Digging Deeper podcast | The CG power fraud

A case of misstatement

CG Power & Industrial Solutions Ltd., which makes power equipment - electrical switchgears and the like -  declared earlier this week it would restate earnings after becoming aware of some “suspect, unauthorized and undisclosed” transactions. Shares of the already beleaguered company slumped by the daily 20% limit to, taking the year’s decline to 70%.

CG Power said some liabilities and advances to related and unrelated parties have been understated and some assets were purportedly provided as collateral. Money from the loans was allegedly siphoned off by “identified company personnel, both current and past, including certain non-executive directors.” 

For India Inc, these revelations add to the spate of  lapses in corporate governance that have spooked investors over the last year, and prompted many audit firms to abruptly cancel their contracts with companies like Fortis and Manpasand Beverages. Such cases have led to increased scrutiny and regulatory catch-up to plug any and all loopholes.

So what exactly happened in this fraud case?

CG Power’s BSE filing claimed, “While working on one of its priority tasks of seeking refinancing of certain facilities and as a part of conducting financial analysis in this regard, the Operations Committee was made aware of some unauthorised transactions by certain employees of the company.” The filing stated that the total liabilities of the company and the group may have been potentially understated by approximately Rs 1,053.54 crore and Rs 1,608.17 crore, respectively.

CG Power added that advances to related and unrelated parties of the company and the group may also have been potentially understated by Rs 1,990.36 crore and Rs 2,806.63 crore, respectively. The company’s board noted that certain assets were purportedly provided as collateral without due authority and that CG Power was made a co-borrower and/or guarantor for enabling seemingly unrelated third parties to obtain loans without due authorisation.

Their statement claimed, “These (transactions) were purportedly carried out by identified company personnel (both current and past) including certain non-executive directors, certain KMPs (key managerial personnel) and other identified employees in breach of the Rules of Procedure of the Company. These transactions appear to have been carried out by various means, including inappropriate netting off, using ostensibly unrelated third parties, routing transactions through subsidiaries, promoter affiliate companies and other connected parties.”

According to CNBC-TV18, 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.

Domestic lender Yes Bank acquired 8 crore shares in CG Power in May of this year,  a 12.79% stake. Reacting to news of the fraud, shares of Yes Bank registered an overall 8.02 % fall to the intraday low of Rs 70.55. The share fell over 10% in 2 days.

Mutual Funds have invested a large chunk of their equity portfolio in the beleaguered company. In all, five of the 44 mutual fund participants have exposure to the company. HDFC Mutual Fund had 9.17% invested in the company as on June 30, 2019, followed by Aditya Birla Sun Life, which had deployed 8.92 percent. IDFC Mutual, Reliance Mutual Fund and Franklin Templeton Mutual Fund also had exposure in the range of 1%-3% as on June 30.

The CG Power fraud, which went ‘unnoticed’ for almost three years, has raised questions regarding regulatory oversight. The company disclosed the findings of its risk and audit committee (RAC), which revealed that the firm and the group, together, could have under-reported liabilities to the extent of over Rs 3,600 crore in the previous two financial years. Essentially, the funds raised were routed out of the company.

It also emerged that its Managing Director had received a request from a bank to replace a cheque the validity of which was about to expire. "The committee could not relate this to any obligations of the company," said the company. The company said it would cooperate with regulatory authorities and promised to restore the highest level of governance standards and internal control within the company.

Business Line quoted legal and shareholder advisors as saying the company’s independent directors should be in the dock for failing to raise the alarm on questionable deals for years.  JN Gupta, former SEBI Executive Director and founder of shareholder advisory SES, said, “Independent directors should be asked why they failed in raising concerns when all these questionable deals were going on. After all, they have a role to play on the board ... but nobody seems to hold them responsible. It has been seen in the IL&FS fiasco, too.”

Filmi story

One Moneycontrol report pulled no punches, claiming that “the story (CG Power is) selling to investors can be straight out of a Hollywood movie laced with all the thrill and suspense.”

Here’s how the script went: First, a financing company issued a letter of failure of interest payment to CG Power, which could not be “traced”. A cheque replacement request followed. The managing director then realised that the company had no role to play. Therefore, there were fears of something amiss and an audit committee was set up to probe the issue. In a marathon 13-hour meeting, which wound up at 4 AM on Tuesday, the board of CG Power discussed the issues related to unauthorised transactions by some employees, understatement of liabilities, advances and its impact on financials. The panel’s findings are now out and the figure at stake runs into, you guessed it, thousands of crores.

The 1608 crores and 2807 crores we spoke about earlier? Those are huge numbers for a company whose total market capitalisation approaches just 757 crores. Little wonder then, that its shares were locked at 20 percent lower circuit. The Moneycontrol reports was plain in its criticism, calling it hard to digest given the magnitude of the amount involved and the nature of transactions.

As for that part about “misstatement of past financial statements” - you know, the inappropriate netting off, using unrelated third parties, routing transactions through subsidiaries, promoter affiliate companies and other connected parties - it is a matter of concern that divergence of such magnitude was not spotted by the auditors and the management earlier. These transactions were found to have been routed through subsidiaries that took the shelter of accounting under contingent liabilities.

Avantha Group’s troubles 

As for Gautam Thapar’s Avantha Group, the inability of the Group to meet debt obligations meant that group companies had to cede control of CG Power to lenders, although they are still listed as the promoter group. As on June 30, Avantha had a negligible stake in the company, with lenders invoking the entire pledged promoter shareholding earlier this year. According to a report in Mint, the Avantha Group’s troubles can be traced to ambitious expansion plans fuelled by debt in the pre-Lehman Brothers period - it made the largest overseas acquisition by an Indian paper maker in 2006, buying Malaysia’s largest pulp and paper company Sabah Forest Industries in a $261 million deal. That, and other acquisitions, eventually stretched the group’s balance sheet too thin. Ballarpur Industries Ltd, another group company, reported a debt of ₹5,496 crore as on 31 March. The promoter group holds 25% in Ballarpur, however almost all of it is pledged with lenders as of 30 June. In 2017, lenders to Ballarpur Industries took management control of the company as part of strategic debt restructuring, a Reserve Bank of India mechanism to address bad loans.

The group’s entry into the power business didn’t bring success either, saddling it with additional debt. Its 600 megawatt thermal power plant in Chhattisgarh under Korba West Power Co. was sold to the Adani Group by lenders. Banks are trying to find a buyer for its other power plant in Madhya Pradesh - Jhabua Power - which has 600MW of operational thermal capacity, with an additional 660MW under implementation.

The Crompton Greaves debacle

It is not a surprise then to learn that the markets had wised up to the fact that trouble was brewing at CG Power. The company’s market capitalization has fallen from around 6,000 crores in January 2018 to 1,156 crore this August, even before it reported the unauthorized transactions. The trouble began when the company, in its earlier avatar as Crompton Greaves, aggressively acquired firms overseas. Between 2006 and 2010, it acquired several firms in the UK, France, Ireland, Belgium and Hungary in a bid to become an $8 billion conglomerate, in revenue terms, by 2015. It wanted to compete with multinationals in the power solutions space but those grand plans have run CGL aground.

According to Mint, the overseas businesses, which accounted for half of CGL’s revenue, were an overhang as the global slowdown began hurting profitability. The industrial segment, which was a drain on cash flows, was earlier funded by its consumer electricals business, which was its cash cow. Analysts sussed out problems when the demerger of its cash-rich consumer electricals business did not turn out to be a plain vanilla deal. Along with the demerger, the promoter group also cashed out. It sold its entire stake in the consumer electricals business to a consortium of private equity investors for about 2,000 crores. With no cash flow, and debt mounting, CG Power was struggling. The consolidated debt of CG Power was about 2,000 crore by 30 September. Meanwhile, promoters started pledging more shares. As of 30 June, the Avantha Group had zero stake in CG Power, from 34.3% a year ago. Stranded bankers and lenders such as private equity firm KKR, are now left holding what seems a dud asset. This happened because of creditors invoking pledged shares of promoters following defaults. A slight twist in the tale is the acquisition of an over 8% stake this year by Bharti (SBM) Holdings Pvt. Ltd, a firm owned by Sunil Bharti Mittal. With industrial business in India and Europe facing a cyclical downturn, the future doesn’t look too promising.

Now, CG Power plans to conduct a detailed forensic investigation to establish the accountability of wrongdoings and will take appropriate legal actions to protect its interests. But it remains to be seen if that will be enough. The company is already feeling the pinch. Its failure to restructure business, both in overseas and domestic markets; delay in asset monetisation; shrinking liquidity; absence of true and timely financial information; drop in credit ratings and mounting debt in books, could cause a prolonged pain, which may or may not ease.