The above article is a must read and very enlightening to
understand the crisis of credit that is plaguing the Indian economy. the more
pertinent question to be understood here; should we be blaming our public
sector banks for the mess they are in due to bad loan crisis. When the
internationally managed PE fund is bungling its small book of portfolio of
India in which there are barely 30 accounts. or is it the other way around,
that if KKR is willing to lend to AA rated accounts at 15%, it is
understandable that the account is about to default on all its limits and
loans.
While the most worrying element is the frauds, which are
widely prevalent in Indian corporate sector and which are apparently visible on
the face of it. It leads to serious introspection of the fact that what and how
KKR (it applies to all types of lenders) is undertaking due diligence of the
financial and legal, that they completely ignore the red flags; which are all
pervasive and compulsive on some of its business accounts. If KKR cannot avoid
fraud, after paying tens of millions of rupees for due-dilligence to some of
the finest Chartered Accountants and lawyers in the country, what is it that
the lenders are looking in the corporate to fund. KKR is only used as an
example as they are known as the baddest sharks in the water, when it comes to
scouring deals in the market.
On the other end of the spectrum, we are only taking the
case of Kwality Ltd. and CG Power and Industrial Solutions Ltd. Kwality Ltd.
generated turnover of Rs. 6724 Crores for FY18 with Net Profit of Rs. 71 Crores
and it had grown from Rs. 5269 Crores with Net Profit of Rs. 140 Crores.
Kwality Ltd. manufactures or processes, milk, dahi, chaach, cream and ready to
drink milk products.
I don’t know or wish to discuss, what is the level of
financial due-diligence that had undergone the Kwality Ltd. account by KKR but
lets not get subjective about the process. But before conducting the financial
due-diligence, perhaps they could have done market due-diligence to understand
at how many outlets and through how many distributors, Kwality Ltd. is selling
its milk products. If Kwality Ltd. is only selling milk in the market with
turnover of Rs. 6700 Crores, it was moving 134 Crores litres of milk (taking
milk price at Rs. 50 per litre) in the financial year. A commodity which is
perishable with shelf life of less than 24 hours. The logistics required to
move such huge amount of quantity of milk everyday, which is typically done in
the morning or the evening. The processing required for the same to bring
consistency with turnaround time of less than 6 hours. I certainly doubt the
processing capability in terms of production.
Even if any accountant had tried to talk to Kwality Ltd.
competitors in the market, they would have understood the capability of Kwality
Ltd. in terms of procuring, processing and selling milk. i had never seen
Kwality Ltd. milk sold in the markets. two or three years back, after KKR gave
them money, the only thing they sold in the market was Akshay Kumar hoardings
with unique packaging. But nobody knows on which shops, those glitzy packets
were sold. It was far and wide marketing reach program of Akshay Kumar posing
with Kwailty Ltd. milk and packaged products with no products on the shelves.
Kwality Ltd. has debtors of more than 3 months amounting
to Rs. 1700 Crores in FY18. which milk processing company can afford debtors of
3 months. Milk is sold on cash by the companies to the shopkeepers or chains.
They may compromise on margins but no credit. For frozen products, I can
understand they have to extend credit but milk related products help rein in
profits and not the turnover. Milk generally contributes to the turnover of
milk processing companies and milk related processed foods help bring in better
profitability.
Kwality Ltd. is a cat and mouse game in which KKR also
got whipped. But what I don’t understand for the amount of resources they put
in underwriting a transaction; they didn’t verify the marketing composition of
the Company. Now Kwality Ltd. proudly puts the top link to CIRP (Corporate
Insolvency Resolution Process) on its website. Kwality Ltd. market capital is
Rs. 37 Crores with price ranging from Rs. 1 - 2 from their life high of close
to Rs. 4000 Crores, two years back.
Can lenders avoid such companies, who have no products to
sell in the market? Certainly if they do detailed marketing survey of how, why,
where the companies products are sold. Kwality Ltd. was perhaps not even
processing the fraction of what their numbers claim.
CG Power and Industrial Solutions Ltd. is another case study
to understand. CG Power manufactures transformers, which are so essential for
the power distribution in India, a power hungry country, with our energy needs
still not largely met. CG Power is the only Indian company with that
capability. They compete with international companies like Alstom and its likes,
whose products cost at least 2x the CG’s equivalent products.
CG Power is the fundamental piece in the power
distribution infrastructure of India. Now the company is under investigation
for fraud allegations. With the fundamentals intact, it may not be the case of
NCLT for IBC. But KKR was generous in writing cheques to CG Power.
CG Power fundamentally does not have larger problems that
are ailing companies like Kwality Ltd. CG Power is part of Thapar Group, whose
Group had investments exceeding Rs. 25000 Crores or Rs. 50000 Crores. But then
all its other operating and cash generating companies are closing, shutting
down and not to mention have defaulted on their loans.
CG Power was only plagued by the fact that it was the
part of the group in which it only remained the performing from half a dozen
large assets owned by the group. CG Power is a failure of legal due-diligence
to understand, how and why the money was lent to CG Power and Thapar Group and
how loosely bankers had tied CG Power in the fine print for some of the other
assets of the group. CG Power possessed the joint and several liability of the
group, if yes, then perhaps its management should have been changed as soon as
the other assets were closed or shutting down.
I am pretty sure, KKR lawyers would have sought detailed
clarifications from the existing bankers of the CG Power about their security
and the charge they carried on CG Power, resulting from giving money to CG
Power or Thapar Group. With the structured transaction that KKR undertakes,
they must have taken proper clarification from the Banks. How CG Power
international web of operations was spread across the globe, they were in best
position to understand the structure of the CG Power (Indian and Global)
business better than any Indian banker as they don’t understand the complicated
route via which international banks offer products and solutions to corporates
like CG Power.
Now we can always blame the market or the various cycles,
which operate the market. But the fact remains, it is a systematic failure of
the accountants and lawyers, which owe the primary responsibility of helping
the banker/lender understand the company and its operations. They can always
meet the promoters and the management for informal chats on how they are gaming
the system, with which they have built their castle in the air, which can so
easily be wiped in a single storm.
Good sound companies are built with the cushion to
survive the storms (like CG Power), of course, in bad market conditions,
everybody possess the likelihood of going under the weather like currently even
our economy is. But CG Power is a casualty of the bungling’s in the group, so
that had to be studied properly for all the surprises we are yet to hear.
Moreover never ever lend to a promoter, who does not
value his own shares. A lot of promoters treat their own shares as an expensive
paper but if they themselves do not respect their paper; perhaps we should be
avoiding them at all costs. They do not deserve a single penny of the
bankers/lenders or certainly the public.
For lenders, it is the good case of incompetence at how
they fail to understand the businesses in which they are taking exposure.
Kwality Ltd. Is the classic case, which exposes us to all the perils that
lender should understand in order to avoid tripping on to the landmine, where
they visualize gold.
