In an earlier note, I highlighted the nearly £4bn of off-balance-sheet property bonds that are not fully disclosed in Tesco’s financial statements (see Tesco’s hidden debt). In the earlier note, I discussed in detail how the transactions were structured. In this note, I focus on the relevant accounting issues; in particular, whether the underlying leases were correctly accounted for as operating leases. In my view, it is clear that they should have been treated as finance leases and capitalised on Tesco’s balance sheet, which would increase on-balance-sheet net debt by around £3.5bn to £11bn.
Tesco (ticker: TSCO.L) delivered another shock to investors on 22 September, announcing an estimated £250m overstatement of its first-half profit guidance (for the year to February 2015) “principally due to the accelerated recognition of commercial income and delayed accrual of costs” in its UK food business. Describing the issue as “serious”, the company delayed the announcement of its interim results and appointed Deloitte to conduct an independent review with the help of its external lawyers.
As part of my due diligence on another potential investment, I recently came across 21 Holdings (ticker: 1003.HK), a Hong Kong-listed holding company with a market cap of only HK$205m. This has proved to be a truly terrible investment over the last few years: a story of repeated, dilutive equity issues, share consolidations and dubious acquisitions: 100,000 shares at the end of 2007 have now been consolidated to a single share. During the last six years, the company has raised over HK$800m through numerous equity issues and spent around HK$600m, on what have proved largely worthless acquisitions.