Situation already so bad that hiding debt becomes a priority?
By Nick Corbishley, for WOLF STREET:
Australian engineering group UGL, which is working on large infrastructure projects such as Brisbane’s Cross River Rail and Melbourne’s Metro Trains, recently sent a letter to suppliers and sub-contractors informing them that as of October 15, they will be paid 65 days after the end of the month in which their invoices are issued. The company’s policy had been, until then, to settle invoices within 30 days.
The letter then mentioned that if the suppliers want to get paid sooner than the new 65-day period, they can get their money from UGL’s new finance partner, Greensill Capital, one of the biggest players in the fast growing supply chain financing industry, in an arrangement known as “reverse factoring”. But it will cost them.
Reverse factoring is a controversial financing technique that played a major role in the collapse of UK construction giant Carillion, enabling it to conceal from investors, auditors and regulators the true magnitude of its debt.
Here’s how it works: a company hires a financial intermediary, such as a bank or a specialist firm such as Greensill, to pay a supplier promptly (e.g. 15 days after invoicing), in return for a discount on their invoices. The company repays the intermediary at a later date. This effectively turns the company’s accounts payable into debt that is owned a financial institution. But this debt is not disclosed as debt and remains hidden.
In its letter to suppliers, UGL trumpeted that the payment changes would “benefit both our businesses,” though many suppliers struggled to see how. One subcontractor interviewed by The Australian Financial Review complained that the changes were “outrageous” and put small suppliers at a huge disadvantage since they did not have the power to challenge UGL. Some subcontractors contacted by AFR refused to be quoted out of fear of reprisal from UGL.
Reverse factoring is that it can be used by companies to create the illusion of cash flow, reduce the appearance of debt, and mask the true state of their leverage ratios. UGL’s massive parent company, CIMIC, has been accused of doing just that by Hong Kong research group GMT. Since the allegation went public, in May, CIMIC’s shares have lost 38% of their value.
CIMIC is one of Australia’s largest construction and infrastructure groups. It is majority owned by the German company Hochtief, which in turn is majority owned by the Spanish consortium ACS. In August ACS, the world’s seventh largest construction company, admitted it is making “extensive use” of both conventional factoring and reverse factoring “across the group,” to “more efficiently manage cash flows and match revenues and costs over the course of the year.”
Conventional factoring is a perfectly legitimate, albeit expensive, way for cash-strapped companies to speed up their cash flow. It involves selling accounts receivable — an asset in the amounts a company has billed to its customers and expects to be paid in due time — at a discount to a third party, which then collects the money from the customers.
Reverse factoring, by contrast, is a much more pernicious form of supply chain financing that is being used by large companies to effectively transform their supply chain into a bank. Put simply, if suppliers want to get paid in a reasonable period of time, they must pay an intermediary for the privilege. But importantly, in most countries there is no explicit accounting requirement to disclose reverse factoring transactions.
The companies can effectively borrow the money from the third party lender — thus incurring a debt — without having to disclose it as debt, meaning it expand its borrowing while maintaining its leverage ratios. This process causes the debt to be understated.
Credit rating agency Fitch warned last year that reverse factoring effectively served as a “debt loophole” and that use of the instrument had ballooned, though no one knows by exactly how much since there is so little disclosure.
In the six months to June, CIMIC used reverse factoring and other supply chain financing techniques to increase its total days payable to 159 days from 135 days in the previous six months, according to New Zealand investment bank, Jarden. By the end of June, its total factoring level was almost $2 billion.
More and more Australian companies are following the same playbook. Rail group Pacific National told suppliers in May that it was using global financial group C2FO‘s services to facilitate what it calls “accelerated payment of approved supplier invoices.”
Telecoms giant Telstra has ramped up its exposure to “reverse factoring” more than 14-fold in the space of just one year, from $42 million to almost $600 million. This $551 million increase, which is also reportedly being provided at least in part by Greensill, represents a staggering 18% of Telstra’s 2019 free cashflow, according to a report by governance firm Ownership Matters. Yet the company’s credit is still rated A- by S&P Global, making it one of Australia’s highest rated industrial corporations.
A Telstra spokesman said the company strongly denies that its accounts “are not an accurate reflection of our business,” adding for good measure that “supply chain financing is a practice commonly used worldwide – it provides our suppliers the option of getting paid upfront while at the same time getting the benefit of Telstra’s strong credit rating.” Once again, it’s a win-win for both company and suppliers.
Yet in its last financial report, Telstra disclosed that it had extended payment terms to suppliers from 30 to 45 days to 30 to 90 days. This is part of “a persistent trend” that is hurting the cash flows of small and family businesses across Australia, revealed a review of payment terms released in March by the Australian small business and family enterprise ombudsman. Not only that, it’s also making it more likely that Australia will sooner or later have a Carillion of its own on its hands. By Nick Corbishley, for WOLF STREET.
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