Let me explain it to you again...

In 2003, Mohan Bhandari, chairman and CEO of Pune-based pharma packaging company Bilcare, met legendary investor Rakesh Jhunjhunwala at the latter’s palatial Nariman Point office to seal an investment proposition. Prior to that meeting, Jhunjhunwala had visited Bilcare’s factory to inquire about its growth plans. As a vote of confidence in Bilcare’s solid dosage blister packaging business, he bought a 10% stake in the company. The entry of Jhunjhunwala enhanced management credibility substantially.

Many institutional investors followed as they believed in Bilcare’s ability and the huge demand for pharma packaging. Jhunjhunwala’s call turned out right initially as the company expanded rapidly and its stock price reached an all-time high of around ₹1,800 in January 2008 from around ₹100 in 2004. However, since then, Bilcare’s fortunes have turned for the worse. The stock is trading around ₹53 presently and its market cap has eroded from a peak of about ₹3,000 crore to ₹125 crore at present. What, then, accounts for this investor apathy when the benchmark Sensex and many other stocks are trading at an all-time high?

Well, much of it has to do with an earlier acquisition and how Bilcare has been presenting its financial statements of late. It is no big secret that many listed Indian companies indulge in shady accounting practices to present a picture which is far from true or fair. In some cases, though, the curtain used for window dressing is not the best.

For instance, what Bilcare has done in its FY14 balance sheet takes the cake. Out of the blue, the management has inflated the assets in its standalone balance sheet. We will come to that shortly but before that, here’s a little background on the acquisition.

In 2010, with the aim of expanding into the global market, Bilcare acquired the packaging films business of Swiss chemicals company Ineos, for a consideration of ₹607 crore. As a result, in FY11, its consolidated debt jumped from ₹599 crore to ₹1,220 crore. Vitally, although the acquisition helped Bilcare double its sales, its profit grew only slightly, due to the lower operating margin enjoyed by the acquired business and the ensuing jump in interest cost.

Additionally, it started spending borrowed funds on non-core capex where the intent was to create an alternate revenue stream. This mounting debt created doubt among investors about the authenticity of such investments and since the management’s explanation was less than satisfactory, institutional investors started piling out of the stock. In fact, in early 2013, it lost 50% of its market cap in just four sessions. ICICI Prudential turned out to be among the big sellers, cleaning out its 5% holding.

The sign 

It is as if institutional investors had a premonition of the rot that was to show up in the FY13 balance sheet. Dubious accounting showed up in the form of incremental term loans of ₹750 crore and corresponding assets of ₹785 crore as capital work-in-progress, up from ₹33 crore in FY12.

Not only was the increase manifold, its timing was also suspicious, given the company’s precarious debt-servicing status. Thereafter, in FY14, of the ₹785 crore, ₹685 crore was added to net block under the head ‘Tools and Equipments’, amounting to 21% of its fixed assets. By any stretch of imagination, ₹750 crore of R&D-related expenditure in one year was huge, relative to the size of its balance sheet.

What invited further scrutiny was the company’s poor financial performance in FY14. Along with United Bank of India declaring it a wilful defaulter, it posted a loss of ₹121 crore in FY14 on a standalone basis compared to a profit of ₹6.57 crore in FY13.

Revenue in the same period was down to ₹394 crore compared with ₹727 crore in FY13. On a consolidated basis, Bilcare posted a loss of ₹114 crore compared with a net profit of ₹44 crore in FY13 and consolidated revenue also declined to ₹3,076 crore in FY14 from ₹3,552 crore in FY13.

If there was a bright spot, it was that the percentage of pledged promoter holding reduced substantially from 95% in June 2012 to 9% in September 2012. This development and the worsening quality of the balance sheet led to murmurs about whether company funds were being used by the promoter to cover personal liabilities.

Mohan Bhandari, on his part, claims that the reduction in pledge was partly because the lenders concerned sold some of his pledged shares in the open market, but this is not reflected in the size of his promoter holding, which stood still at 32.61% for the period in question. This is the same period when a debt of ₹625 crore entered Bilcare’s books, leading to doubts about whether Bhandari shifted his personal loans to the company’s books and balanced it with non-existent fixed assets.  

Regarding the increase in loans, the management says, “The ₹625 crore loan was not just in one year but over a period of time (2-3 years) which was taken to augment and utilise long-term working capital and was partly used for tools and equipment which has been explained before.” This explanation fails to cut ice with chartered accountant Abhishek Asthana who points out, “Since business development comprises both investment and operations, the company should specify what portion of these loans were utilised for capital expenditure and how much was used for operating expenses.”

The company has so far refused to provide that break-up, but when questioned about the sudden spurt in capital expenditure, says, “This capital work-in-progress is the ongoing investments on technological solution and projects for the Non-clonable ID (NcID) technology which has now been capitalised in the current year. These project investments were made in the last few years, keeping in mind that each one would result into significant revenue when commercialised and fully implemented. Hence, it is not a sudden spurt in one year.”

Here, it is pertinent to note that Bilcare’s NcID technology was developed by its Singapore subsidiary, Bilcare Technologies. Therefore, it would be reasonable to presume that Bilcare’s ‘ongoing investments’ must have flown through Bilcare Technologies in the form of loans and assets continuously over the ‘last few years’. It is perplexing why the management decided to capitalise these assets, at one go, in its standalone balance sheet under ‘Tools & Equipments’. “The term ‘Tools & Equipments’ has been used to refer to investment in software and related hardware integration for the development of technological solutions/development projects, including a few pilot projects for the Indian government and PSUs,” states the company. It goes on to mention 17 technological solutions — mainly anti-counterfeit and track-and-trace solutions — that the company developed for state-led bodies in a host of sectors such as FMCG, fertilisers, jute, etc. 

When questioned about such a conspicuous addition to a usually insignificant category such as ‘Tools & Equipments’, the company refused to give an explanation. A more important question is, if the technology was being developed over the ‘last few years’ by the Singapore subsidiary, what purposes were the term loan amounting to ₹750 crore in FY13 utilised for? Asthana opines, “It is dubious that the company is crediting so much in the loose tools accounts. The purpose and nature of those investments should be made clear. Appropriate disclosures have not been made by the auditor or management and it is difficult to ascertain the utility and purpose of these investments.”

Loose packaging

Moreover, it remains unclear why Bilcare has not written off these non-remunerative investments, choosing, instead, to capitalise them surreptitiously. While the company concedes that there is no specific mention in the management’s discussion and analysis, it says that this was on account of it being capitalisation of investments made over a period of time for the NcID project.

“Regarding the NcID technology, our annual report has been giving various updates on a regular basis for the last five years or so, including in FY14, in all our sections of MDA, chairman’s message and directors’ report. The shareholders as well as all others have been given this development continuously, so one cannot say it was not informed,” says the management in its defence. Investors, however, are clueless as the company has only offered reassurance in inconclusive terms, instead of any official revenue estimate that is going to result from this massive addition to net assets. Regarding the revenue generated by NcID technology, the company says, “The revenue generated by NcID technology is too negligible to be mentioned, though we have a few customers in pharma.” 

When further questioned, Bhandari says, “Each of the projects ran into hundreds of crores. I feel bad to disclose expectations because none of the projects managed to materialise. I’ve been talking to all ministries and considering what I’m hearing regarding e-governance, I’m very confident that something will materialise,” he says. This non-materialisation of projects further raises the question of how the company arrived at the valuation of the assets, considering most of them were developed in-house by the Singapore subsidiary.

The Singapore subsidiary incurred a net loss of ₹61 crore in FY14 and its track-and-trace projects were directed at curbing leakages in India’s public distribution system and also at putting an end to counterfeiting activities in segments such as currency and pharmaceuticals.“Valuations of the prototypes were continuously happening over last few years. None of the projects have been signed off, unfortunately. They was being built and suddenly we realised the government was not able to take decisions,” vaguely adds Bhandari. 

Since these investments were in ‘software and related hardware integration’, it is safe to assume that there is a significant software component in the investment. However, Indian accounting standard 26 (AS-26) clearly states that ‘Where the software is not an integral part of the related hardware, computer software is treated as an intangible asset.’ Surely, not all the 17 solutions Bilcare has developed contain hardware which has software as an integral part. Says Asthana, “I’m surprised that the company decided to add software in tangible assets. In the case of integrated hardware and software solutions, it should provide a clear breakup of investment in software and hardware.” Bhandari counters, “The treatment was given due to the nature of investments done and the parallel backed-up security of various lenders and companies. Otherwise, the treatment would have been non-tangible.”

AS-26 also states, ‘At the preliminary project stage the internally generated software should not be recognised as an asset. Expenditure incurred in the preliminary project stage should be recognised as an expense when it is incurred. The reason for such a treatment is that at this stage of the software project, an enterprise cannot demonstrate that an asset exists from which future economic benefits are probable.’

Since most of the Bilcare’s projects are in the preliminary stage, it is a violation of accounting standards on Bilcare’s part to capitalise them and not recognise it as an expense. AS-26 further states that software should be recognised as an asset if, and only if, a company can demonstrate ‘how the software will generate probable future economic benefits and the availability of adequate technical, financial and other resources to complete the development and to use the software’.

Not only has the company failed to declare future economic benefits, but it has, instead, conceded that it has been difficult to sell its solutions to the government given policy flip-flops. 

When Outlook Business approached Bilcare’s auditor Ratan Rathi for clarification on the accounting treatment, he said that he wasn’t obliged to respond to any questions. Also, since Bilcare has maintained the same auditor since the time that public records have been available and has extended the auditor’s term till 2017, it raises questions about corporate governance. Further, four independent directors have resigned between April and September 2013, around the time that Bilcare was declared a ‘wilful defaulter’s in May 2013. The only independent director, who has stayed on, Rajendra Taparia, holds a 1.15% stake as of December, 2014. 

JN Gupta, managing director of Stakeholders Empowerment Services, says, “According to latest Companies Law, a three year transit period is granted to companies in order to adjust to the fresh regulation. So, Bilcare is legally compliant in extending its auditor’s term. According to the new regulation, an individual auditor is allowed a term of five years, while a company auditor is allowed two terms of five years each. So far, auditors have been retained by companies for as long as 40 years. While such a practice is legally compliant, corporate governance falls short since such long association of auditors compromises their independence.”

Future vacuum

All criticism notwithstanding, Bhandari is far from throwing in the towel. He maintains that his business in Europe and the Americas is ‘thriving’. “My business abroad is secure. Local banks there have ringfenced my assets. We have been posting a growth of 5-7% in foreign markets which is much higher than the industry growth in those geographies which is typically 1-2%,” he says.

What is confounding is that while the world is going gaga over India’s domestic market, it is failing to deliver for Bilcare. “Revenue has been dropping in India while overseas revenues are growing. In India, revenues are declining because of stress in working capital and because overall, the pharma industry is not booming as it was supposed to. It’ll happen now. Since pharmaceutical companies are going through regulatory challenges abroad, there will be more focus on packaging and de-emphasis on cost-cutting. We see 15-20% growth in India going forward,” he says. 

Apart from a working capital crunch, profitability is also being significantly affected by rising interest costs (see: Decline and fall). Bilcare has raised public FDs worth ₹165 crore, which have stringent penal provisions in case of default. “We are making a profit at Ebitda level. However, after paying out interest, we are going into loss. The highest priority of interest payment is given to retail FD investors,” says Bhandari.

About addressing the working-capital shortage, the management says, “We have estimated that we would need an incremental ₹40 crore to bring our total working capital limit to ₹80 crore, which would enable the company to achieve an 80% production level. We will be able to organise the same from our lending banks itself.”  How accommodating these banks will be is open to question, given the ‘wilful defaulter’ tag. In FY14, the auditors reported that the company defaulted on payment of principal amount of ₹490 crore and interest of ₹86 crore and delayed payment by 6-17 months. Last year, Fitch downgraded Bilcare’s debt from BBB+ to D, a non-investment grade. The reason cited was that “Bilcare’s management had misrepresented to India Ratings on the status of its debt servicing through a letter in March 2013 confirming timely servicing of interest and principal on all its debt obligations.” 

All this turbulence is far from evident at Bilcare’s sprawling manufacturing plant at Rajgurunagar, Pune, where the extended lawns are landscaped to resemble a miniature golf course. At the far end is a row of trees planted by former board members and visiting dignitaries. One such tree was planted by Jhunjhunwala, who used to be a non-independent director on Bilcare’s board and remains a major investor with an 8.5% stake. The sapling has today grown into a strapping young tree, unlikely the company, which has only withered since. 

When questioned about his biggest mistake in Bilcare’s journey, Bhandari turns pensive. After a long silence, he says, “I should have been more realistic in my assessment of the business value of some futuristic projects. But since I was so invested in them, I wanted to take them to their final conclusion.” For all of Bhandari’s earnestness, institutional investors have lost faith and have exited en masse as Bilcare’s books are stressed with unmanageable debt, sliding profitability and dubious accounting entries. It is, indeed, Bilcare’s darkest hour, unless its NcID investment pays off.