25 January 2017: BT plc yesterday saw its shares fall almost 20% as it revealed that accounting irregularities in its Italian business were much worse than advised last October, with “a complex set of improper sales, purchase, factoring and lease transactions” lying at the heart of the problem.
Following an independent review by KPMG, the company revealed that write-downs on the balance sheet would be £530m, more than three times the £145m estimate unveiled less than three months ago when the problem in Italy was first disclosed.
In a conference call with investment analysts yesterday, CFO Simon Lowth said that the Italian business had taken loans from factoring companies against its receivables and used the proceeds to pay suppliers. “Those working capital loans [were] clearly improper and we are unwinding them,” he said. “That is overwhelmingly the most significant contributor to the one-time cash unwind in this [year 20]16-17.”
There are some additional smaller cash effects from unwinding some “improper” sale and leaseback transactions “but the main component is to unwind the inappropriate, improper working capital loans.”
It is believed that these factoring and leaseback arrangements had been kept off the balance sheet and hidden from group headquarters so as to artificially reduce costs and inflate the Italian subsidiary’s cash flow numbers.
“That has taken a business that we thought was profitable but in truth has probably been unprofitable for a number of years,” BT CEO Gavin Patterson told the analysts.
It is not currently known how the practice was kept under wraps and evaded the detection of the auditors for so long. A number of senior executives from the Italian business, including the chief executive and chief operating officer, have been suspended or have left the company.
The Financial Times reports that Italian prosecutors have opened a criminal investigation into allegations of “false accounting and embezzlement”. The UK’s Serious Fraud Office would not say whether it was examining the matter.
“A complex set of manipulations”
The company said in a statement that for financial year 2016-17 as a whole, relative to the prior outlook, analysts should expect a decrease of up to £500m of normalised free cash flow “due to the EBITDA impact and the one-off unwind of the effects of inappropriate working capital transactions”.
Patterson told the analysts that the problem appeared to be confined to Italy. “We don’t believe an issue like this exists in any of the other markets at this stage,” he said. “It’s a very complex set of manipulations that involved a lot of people over a number of years and it was specific, we think, to the accounting business – and that’s what’s so disappointing about it.”
Asked whether factoring was a common practice within BT, Lowth replied: “There are some genuine and sensible business reasons why companies will from time to time factor some element of receivables and that is a practice that is common in Italy and it is a practice that has been undertaken by BT Italia in the past.
“The practices that we note here and we are unwinding are more extensive receivables factoring – often against inappropriate customer bases and debt. And secondly, more material was the factoring activity against payables – in effect taking out working capital loans in order to settle creditors. And that is not a practice that we would tolerate anywhere in BT.”