Forensic-cum-activist investment firm Muddy Waters in its latest report said that that promoter Fairfax Financial Holdings used India-based Quess as an accounting lever to create $889.9 million of profit and book value in 2018.
In a report dated February 8, Muddy Waters flagged accounting manipulations by several of its holding companies.
Prem Watsa, known as the Warren Buffett of Canada, is the founder of Fairfax Financial Holdings. Fairfax has been increasing stakes in Indian companies, prominent among them apart from Quess Corp are Thomas Cook and Bangalore International Airport.
According to the Muddy Waters report, in the Q1 2018, Fairfax used Quess as an accounting lever to create $889.9 million of profit and book value. Muddy Waters estimates that in reality, Fairfax could have reported a loss of around $205 million for Q1 2018 which was done by de-consolidating the company.
Quess was listed in 2016. Fairfax, which owns its stake through Thomas Cook India, owned 49 percent of Quess when it de-consolidated it.
Fairfax justified the de-consolidation by claiming it had entered into an agreement to transfer sufficient control of the company to a 12 percent shareholder. Since then, Fairfax has changed the accounting policy that applies to its Quess stake at least twice.
These repeated policy changes seem to have been designed to avoid testing Farifax's Quess investment for impairment, said Muddy Waters. As of September 30, 2023, Fairfax carries Quess at a $225 million, which is a 87 percent premium to Quess' orginal market value.
Changing accounting method
When Fairfax de-consolidated Quess, it accounted for its stake at Fair Value Through Profits and Losses (FVTPL). FVTPL required Fairfax to adjust the carrying value to Quess' market price. However, after de-consolidation, Quess' shares lost around 39 percent.
Rather than booking losses, during Q4 2018, Fairfax changed the accounting method to the Equity Method. Under this, Fairfax kept the initial fair value as its basis, and was required to add proportional shares of profits or subtract losses. This change to the Equity Method enabled Fairfax to avoid booking a $372 million loss during Q2 to Q4 2018.
Reason behind deconsolidation
Muddy Waters said that Fairfax's basis for de-consolidating Quess was because it entered into a strategic agreement with the founder of Quess. However it said, the agreement was more about a desire to produce a large accounting gain rather than being a strategic one.
"We infer that the strategic agreement purported to transfer control of Quess to the founder. We suspect that there was little "strategic" about this agreement, other than the desire to produce a large accounting gain," said Muddy Waters.
Muddy Waters said that they assume that Quess founder is Ajit Issac who owned 12.1 percent in Quess.
According to shareholding reported on the exchanges, promoters held 56.65 percent shareholding in Quess Corp as of December 30, of which Fairbridge Capital held 34 percent, Ait Isaac held 11.80 percent, Isaac Enterprises held LLP held 10.35p percent, and Hwic Asia Fund A Class held 0.50 percent.
Reporting a higher market value for Quess
In 2019, Fairfax took a $190.6-million impairment on its Quess investment, however its carrying value was still well in excess of the market value. At September 30, 2019, according to Fairfax's financials, the market value of its shares in Quess was $477.2 million while Fairfax continued to show it around $1 billion.
Some of the changes FairFax did was that it altered its valuation assumptions by changing from an after-tax discount rate of 13.1 percent in Q3 2019 to a discount rate of 12.8 percent in Q4 2019. Muddy Waters also suspects that there were additional, undisclosed, modeling changes.
If Fairfax had used the FVTPL method throughout 2019, it would have had to disclose the original Quest investment value which was significantly lower. "Had Fairfax had employed FVTPL throughout 2019 as it initially had in 2018, Fairfax seemingly should have written down the value of its stake in Quess by more than half," said Muddy Waters.
Over the last one year, shares of listed Quess Corp have gained over 24 percent and was last trading at Rs 491 at close on February 9.
Moneycontrol has reached out to Quess Corp for comments.
Quess shares were trading 0.30 percent lower at Rs 498.95 at 2.34 pm on the NSE. It had fallen to Rs 487.15 at 12.36 pm, down 2.07 percent.
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