Vodafone SCF: Who's supporting who?
Vodafone has been using complex financial engineering devised by GAM and Greensill to enable it to profit from and invest in its own SCF offerings and bolster its DPO. The trouble is the system leaves little reason for procurers to pay suppliers on time.
The transparency of accounting practices for supply chain finance (SCF) programmes is once again being called into question. Vodafone is investing in its own SCF programme, enabling it to profit off its suppliers and boost its working capital position, market sources tell TXF.
With the help of Swiss asset manager GAM and London-based SCF specialist Greensill – two companies whose relationship has already been at the centre of a media storm – Vodafone is using at least one investment fund to invest in its own SCF programme. The scheme allows Vodafone to take a share of the discounts offered by its suppliers in exchange for early payment, and to boost its balance sheet by keeping the related trade payables on its books.
The GAM Greensill SCF Fund
The fund in question, the GAM Greensill Supply Chain Finance Fund (the Fund), is an open-ended alternative investment fund based in Luxembourg. It is managed by GAM and equipped with approximately €2.4 billion ($2.7 billion) of assets. According to its listing, the Fund's primary investment objective is to generate steady and uncorrelated returns through selective investment in a portfolio of buyer-confirmed trade receivable notes (ie SCF) with the underlying credit risk insured by insurance companies with ratings of A2 or higher.
The Fund, rated A-bf by Moody’s, invests in receivables with a duration of less than one year, which are originated and structured by Greensill. According to 2017 marketing documents seen by TXF, the insurance comes from Markel, Allied, Euler Hermes, Zurich and AIG; the notes are offered through Morgan Stanley; and the SCF programme is facilitated by US technology platform Taulia.
Although not advertised as such, a portion of the underlying assets are outstanding Vodafone payables and much of the investment is coming from Vodafone’s treasury, sources tell TXF.
According to Vodafone, “less than half of the assets in the Fund are made up of Vodafone payables,” and Vodafone’s investment in the fund is part of its Liberty Global acquisition financing strategy: “Vodafone has raised around €18 billion in total to fund our acquisition of Liberty Global’s assets in Germany and several Central European Economies, which is due to complete this summer. To manage these proceeds until they are required, we have placed the money into a range of low risk instruments including gold-backed bank deposits, government-backed repo, bespoke investment funds and around 6% [around €1.08 billion] in the GAM Fund. The insurance wrapper on the GAM assets means that investors are not at risk should any company default on their payables.”
Whatever the motivation behind the GAM Greensill SCF investment – the scheme started before any public announcements about buying Liberty Global – the result for Vodafone is more than just a low risk investment. Using a simplistic theoretical example, the system works as follows: A supplier sends Vodafone an invoice for €100. Vodafone accepts the invoice and agrees to pay it in 90 days time. The supplier turns to the SCF provider with its Vodafone invoice and the SCF provider pays them 98.5% of the value. The supplier has now been paid. The SCF provider, in order to get the money to pay the supplier, issues notes to a group of investors, with an expectation that in 90 days time Vodafone will be making a payment that will pay off the notes.
Those notes would typically in an SCF programme be sold to a variety of banks and institutional investors. In this case, however, they are being sold to the Fund in which Vodafone is an investor, and therefore indirectly to Vodafone’s own treasury.
“Vodafone, GAM and Greensill share the discount from the supplier. If the supplier gets €98.50 and there's €1.50 difference, Vodafone is probably getting half of that, with Greensill and GAM sharing the other half,” says a US banker. So, Vodafone is receiving 0.75% of interest (€0.75/€100) for a 90-day investment, which equates to a 3% annual return. “There are not many 90-day commercial papers that yield 3% today,” adds the banker. “Vodafone is still getting a very good return on its money, even though its suppliers are paying a high discount rate for the Fund taking Vodafone risk.” According to Vodafone a 3% annual return is “very wide of the mark”, but it does not dispute it gets a return.
The other benefit for Vodafone is that by using the Fund, the monies involved in the process are not accounted for as an early payment to the supplier but as a continued outstanding payable coupled with an investment in a money-market security. For example, if Vodafone discounted the notes directly with the supplier, the accounting would be a reduction in cash of €98.50, reduced payables of €100 and interest income – or lowering of Cost of Sales – by €1.50. But under the Fund system, Vodafone is instead moving the cash into short-term investments and continuing to book the payables as outstanding.
According to Vodafone it “invests in the Fund, not in specific assets within the Fund.” Consequently “the cash invested in the GAM fund is properly accounted for as part of Vodafone’s short-term investments as the actual average life of the receivables is short and there is the ability to liquidate our investment within an even shorter timeframe. See Note 13 in the 2018 Annual Report (page 138) for more details.”
But Note 13 is hard to interpret. Note 13 outlines Vodafone’s ‘Other Investments’ and contains the following footnote to the €4,896 million of ‘other debt and bonds’ quoted in the accounts: “Other debt and bonds includes €3,087 million (2017: €2,039 million) of assets held for trading in managed investment funds with liquidity of up to 90 days… and €976 million (2017: €182 million) of short-term investments, also classified as loans and receivables at amortised cost, where the underlying assets are supply chain and handset receivables.”
According to Vodafone, the €976 million of short-term investments is not “supply chain and handset receivables” but only supply chain finance. This is significant because it is this €976 million under which Vodafone claims its GAM Greensill SCF Fund investment is accounted for and not, as some non-Vodafone sources have speculated to TXF, in the “€3,087 million of assets held for trading in managed investment funds with liquidity of up to 90 days”. In a written clarification to TXF Vodafone states: “The €3,087 million is invested in funds which invest in high quality liquid investments, such as government treasury bills, commercial paper etc. The €3,087 million does not include any investment in GAM Greensill SCF. Our investment in GAM is included within the €976 million disclosed in the footnotes to Note 13.”
The evolution of the system
Vodafone’s SCF activities go back to 2009 when, keen to find ways to use its surplus cash, it issued a request for proposals (RFP) for an SCF programme. Citibank won the tender.
According to sources close to the transaction, the programme involved Vodafone using its cash to effectively self-fund the scheme. Vodafone will not explain how the programme was structured, other than it did not involve an SPV or notes, but it does not dispute that the structure enabled it to convince its auditors that the payable was still outstanding and that there was a separate decision by Vodafone’s treasury to purchase a liquid instrument. “So, they were continuing to have a working capital liability to a supplier and could still book the cash in ‘cash and short-term investments’ because they were investing in something that had a short-term lifecycle,” says an SCF financier familiar with the programme.
Vodafone is quick to stress that its “auditors have always supported Vodafone’s accounts.” But around 2013, the company's then auditor, Deloitte, told Vodafone it had to net the investment and the payable. Vodafone's relationship banks consequently needed to step in and buy out its self-funded positions – around £2 billion, according to the US banker – so that at year-end the firm could continue to keep the payables outstanding.
Vodafone then issued a new RFP for an SCF programme, but this time one that could onboard the tail-end of its supplier base and, importantly, allow it to continue to keep the trade payables on its books. Greensill’s founder, Lex Greensill, had left Citi to start his own venture in 2011. “He had a very close relationship with Vodafone’s treasury department from his time at Citi, and Vodafone decided to work exclusively with Greensill to come up with a structure,” says the US banker.
A Spanish banker who received the RFP at the time tells TXF that his bank didn’t submit a proposal because Vodafone “wanted to self-fund as much of the programme as possible using their own liquidity… and were trying to secure a rebate from their suppliers in exchange for early payment”. A German banker recalls that Vodafone’s demands of taking a share of the supplier discount and the “aggressive” accounting of buying its own payables “was, from the legal and reputational point of view of the bank, not something we wanted to get into. We would want any fee sharing in a transparent way.”
So, one of Greensill’s foundation clients was Vodafone, with a programme substantially funded by Vodafone itself through the purchase of notes that were used to fund its suppliers. “However, this was now being done to a much more substantial degree, and the auditors began to look at it and say that it needed to be better disclosed as it represented a material part of Vodafone’s balance sheet,” says the SCF financier. In 2014, a year after the Greensill programme started, Vodafone switched auditors from Deloitte to PwC.
GAM and Greensill then established the Fund in July 2016, equipped with an insurance overlay. The insurance was aimed at convincing the auditors that the fund wasn’t just Vodafone risk, says the SCF financier. “The fact that the overwhelming majority of the assets sitting in the fund [now less than 50% according to Vodafone] are referenced to Vodafone’s payments is obviously a major concern for the auditors, but in the end they are persuaded to sign off by the presence of the additional credit insurance... which is sufficient to say that the fund’s assets are not simply Vodafone risk and as such allows Vodafone to continue to keep both the short-term investment and the payable on their books,” he says.
Two sources have indicated that the insurance only covers a small portion of the Fund’s assets; however, TXF hasn’t found evidence to substantiate those claims. The marketing documents for the Fund state that insurance is provided on a per-obligor basis for the full payment due on redemption (ie full outstanding amount/face value of the Note), and that clients benefit from 100% cover (ie full indemnity, no deductible) through GAM as loss payee. Moody’s A-bf rating, awarded in March 2017, also appears to be based on the credit ratings of the insurers rather than the obligors. “The A-bf rating, which is higher than the weighted average credit quality of the trade receivables held by the Fund, is based on the Insurance Financial Strength of the insurance companies that provide trade credit insurance policies,” said the Moody’s note. The agency rates Vodafone as Baa1.
According to the US banker, the Fund’s structure allows for investors to choose the risk in which they invest, meaning Vodafone is able to fund just Vodafone risk along with the related insurance. But Vodafone claims that choice of risk is limited to the assets chosen by the fund manager: “Vodafone has no influence over what specific assets are in the Fund and only owns non-voting (B) shares in the Fund. The assets are purely selected by the GAM Fund Manager, who has a fiduciary duty to select the best trade receivable assets for the Fund. The Fund includes assets from a number of companies and less than half of the assets in the Fund are made up of Vodafone payables.”
“They have other names in the Fund and other investors that fund those risks,” concedes the US banker. But “investors weren't buying a pro-rata share risk in all the assets in the pool. You could buy individual risks, all of which is covered by the insurance,” he adds.
“Vodafone is having its cake, eating it, and drinking all the wine as well,” says an SCF consultant who has heard about the programme. “Normally when someone is buying their own risk in a self-funded programme, they do it for two reasons: they either account for it as a yield on capital, or it can be viewed as savings on invoice purchases/corporate spend. But in this case Vodafone are really taking two bites of the same apple: they’re keeping the DPO nice and long but they’re also paying the suppliers early. It actually worries me.”
One of the key questions for Vodafone investors is how the €976 million of underlying SCF short term investments affects Vodafone’s liquidity position. Short-term investments are booked alongside cash as they are meant to be easily liquidated assets that can be quickly converted into cash in times of need. However, the money underlying the Vodafone invoice has gone, as the suppliers have already been paid on a non-recourse basis. The company will be paid back by the Fund on the investment’s maturity after 90 days, but in the meantime the company has less at its disposal on its balance sheet because it has no ability to use that cash for anything other than paying it on the maturity date, when it subsequently gets paid back by the Fund.
An investment manager tells TXF: “If they actually needed that cash they would have to raise it from another source. This is pretty material. Cash and short-term investments should be unrestricted.” Vodafone counters that its “short-term investment in the GAM Fund is not restricted and does not have a negative impact on our liquidity. It would make no difference to our balance sheet if we were to take the cash from the GAM Fund and place it in bank deposits.”
Nevertheless, the logical next question is how Vodafone is permitted to account for the programme in the way it does under International Financial Reporting Standards (IFRS)? The short answer is that both the IFRS and its US counterpart, US GAAP, proffer little guidance in respect to supply chain finance. “Granted they shouldn’t be allowed to account it in this way, but I think at the moment SCF is running a little bit ahead of the accountants,” says a former managing director at a leading SCF bank.
IFRS International Accounting Standard (IAS) 7 defines cash equivalents as ‘short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value’. Stripped down, that means that the investment should: a) have a duration of three months or less, b) be convertible into cash without an undue period of notice and without incurring a significant penalty on withdrawal, and c) be held for purpose of meeting short-term cash commitments. In the case of money-market funds, many would be defined as equity instruments, but some could be considered as cash equivalents if the instrument has a readily determinable market value and the amount of cash that would be received is known with a high degree of certainty at the time of the initial investment.
"I'm surprised the auditors sign off on their [Vodafone’s] accounting of these transactions,” echoes the US banker. “IFRS is much more about what is the intent, practical transaction or materiality, compared to the much more rules-based US GAAP"
“In the US, the SEC (Securities and Exchange Commission) came out with guidelines over a decade ago which state that if a company is financing itself, directly or indirectly, it must net the asset and the liability. The US GAAP took that and started to enforce it. The IFRS hasn't been as stringent on it. It's not breaking any legal rules, in IFRS it's an interpretation that the accounting firm and their partner gets to make. What isn't clear is whether its transparent enough for investors to truly understand.” The IFRS and the Financial Reporting Council (FRC), the UK’s audit watchdog, declined to comment when contacted by TXF.
By not netting the investment and the payable, Vodafone is also improving the appearance of its working capital efficiency by boosting its Cash Conversion Cycle (CCC), a criterion for investment for analysts and investors that is calculated as Day Sales Outstanding (DSO) plus Days Inventory Outstanding (DIO) minus Days Payables Outstanding (DPO). The supply chain finance consultant says: “Reducing the payables, as they should be doing, would have an adverse impact on the Cash Conversion Cycle. The lower the number the better, because it implies that a company’s working capital is turning very quickly and efficiently.
“Vodafone are doing this so that they can maintain the DPO at a good long number and have a good positive working capital efficiency, while also benefitting from a good rate of return on idle cash through investment in their own risk.”
Another knock-effect benefit will be on the company’s credit rating. A credit risk consultant tells TXF: “By using a payable or receivable that doesn’t exist anymore as if it existed, you are changing the numbers on the balance sheet and it’s going to have an impact on your statement of cash flows, it’s going to have an impact on your leverage, it’s going to have an impact on some of the statistics that are the basis for Vodafone’s rating.”
Insecurity surrounding its credit rating, and its languishing share price, are two of a number of headwinds Vodafone is facing at present. In February, ratings agency Moody's downgraded Vodafone’s senior unsecured ratings to Baa2 from Baa1, with negative outlook, after considering the impact of its Liberty Global German and Eastern European asset takeover. Moody's also expressed concerns about heavy future investment in upcoming 5G spectrum auctions as Vodafone tries to grab as much of the airwaves as possible.
Similarly, both GAM and Greensill have been embroiled in their own media storm resulting from the suspension and later firing of Tim Haywood, one of GAM’s top portfolio managers, last year: Haywood was the lead portfolio manager on the GAM Greensill SCF Fund.
And this isn’t the first time a Greensill SCF programme has attracted media scrutiny. In 2014 Greensill established an SCF note programme for up to $1 billion for Abengoa, the Spanish renewables developer whose opaque accounting of its SCF programmes would contribute to it eventually filing for bankruptcy in the US.
Greensill’s eponymous founder, Lex, has had some high-profile clients that boost the firm’s credibility. He is a former adviser to David Cameron and Barack Obama on the launch of UK and US supply chain finance initiatives, and Vodafone was one of the initial signatories of the UK’s Supply Chain Finance Scheme when it was launched in 2012. But so was Carillion, whose accounting of its supply chain finance programme has been implicated in its collapse last year.
Vodafone investing in its own SCF programme is not the same as the accusations levelled at Abengoa and Carillion, which essentially used the instrument as a quasi-form of unreported borrowing and had a host of other unrelated problems which drove them to the wall.
Nevertheless, it will add to the growing calls for greater transparency about SCF funding and, more importantly, how it is reported in a company’s accounts. The danger is clear – if procurers can profit from this kind of SCF ‘support’, it gives them good reason not to pay on time, thus perpetuating the curse of late payments in the supply chain.