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Wirecard is a middleman. It stands between online stores and the payment networks of Visa and Mastercard, briefly handling money when purchases are made online. While electronic cash arrives and departs constantly, Wirecard keeps only a small cut.

A German stock market darling, the share price has risen eightfold in the last six years, to value the group at €5bn. It also owns a Munich bank and a small call centre operation, remnants of the reverse takeover which bought it to market in 2005.

The result is accounts which can appear complex, because they describe both big payment flows which fluctuate, and the business derived from Wirecard’s small cut. For six years, with that complexity, the company has directed the way its business is understood by presenting adjustments to its published figures. Berkhard Ley, finance director, asks analysts to focus on his version of cash flows every three months, rather than the “official long version following all the [International Financial Reporting Standards] necessities”.

The adjusted and the official version of cash flows balance out each each year. However, if we look at the adjustments Wirecard has made, rather than the adjusted figures which result, something looks odd in the shape of the business described: an apparent mismatch between assets and liabilities expected to balance.

At the end of March payment related assets — cash held on behalf of customers and so-called receivables — appear to total more than €0.5bn, twice the amount for payments due to go out, so-called payables.

If the part of the business Wirecard directs investors to ignore is made up of transient flows of money in and out, and it keeps only a small cut, how can the money flowing in be so much larger than that due to flow out?

“That’s strange, unless they are really ripping off the merchants”, said Stella Fearney, professor of Accounting at Bournemouth University.

From Wirecard’s perspective, business model effects on the development of its accounts payables and receivables means that they do not always correspond with the overall transaction volume.

Working with capital

Any business can be reduced to a simple level: customer buys something, supplier gets paid. The starting point is to realise there are two ways to extract cash from the process, through a difference in price and a difference in timing.

For instance, buy an apple for 80c and sell it for €1 to make 20c of cash. Now imagine you don’t pay for the apple until some time after you sold it. As well as profit of 20c you will also have use of the 80c for a while, a cash float to support your business. The more apples you sell, the bigger the float becomes.

Supermarkets benefit from this effect, as they get cash when an apple is sold, but won’t pay the farmer who picked it for a month or two. The technical term for the situation is “negative working capital”.

The opposite might be a second-hand car salesman who pays for the vehicles on his forecourt upfront. As he won’t get cash back until he sells them, he needs (positive) working capital to expand.

The payments business should be more like the supermarket than the second-hand car salesman, because the payment company should always get paid first.

Let’s say a consumer buys their apple online. In Europe, Wirecard’s involvement is in getting the consumer’s payment from Visa to the online apple merchant. (In the jargon it is an “acquiring business”).

The timing typically works like this: our consumer enters their card details and clicks “buy”. Wirecard immediately has an asset and a liability. It is owed money by Visa, and it owes a slightly smaller amount to the merchant, after taking a commission.

Within hours or days cash arrives from Visa. Wirecard still owes money to the merchant.

In a few days Wirecard sends on the cash, settling the obligation.

In accounting terms, Wirecard starts with a so-called receivable (the money it is owed) and a so-called payable (the money it in turn owes to the merchant). When the cash comes in, the receivable disappears. When the cash goes out, the payable vanishes in turn.

With millions of transactions occurring every day, a snapshot would show large totals for each of three categories: trade receivables, cash, and trade payables. The important point to realise is the total for cash and trade receivables in this acquiring business should match the total for trade payables, minus Wirecard’s commission, usually 2 per cent. In practice, timing effects may mean on any one day the totals do not correspond precisely, but over the long run the transient flows should roughly balance out.

Outside Europe, Wirecard acts as a processor, rather than an acquirer, which creates different sets of assets and liabilities. An acquirer can hold back some fraction of payments due to the merchant for six months as a “rolling reserve” in the event of problems such as cancelled or reversed payments, so the processor holds a set of longer lasting receivables and slightly smaller offsetting payables.

The acquiring business represents the majority of payment volumes, however, and in both cases Wirecard should receive cash and hold it briefly, before paying it on to merchants. So we might expect it to have thrown off some cash as the volume of transactions has steadily risen over time, giving it a larger cash “float”.

Yet Wirecard has required cash to grow. It doesn’t seem to be a negative working capital business after all.

Look at the hole, not the doughnut – our analysis

In the first quarter of 2009 Wirecard said “due to the special system involved in acquiring” it would present an adjusted set of cash flows “to eliminate those items that are merely transitory in nature”.

The adjustments made every three months since principally affect two lines found near the top of the cash flow statement, which record changes in the balance sheet totals for trade receivables and trade payables. Movements in those totals contribute to a number crucial for any company, cash produced from operations, and it is reasonable to exclude the big payment flows which fluctuate quarter to quarter.

Note that Wirecard has, by implication, published figures for the way the acquiring business has evolved over the last six years. Subtract the adjusted cash flow numbers from the official version, and out pop the adjustments.

For instance, in the first quarter this year the impact of the change in trade receivables on the full cash flow statement was minus €12m, and on the adjusted version it was plus €10m. Acquiring trade receivables therefore rose €22m, the difference between the two. (€10m – €22m = €-12m).

Armed with the €271m cumulative rise in acquiring receivables since Wirecard began making adjustments, we can then calculate a range of values for the figure at the end of 2008. The constraints are that each quarter acquiring receivables and what we’ll call “other trade receivables” must sum to the published total for trade receivables, and neither figure can be less than zero. The maximum value for acquiring trade receivables at the end of 2008 would therefore be €41m, and the minimum zero.

So, the lowest value for acquiring trade receivables in the first quarter of 2015 would be €271m

Repeat the process for acquiring trade payables, which have risen by €160m over the same period. The minimum value at the end of 2008 is €28m, the value of customer cash ascribed to the acquiring business. The maximum value such that “other trade payables” does not go below zero is €106m.

The highest possible value for acquiring trade payables in the first quarter this year is thus €266m.

Receivables have grown faster than payables, which is not the negative working capital effect which might be expected as payment volumes rose.

A bigger question arises, however, when considering the transitory customer cash Wirecard holds.

Recall our simple model of payments. A transaction occurs, credit card company sends cash to Wirecard, which eventually sends cash to the end business. Acquiring trade receivables and cash might be expected to roughly match the offsetting acquiring trade payables at any moment in time, minus Wirecard’s cut. It appears they do not.

Wirecard discloses the level of cash deposits in its acquiring business each quarter and the most recent figure was €234m. So, cash and receivables in the acquiring business are more than €0.5bn, twice the size of the corresponding trade payables. If Wirecard has most of the cash to meet those transient transaction related liabilities, then who owes it so much money?

What is going on?

The company maintains different accounting principles apply when Wirecard is acting as the acquiring bank and when reporting the acquiring business of other banks, which boosts the total for receivables relative to payables. Since 2010, as a result of the European Payment Service Directive, when another bank is involved the merchant’s reserve liabilities and corresponding receivables are shown in the accounts of the other bank, while Wirecard’s accounts show only receivables relating to commissions and the rolling reserve it facilitates.

From Wirecard’s perspective, in the case of third party banks the rolling reserve is similar to Wirecard’s own cash held in a corporate bank account, but for accounting purposes must be treated as a receivable.

If there are no payables and Wirecard is committing its own capital to fund payments by third parties — a rolling reserve is held to cover reversed payments in the event a merchant such as our online apple supplier goes bust — shareholders might reasonably want some disclosure of the sums and risks involved.

Should there be payables associated with these rolling reserves as well? Jochen Reichert, analyst at Warburg Research, has covered Wirecard for a decade. In a recent report addressing investor questions about cash flow he described “type B” transactions where Wirecard acts as processor. For a typical €100 payment Wirecard first has a receivable of €98.8 (€100 minus the bank fee) and a payable of €98.3 (the receivable minus Wirecard’s fee). Then:

The merchant’s acquiring bank keeps a security reserve in its own accounts. Assuming that the reserve rate is 10 per cent again, the acquiring bank pays out €89.92 and keeps €9.98 as a reserve for a certain time period. Hence, Wirecard reduces its accounts receivables from €98.8 to €10.08 and its accounts payables to €9.48.

We have pondered the point that if there are offsetting payables to those reserve related receivables, and they are not recorded on Wirecard’s balance sheet, where does the liability appear?

The company is adamant that our suggestion of an apparent gap between transitory assets and liabilities is based on a misunderstanding, does not reflect reality, and it stands by its published accounts.

Receivables rising

While Wirecard has grown sales fast over the last six years, by a fifth each year, trade receivables have grown faster, increasing by more than a third each year. Almost all of the €314m rise in the total for trade receivables since 2008 can be attributed to the acquiring business, so should be transitory in nature.

In general, investors tend to notice when receivables grow faster than sales because it can be sign of underlying problems at a business, a deterioration in the quality of those sales which can sometimes lead to the restatement of past sales and profits. For instance “channel stuffing” can occur if sales are recognised when goods are shipped to a retailer, rather than sold to actual consumers: in the late 1990s the US company Sunbeam was forced to restate its accounts after a surge in receivables caused by inflated sales of barbecue grills which could be easily cancelled by retailers left with unsold stock.

In Wirecard’s case it appears that the rising receivables were offset by rising payables, and the receivables total has broadly risen at the same pace as payment volumes. In light of our analysis and opinion above, however, which outlines that payment related receivables and cash appear to be far larger than payment related payables, investors should perhaps question the growth in the receivables line.

In a previous post we looked at Ashazi, an unusual Bahrain group responsible for €1m of licence fee revenues per quarter at Wirecard in 2010 and 2011.

Ashazi caught our attention because auditors of a Wirecard subsidiary in Singapore qualified their opinion on the accounts as they were unable to verify collection of licence fee receivables. The following year Ashazi’s business was shifted to another subsidiary, audited by the local arm of E&Y, which oversees the group accounts, and that entity also reported little collection of licence fee revenue at year end.

However Wirecard appears to have no outstanding balances with Ashazi, and receivables, in general, are current.

Cash to use, but not to keep

Wirecard’s story is one of payment volumes. These have grown steadily over the years, and the company has made a series of piecemeal deals and asset purchases which have kept the expansion going, funded by raising €130m of debt, and another €0.5bn from shareholders.

The surprise in our analysis began with the observation that the rising volume of payments had required working capital. Discovery of what we consider to be a mismatch between short term assets and liabilities described above followed, and we are left with the puzzle of a business which has not behaved as might be expected.

The final point of interest is that even if Wirecard does not show the negative working capital float expected, cash flowing through the payments business is treated as belonging to the company when calculating its net financial position, a measure of financial health. Higher volumes mean more customer cash on the balance sheet.

However the picture of transitory assets and liabilities revealed in Wirecard’s published adjustments to its accounts prompts a question: what cash is Wirecard’s and what ultimately belongs to its customers? Answering that leads to the last chapter of our analysis, about the evolution of Wirecard’s financial position over time, something we’ll cover in the second part of this post.

In part one we looked at an apparent mismatch in the transient assets and liabilities reported by Wirecard for its payments business. The German listed group does not disclose these figures explicitly. Rather, it is possible to deduce the totals from adjustments it has made to its published accounts for the past six years.

What assessment did we make? At the end of March payment flows in — cash held on behalf of customers and so-called receivables — appear to total more than €500m, twice the amount for payments due to go out, so-called payables.

Our analysis prompts a question: what cash belongs to Wirecard and what is due to customers? This in turn prompts others: what is the appropriate way to assess Wirecard’s financial health, and how has it changed over time?The issue here is how to calculate the net cash or net debt position of a company. It’s an analytical question, as the figure isn’t one found on a balance sheet, requiring decisions about which assets and liabilities to include.

Here is a standard definition:

Net debt = short term debt + long term debt – cash and equivalents

The choices to make are what liabilities count as debt, and what assets are sufficiently liquid to be treated as equivalent to cash.

Wirecard has directed our attention to a report from Warburg Research, which asks “what is the economic net cash figure of Wirecard?”.

We calculate a net cash figure of EUR 413.8m by the end of 2014. We want to point out that long-term financial assets include mid-term financial agreements with distribution partners of EUR 40m. In other words, Wirecard provides some distribution partners financial support and credits. Furthermore, other financial debt includes earn-out components relating to acquisitions in the past.

Using this approach Wirecard’s net cash position rose from €157m to €414m during 2014, helped in large part by shareholders who contributed €360m in an equity raise, capital the company said it wanted in order to fund acquisitions.

Now, consider the following table from the notes to Wirecard’s accounts, detailing cash and equivalents:

The total cash and equivalents figure is €695m, however Wirecard subtracts customer deposits held in its banking operations of €238m to get to its stated cash and equivalents figure. These are deducted because customers control the cash (they can ask for it back on demand).

In the left hand column are €240m of customer deposits related to the acquiring business. These are included in the cash and equivalents figure because Wirecard controls when it pays the cash on to merchants to whom it is owed. Warburg deducts these customer deposits when calculating the net cash position.

Bear in mind the apparent mismatch in the short term assets and liabilities discussed in part one. Given that in our analysis assets seem much larger than liabilities, when they might be expected to balance, is it appropriate to include the trade receivables and payables relating to the payments business?

Or to put it another way, what would Wirecard’s net cash position look like if we excluded the payment related assets and liabilities?

Consider it this way, on the asset side we’ll include:

Cash & equivalents

Interest bearing securities and fixed deposits

Non-current interest bearing securities (usually described in note 3.3)

And here’s what we’ll start with on the liability side:

Interest bearing liabilities

Non-current interest bearing liabilities

Customer deposits in Wirecard bank

(We have excluded medium term loans to sales partners for the purpose of this analysis on the basis the assets are not cash-like.)

Here is the evolution of the net cash position over time:

We’ve still included cash in the acquiring business in these totals. Wirecard has use of the money so long as volumes remain stable, but the money is in effect a liability as it is due to be paid on to merchants. Let’s see what the net cash position looks like if we deduct acquiring deposits also, to get a sense of the underlying position.

In this analysis, at the start of 2010 Wirecard had net cash of €67m. The net financial position then deteriorates until in the final quarter of 2011 it becomes net debt of €-12m. At the start of 2012 Wirecard raised €140m from shareholders.

The net financial position again deteriorates in this analysis, from €129m of net cash in the second quarter of 2012, to net debt of €-101m in the fourth quarter of 2013. The following quarter Wirecard went back to shareholders, this time raising €360m.

On this basis the net cash position has since fallen by €100m, to €106m as of the end of March 2015.

Finally, consider what the evolution of Wirecard’s finances would look like in this analysis if it had not raised €500m from shareholders, or paid out €66m in dividends.

On this basis the adjusted net cash position has declined by €396m over the last five years. During those five years Wirecard has reported generating €374m in cash from operations.

Where would the money have gone? Direct spending on mergers and acquisitions reported in the cash flow statements was only €170m.

From the company’s perspective the total spent on deals is actually more than €450m, which reflects Wirecard’s piecemeal approach to buying companies and assets (described in our first post in this series). It has struck a string of deals for obscure Asian payments companies, sometimes making pre-payments before closing deals, as well as significant follow-up payments to sellers known as “earn outs”. Wirecard has also invested in intangible assets, for instance buying portfolios of so-called “customer relationships” from unidentified sales partners.

In early 2014 Wirecard raised €360m for dealmaking. Last year it spent €83m on mergers and acquisitions, and spent nothing in the first quarter of this year, when the balance sheet total for interest bearing debt rose by €35m, reflecting a partial refinancing of the 2014 transactions.

The point of our analysis is to consider the financial position of Wirecard with and without the benefit of third party payments flowing through its systems.

Should they be be included? Wirecard is a payments processor after all, so it may not be sensible to exclude the effect of payments. If a significant proportion of receivables is Wirecard’s cash held at other banks to facilitate its payments business, and merchants have no claim on that money, then those receivables should be considered cash-like.

On the other hand, the first part of this article described what appears to be a mismatch, that the payment related assets seem to be much larger than the payment related liabilities. So if those assets and liabilities are included, the greater the volume of payments running through Wirecard’s systems, the healthier it will look, irrespective of the underlying profitability of that business.

For six years Wirecard has suggested adjustments to exclude the transitory effects of payment volumes when assessing its cash flow statement. Shareholders who have contributed capital may also want to consider adjustments to the way they view the balance sheet.