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Institutional EYE

Commentary on Corporate Governance Issues

Rescuing CG Power: Lessons from Fortis’ playbook

It is in the interest of all stakeholders to ensure CG Power and Industrial Solutions Limited (CG Power) remains operational. For the company to continue to run - taking a leaf out of Fortis Healthcare Limited’s (Fortis) playbook - the immediate task is to ensure liquidity does not dry up. For this the company needs to present a true and fair picture to all stakeholders, particularly its lenders. And, to instil confidence regarding the seriousness of purpose, it needs to change its board and management. The buck stops with the board; it is also the starting point from which to rebuild the company.

Sever the past and think about the future. That is the only way CG Power is likely to get out of its current bind. In the interest of all stakeholders, the company needs to be rescued. Selling the company for parts or going through the Insolvency and Bankruptcy Code (IBC) will return little to existing stakeholders – both on the debt and equity side – and will likely result in job losses that the current economy can ill afford.

At this stage, we assume that the company’s operations are still viable. The disclosures put out by the company seem to suggest several concerns over the balance sheet. The limited disclosures with respect to operations were limited to inflated revenues (Rs.1.20 bn) and inventories (Rs.2.58 bn), and unauthorized expenses towards avoiding warranty claims on transformers (Rs. 2.16 bn for the period under restatement). These have already been rolled-back, following which FY19 revenues stood at Rs.53.6bn and EBITDA (before forex losses) was Rs. 6.37 bn.

CG Power’s rescue will require multiple aspects to be managed simultaneously. The role of the board will become critical, now that the financial shenanigans have been disclosed. The immediate focus areas for the company are:

1. Keeping liquidity afloat

The restatement of liabilities effectively means that debt levels have almost doubled, assets against these loans are not return yielding, and the cash flow from operations is likely unchanged. The focus for the business, at this point, will be to ensure operations continue to generate cash and that the liquidity in the company does not dry up.

The company will need to raise both equity and debt. In the current economic environment, bankers are already reticent in lending, and investors are shy of taking on risks. Asking them to lend to a company that has restated its financial statements and disclosed under-reporting of loans of over Rs. 10bn is going to be a tall task. There needs to be a dedicated board member, with decision-making power, to regularly talk to both lenders and institutional shareholders.

Fortis’ experience was that directors had to go down to the details of monitoring monthly cash flows, project monthly cash flows and continuously engage with lenders to ask for a moratorium or negotiate new lines. In the absence of any support from investors and lenders, the company will likely to have find a buyer – like Fortis did in IHH – to infuse sufficient funds to keep the business running.

2. Biting the bullet on financial restatements

For there to be a precise discussion on funding requirements for the business, the size of the hole in financial statements needs to be defined. The current restatement of accounts is based on the findings of a task force (Operations Committee) created by the board. But it remains unclear if we have reached the nadir or there is more to come. A forensic audit needs to be conducted as soon as possible and the board needs to take as many write downs as required. This may require taking some difficult decisions and could result in the financial statements being more depressed than already disclosed – but this will at least establish the new starting point and stop any further surprises.

The other big agenda for the board is to establish internal controls. The degree of unauthorized transactions suggests almost absent internal controls, independent of the auditors’ assertions in their FY18 audit report. The board needs to quickly identify and plug the gaps so that further leakages are stopped.

It seems unconscionable that auditors were not able to catch some of the egregious transactions that have been reported by the board. Inflated cash balances (on 31-Mar-17 and 31-Mar-18), writing off loans against debtor positions (in 2017-18), and mutual fund investments (made by foreign subsidiaries) being netted off against loans (in 2017-18) should have been caught even by rookie auditors. In light of the number and size of unauthorized transactions, certifying that “the Company has, in all material respects, an adequate internal financial controls system over financial reporting” and that these controls “were operating effectively as at March 31, 2018” makes a mockery of the audit, even if one were to respect the “inherent limitations of internal financial controls over financial control”. SRBC & Co LLP, which was appointed for five years in September 2018, may just be able quell some of the stakeholders’ concerns with respect to audit quality.

3. Balancing the need to keep some people and letting go of others

For the company to be rescued, there needs to be continuity in operations and management. The board will need to spend time with the key people at the operating level to ensure they stay through what will be a significant upheaval within the company. The board will also need to let go of people – those that were party to some of these fraudulent transactions, and others that possibly turned a blind eye as these violations occurred. Fortis decided to keep the CEO on despite him having been appointed by its previous promoters and it was only after IHH took over that the CEO was replaced.

4. Getting the regulators involved and yet keeping them at bay

The regulators will have to step in – and it will likely be a myriad of them. SEBI, MCA, SFIO, and the ED will be just the first few to kick in almost immediately. In the past, regulators have been over-zealous, sometimes freezing assets of Independent Directors, audit firms, and audit partners, before establishing their culpability. The board needs to proactively manage the communications with the regulators in two aspects – to isolate the nature of the problem and the people involved and support them with all the information that these regulators need. This will ensure that when regulatory action takes place, it is consistent, coherently and keenly targeted.

5. Severing from the past by refreshing the board

The board, especially members of the Risk and Audit Committee, during the restatement period of FY17 to FY19 must be held accountable for the improper transactions that have taken place. The recent disclosure articulates the involvement of certain management personnel and non-executive directors in the financial shenanigans, and yet there have been no resignations. The Managing Director has been kept away from day-to-day management, and Sudhir Mathur, who joined the board as an Independent Director, has become a whole-time director. But that is not enough. To instil confidence and garner support from market participants, stakeholders need to know that the company is making a fresh start, with a new board and a new management are in control. Not only does the old guard have to cede control, but a new guard comprising well-respected individuals need to take control. Institutional investors have raised concerns over the reappointments of certain non-executive directors in the past, but now there cannot be any ambiguity on how they view these decisions. Shareholders holding more than 10% of the capital must move a resolution to remove directors and appoint Independent Directors or even nominee directors (just as Fortis’ shareholders).

There has been wrongdoing - several, actually - and there must be punishment. But first shareholders need to play their part in ensuring that an effective solution is found for CG Power. There are several parallels that can be drawn from Fortis – and the most important one is to keep the company and its operations alive. Shareholders must swing into action to save the company from its current board and leadership.

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