to spawn a new asset class; perhaps authentic new asset classes only come along once every twenty years.
Three Main Takeaways
Here's Stephen's update this week: Greensill Revisited. Excerpt:
We have three main takeaways:
- What was Softbank doing? A 10 minute scan was enough due diligence to indicate that Greensill Capital was not worth $1bn, let alone $3.5bn.
- Why are the accounting authorities vacillating? Factoring needs to be disclosed in accounts immediately.
- Fewer companies are listing than ever before. A hidden consequence is that unquoted companies are not subject to market scrutiny and therefore we should expect more events like the demise of Greensill Capital. Let's see what happens with the Gupta empire.
There are many other questions, like who was investing in this toxic fund? We believe that it was a high ticket entry and professional investors should have been asking these obvious questions. We also wonder what made the credit insurers withdraw cover, but then why did they extend it in the first place?
In summary, Stephen told me: "I think Credit Suisse and Tokio Marine could be in for as much as a $5bn hit."
John Hempton of Bronte Capital also explores this topic: Greensill – who is holding the bag?