There Is No Substitute For In-Person Due Diligence

There Is No Substitute For In-Person Due Diligence

This week Wirecard announced that EUR 1.9 billion of cash is missing. A trip to the company’s profit center would have spared investors from suffering a major headache and major losses.

The Financial Times put forth a detailed case about Wirecard’s red flag-waving accounting practices in its October 2019 article: Wirecard’s suspect accounting practices revealed,” which is a very informative read. A Wirecard partner company – Dubai-based Al Alam Solutions – contributed approximately half of the German company’s 2016 profits. The FT described Al Alam’s offices as threadbare.

This reminded me of a San Francisco CA-based fintech company – Canopy Financial – that I met in the 2007-2008 time frame. CEO Vik Kashyap met me in an empty San Francisco office. I don’t recall the firm’s revenue run rate but is was in the double-digit millions with a purported 40%-ish operating margin. Too small to go public, Canopy didn’t pass the sniff test given the empty office and the fact that operating margins were approximately 30 points higher than competitors’ margins. A short time later the firm was accused of financial fraud with two of the firm’s co-founders serving jail time. A few institutional investors put money in to Canopy. I know them and won’t embarrass them here. Millions in losses could have been avoided with a trip to Canopy’s San Francisco and midwest-based offices and a few prodding questions about how Canopy managed to generate operating margins that were multiples higher than the competition.

Bubbles like the one we are in marked by lofty equity valuations and cheap debt tend to bring out the fraudsters. In addition, generous government stimulus programs are akin to red meat for fraudsters.

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