AT&T has a lot of debt. The US telecommunications company’s total borrowings stretch well north of $130bn, a bigger debt pile than many countries.
AT&T also has a lot of what could be termed “hidden debt”. Hidden, that is, until a recent accounting change cast a light on billions of dollars of liabilities buried in its books for the first time.
As astute readers may have already guessed, FT Alphaville is talking about supply-chain finance, a once-niche way of juicing corporate balance sheets that became notorious when specialist firm Greensill Capital imploded in 2021.*
For the uninitiated, supply-chain finance is sometimes called “reverse factoring”, because it is a newer spin on the centuries-old technique of “factoring” invoices to raise cash.
In simple terms, a (typically large) company has an agreement with a financial institution to pay the bills it owes to its suppliers earlier than planned. While the smaller suppliers get paid more quickly, the trade-off is that they receive slightly less than they’re owed. The financial institution later collects the full amount of the invoice from the large company, pocketing the difference.
Here are the basics in chart form, for those who like arrows going back and forth:
The technique has all sorts of balance-sheet flattering benefits, such as helping a company push out the time it takes to pay its bills (increasing its “days payable outstanding”). But the most notorious one is this: while a company that uses supply-chain finance owes money to a financial institution, accountants do not class these facilities as debt.
The key problem for investors trying to get to grips with companies’ use of supply-chain finance has been the lack of disclosure.
Supply-chain finance obligations are typically booked through the “accounts payable” line of a company’s balance sheet, where they are co-mingled with all the other bills owed to suppliers. If you’re lucky, a footnote might explain how much of the money is actually owed to financial institutions, rather than suppliers. However, historically there was no requirement to disclose the use of supply-chain finance.
In the US, the Financial Accounting Standards Board has recently tried to close this loophole, last year introducing new accounting rules mandating companies to disclose their use of what FASB terms “supplier finance”.
As a result, scores of US companies disclosed their supply-chain finance programmes for the first time in their first-quarter results this year. Our friends at Bloomberg totted up $64bn of hitherto “hidden leverage” revealed across corporate America through these disclosures, producing this handy chart of the biggest users of supply-chain finance:
But FTAV noticed that one household name is conspicuously absent from this top five, even though it has what can be broadly termed “payables finance” programmes stretching to nearly $13bn.
And in trying to understand why the company in question does not class all of these facilities as supply-chain finance, we hit upon some of the critical limitations of the new FASB-mandated disclosures.
The Texas three-step
Before we delve into the nitty-gritty of AT&T’s supplier finance disclosure, it makes sense to look at rival telecommunications company Verizon’s as a benchmark.
After all, not only are both companies fierce competitors in the US wireless communications market, but they both carry investment-grade credit ratings (albeit the three major agencies rank Verizon’s debt one notch higher).
Here is Verizon’s latest disclosure in full, taken from its quarterly report for the period ended March 31, 2023:
We maintain a voluntary supplier finance program (SFP) with a financial institution which provides certain suppliers the option, at their sole discretion, to participate in the program and sell their receivables due from Verizon to the financial institution on a non-recourse basis. The eligible suppliers negotiate the terms directly with the financial institution and we have no involvement in establishing those terms nor are we a party to these agreements.
Our payments associated with the invoices from the suppliers participating in the SFP are made to the financial institution according to the original invoice terms generally at 90 days from the invoice date and for the original invoice amount. No additional payments are exchanged between Verizon and the financial institution related to the SFP. Verizon does not pledge any assets nor provide any guarantees to the financial institution in connection with the SFP. The SFP can be terminated by Verizon or the financial institution with a 60-day notice period.
Confirmed obligations outstanding related to suppliers participating in the SFP are recorded within Accounts payable and accrued liabilities in our condensed consolidated balance sheets and the associated payments are reflected in the operating activities section of our condensed consolidated statements of cash flows. As of March 31, 2023 and December 31, 2022, $705 million and $1.0 billion, respectively, remained as confirmed obligations outstanding related to suppliers participating in the SFP.
As these new disclosures go, it seems fairly benign.
The New York-based telco does not appear to be stretching out its payables for an egregiously long time (in contrast, some other companies have disclosed that they do not repay the financial institutions involved for as long as a year) and the amounts are relatively small. Verizon’s $705mn outstanding at the end of the first quarter of 2023 represents a small fraction of its $19bn accounts payable and an even smaller fraction of its $153bn total debt.
Turning to its Dallas-based competitor, however, and the numbers involved are not only much bigger, but the disclosure is more convoluted:
Supplier Financing Program
We actively manage the timing of our supplier payments for operating items to optimize the use of our cash and seek to make payments on 90-day or greater terms, while providing suppliers with access to bank facilities that permit earlier payment at their cost. Our supplier financing program does not result in changes to our normal, contracted payment cycles or cash from operations.
At the supplier’s election, they can receive payment of AT&T obligations prior to the scheduled due dates, at a discounted price to the third-party financial institution. The discounted price paid by participating suppliers is based on a variable rate that is indexed to the overnight borrowing rate. We agree to pay the financial institution the stated amount generally within 90 days of receipt of the invoice. We do not have pledged assets or other guarantees under our supplier financing program.
Based on data from our financial institution partners, suppliers had elected to sell $2,557 of our outstanding payment obligations as of March 31, 2023 and $2,869 as of December 31, 2022, which are included in “Accounts payable and accrued liabilities” on our consolidated balance sheets. Our supplier financing programs are reported as operating or investing (when capitalizable) activities in our statements of cash flows when paid.
Direct Supplier Financing
We also have arrangements with suppliers of handset inventory that allow us to extend the stated payment terms by up to 90 days at an additional cost to us (variable rate extension fee). All payments are due within one year. We had $5,129 of direct supplier financing outstanding at March 31, 2023 and $5,486 as of December 31, 2022, which are included in “Accounts payable and accrued liabilities” on our consolidated balance sheets. Our direct supplier financing is reported as operating activities in our statements of cash flows when paid.
Vendor Financing
In connection with capital improvements and the acquisition of other productive assets, we negotiate favorable payment terms of 120 days or more (referred to as vendor financing), which are reported as financing activities in our statements of cash flows when paid. For the three months ended March 31, 2023 and 2022, we recorded vendor financing commitments related to capital investments of approximately $1,021 and $954, respectively. We had $5,003 vendor financing payables at March 31, 2023, with $3,531 included in “Accounts payable and accrued liabilities” and $6,147 vendor financing payables at December 31, 2022, with $4,592 included in “Accounts payable and accrued liabilities.”
Let’s break it down.
The disclosure under the first heading “Supplier Financing Program” is broadly similar to Verizon’s, albeit the amounts involved are multiples larger. AT&T’s more than $2.5bn of supplier financing outstanding at March 31 is over 3.5 times the equivalent at Verizon.
But then, on top of that, AT&T had even larger amounts outstanding under so-called “Direct Supplier Financing” and “Vendor Financing” programmes. And the numbers get very large indeed when you sum up the liabilities under these three programmes, with $12.69bn outstanding as of March 31, 2023 and $14.5bn as of December 31, 2022:
As with the supplier finance, AT&T is largely booking this stuff through its accounts payables line. We say “largely” because a chunk of the vendor financing is somewhere else, we presume because it has a longer term than a year, making them noncurrent liabilities.
In contrast to its supplier financing, however, AT&T books repayments of the vendor financing through the financing activities section of its cash flow statements, along with debt and dividend payments, suggesting that in some ways it is even more finance-y:
This all presents an obvious question: aren’t these three forms of financing just different spins on supply-chain finance?
Linguistically at least, “direct supplier finance” seems quite straightforwardly a variant of “supplier finance”, while the word “vendor” is also a synonym of “supplier”.
Shouldn’t AT&T really lump them together and disclose it all as one double-digit billion dollar figure?
After a long time playing spot the difference with the three descriptions, however, we noticed a subtle distinction: there is no mention of a “third-party financial institution” in the direct supplier finance and vendor finance disclosures.
It suggests that AT&T, rather than a bank it has hired, pays these invoices.
And for the purposes of the new US disclosures, that distinction matters. See this extract from FASB’s accounting standards update on “supplier finance programs”, our emphasis in bold:
Supplier finance programs, which also may be referred to as reverse factoring, payables finance, or structured payables arrangements, allow a buyer to offer its suppliers the option for access to payment in advance of an invoice due date, which is paid by a third-party finance provider or intermediary on the basis of invoices that the buyer has confirmed as valid.
Typically, a buyer in a program (1) enters into an agreement with a finance provider or an intermediary to establish the program, (2) purchases goods and services from suppliers with a promise to pay at a later date, and (3) notifies the finance provider or intermediary of the supplier invoices that it has confirmed as valid. Suppliers may then request early payment from the finance provider or intermediary for those confirmed invoices.
On the face of it then, it seems that with no intermediary involved in AT&T’s so-called “direct supplier financing” and “vendor financing”, they do not meet FASB’s criteria for “supplier finance”.
With these other sorts of arrangements, AT&T could either settle invoices early itself at a discount — booking the gain a bank would typically earn — or pay an interest-like fee to the supplier in exchange for pushing out the payment date. As one supply-chain finance specialist put it to FTAV: “You’re really putting your supplier in the role of a bank”.
And this does not necessarily mean that banks are not involved at all.
After earning a fee from AT&T in exchange for extending payment terms, a supplier could then turn around and factor those same outstanding invoices with a bank of its choosing. As long as it wasn’t AT&T’s bank that the telco had enlisted to acted as an intermediary, it wouldn’t technically be supplier finance under the FASB guidelines.
FTAV asked AT&T about its supplier finance disclosures and it said the following:
Supplier financing provides diversification and flexibility as part of our overall capital management strategies. Our disclosures are consistent with our focus to provide transparency for our stakeholders.
Clouds on the Verizon
Having established that the new US accounting standards do not require companies to disclose financing arrangements with suppliers where they have not enlisted an intermediary to pay their invoices, it struck FTAV that other large US companies could engage in similar practices to AT&T and not disclose them at all.
At this point, we decided to go back to Verizon. Did the company also engage in “direct supplier financing” and “vendor financing”? Verizon answered as follows:
“Direct supplier financing” and “vendor financing” programs that you refer to are outside of the scope of the [Accounting Standard Update] for supplier finance programs.
FASB’s Accounting Standard Update (ASU) 2022-04, applies to disclosure of supplier finance program obligations. Verizon’s disclosure in our Q1’23 10-Q includes a disclosure of outstanding amounts under such obligations, as well as a description of payment and other key terms of the program. Verizon does participate in Vendor Financing Arrangements, as disclosed under our “Liquidity and Capital Resources” discussion in the [management discussion and analysis], and additionally with our Cash Flow from Financing discussion, when material. Verizon does not have a direct supplier financing program.
So, Verizon does not engage in direct supplier financing, but it does make use of vendor financing. And while the company says it discloses its use of the financing technique, in its last quarterly and annual results Verizon did not report the amounts outstanding, simply that its “external financing arrangements” include “vendor financing arrangements”.
Verizon also only discloses vendor financing payments in its cash flow statement when they are “material”. While the telco disclosed “$320 million in payments related to vendor financing arrangements” in its 2021 annual report, there was no such disclosure in 2022, presumably because it did not deem that year’s payments as material. (In response to further questions about this, the company reiterated: “We only disclose when activity is material to Verizon.”)
It is worth noting that Verizon’s use of vendor financing appears low compared to AT&T.
While as recently as 2018 the former’s annual vendor financing payments outstripped the latter’s, Verizon’s have since dwindled while the AT&T’s have ballooned:
It bears repeating: the numbers involved at AT&T are big. The $14.5bn of liabilities outstanding under its three payables finance schemes at the end of 2022 equated to over 10 per cent of its total debt.
But at least AT&T now discloses all of this in one place. Other US companies could be paying their suppliers to extend payment terms with their shareholders none the wiser.
With US publicly listed companies gearing up to report their second-quarter results in the coming weeks, FTAV recommends that interested analysts and investors probe a little further on what is and isn’t included in their supplier finance disclosures.
The devil is, as ever, in the detail.
* (As an aside, we are still disappointed that no one on the Treasury select committee asked Greensill’s highly paid boardroom adviser David Cameron to explain simply the mechanics of how supply-chain finance works. We will forever cherish, however, the former British prime minister’s statement that while “there were faults with the business . . . it doesn’t mean that the whole thing was necessarily a giant fraud”.)
Source: Economy - ft.com
