About the Company:
Company is a technology driven company providing last-mile retail touch points to deliver real-time banking, insurance, e-governance, e-commerce and ATM services to the rural, semi-urban and urban markets. These retail touch points (sometimes referred as “Kendras”) act as the “One-stop shop” for availing various services and products.
Quality of Earnings & Corporate Governance Issues:
1.Misreporting of Shareholding & Likely Manipulation of Exchange Volumes –
While analysing company’s shareholding pattern, we came across some misreporting within the annual report of financial year 2016. The shareholding pattern reported in Directors’ Report showed Non Promoter Institutional shareholding as 17.90%, while the shareholding pattern reported in Corporate Governance Report showed the same as 13.82%. (Auditors are required to comment on corporate governance report & not on directors’ report).
On further scrutiny, we also observed that the shareholding of some of the shareholders as on 31st March, 2015 was restated in the annual report of financial year 2016.
|Shareholding for 31.03.2015 in|
|Shareholder||2015 AR||2016 AR||Difference|
|SH Mercantile Co.||8.91||13.98||5.07|
|ABR Trading Private Limited||3.53||14.38||10.85|
|ABR Trading Pvt. Ltd.||10.00||–||(10.00)|
(number of shares in millions)
Another important observation here was reporting of shareholders with very similar names as 2 different shareholders with different shareholding. For example, in financial year 2015 company reported two shareholders with names “ATC Trading Private Ltd.” (3.53 million shares) & “ATC Trading Pvt. Ltd.” (10 million shares). Similarly in its BSE filing for March 2015, company reported two shareholders with exactly similar names “ATC Trading Company Pvt Ltd” (one with 26.19 million shares & the other with 8.23 million shares). While this could be perfectly legal to have similar sounding name entities, it could give misleading signals from a good corporate governance perspective.
We also observed the volume of shares contributed by these entities as a % of total traded volume on both the exchanges to be significantly high at 39.3% & 12.0% in financial year 2015 & 2016 respectively.
A recent news article has also highlighted that between January 1 and June 30, 2016, a group of 22 investors related to each other as well as to the company were continuously buying and selling the scrip, accounting for 74.87% of market gross volumes on certain days. Also noteworthy is that 18 of these 22 had more than 90% trading activity in this scrip only.
Another interesting observation during our exercise was the difference between shareholding reported in annual report & shareholding reported in BSE filing for the quarter ended 31st March, 2016.
|Shareholder||BSE Filing||2016 AR||Difference|
|SH Mercantile Co.||16.00||4.52||(11.48)|
(number of shares in millions)
Such gross misrepresentations in statutory filings raises concerns on corporate governance practices, particularly from minority shareholder’s perspective.
2.Investments in Subsidiaries & Subsequent Disposals –
Company had developed few software through one of its wholly owned subsidiary, with an accumulated investment of ~INR 500.5 million till 31st March, 2012. The said subsidiary was able to develop software like Document Management Services (DMS), Human Capital Management (HCM) and School ERP, which were to be commercialized soon. However in FY 13, company disposed this subsidiary for an amount of ‘INR 500.8 million’. The sale of a subsidiary with potential of revenue generation to be sold off for a sum, very similar to its cost of investment again raises red flag on corporate governance practices.
Similar was the case with another subsidiary company, which was sold for INR 81.5 million in 2014 (cost of investments was also co-incidentally INR 81.5 million). This subsidiary had been allotted an Industrial plot admeasuring to 5 Acres from HSIIDC at IMT Manesar, Haryana, where the Company was planning to develop an IT Centre.
We don’t have the details as to whom they were sold off to. ‘If’ the company sold these subsidiaries to promoters or some entities related to them, then the virtue of such transactions will be under cloud of questionable corporate governance practices.
3.Large Capex & Subsequent Write-offs –
In FY 2007 & 2008, company had incurred large capex of 100% & 67% of its annual sales respectively (amounting to INR 2.7 billion). However in FY 2009, company wrote off assets worth INR 493 million, raising question marks over efficacy of capex incurred in prior years.
SEBI also investigated the company & some of its officers for charges of insider trading for transactions just before announcement of Q4FY09 earnings (quarter in which assets mentioned above were written off). However SEBI couldn’t get the conclusive evidence & dropped the charges later.
4.Aggressive Accounting Assumptions – Inconsistency in Effective Tax Rate & Cash Tax Rate –
|Tax Rate (Tax/PBT)||34.3%||32.9%||7.2%||25.5%||27.9%||31.1%||27.4%||37.9%||34.2%||35.0%||35.9%|
|Cash Tax Rate (Tax Paid/PBT)||3.2%||6.4%||16.6%||4.1%||16.2%||20.0%||18.4%||34.6%||29.1%||48.2%||35.6%|
Till 2013, there appears to be large inconsistency in the profits as per income tax and the reported income, as can be seen from the above table. Major reason for this deviation is ‘Deferred Tax Liability (DTL) on account of Difference between Book and Tax Depreciation’ due to aggressive assumption for useful lives of assets (almost double the useful life assumed by peers). This had led to higher reported profits for the company till 2013.
In 2014, adoption of depreciation rates as per new Companies Act, 2013, resulted in higher cash tax payments & more aligned cash & statutory tax rates thereafter. Now that company does not have any deferred tax asset/liability on its balance sheet, cash tax & statutory tax rates are expected to remain aligned going forward.
5.Deterioration in M-Score –
M-score is a score indicating possible manipulation of financials (developed by Messod D Beneish Study, Professor, Indiana University). In case of this company, out of the total 19 years, M-score shows possibility of manipulation in 9 years. High Sales growth, volatile debtor turnover & high accruals has kept the M-score in danger zone in 6 of the last 8 years, which might be indicating possibility of aggressive revenue recognition and poor cash flow generation.
Please refer Appendix 1
This exercise reaffirmed our strong belief that an in-depth assessment of a company’s quality of earnings is indispensable before using the reported numbers and filings for valuation & investment decisions.
In May, 2017, we had covered the subject company for one of our client & had highlighted all the above points as Key Highlights. The said client found it interesting and concurred with the issues/red flags raised by us on the quality of earnings and corporate governance and therefore avoided any investment in the company.
Note: Names of parties/companies have been masked/changed for compliance purpose.
Statutory Details:- Multi-Act Equity Consultancy Private Limited
(SEBI Registered Portfolio Manager – Registration No. INP000002965)
The views expressed in this article are for educational and reading purpose only. Multi-Act Equity Consultancy Private Limited (MAECL) does not solicit any course of action based on these views and the reader is advised to exercise independent judgment and act upon the same based on its/his/her sole discretion, their own investigations and risk-reward preferences.
The article is prepared on the basis of publicly available information, internally developed data and from sources believed to be reliable. Due care has been taken to ensure that the facts are accurate and the views are fair.
MAECL, its associates or any of their respective directors, employees, affiliates or representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such views and consequently are not liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way for decisions taken based on the said article.
It is stated that, as permitted by SEBI Regulations and the Company’s Employee Dealing Policy, the associates, employees, affiliates of MAECL may have interests in securities referred to in the information.
The contents herein – information or views – do not amount to distribution, guidelines, an offer or solicitation of any offer to buy or sell any securities or financial instruments, directly or indirectly, in the United States of America (US), in Canada, in jurisdictions where such distribution or offer is not authorized and in FATF non-compliant jurisdiction and are particularly not for US persons (being persons resident in the US, corporations, partnerships or other entities created or organized in or under the laws of the US or any person falling within the definition of the term “US person” under Regulation S promulgated under the US Securities Act of 1933, as amended) and persons of Canada.
General risk factors
a. Securities investments are subject to market risks and there is no assurance or guarantee that the objective of the investments will be achieved.
b. Past performance of MAECL does not indicate its future performance.
b. As with any investment in securities, the value of investments can go up or down depending on the factors and forces affecting the capital market. MAECL is not responsible / liable for any losses resulting from such factors.
c. Securities investments are subject to external risks such as war, natural calamities, and policy changes of local / international markets which affect stock markets.
d. MAECL has renewed its SEBI PMS registration effective October 14, 2011 and has commenced its portfolio management activities with effect from January 2011. However MAECL has more than 10 years of experience in managing its own funds invested in the domestic market.
- M-Score: In his out of sample tests, Prf. Beneish found that he could correctly identify 76% of manipulators, whilst only incorrectly identifying 17.5% of non-manipulators ↩