Patisserie Valerie was subject to one of the biggest and most lucrative frauds in the history of high street franchises. Find out why a stable café chain came under a £40 million scandal.

Background

The cake and coffee shop chain, which had its origins in the ‘20s as a single shop in Soho [1], slowly grew under the management of three Italian brothers who expanded it to around 8 stores in London. The target market of the franchise tended to be mothers with young children or the elderly, and the shop retained a focus on dining-in as opposed to take-away cafes such as Costa etc. In 2006, a reputable and experienced operator, Luke Johnson, who was known for controlling and driving Pizza Express from a share price from 40p to over 900p [2], acquired Patisserie.

The deal was small and seemed odd at that time. However, under Mr Johnson’s management, the chain grew rapidly with new store openings (140 retail branches over the country) [3]. The business garnered popularity in market towns with high streets and shopping centres. Mr Johnson believed that excessive EU regulation was disadvantageous for UK businesses and for job creation and was not afraid to publicly express his views. Shockingly, this story runs deeper than just his actions, and in fact does not hold Mr Johnson as a culprit. [4]

The IPO

Patisserie Valerie went public in 2014 and sold shares at 170p [5]. The money raised from the IPO was used to pay off debt. After listing, the company came under the public radar and was able to grow fairly rapidly with new store openings, increased dividends and profit boosts. Moreover, the share price almost doubled, and the company aimed to open 20 branches across the country every year. Ultimately, the chain was dubbed to be relatively successful.

But what went wrong? Why did Patisserie Valerie catch the attention of regulators and financial journalists in the past few months?

Fictitious Accounts

In late 2018 (particularly 10th of October), it became apparent that the accounts produced by the chain were fake and had been heavily manipulated with fraudulent and significant irregularities.

The company declared, through an internal report, that this fraud had been detected. The company was extremely short of capital [7]. What I find amazing is that even some of the management team were unaware of what was occurring behind their backs until of course their bank accounts had been frozen.

At the last company presentation [8], the company stated how £28 million as net cash was sitting on its balance sheet. This was far from the truth, as was discovered in October. Instead of £28 million of cash, the company was in £10 million of debt. That difference between the numbers by £38 million wasn’t a silly mistake, but rather it was clear manipulation. The company’s operations were extremely dubious. Cheques were being paid that bounced and suppliers and landlords were being paid as late as possible before legal action was taken [9]. Flour, butter and cream alongside shop fittings, refrigeration equipment, software/technology and even land is required to operate bakeries; so, when annoyed suppliers cut off their supply, the business suffers terrible downside effects. Having lost patience, suppliers even turned up at Patisserie Valerie’s offices in Birmingham with baseball bats, demanding payment [10].

There was an elaborate operation occurring to make the company seem more profitable than it actually was. I think this reflects the human tendency to believe and see what one wants to – wilful thinking. The misdemeanour stretched as far back as 2015, with rumours that it had been occurring before that. This would be extremely detrimental as the IPO took place in 2014, so such behaviour pre-IPO could lead to further regulatory issues for Patisserie.

Ultimately, this is a punch in the face to regulation within capital markets and there are strong repercussions to this particularly because this criminal behaviour occurred simultaneously as the company went public – which demonstrates a lack of integrity and honesty towards the investors. This was bad business. [11]

Rescue Efforts

Mr Johnson was completely unaware of the fraud until it had been discovered. The Chief Financial Officer, Chris Marsh, has been held responsible and was arrested as subject of a fraud office investigation. He has yet to be charged.
Mr Johnson was praised for how well he organised a financial rescue. He provided a loan to the company for £20 million and organised a share issue which raised another £15 million from investors. However, this decision required approval from investors. Mr Johnson and his executive team held a meeting with private investors (who were losing money through the situation) [12]. His team experienced relentless criticism and was fiercely reprimanded at the meeting. Nevertheless, Mr Johnson managed to get approval and he recruited Steve Francis (a turnaround expert in the food industry) in November [13], changed the non-executive directors, cut back on his other commitments, focused on getting operations back on track and also secured 200 cafes and 2500 staff. The company recovered very slowly despite a tarnished reputation. Value for stakeholders had been irreparably damaged. [13]

Trouble in Paradise, Again

On the 16th of January, Patisserie Valerie warned that its accounting scandal could be worse than it had thought with “thousands of false entries into the company’s ledgers” [14]. The accounting problems had turned about to be more serious, and so the café chain had desperately asked for extra credit from banks. However, banks disagreed to extend credit facilities, and this caused Patisserie Valerie to fall into administration.

The Effects and What Now?

The company had to resort to being run by administration. KPMG stepped in to control the management and operations. 70/200 stores were closed, and 900 people were unemployed. KPMG is seeking buyers for the remaining 130 stores. A Private Equity firm or an external investor would perhaps lack confidence in the past financial statements of the chain, particularly because now only a couple of months of allegedly legitimate financial accounts are available. This could potentially make it more likely for investors to buy stores for their location and hence Patisserie Valerie could be broken up so that e.g. Starbucks or Café Nero have more stores in certain locations. Such a situation would be upsetting for the remaining employees of Patisserie Valerie who are uncertain of their eventual employer

Personally, I believe that history has shown us that entrepreneurs experience set-backs and this may be for Mr Johnson a large one at that. Also, I think that with KPMG, the future of Patisserie Valerie looks more promising. It will be interesting to see if Patisserie Valerie is given another chance, despite its proven track record of unreliability. [15]

Update: Causeway Capital Steps In

As of the 14th February, Patisserie Valerie was successfully bought out of administration. Investment firm Causeway Capital is set to take over 96 shops, saving nearly 2000 jobs for the coffee chain. The move will end a “disruptive period of uncertainty for the business” and give hope for “an exciting future”, according to Patisserie Valerie’s chief executive. [16]

Sources :  1) 2) 3) 4) 5) 6) 7) 8) 9) 10)11) 12) 13) 14) 15) 16)

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