Baked or Mexican

As I regularly do, I was perusing companies for investment opportunities. Previously I hadn’t given much of a look at Webjet and decided to scan their recent results and announcements. Ultimately I decided it wasn’t a good fit for my own portfolio for one reason or another. However, the curious case last year with BDO (and let’s not forget ASIC) peaked my attention.

It seems the bean counters couldn’t agree whether they should use the beans to make a good old fashioned English Breakfast with a simple side of baked beans (we could quibble about the variety later) or opt for the flashier Spicy Mexican dish. There were certainly lots of cooks given apparently two “Big-4” accounting firms also looked at the matter, in addition to themselves and their auditor, BDO, at the time! Even the head chef (ASIC) got involved as there was clearly some confusion and bean stirring supervision was required.

I should apologise for the technical bean counting talk and lay it out in a few words: the deal with Thomas Cook.

In August 2016 WEB (via Sunhotels) entered into a “strategic sourcing partnership”, in which Sunhotels will “take responsibility for the majority of the volume of Thomas Cook’s complementary hotel business.” WEB paid a grand total of GBP21m for the pleasure of entering the, so called “supply”, agreement. They also took out a 5 year-loan (in USD) to finance this payment, rather than deploying some of their cash balance.

When looking at the beans so far they all appear pretty vanilla. That is until one comes to the debit entry for the GBP21 paid for entering the Supply Agreement. Don’t worry if you aren’t sure about what a debit is in Beanglish, because my first accounting teacher has a useful definition, “the one by the door” [credits are by the window by the way]. I have a funny feeling my mentor wasn’t sure I should pursue a career as a professional bean counter and was trying to put me off!
The crux of the mystery of the Bean by the Door comes down to a question of what did WEB actually get in return for its GPB21m? BDO puts it, seemingly, plainly enough in their audit report,

“As set out in the contract, the Group paid $35.9m to Thomas Cook for the right to enter the supply agreement, the transfer of approximately 3,000 hotel contracts and for the implementation costs of the deal. In addition, Thomas Cook agreed to pay the Group a fixed management fee of $35.9m in instalments in order to retain access to the hotel contracts.”

Not so fast Mr Bean Slinger, there appears to be no mention in the BDO audit report of a few extra snippets contained in Roger Sharp’s ASX announcement on 28 July 2017, which to this simple-bean seem pertinent,

“During the initial transitional period, Thomas Cook agreed to pay Webjet a fixed management fee (in instalments) in order to retain access to the hotel contracts. Thereafter, Thomas Cook will pay a volume based fee for ongoing access to the hotel contracts. Webjet's current expectation is that the revenue earned under the Contract, once it becomes a volume based service fee arrangement, will be greater than the fixed management fee being paid during the initial transitional period.”

So……in return for the GBP21m WEB get: (1) a fixed management fee (2) a volume based fee for ongoing access to the hotel contracts (3) not least the transfer of the actual 3,000 hotel contracts [presumably under some novation process] (4) a return to the vendor of the implementation costs of the deal (5) a commitment to managing an improved health and safety audit process (6) who knows what else. From what this bean has seen, we seem to be left lacking a bit of information about the terms of the volume based fee, including whether there are any non-cancellable commitments, and also whether the access that Thomas Cook has under the arrangement is for all of the 3,000 hotel contracts, some fixed part of this, or a flexible portion.

Without all of the facts and the actual contracts one must speculate as to the exact contractual terms. However, it doesn’t seem quite as simple as put the cash outflow being by the window (actually that bit's quite simple) and the entry by the door being a “Loan Receivable”. WEB seems to get more than just the fixed payments for a period of time….. Surely the consideration was paid in return for a collection of assets (i.e. an asset acquisition) and thus the amount paid should be allocated to each of those assets accordingly (usually in proportion to their fair value)? It seems pretty clear it wasn’t the acquisition of a business, so an asset (plural) acquisition would seem appropriate. Under this approach I would have expected to see a Loan/Receivable for the fixed payment stream promised by the vendor, potentially a financial asset for the variable payment stream and an other asset (probably intangible) for the value of the contracts excluding the rights provided back to Thomas Cook.

The above pontification aside, we are left wondering what the subsequent treatment for this innocuous Loan Receivable is. Especially given the new financial instrument rules that came into play just over a month ago. These new rules would have the subsequent bean weighing (measurement) method at amortised cost if the instrument doesn’t have SPI features. Now we’re not talking about a double agent here, and frankly it would be probably more interesting if we were, but rather “Simple Principle and Interest” characteristics (not also forgetting the business model overlay). If a chunk of the future payments are in fact variable (“volume based service fee”) and no separate value was attributed to this (or anything else), then I would expect the Loan Receivable wouldn’t meet the SPI rules and would need to be subsequently weighed at fair value. Essentially profit emergence accounting, which would include changing estimates of the amount of future variable cash flows a willing buyer and seller would consider in setting an exit value for the instrument. Now, if that’s the case, that’s some Spicy Mexican dish!!

Either way, the absence of any disclosure or bean-counting policy leaves us wondering what is really being done with this item or will be done when the new rules counting certain beans apply. Either way WEB spilt some of its beans as it appears to no longer be BDO in the external audit chair. It would be interesting to know if one of the big-4 bean counters, previously referred to as providing a view on the matter, was Deloitte. If so I would be curious to also know how they reconcile their previous view (or potentially advice) with signing off an audit opinion on a different treatment. Perhaps it's simply a matter of I like both baked beans and Mexican.

DYOR/All the above is opinion or guess work only.