A new research alleges that Reliance Industries and Reliance Communications have shortchanged investors by over Rs25,000 crore at the RCom formation and that profits have been inflated at RCom between 2006-2010 by almost Rs11,000 crore
A new research just released by Veritas Investment Research of Canada on 18th July titled "Brothers in Arms. Misappropriating a Fortune—The Full Version" alleges that Reliance Communications Limited "is the poster child of everything that is wrong with corporate India, and irrespective of management's assertions about "values" and "integrity" in various annual reports, we find no credible evidence of either in its financial statements or those of its former parent, Reliance Industries Limited."
One of the key discoveries of Veritas is that between the time RCom was demerged from RIL on 31 August 2005 and listed on 6 March 2006, "the ownership of promoters ballooned from 38.27% to 63% in RCom, under the guise of improving shareholder value and transparency. We firmly believe that the 821,484,568 shares issued to management, as per the "Scheme of amalgamation and arrangement involving reorganization" of the group telecom business, as approved by the High Court of Bombay and Gujarat vide orders dated July 21st , 2006 and July 18th, 2006, should be nullified."
As the detailed 50-page report, painstakingly put together by Veritas, bluntly puts it "…the much discussed Ambani split is a charade to deflect attention from a well thought-out plan to split family wealth via formation of similarly named companies, emboldened through strategically timed share allotments within those companies, confusing nomenclature and repeated name changes to enrich insiders at the expense of public shareholders."
The report argues that "the shareholders of RIL are the true owners of these shares, and that the risks and rewards of funding and creating the telecommunication business have been disproportionally allocated to management. We believe minority RIL shareholders should initiate action to recover monies usurped by RIL's majority owners." Veritas estimates that during the formation of RCom, RIL shareholders invested Rs13,675 crore into the business, compared to a paltry Rs186 crore by the management, but after listing on the BSE, the shareholding of minority RIL shareholders declined to 37% from 61.73%. According to Veritas, for the 821.48 million shares issued to management at the formation of RCom, RIL shareholders suffered a loss of Rs25,204 crore based on the March 06, 2006, RCom closing price of approximately Rs307. There are many other allegations in the report which we summarise as follows:
R Com's profit has been inflated: "We believe that on a cumulative basis from FY07-FY10, the Company has inflated its normalized profit before tax ("PBT") in the core telecommunication business by Rs 10,944 crore (US$ 2,408M).
Accounting Standards subverted: "We believe RIL and RCom have used Indian Accounting Standards and associated disclosures, the Court System, the Companies Act and various other mechanisms to enrich insiders at the expense of institutional money managers, minority shareholders and foreign institutional investors. We believe investors in RIL should be aware of management's hubris. Subsequently, via various accounting maneuvers, Reliance has inflated its EBITDA, EPS and book equity. Moreover, year-on-year comparability in most instances is compromised on account of whimsical accounting policy changes, use of "cookie jar accounting" to circumvent the P&L impact of cash expenses via creative use of unreliable non-cash general reserves, understatement of cash interest expenses via intermingling non-cash foreign exchange gains and losses in some years and excluding those in others, and changing depreciation policies enabling a one-time boost to earnings, etc."
Zero on Governance: "All these measures cloud the very purpose of the P&L statement. We believe that EBITDA, EPS, and book equity reported by the Company since 2006 are open to interpretation. We give the Company a zero rating on each of corporate governance, balance sheet strength, and accounting and disclosure."
Directors' role: "We also believe that directors at the helm of RCom and RIL have failed in their fiduciary duties, and that significant and meaningful reform is needed in Indian governance standards for the protection of minority interests and the institutional and retail shareholder base".
The shares of RCom are down 70% from the time it was listed in March 2006 while the Sensex is up 70%. According to Veritas, the equity value of RCom on a going concern basis is just Rs40 per share, compared to the current price of Rs94. RCom has just been booted out of the Sensex, which will take effect in August.
The bigger issue, as pointed out by Veritas is that "if the malaise identified by us at RIL and RCom runs deep in corporate India, and audited financials—which in the case of RCom are of questionable authenticity—are a hodgepodge of audited and unaudited results, SEBI guidelines and Indian Accounting Standards, the Companies Act and "legal opinions" based on interpreting the Companies Act, then investors have very little reliable information on RCom and many other Indian Companies."
India and China have been the darlings of global investors for years, since the worries about governance that kept investors worried in the 1990s, have faded now. However, questionable Chinese companies getting listed in the New York Stock Exchange through reverse mergers have brought back issues like corporate governance and accounting frauds to the forefront.
John Paulson, one of the best-known hedge fund managers (who profited hugely from the sub-prime crisis) lost $720 million when Sino-Forest, which claimed to have forest lands in China, turned out to be cooking up its books and lost 90% of its market value. Sino-Forest is just one of the scores of suspect Chinese companies dubbed "fraud-caps" which have got listed in the US, bypassing the supposedly tough scrutiny of the US regulator.
As Veritas points out, while it is all very well to chase the potential riches available to brave investors in large emerging markets far way from North American climes, "the economics of forecasting differs from the nitty-gritty of investing, and therefore, international investors have suffered both politically (BP in Russia, Google Inc. in China) and financially (Yahoo Inc. and Softbank in China), and more recently, investors have taken a bath on Sino-Forest."
As for India, Veritas points out "Then there is India, the land of the Taj Mahal, the Raj, Yoga, democracy and supposedly "rule of law". The western media has been recently enamoured with the enormous wealth of Indian billionaires and a rapidly rising middle class with its insatiable needs, giving rise to the next great consumer economy of the world. It is our contention that notwithstanding the many positives of a growing Indian economy, corporate governance, accounting standards and disclosure practices adopted by some of India's prominent companies are questionable."
Veritas claims to be Canada's largest and most followed independent equity research firm which writes "objective fundamental research you can trust."
It claims that its unique forensic accounting-based research approach has proven that a careful understanding of financial information provides the key to a secure investment decision. Veritas, a 100% employee owned firm, claims to be a pure research company "which allows us to provide unvarnished advice when others might be conflicted."
In several instances, funds have overstepped their mandate to ‘boost’ returns; infrastructure funds have major holdings in Bharti Airtel, ICICI Bank, Reliance Industries and ONGC
An infrastructure fund that invests in sugar or banking—and a power sector fund that invests in steel? Don't be surprised. Some of these funds invest as much as 42% of their money in stocks unrelated to the sector in which they are supposed to be parking their investments.
Since the mutual fund industry is down in the dumps, you don't hear of mis-selling or misbehaviour by players in the fund industry. But under pressure, they easily twist the mandate for which you have given them your money. What else explains infrastructure funds investing in banks and sugar industries and a power sector fund investing in steel and engineering?
If an investor wants to diversify only to a particular sector and chooses a sector fund for the purpose, he may as well think twice before investing in such funds; some of these funds invest up to 42% of their total assets in stocks that are not related to their sector.
In fact, most sector funds invest in stocks which have little to do with the concerned sector. Some include stocks of unrelated sectors to 'boost' their returns. There are several instances where funds have stretched their investment mandate beyond recognition. Surprisingly, out of the sector funds, majority of them invest mostly in banks, petroleum, gas & petrochemicals and telecom service sectors—which are not related to the sector of the fund.
The fund industry raised a lot of money in 2006 to invest in infrastructure stocks. Infrastructure stocks have done disastrously as can be expected from a sector that was hot. And where have these funds parked that money? Essentially, in four companies—Bharti Airtel, ICICI Bank, Reliance Industries and ONGC. Surprisingly, out of the 17 infrastructure funds, 13 have Bharti Airtel—a telecom major—in their top 10 holdings. ICICI Bank and Reliance Industries follow closely behind finding a way into the top 10 holdings of a majority of these funds. ONGC also forms a constituent of sector funds.
Apart from the infrastructure funds, there are other sector funds which diversify into other sectors as well. DSP BlackRock Technology.com fund has 7% of its total assets in Bharti Airtel and Entertainment Network Ltd which comes under the media and entertainment sector. Tata Life Sciences and Technology Fund has 6% in Nestle India, a company which is a food & beverages company. UTI Energy has 6% in Larsen and Toubro Ltd, a capital goods company.
Meanwhile, Reliance Diversified Power Sector Fund has 17% of its assets in banks, construction, engineering and steel & ferrous metals. ICICI Bank constitutes 6% of the assets.
Though Bharti Airtel and ICICI Bank did well in the past year, registering a return of 34% and 19% respectively, ONGC and Reliance Industries took a beating, falling by 12% and 16%. The Sensex grew by 4% in this period. From the perspective of the mutual funds industry, companies in sectors as diverse as telecom, petrochemicals, oil & gas, banking, steel and engineering—are all supposed to be infrastructure players.
Corporate earning numbers and the weekly food inflation numbers will drive the market today
The domestic market is likely to open sideways on fears of the Reserve Bank of India hiking rates once again to control rising prices in its policy on 26th July. Also, corporate earnings and the weekly food inflation data will give some direction to the market as the day progresses.
On the international front, US markets closed lower overnight as the debt ceiling deadline offset good earnings reports. Markets in Asia were mostly lower in early trade on Thursday as the impasse over the US debt ceiling weighed on investors. Meanwhile, Germany and France have reached a common position on a second bailout for Greece in their effort to prevent the country’s debt crisis from spreading through Europe, officials said on Thursday. The SGX Nifty was down 6.50 points at 5,559.50 compared to its previous close of 5,556.
The market on Wednesday fell on high volumes, despite the fact that the US market was sharply up on Tuesday and Asian markets were in the green. Weak corporate earnings and a stock-specific event led the benchmarks lower. This apart, the comment by finance minister Pranab Mukherjee that inflation would remain high till December also weighed heavy on investor sentiment.
The market opened higher on a positive trend in the Asian markets this morning, ignited by hopes that the US debt impasse will end soon. The Nifty opened at 5,642, up 28 points from its previous close, and the Sensex added 102 points to start at 18,756. Realty, consumer durables, banking and auto sectors led early gains and the market touched its intra-day high in initial trade as the Nifty rose to 5,645 and the Sensex touched 18,766.
Lower-than-expected results by IT major Wipro pulled the stock down by over 3% in morning trade. The market gradually drifted into negative terrain in the mid-morning session, on selling pressure in the heavyweights.
The indices bounced back into the positive, but the gains were short-lived, as the market dropped southwards in noon trade following the finance minister’s warning on inflation. The market fell to the day’s low in the late session, after news that a large investor offloaded nearly half his stake in drug maker Lupin. The investor’s entire stake was valued at over Rs300 crore. At the day’s low, the Nifty lost 90 points from the day’s high to 5,555, and the Sensex fell to 18,474, down 292 points from its intra-day high. However, the market closed off the lows, the Nifty at 5,567, down 47 points, and the Sensex settled at 18,502, a decline of 151 points.
Wall Street closed lower on Thursday as the failure to broker a deal to increase the debt ceiling pushed the indices into the red a day after the markets’ best rally since March.
Among stocks, Apple Inc closed 2.7% a day after reported good quarterly earnings. United Technologies declined 1.8% as investors brushed its quarterly profit and focused on Boeing’s selection of a rival engine maker to upgrade its 737 model. Yahoo tumbled 7.6% as the most visited web portal missed earning expectations.
On the economic front, existing home sales unexpectedly fell to a seven-month low in June as cancellations of pending contracts soared, according to the National Association of Realtors.
The Dow fell 15.51 points (0.12%) at 12,571.91. The S&P 500 shed 0.89 points (0.07%) at 1,325.84 and the Nasdaq Composite lost 12.29 points (0.43%) at 2,814.23.
Markets in Asia were mostly lower in early trade on Thursday as the deadlock in the US over its debt ceiling worried investors. Meanwhile, Germany and France have reached a common position on a second bailout for Greece in their effort to prevent the country’s debt crisis from spreading through Europe, officials said on Thursday. The development lifted banking stocks in the region.
The Shanghai Composite and the Hang Seng declined 0.25% each, the Nikkei 225 fell 0.12%, the Straits Times was trading 0.32% lower and the Seoul Composite tanked 0.48%. On the other hand, the Jakarta Composite gained 0.10%, the KLSE Composite added 0.07% and the Taiwan Weighted rose 0.08%.
Back home, the government on Wednesday signed a loan agreement worth $315 million with multilateral funding agency Asian Development Bank (ADB) for the Karnataka State highway improvement project. The loan will help the government to rehabilitate and upgrade about 615 km of state highways, a finance ministry statement said.