Home / Market / Mark-to-market /  Fortis Healthcare investors’ cheery diagnosis ignores red flags

The recent banking scams have seen auditors attract justifiable criticism for failure to spot them in time. But when Fortis Healthcare Ltd’s auditor distanced itself from the company’s financials, instead of seeming worried, investors greeted its results with a 0.6% gain on Thursday. Shares were trading even higher earlier in the day.

The auditor Deloitte, Haskins and Sells said it could not give an opinion on the company’s results for the September and December quarters as it could not obtain evidence on some significant matters. Usually, when auditors think it necessary, they draw attention to any events or provisions and subject to these, say that the numbers look alright. In this case, the auditor is clearly waving a red flag. Yet, investors seem unperturbed.

The main issue is a large inter-corporate deposit given by a Fortis subsidiary to three firms. The amount due is Rs472 crore. These three companies were later said to have become promoter-group companies, making this a related-party transaction. This was explained as having happened due to a change in their ownership pattern. The auditor does not seem satisfied by this explanation.

In effect, this money is now with promoter-owned entities and is in default, and only Rs70 crore has been repaid in February. Given the financial difficulties faced by the promoters, whether this money can be recovered and when is in question. The balance sheet as of 30 September shows cash and equivalents at Rs63.2 crore against Rs544.3 crore as of 31 March.

The audit and risk committee has initiated an independent probe into this transaction. Market regulator Securities and Exchange Board of India (Sebi) is also investigating this transaction. Pending these investigations, the auditor has said it cannot say what effect this transaction may have on Fortis’s financials. It has also expressed concern on the recoverability of an advance to a vendor, but the amount is relatively low.

If nothing else, this transaction should make an investor very cautious. The promoters’ stake has fallen to 0.77% from 34.1% as of 31 December. On paper they have lost control. This seems to have given rise to speculation that its ownership will change hands. That depends really on the banks and institutional shareholders, and whether they join hands to find a new owner. Till they make the first move, it would be risky to make an investment decision on that basis.

A new promoter and management could indeed bring focus back on the hospital business. But that is not all. Any acquirer also has to deal with a large transaction in the works.

In November, Fortis had proposed a restructuring under which it would pay Rs4,650 crore to the Singapore-listed business trust that owns its hospital assets. On 8 February, Malvinder and Shivinder Singh submitted their resignation to the Fortis board after they lost a court case and on 13 February, this was accepted. Just a day before that, on 12 February, the board signed a definitive agreement with RHT Trust, in which Fortis owns a 29.7% stake.

A new owner may also want to look into this transaction, which was approved in such trying circumstances for the company, and also evaluate if the valuation was fair. Existing institutional investors and the bankers, who now own a significant stake, also need to ask tough questions before giving their assent when they are asked to vote on this proposal.

If the transaction sails through, Fortis will have to raise Rs4,650 crore for this acquisition, a part of which will return to it, to the extent of its equity stake in the trust. The acquisition price is over half of Fortis’s current market capitalization, indicating any equity/debt raising will have a significant impact both in terms of equity dilution and on its balance-sheet. Borrowings as of 30 September were Rs1,756 crore.

An acquirer also has to contend with the slippage in its performance in the past few quarters, which the company attributes partly to challenges faced by the sector and to the management-related issues drawing attention away from the business. It incurred a loss in both quarters: Rs19.1 crore in the December quarter and Rs23.6 crore in the September quarter.

A new owner could potentially turn around the business but needs to be found first. Till then, other uncertainties remain. The findings of the investigation conducted by Fortis and Sebi are awaited. The government is also looking into the company’s affairs. There could be some nasty surprises lying in wait, depending on what these investigations uncover.

Even as speculation on a change in ownership swirls around the shares, investors should pay heed to a Financial Times report, which says this is a temporary retreat for the Singh brothers. Although it does not say how and where they will return, even the slightest possibility that they may come back as promoters of Fortis should give shareholders pause for thought.

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