A Messaging Platform with Multiple Red Flags?

Over the last several years, a certain business has done quite well with a ~14x increase in the last four years. While both retail and large institutions have been gung-ho on the stock and the business has been widely discussed. - we’d like to highlight some aspects of the business that investors should be cautious about. After all, India is full of quality businesses that fail to deliver returns due to sub-standard corporate governance.

That said, this analysis doesn’t intend to cast aspersions but is more of an exercise on attempting to identify potential red flags.

The company shall go unnamed to avoid any needless trouble/hate.

Without further ado, we’ll jump straight into some of the potential red flags that we could identify:

A Huge Number of ‘Computers’:

Below is a screen grab from the FY11 annual report.

If one notices, the company has a netblock of Rs 180 crores worth of computers, and an addition to the gross block of Rs 108 crores (that is purchase of computers worth Rs 108 crores). Even at Rs 60,000 per computer, the total number of computers comes to 30,000. This is certainly possible, but the company even in 2018 had 150 employees on rolls. Foolishly assuming a similar number of employees even in FY11, that means 200 computers per employee - a stretch for a company.

It is quite possible that “Computers” as a segment include other assets like servers and other equipment, but the other facts of the case put this hypothesis into question. Sales too, were nearly half the the fixed asset investments - extremely surprising for a technology company.

In FY12, the asset value of computers went sharply up to Rs 288 crores- which does appear to be even more disproportionate to the number of employees in the firm. As visible, total purchases of computers amounted to Rs 213 crores, again quite a disproportionate purchase at first glance.

However, the next year deletions (which generally refer to the sale of fixed assets) shot up to Rs 282 crores.

This begs the question about the business changed so drastically within a year that a large chunk of assets were disposed of.

Another thing to notice, is the incredibly high rate of depreciation of fixed assets. In FY14, depreciation made up 80% of consolidated revenues, while in FY13 depreciation was 144% of revenue (depreciation was higher than revenue!!!!). In FY12, the number was again ~80%, and 56% in FY11 - and a major chunk of this depreciation came from the “Computers” line item.

The question here is why would the management invest so heavily in “Computers” for a couple of years and then depreciate/dispose everything off so quickly. Between FY12 and FY15, the net block of computers fell from Rs 288 crores to Rs 35 crores. Given that the amount invested in computers was disproportionate to the number of on roll employees, sales were lower than fixed assets, and the asset was depreciated so quickly in a large amount, this is a worthy line of questioning.

LEARN FORENSIC ANALYSIS FROM OUR BOOK HERE.

Below is the asset breakup picked up from www.screener.in, that highlights the drastic decline in the “Computers” line item, and the sharp rise in the “Other Fixed Assets” line item. We will investigate this change further.

Large Intangible Additions and Write Offs

Continuing the above discussion, we can see that capital-work-in-progress (CWIP) increased to ~ Rs 500 crores till it was shifted into fixed assets. As highlighted above, this shift was made, and “Other Fixed Assets” seems to be a major beneficiary of the move.

From the screen grab below from the FY14 AR, one can see that the CWIP shown on screener is a combination of CWIP and Intangibles under development.

So far, so good.

Here’s the surprise.

In FY17, “Other Intangibles Assets” is a new line item introduced - which is the single largest component in the balance sheet after reserves, but has no detailed explanation provided. It appears that intangibles under development and CWIP have both been converted into Other Intangible Assets (there appaers to be no new expenditure made on goodwill, brand acquisitions, or other intangibles etc in the year). The apparent conversion of CWIP to intangible assets is surprising since there is already a separate line item created for this very purpose (Intangibles under Development) - one would have expected CWIP to be tangible asset in this case.

A screenshot from the concall, the management appears to have indicated that CWIP was translated into intangibles on books.

In FY20, the intangibles (classified under “Platforms and Deployments” now) again saw a write-off of Rs 305 crores through depreciation citing a move to blockchain technology and obsolence of existing technologies.

However, the same report says that these regulatory changes had been announced by TRAI in FY19. While it might be a legitimate reason for a delayed write-off, implementation of the blockchain based system still remain in the works as per ET reports. But, the write-off story doesn’t end here.

LEARN FORENSIC ANALYSIS FROM OUR BOOK HERE.

Investments Made In & Simultaneous Write-off of Foreign Acquisitions

The company XYZ had acquired 85% in a foreign sub, and later another 15% in FY11 - at the same time when it was already writing off the existing investment in the same company. The full value was written off within the next 2-3 years. 

Similarly, a quarter of the new goodwill was written off in the same fiscal after 2 acquisitions in FY20, which they put down to Covid uncertainty - which is slightly surprising given that a digital business would have benefitted from Covid, unless it was a very conservative decision.

While all of the above might have some legitimate reasoning, the constant spate of investments could be questioned by an investor. One argument can be that these are old issues, and shouldn’t be dragged up. But, as investors we only have the past as an indicator of the future. Again, this isn’t an exercise to claim wrongdoing or malign a company, but a genuine attempt at asking questions.

Disclaimer - Not invested.

We are not registered analysts or investors. We’re just laymen trying to make sense of companies, their past, and their future.

Don’t even try to trade/invest based on this information/analysis - don’t be an idiot.