Mumbai: Neeraj Monga, executive vice-president and head of research at Toronto-based Veritas Investment Research Corp., wrote in September that Vijay Mallya’s United Breweries Holdings Ltd (UBHL) and Kingfisher Airlines Ltd are “teetering on the verge of bankruptcy”.
Kingfisher Airlines executives rubbished the report, dismissing Veritas as a firm that nobody’s heard of.
That’s not quite true. Monga, reputed overseas for attacking companies following investor-unfriendly practices, achieved a certain renown in his country of origin after scathing commentary on Reliance Industries Ltd and Reliance Communications Ltd. Before that, he’d given similar treatment to Research In Motion Ltd and Nortel Networks Corp., among others.
Monga, 40, an MBA from the Richard Ivey School of Business and former strategy consultant at Bain and Co., wants to bring Life Insurance Corp. of India and the Employees’ Provident Fund Organisation under his scrutiny apart from unearthing corporate malfeasance in India.
He said in an email interview that Kingfisher Airlines may find it difficult to raise the targeted Rs 2,000 crore from its rights offer. According to him, the airline needs at least Rs 4,000 crore to survive. “Airlines rarely earn their cost of capital over a business cycle. It’s the most important business to grease the wheels of global commerce, but the worst business to be in as a shareholder,” he said. Edited excerpts:
Mallya said you didn’t contact the airline while preparing the report and got the calculations on aircraft leasing wrong.
We are an independent organization and we take pride in our independence. To the extent lease calculation refers to the time associated with non-cancellable leases, we have quoted from the annual report for FY11. Its page 74 says, “Lease periods range up to 12 years and are usually non-cancellable”.
It is possible that some leases might have aged for a time, and hence, the remainder of the time period might be less than the contracted period at inception. For valuation purposes though, the time period argument is irrelevant, because we use Kingfisher Airlines’ undiscounted non-cancellable disclosed obligation from its FY11 notes to the financial statements, which is based on the weighted life of the existing lease agreements in place.
How do you react to Mallya’s response to shareholders at Kingfisher annual general meeting (AGM) on Wednesday?
(The) management is making its best attempt to garner resources in a cash-starved business. I wish them the best of luck. It appears that the media has made our research personal to VM (Vijay Mallya). It is not and was never intended to be. We are just highlighting poor governance and aggressive accounting issues rampant in Indian disclosure. While the society at large is focused on corruption among the politicians and bureaucracy, recent events have shown that a segment of the Indian corporate sector is equally culpable.
Mallya clarified points of worry—being a going concern, accounting treatment of maintenance costs, subsidy and statutory dues.
Auditors raised the going-concern issue and have subsequently issued another opinion after our report, and a day prior to the AGM, outlining that it is not an adverse opinion. I think we can all read between the lines. On maintenance costs—the company’s position is untenable. The auditor outlines and we quote in our report that “the accounting treatment is not in line with Indian accounting standards”. That’s all that matters.
Blunt views: Neeraj Monga, head of research at Veritas.
As of the day of the annual report, 25 August, the statutory dues were outstanding for more than six months. Our report was published on 12 September, and then chief financial officer (CFO) of UBHL gave an interview to the media on 15/16 (September) and said that the dues were paid. You should confirm from the Indian authorities. I have to accept management’s disclosure at face value.
Mallya said he will personally step in to provide a third level of comfort to the lenders.
How do you see Kingfisher Airlines’ decision to exit the low-fare segment?
What prompted you to pick Kingfisher, while market leader Jet Airways (India) Ltd also has a huge debt burden of Rs 13,000 crore and has been posting losses?
We have not analysed Jet Airways. So I have no comment on that specific situation. Liquidity is paramount for running a business—Kingfisher Airlines is running out of cash, and now has to sell its office space to raise funds. What’s next? Based on the CFO’s comments to the media, it seems they have room for three months. After that, it’s anybody’s guess.
All airlines are looking to raise money from equity, but can’t because of market conditions.
We have not raised any questions regarding timing. We have looked at Kingfisher Airlines as of a specific date and found that the company is in duress and that it may not survive. That does not mean we are saying that others are better/worse off. To suggest otherwise is unfair and prejudicial to our research.
Do you doubt the promoters’ ability to save the airline?
The airline is at the mercy of the financial institutions. The management of UB Holdings is trying its best. Whether that is sufficient remains to be seen.
What are the prospects of the rights issue getting fully subscribed?
The airline is approximately 60% owned by UBHL (including Mallya’s ownership) and 23% by banks. Therefore, 83% of the funds have to come from the two groups. I do not believe that the other 17% shareholders will subscribe to the rights issue. A related party has agreed to convert Rs 709 crore OCDS (optionally convertible debentures) into equity at the time of the rights offering. That just means that funds that have already been committed and used up in the operations will undergo a nomenclature change to equity. It would not amount to an injection of new funds from the related party.
UBHL does not consider OCDS as debt anyway and that implies that for all intents and purposes, there would be no reduction from the currently reported debt on the books of Kingfisher Airlines.
The banks have term loans outstanding of approximately Rs 4,500 crore, backed up by an equivalent amount of securities owned by UBHL in United Breweries Ltd, United Spirits Ltd, Mangalore Chemicals and Fertilizers Ltd, etc. Therefore, I assume unless the banks can get additional collateral, they would not lend more money. Will they subscribe to the rights? They will, if UBHL pumps cash funds in addition to OCDS.
To what extent do you think the forthcoming rights issue of Rs 2,000 crore will provide relief?
If the rights issue is priced at the CMP (current market price) of Rs 20 or thereabouts, it will result in the issuance of 1,000 million shares, in addition to the 498 million shares outstanding. A cash infusion of Rs 2,000 crore would be good for the company. A non-cash conversion of unpaid dues to the banks and OCDS will do nothing for the company’s financial well-being.
How much of an equity infusion does it need?
The company is planning to change its business model. So, only the management knows what the ultimate size of the organization needs to be to support a changed business plan. The company needs upwards of Rs 4,000 crore to become viable. They need to have a cash cushion of at least Rs 1,000 crore and need to repay debt of Rs 3,000 crore.
What do you blame for the airline’s plight—debt, management skills or corporate governance?
Debt and the current cash burn rate. Airlines rarely earn their cost of capital over a business cycle. It’s the most important business to grease the wheels of global commerce, but the worst business to be in as a shareholder.
Many Indian companies have gone through a bad spell. Is this a temporary blip for Kingfisher Airlines, considering Indian aviation’s growth potential?
Growth per se does not make for good business. Pricing power, competitive intensity and differentiation are all the more important. Indian telecom has growth, but no pricing power. Growth is also associated with a requirement to undertake capital expenditure to meet that growth. If organizations don’t have free cash flow to fund capital requirements, then the resultant equity dilution or debt increase is always detrimental to shareholder interest.
You are known for blunt reports on big Indian groups. Do you do that to attract attention?
My research is based on facts. It is also insightful, strategically and conceptually. No one has said that our facts are wrong. The intent is to be factually correct and be objective.
Veritas is in the process of developing an India-focused business, given that there is significant interest in emerging markets such as India. We specialize in governance and accounting-based research, in addition to the usual fundamentals-based analysis. In many instances, the Indian market is led by rhetoric rather than facts, and we are trying to dispel the myths surrounding Indian organizations, so that investors can make an informed decision.
I would have thought investors and the media would raise questions of the banking consortium, given that a sound financial system is the backbone of any economy. You can see what is happening in Europe and North America. Perhaps we have taken Gandhiji’s monkeys to heart, and we do not want to see, talk or hear of evil, even when that evil is undermining our society at large. Endemic corruption in India is not limited to politicos and the babus. It has become the hallmark of our society and permeates all walks of life, including corporate India, which has never been scrutinized to the extent required. We will change that.