Wednesday was a day to forget for Patisserie (CAKE) shareholders. At 7:30 in the morning, the company announced that:
"Patisserie Holdings announces that, during the course of 9 October 2018, the board of directors of the Company has been notified of significant, and potentially fraudulent, accounting irregularities and therefore a potential material mis-statement of the Company's accounts.
"This has significantly impacted the Company's cash position and may lead to a material change in its overall financial position. As a result the Company has requested that its shares be suspended from trading on Aim while it conducts a full investigation with its legal and professional advisers into its true financial position.
"In the meantime Chris Marsh, the chief financial officer, has been suspended from his role."
Later on at 13.53 it further updated the stock market:
"Patisserie Holdings announces that, further to the Company's announcement made earlier today, the board of directors of the Company has today become aware that a winding up petition in respect of Stonebeach Limited was filed at The High Court of Justice, Companies Court on 14 September 2018 (the Petition). Stonebeach is the Company's principal trading subsidiary.
"The Petition relates to sums due to HM Revenue & Customs (HMRC) of approximately GBP1.14 million with a hearing date listed for 31 October 2018. The Petition was advertised in the London Gazette on 5 October 2018. The Company and its advisors are in communication with HMRC with the objective of addressing the petition."
Then, just before you thought things couldn’t get any worse, an announcement on Thursday afternoon stated that the company was effectively bankrupt without a fresh injection of capital:
"Patisserie Holdings announces that the Company, in conjunction with its professional advisers, has during the last twenty-four hours, undertaken further investigation into the financial status of the Company. The Board has now reached the conclusion that there is a material shortfall between the reported financial status and the current financial status of the business.
"Without an immediate injection of capital, the Directors are of the view that that is no scope for the business to continue trading in its current form.
"As a consequence, the Directors and the Company's professional advisers are assessing all options available to the business to keep it trading and will update the market in due course."
I was absolutely gobsmacked to read these announcements. Along with everybody else, I was left thinking, 'how could any outside investor have spotted this?'
Based on the financial statements of the group, all had seemed well. Despite opening up lots of new shops, the company had been generating increasing amounts of free cash flow in recent years and supposedly had £28m of net cash at the end of March 2018.
There are lots of warning signs out there for outside investors such as poor cash conversion, but this was not a red flag with Patisserie Valerie. There was also an absence of big liabilities on the balance sheet with outstanding trade creditors of just over £5m at the end of March.
In terms of hidden debts such as rents. The annual rent bill of £14m was covered 2.6 times by the past 12 months’ trading cash flow.
The truth is that it was probably impossible for any outsider to spot if a fraud was being committed.
In just over 24 hours, the company has gone from being a highly regarded growing business to one that is effectively dead.
What is clear is that there has been a complete breach of trust between the company and its shareholders. There is a harsh reminder for all outside investors that numbers in accounts may not be what they seem. Thankfully, most companies’ accounts are trustworthy, but it is always worth reminding yourself that the numbers you are reading in accounts are for a group of companies. You do not get to see how those numbers are made up from lots of different subsidiary companies within it. This is where most of the potential for financial shenanigans exists.
Alpha subscribers can read Phil's latest full shares round-up here.
