Whether serial acquisitions helped camouflage losses and diversion of funds?

CG Power and Industrial Solutions Ltd (“CG Power”), which makes power equipment - electrical switchgears have tumbled 70% in the last 3 months on the stock exchanges with news of serious accounting lapses at the company. The stock of the company is brooding at the bourses as to what extent the problems are! From outlook, it seems erstwhile promoters of CG Power used acquisition as a tool for syphoning of money & to hide its losses. In this article, we have articulated how promoters used acquisition as a tool.

In March 2019, the Board of Directors of CG Power constituted Operations Committee (“Ops Committee”) with aim of improving stakeholders’ value. However, while working on one of its priority tasks of seeking refinancing, of certain facilities and as part of conducting financial analysis, the Ops Committee was made aware of some unauthorised transactions. Digging further, they came out with some serious accounting lapses. As a result of this, on 10^th May 2019 the CEO and Managing Directors K N Neelkant, sent on leave by board to enable proper investigation into financial irregularities, continues in his role for now. On 21^st June 2019 Letter by the Company for delay in submission of audited financial results for 4th quarter and year ended March 31, 2019 submitted with exchange. On 19^th August, the Board of Directors released a note explaining all accounting lapses they came across.

On 29^th August 2019, Mr. Gautam Thapar removed as the chairman of board with the immediate impact. Meanwhile, CG Power recently saw many management changes. Managing director K N Neelkant was away from day-to-day management during the period of investigation. Sudhir Mathur, who was then an independent director of the company and a member of the operations committee, was re-designated as a whole-time executive director of the company with effect from May 10, 2019, to be more involved in the day to day management of the company. CFO VR Venkatesh, who had resigned on March 8, 2019, was asked to continue till the finalisation of financial results for the year ended March 31, 2019 however on 30^th August 2019 removed from the position of CFO with immediate effect.

Certain transactions were carried out by some key managerial personnel and other employees prejudicial to the company’s interest, according to an exchange filing. The transactions appeared to have been undertaken in a seemingly “fraudulent manner” warranting investigation.

While working the Ops Committee was made aware of some unauthorised transactions by certain employees of the Company. This panel received a letter from a financing company about an interest payment failure, which the committee was unable to track in CG Power’s books, implying that the loan on which the power which equipment maker defaulted was not shown in the balance sheet. The Ops Committee was also made aware of a letter received by the Company from a financing company regarding a certain interest payment failure which the Ops Committee was unable to trace or ascertain from the financials of the Company.

In a separate case, CG Power’s managing director received a request from a bank to replace a cheque whose validity was about to expire. And here, too, the operations committee could not track the said liability in the company’s financials. To asses this, the panel appointed an independent legal firm to investigate.

The Legal Firm also took assistance of an independent consultancy firm for the purposes of the said investigation. In the meanwhile, during the audit of the Company, one of the joint statutory auditors of the Company (viz. M/S S R B C & CO LLP), sought information and explanations from the Company regarding certain other transactions as part of the notice issued to the Company under Section 143(12) of the Companies Act, 2013. These additional transactions were also included in the scope overview of the Legal Firm.

Further, certain additional suspect, unauthorised and undisclosed transactions and entries were identified during further verifications. The said report was submitted to the Risk and Audit Committee (RAC). The RAC has also received from the management the compilation of unaudited standalone and consolidated financial position and profit and loss of the Company for the year ended 31 March 2019 and restated financial information and profit and loss for the year ended 31 March 2018 and statement of financial position as on April 1, 2017, after taking into consideration the potential impact of the Report Transactions and Additional Transactions.  Further RAC gave inputs to the Board and which were as under,

Key Findings of The Investigation (Source BSE)

• Understatement of the group’s total liability by Rs 1,608 crore as of March 2018 and by Rs 402 crore as of April 2017.
• Understatement of advances to related and unrelated parties by Rs 2,807 crore as of March 2018 and of Rs 1,331 crore as of April 2017.
• Assets provided as collateral without due authority. The company was made co-borrower and guarantor for unrelated third-party loans without due authorisation. These funds were immediately routed by the company to related parties without due authorisation.
• Understatement of the group’s net worth by ‘unauthorised’ and ‘inappropriate’ write-off.
• The company said it has restated last two years’ financial statements, including the impact of all the undisclosed or the understated transactions and making appropriate disclosure.
• Based on the observations in the legal report, the power equipment maker has now restated its financials for the year ended March 2017 and March 2018. While the company didn’t disclose the restated profit/loss for 2016-17, its revised 2017-18 loss was Rs 404.21-crore higher at Rs 728.93 crore. For the year ended March 2019, it reported a consolidated loss of Rs 486.79 crore.
• In May 2016, CG Power executed an assignment for leasehold land along with factory building for a consideration of INR 264 crores with Blue Garden Estates Private Limited (“BGEPL”) which is subsidiary of Acton Global Private Limited (“AGPL”). The shares of both the companies were owned by certain employee, who had not declared such ownership.
• The company received INR 200 crores from BGEPL. Out of 200 crores INR 145 crores advance to Avantha Holdings Limited (“AHL”) and INR 53 crores to AGPL. The above transaction is inappropriately netted off against payable to BGEPL. Hence no interest payments were made by the two entities to the company.
• Company further received INR 190 crores from BGEPL and made advances to AGPL INR 192 crores in multiple tranches and this transaction were also inappropriately netted off. The company officials show interest payment made to BGEPL as professional fees and advances to suppliers.
• A provision for slow moving inventory of INR 155.67 crores was recorded under ‘exceptional items’ the company did not have sufficient documentation evidencing the receipt and dispatch of and requisite approvals for aforementioned transactions. The parties are not traceable.
• Company disclose amount INR 391.88 crores in current year as contingent liability.
• In 2018, financial company had write-off amount INR 478.73 crores in the absence of enough documentary evidence. Segregation of this amount is as follows as the statement given by company to BSE:
  • INR 175.28 crores advance given to connected party.
  • INR 202.45 crores to AHL and
  • INR 101 crores to other third parties.

Journey in last 5 years

In 2014, the company announced demerger of its Consumer electrical business into separate company. Later, they announced promoter intention to sell its stake in Consumer electrical business. Promoters got good amount of money by selling its share to Private Equity. Post-demerger, CG power relentlessly tried to find out way to focus on their core business with an objective of reduction of debt. As a result, they announced quite a few divestments, some sailed through some not.

In 2015, the company sold its Canadian Operations and subsequently recognised loss on the transaction. During the same year, it also sold some land parcel, liquidated investment in subsidiary, sale of investment in associate, etc.

In 2016-17, the company signed biding agreement to sale its B2B Automation Business to Alfanar Electric System Company of The Kingdom of Saudi Arabia, comprising of ZIV Aplicaciones y Tecnologia, its subsidiaries along with the related automation business in UK, Ireland, France, and India at an enterprise value of Euro 120 million. Persuant to this, the company transferred its Automation Business in India under Slump Sale Agreement to ZIV Automation India Limited, a special purpose vehicle incorporated for this transaction. Later, the company sold its stake in this SPV to Alfanar. Consequently, the company has recorded loss of INR 239 crores on this transaction.

In the same year, the Share Purchase Agreement executed with  First Reserve, an offshore private equity firm for sale of overseas Power T&D businesses of the company at Indonesia, Hungary, Ireland, France, US and Belgium at an enterprise value of Euro 115 million has been terminated.

However, the company continued to find a new buyer for those operations.

During same period, the company discontinued Electricity Distribution Franchise Business of Jalgaon.

In 2017-18, the company accepted the binding offer from Ganz Villamossagi Zrt. And Alester Holdings Limited for sale of the Assets and Shares of the Company’s business in Hungary(excluding switchgear business) for an Enterprise Value of Euro 38 million. The company made provision of INR 265 crores on account of expected loss. Later in 2019, the company cancelled this transaction stating some conditions agreed between parties to performed not met. However, the company is still evaluating the option for divestment of business in Hungary.

The company concluded sale of its Power Business in United States of America for an Enterprise Value of USD 37 million. The company made a provision of INR 16 crores towards expected loss on this transaction.

Further, the company announced its plan to divest its two subsidiaries CG Power Equipments Limited & CG Power Solutions Limited.

In 2019, the management decided to not to sale its remaining international power business. As result of this, the company re-classified this business in its financial statement as continued business from discontinued operations. The non-cash impact of this re-classification will be around INR 200 crores in the consolidated financials statements on account of depreciation during the interim period.

Recently, in one of its con-call, the management of CGP said that the non-compete clause with consumer business has been extinguished now with the time period getting over and now the company is open for accessing the market of those products segments.

Key Financial Ratios:

Table 1: Some Key Ratios

Key Ratios	FY 2019	FY 2018		FY 2017
		Reported	Restated	Reported	Restated
Debt-Equity Ratio	1.06	0.49	0.65	0.37	0.49
Interest Coverage Ratio	1.40	2.06	1.98	2.57	-
Return on Equity	-0.56	-0.07	0.03	0.03	-

Auditor comment in audit report on Quarterly and Year to date Standalone Financial Results issued as on 30th August 2019

“With reference to pending completion of investigation of matters stated and determination of recoverability of loans and advances from related and unrelated parties and classification between current and non-current of the financial liabilities, we are unable to obtain sufficient and appropriate audit evidence as to whether the company will able to serve its debts, realize its assets and discharge its liabilities as and when they become due over the period of 12 months. Accordingly, we are unable to comment on whether the company will be able to continue as Going Concern”

Conclusion

CG Power is the case of promoter’s vision backed by aggressive planning. In a move to expand their business worldwide, the company acquired/expanded its business in many countries without assessing and creating required management bandwidth. But sooner it went on toss, and company started facing many operational difficulties in running them profitably nor it can integrate Indian and its worldwide operations. In due course, losses expanded & so did the debt. To service its debt, the company announced demerger of consumer electrical business and later promoter sold their stake to private equity.

The company also announced its plan to exit foreign operations, however, in many countries they were unsuccessful in selling. From the latest press release; now it looks they used these acquisitions as a tool to divert and camouflage losses and may be even syphoning money from the company. In coming period, as Warren Buffet once said, "There’s never one cockroach in the kitchen", it is likely that more such transactions are likely to come which might result in more severe problems for the company. All stakeholders including minority shareholders meanwhile suffered irreparable and irreversible loss because of irregularities and irrational and irresponsible decisions of top management. It is also intriguing how various internal controls, internal auditors, statutory auditors and whistles blowers and independent directors could haven’t been able to have a hint earlier.

Now, as erstwhile promoters hold miniscule percentage in the company, majority owners of the company are Private Equity and Financial Institutions. Going ahead, they will try to clear all mess and later selling the company. It will be interesting to see whether any peer will be interested in buying such company or worst is yet to come for Private Equity, Financial Institutions and Minority Shareholders.


Somehow regulations, control and systems needs to be strengthened in a way that identification becomes easier and early so that losses can be minimal and revival and retrieval is quicker.