FRANKFURT – Just a few weeks after Berkshire Hathaway bought what seemed like a prime example of German engineering prowess, a widely admired corporate empire manager from Warren Buffett received a disturbing email.
“I have to get rid of something I have witnessed in the past few months,” the anonymous author wrote in somewhat uncomfortable English. “There is ongoing falsification of data.”
The whistleblowers’ suggestion eventually led to the exposure of an elaborate conspiracy involving fake sales invoices, ghost customers, and hacked computer systems, according to testimony in a legal dispute. The case showed that even Buffett, one of the world’s smartest investors, can be fooled.
What looked like a profitable German manufacturer of specialized pipes for the oil and gas industry was, in fact, almost bankrupt, according to testimony.
As a result, according to the findings of a U.S. arbitration panel, Precision Castparts, a Berkshire Hathaway subsidiary, paid € 800 million, or $ 870 million, for a company that was worth only about a fifth of that price.
The acquisition of the company, Wilhelm Schulz, was a costly misstep for Mr. Buffett’s holding company, which has also been greatly affected by the pandemic. In early May, Berkshire Hathaway reported a loss of nearly $ 50 billion in the first quarter due to blockages and the economic downturn that affected the company’s portfolio of airlines and financial firms.
The case also affects the myth of Mittelstand, the midsize manufacturing companies that underpin the German economy. German prosecutors have opened a criminal investigation targeting eight suspects in Wilhelm Schulz, all of them former high-ranking executives, financial officials, or information technology specialists. None have been charged.
The investigation was previously reported by the Handelsblatt newspaper.
The circumstances that allowed Mr. Buffett’s organization to be tripped over by a little-known German manufacturer were detailed by the arbitration panel that considered a complaint filed by Portland, Oregon-based Precision Castings. The court found that Wilhelm Schulz executives and employees had “engaged in a blanket scheme” to hide the company’s dire financial situation for Precision Castparts to go ahead with the acquisition.
“This is not a closed case,” the court found. “The evidence strongly points to fraud, and there is little in the record to suggest otherwise.”
Lawyers representing the interests of the sellers, three German holding companies owned primarily by members of the Schulz family, deny the allegations and have petitioned the United States District Court for the Southern District of New York to dismiss the decision of the arbitrators.
On the surface, Wilhelm Schulz seemed like the kind of solid industrial company that has made Germany an export powerhouse. Based in Krefeld, north of Düsseldorf, in the industrial heart of Germany, Schulz seemed to have a strong position in his niche: specialized pipes for the oil and gas industry.
CEO Wolfgang Schulz was the son of Wilhelm Schulz, who put his name on the company when he founded it just a few months after the end of World War II. Wolfgang Schulz was known locally as the owner of a professional ice hockey team, the Krefeld Penguins. Schulz denied wrongdoing and promised to clear his name.
Precision Castparts started thinking about acquiring Wilhelm Schulz after being contacted by a broker in 2016.
Berkshire Hathaway had acquired Precision Castparts just a few months earlier for $ 37 billion, Buffett’s largest acquisition. Although best known for its aircraft parts, Precision Castparts also makes products for oil and gas production, an industry that was suffering even before the pandemic brought fuel prices down.
Wilhelm Schulz seemed like a way for Precision Castparts to increase its presence abroad, and a rare opportunity to buy a German company. Many medium German manufacturers are owned by families who are reluctant to sell.
Precision Castparts sent employees to Krefeld, where they spent six months carefully studying Wilhelm Schulz’s financial records. They examined the lists of the main customers, interviewed Schulz employees and visited Schulz facilities.
But without being known to Precision Castparts, Schulz had narrowly avoided bankruptcy just a few weeks earlier. The company had been unable to make payments on a € 325 million credit line from Commerzbank, according to the arbitrators’ report. A lawyer hired by Schulz had informed the company that he was required by German law to apply for insolvency.
Schulz avoided that fate only because he persuaded Commerzbank to face him with an additional € 8 million, saying he was waiting for a large customer to pay. The bridge loan came with one condition. If Schulz was unable to pay, Commerzbank would effectively take control of the company.
Schulz was also raising cash through loans against accounts receivable, money that customers owe but have not yet paid, a common practice known as factoring. But some of the documentation Schulz presented to the lender (and then reviewed by Precision Castparts before the purchase) was fabricated using Photoshop software to create fake invoices and delivery receipts, the arbitrators found.
How could Precision Castparts auditors lose these obvious problems? An incident described in the referees’ report illustrates how Schulz employees made the company look healthier than it was.
In October 2016, when Precision Castparts reviewed Schulz’s financial records, a Schulz information technology employee designed a five-day outage of the computer system used to track sales and orders. A Schulz team took advantage of the downtime to manufacture nearly 50 orders, worth tens of millions of euros, which were delayed to make it appear that they had been placed in 2014 and 2015, according to the referees’ report.
According to testimonies, requests were made from companies with which Schulz was no longer doing business. An alleged client had effectively ceased to exist years earlier.
The deal closed in February 2017, and the news was reported in Bloomberg News and The Wall Street Journal. Handelsblatt said: “Warren Buffett strikes again in Germany.”
The complainant’s email arrived in early March.
The informant, identified later in the arbitrators’ report as someone who worked in information technology at Schulz, wrote that a small team of coworkers was entering bogus customer requests into the company’s computer system to “make it our company will look much better than we really do. “
“I consider this to be a criminal act and I don’t want to work for a company that uses such methods any longer,” the email said.
Alarmed, Precision Castparts turned to accounting fraud consultants, along with its own financial controllers.
After months of digging, an investigator discovered outdated computer bills. Another learned from Schulz employees who were not involved in the fraud that the companies that were supposed to be among the company’s largest customers were not customers at all. The auditors found emails in which Schulz employees seemed to be discussing how to artificially increase sales.
In 2018, in an attempt to recoup some of his money, Precision Castparts invoked a provision of the sales contract that required arbitrators to resolve disputes.
In April, a New York court found that Wolfgang Schulz and his employees had “made a widespread effort to present a fundamentally misleading picture of the company’s financial situation”. An expert who testified concluded that the false transactions increased Wilhelm Schulz’s profits by € 160 million.
Through a spokesperson, Mr. Schulz, 73, declined to respond to the allegations in detail, citing the ongoing criminal investigation. Last year, the German authorities searched his house. Schulz said through a spokesman that “he clearly rejects the allegations of fraud.”
His lawyers argue that Wilhelm Schulz was worth the € 800 million that Precision Castparts paid for him. They say any loss in value was caused by mismanagement since the acquisition took place, including the decision to fire all top executives after irregularities were discovered.
Precision Castparts “continues to aggressively use the Schulz brand in the marketplace, even when it demands a refund of the purchase price,” Schulz Holding said in a statement.
Precision Castparts has prevailed in the legal battle so far. The arbitration court awarded him € 643 million in damages, the purchase price less Wilhelm Schulz’s estimated actual value of € 157 million.
It is doubtful that Precision Castparts can collect the money. The three holding companies that sold their shares in Wilhelm Schulz went bankrupt. Wolfgang Schulz sold almost his entire stake in the Krefeld Penguins in April for an undisclosed price. Jan-Philipp Hoos, a Düsseldorf lawyer who serves as bankruptcy administrator for the holding companies, declined to comment.
The financial hit comes at an especially bad time for Precision Castparts. Its main customers, aircraft manufacturers like Boeing, as well as oil and gas producers, have been hit hard by the economic effects of the pandemic.
But Wilhelm Schulz does not appear to have shaken Mr. Buffett’s faith in Germany, a country whose engineering he has often praised.
“We see this as a unique situation involving individual circumstances,” David Dugan, a spokesman for Precision Castparts, said in an email. The experience with Wilhelm Schulz, he said, “does not affect our view of German industry.”
