Analysts bashing Indian cos on accounting habits

Many large Indian companies these days are at the receiving end as the equity research firms, foreign and Indian have turned their heat on major corporate entities questioning their accounting as well business practices.

The latest instance is the Canada-based equity research firm Veritas assigning a value of Rs 15 per share to the Anil Ambani-promoted Reliance Communications (RCom), as against its market price of around Rs 60.

The reason for the massive downgrading of stock prices, according to Veritas, was the high debt burden of RCom. Other reasons include RCom’s accounting policies being “whimsical” and the company suffering from poor corporate governance standards, it said.

Naturally angry, RCom’s rebuttal said the report “lacked credibility” and was “full of factual inaccuracies, baseless allegations masquerading as research” and that Veritas was destroying investor confidence through sensationalism. It even said Veritas had published a report on similar lines on the stock, last year, too.

It also wondered why was Veritas’ report release held back for 10 days from the date it was printed. The gist of the latest Veritas report amongst many things said, “Exceedingly high financial leverage, accompanied with debt repayment obligations of approximately $2.2 billion over the next twenty four months, at a time when EBITDA (earnings before interest, tax, depreciation and amortisation) in core business operations is stagnating and is a significant challenge for the management team.”

It also sees “significant additional downside” in the RCom stock saying it did not think the company’s accounting policies “provide a clear picture of the underlying operating and business trends”.

Reacting to the report, investors gave a thumbs down as the RCom stock on the day the report became public had hit a record low of Rs 59.45 on BSE immediately, but recovered later to close at Rs 63.55, which was still 2.46 per cent lower from the previous closing.

RCom is not an isolated case involving an Indian company being criticised for its accounting practices by a foreign equity research firm. A fortnight ago, an Australian firm, Macquaire Research, had downgraded the mortgage major HDFC Ltd saying it has been adopting aggressive accounting practices by passing provisioning through reserves and making the adjustments for zero-coupon bonds (ZCBs) through reserves.

Earnings inflated

Macquarie has alleged HDFC of inflating earnings and ROE (return of earnings) over the past two years. “We believe the FY11 and FY12 earnings are overstated by 38 and 24 per cent respectively and reported ROE would have been 600 and 400 bps lower at 16 and 18 per cent respectively, if the adjustments had been made through the P&L.

In other words, earnings growth has been managed,” the explosive report stated.
Like RCom, HDFC too reacted to the Macquaire report saying it completely disagrees with the contents of the report as the concerned analyst made no attempt to meet anyone from HDFC before making the report and verify the facts and statements made therein.

Portuguese financial group Espirito Santo, in a report, raised concerns over the accounting processes of Bangalore-based biotech company Biocon Ltd, mainly during its split with Pfizer on the $350 million insulin deal and its divestment of stake in AxiCorp.

The report alleged that Biocon booked a cash loss of around euro 10 million and a notional loss of euro 21 million in the AxiCorp deal. As expected, Biocon denied all the charges contained in the report saying its accounting practices were in compliance with GAAP (Generally Accepted Accounting Practices) and it had not incurred any additional gains or losses.

Biocon, however, structured the deal in such a manner that it ensured ‘no loss on sale’ in its profit & loss (P&L) account, while the report alleged that the biotechnology firm had also not factored in its P&L the $200 million upfront milestone payment it received from Pfizer when the insulin deal between the two companies was called off. On the contrary, the company chose to keep it in its balance sheet and recognise it with R&D costs, as per the report.

Early last month, Espirito Santo charged Delhi-based Educomp Solutions, whose stock was under attack for the last two years from bears who repeatedly questioned the company’s corporate governance standards and accounting practices – raised all those issues afresh and assigned a fair value to the stock, while the management has denied the brokerage’s views were “sensational in nature” and there was nothing wrong with the company's financial practices.

It is not that all of a sudden, foreign research houses are taking a fancy for Indian companies with strong objections to their accounting practices.

The Satyam scandal in 2009 is all about the outsourcing firm hugely cooking up its books raising questions over accounting standards in India. In this context, Professor R Narayanswamy from Indian Institute of Management, Bangalore, in one of his interviews, said, “Angel Broking was reported to be queasy about certain dealings within Satyam, but they were largely the lone voice.

None of the bigger research firms raised doubts about Satyam.” In this context, SMC Global Securities Head (Research) Jagannadham Thunuguntla said, “Growth is like a red carpet. Once the carpet is removed, the hidden problems will appear. It is the analysts’ opinion and the market has the free will to accept it or reject it. If we have problems, it will show.” If the market reacts badly to the reports of equity research houses, then the concerned stock suffers and touches new lows on bourses, he points out.

However, Kishor P Oswal of CNI Resarch felt, “One should not give too much importance to these downgrades.” He even suggested that there should be some investigation carried out on the “credibility” of these reports.

In July 2011 Veritas had also published a report on Reliance Industries (RIL) promoted by Anil’s elder brother Mukesh Ambani accusing the company causing loss of Rs 25,000 crore to its shareholders by de-merging telecom business and then transferring it to Anil in a family settlement. In the same report, it had alleged RCom of inflating its profit by accounting manoeuvres.

It had also criticised Kingfisher Airlines for its “poor disclosures, capricious accounting policies and understated liabilities.”  It noted Kingfisher’s book equity had been wiped out following persistent cash burn and UB holding has also run out of financial room to accommodate Kingfisher’s cash needs.

Veritas had in March 2012 also slammed DLF by questioning its book equity and asset base saying the realtor undertook questionable related-party transactions to boost the value of DLF Assets prior to its acquisition by DLF, thereby subverting the interests of minority shareholders via a higher purchase price for DAL. It also said DLF had inflated sales by Rs 11,236 crore and profit before tax by Rs 7,233 crore through its dealings with DLF Assets.

Despite so many perceived ‘window dressing of accounts’, one cannot overlook that all those accounting practices have been ratified by their official auditors. If this is to be seen as companies getting aggressive with their accounting treatment to the extent of bulldozing the auditors, then it is time for authorities like the Ministry of Corporate Affairs and Sebi to take a serious note and act accordingly.