Ambit - Strategy - Accounting Thematic - Beware of The Zone of Darkness - 16dec2016 PDF

STRATEGY
December 2016
Ambit Client
Speculator
R2 = 84% 30%
25%
D1
(Nov 10 to Nov 16)
Median share price
D4
20%
D6
performance
D2 D7 15%
D3 D5 D8 10%
5%
D9
0%
300.0 250.0 200.0 150.0 -5% Cash
D10 Pilferage
-10%
Accounting score based deciles (FY11-FY16)
Revenue Expense
Manipulation Manipulation
Forensic Accounting: Beware of the 'Zone of Darkness'!

Research Analysts:
Karan Khanna, CFA Nikhil Pillai
karan.khanna@ambit.co nikhil.pillai@ambit.co
Tel: +91 22 3043 3251 Tel: +91 22 3043 3265
Nitin Bhasin
nitin.bhasin@ambit.co
Tel: +91 22 3043 3241
Strategy
CONTENTS
Beware the ‘Zone of Darkness’! …………………………………………………….3
Executive summary ……………………………………………………………………4
Our ‘forensic’ model: Methodology ………………………………………………..8
Link between accounting quality and investment returns ……………………..20
Why we think accounting quality especially merits ……………………………26

attention at this critical juncture
Debunking myths about accounting quality …………………………………….29
How can clients access our forensic model? …………………........................31
Subjective checks: Can be gauged only with a careful ………………………..33

reading of the annual report
Sample bespoke: Analysing top Indian auditors ……………………………….37
Sample bespoke: Thousands of Miles …………………………………………...38
Analysing top Indian auditors ………………………………………………..37
Thousands of Miles (NOT RATED): Too good to be true! ………………..38
December 16, 2016 Ambit Capital Pvt. Ltd. Page 2

Strategy
THEMATIC ACCOUNTING December 16, 2016
Beware of the ‘Zone of Darkness’! Case studies featured in this report

Company name Pg. no.
The accounting quality of India Inc. remains lower than its global peers.
Examples of companies getting
Instances of alleged accounting malpractices have only increased over penalised on our model
the last couple of decades. GTB, Satyam and Reebok India are associated 8K Miles 9
with some of the biggest accounting malpractices that have shaken the
Omkar Speciality Chemicals 10
Indian markets from time to time. Given that sub-par accounting quality
Biocon 11
is profoundly damaging for investment returns, forensic accounting has
played a pivotal role in shaping our investment philosophy over the past Tata Chemicals 12
few years. With all major listed Indian companies having published their Linde India 12
FY16 annual reports, we present this year’s edition of our annual Tanla Solutions 13
accounting thematic. We reiterate that for meaningful investment
Godrej Consumer 13
returns, the ‘Zone of Darkness’, the bottom three deciles of our
UPL 14
accounting framework, should be avoided at all costs.
Wockhardt 15
Quantifying accounting quality
Balkrishna Inds. 16
We use 11 financial ratios across four categories of accounting checks – P&L mis-
statement, balance sheet mis-statement, cash pilferage and audit quality – to Sequent Scientific 16
rank the largest 1300 listed companies (ex BFSI; with market-cap greater than Unitech 17
Rs1bn) on their accounting quality. Note, however, that whilst these aggressive Other subjective checks
accounting policies raise red flags, they may not necessarily imply fraud. Glenmark Pharma 33
Avoiding the ‘Zone of Darkness’ Arshiya 34
Analysis of long-term (i.e. six years) as well as short-term (last 12 months) share Lanco Infra. 34
price returns of deciles constructed on the basis of accounting quality suggests Crompton Greaves 35
accounting quality is a critical hygiene factor, the lack of which is severely
In-depth case studies
detrimental to portfolio returns. The bottom three deciles, D8, D9 and D10, have
been massive underperformers and are to be avoided at all costs. Emerging IT Solutions provider 38
Top Indian auditors 37
The three zones on accounting quality
Source: Ambit Capital research
30%
25% 'Zone of Safety'
performance (Nov '10
Median share price
20% 'Zone of
15% Pain'
to Nov '16)
'Zone of THIS NOTE CANNOT BE USED BY THE MEDIA

10% Darkness' IN ANY SHAPE OR FORM WITHOUT PRIOR
5% CONSENT FROM AMBIT CAPITAL.
0%
CASE STUDIES FEATURED IN THIS NOTE ARE
-5% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 FOR ILLUSTRATIVE PURPOSES ONLY AND
-10% MAY NOT NECESSARILY IMPLY ANY ILL-
INTENT ON THE PART OF THE COMPANY IN
Accounting score based deciles QUESTION.
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on
annual financials over FY11-16; stock price performance is from November 2010 to November 2016
Accounting quality especially merits attention at this critical juncture

As ‘business as usual’ gets severely hampered by the ongoing demonetisation-
driven disruption, we believe several promoters would resort to more and more
creative ways to flatter their books. At this critical juncture, investors need to be
much more vigilant whilst investigating the quality of accounts of any company Research Analysts
and, hence, our accounting model should be helpful in this regard. Karan Khanna, CFA
How can clients access our forensic model? +91 22 3043 3251
Clients can now use our ‘HAWK’ platform (click here) to screen the entire listed karan.khanna@ambit.co
universe on the basis of accounting quality. For clients interested in their portfolio
Nitin Bhasin
heatmaps, we can also provide an accounting heatmaps of their portfolio within
five working days of receiving requests if the constituent stocks are in our +91 22 3043 3241
accounting model. Finally, for a more detailed analysis, we also conduct nitin.bhasin@ambit.co
extensive bottom-up company-specific bespoke research for clients.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Strategy
Executive summary
Over the past couple of decades, instances of alleged accounting
malpractices have become widely prevalent in India. Global Trust Bank,
Satyam and Reebok India remind one of some of the biggest accounting
malpractices that shook corporate India in recent times. Given poor
accounting quality is profoundly damaging for investment returns, forensic
accounting has become the cornerstone of Ambit’s investment philosophy
over the past several years. With FY16 annual reports out for nearly all the
major listed Indian companies, we bring to you this year’s edition of our
annual accounting thematic.
The accounting quality for India Inc. remains lower than the accounting quality for Accounting quality for India Inc.
most of its global peers. Global Trust Bank (2004; for more details click here for an remains lower than its global peers
interesting article online), Satyam (2009; for more details click here for an interesting
article online) and, more recently, Reebok India (2012; for more details click here for
an interesting article online) are just a few examples of how accounting frauds have
shaken the Indian markets from time to time. Further, with nearly 80% of listed
Indian companies having failed to beat inflation over the last 20 years, the
importance of accounting quality cannot be overemphasised, although this is an area
that is often overlooked.
Before we continue with our discussion on why accounting quality matters, especially GTB, Satyam and Reebok India are
in the Indian context, a look at some of the biggest accounting and financial amongst the biggest accounting
malpractices associated with India Inc. over the past two decades would be malpractices that shook corporate
worthwhile (see exhibit 1 below). India over the past two decades
Exhibit 1: Key accounting and financial malpractices in India over the past two decades
Name of company Year and month Brief description
Alleged falsification of accounts/misappropriation of funds
At the core of Global Trust Bank appears to be the issue of ’inappropriate‘ exposure to capital market activities,
Global Trust which resulted in huge NPAs, which in turn were significantly under-provisioned for by the bank. As a result,
2004
Bank the bank’s reported net worth of Rs4,004mn (as on 31 March 2002) eventually turned out to be negative when
inspected by the RBI.
Ramalinga Raju, Chairman of Satyam Computers, confessed to manipulating the books of accounts of the
Satyam Computers Jan-09
company to the tune of more than Rs70bn.
DSQ and its promoter Mr. Dalmia allegedly made misleading statements "which had the effect of inducing
purchase of securities by public which in turn increased the market price of the shares of the company". Also,
DSQ Software 1998
Lovelock & Lewes- one of the member firms of PwC, and the auditors of DSQ Software, was found guilty of
manipulating share prices and falsification of accounts by SFIO.
Not only were sales allegedly exaggerated through ‘parallel accounting’ and were never passed on to the
company, incidents of goods invoiced merely to inflate sales (but not dispatched), suspicious third party
Reebok India Nov-12
transactions, circular trading, and retrospective increases in the price of good already sold, are all believed to
have been present in some form or the other.
In its annual report for 2013-14, United Spirit's auditors (M/s BSR & Co. belonging to the KPMG group) alleged
that the company had advanced certain amounts (amounting to Rs21bn) to a few UB group entities between
United Spirits Sep-14
2010 to 2013 where there was no clarity on recovery. Both the previous auditors - PwC and Walker Chandiok
& Co. – did not make note of this fund diversion in their auditors report.
Citing one of the issues red flagged by the airline's statutory auditors in the 2006-07 annual report; one of the
former employees alleged that the Air India management dressed up the airline’s balance sheet with
Air India 2006-07
“accounting loopholes” and “deception” to inflate receivable rents (to the extent of Rs0.8bn) to make its losses
look smaller.
KPMG, who was appointed as the statutory auditors of Ricoh India in Sep ’15, identified several accounting
Ricoh India May-16
irregularities in its books; said it is difficult to form an opinion.
16 December, 2016 Ambit Capital Pvt. Ltd. Page 4

Strategy
Name of company Year and month Brief description

Cases of auditors resigning/refusing to sign the accounts/'withdrawing' the auditor's report
In August 2009 (FY10), based on the company filings, PriceWaterhouseCoopers (PwC) expressed their
Arshiya Aug-09 unwillingness to be reappointed as the auditors of Arshiya. Consequently, Arshiya changed its auditor in FY10
(August 2009) from PwC to MGB & Co.
VK Asthana & Co, auditors of Hyderabad based software outsourcer Prithvi Information Solutions Prithvi
Information Solutions (PISL) refused to sign the financial accounts of the company for 2010-11. VK Asthana was
Prithvi Information Dec-11
also the fifth auditing firm the company had in the last three years after Patwari & Co, Ernst & Young,
PriceWaterhouseCoopers and Walker Chandiok & Co.
Financial In Sep ’13, Deloitte took the unprecedented step to ‘withdraw’ its audit report on Financial Technologies for the
Technologies (now 63 Sep-13 year ending 31 March 2013, stating that the company’s standalone and consolidated results are not to be
Moons Technologies) relied upon.
Whilst E&Y replaced PwC in FY11, E&Y and Brahmayya & Co were appointed as joint auditors. In FY12, E&Y
Lanco Infra. Sep-12
refused to be reappointed and highlighted several qualifications in the audit report.
Deloitte indicated unwillingness to audit Alstom in FY10 and PwC was appointed. However PwC too did not
Alstom T&D and
2010/2013 seek re-appointment in FY13 and were subsequently replaced by a mid-sized accounting firm SN Dhawan &
Alstom India
Co.
Cases involving private equity investors
In Oct '13, private equity investors General Atlantic (GA) and India Equity Partners (IEP) had dragged their
investee company Fourcee Infrastructure to court over charges of fraud and embezzlement and willful deceit
Fourcee Infra. Oct-13
running into several hundreds of crores. These allegations surfaced after an audit of the books of accounts for
year ended March 2013 by BSR & Company, an affiliate of KPMG.
In 2014, global private equity firm Bain Capital Partners LLC sued EY in a US court, claiming that the auditing
Lilliput Kidswear Jun-14 firm cost it roughly $60 million by advising it to invest in Lilliput Kidswear, the children's clothing company. EY
was also the statutory auditor of Lilliput.
In 2012-13, private equity investors SAIF Partners alleged that the company had mishandled funds to the tune
Catmoss Jan-13 of Rs2bn (US$ 36.2mn) - half of which were investments secured from SAIF and the remaining raised as bank
loans.
Ponzi Schemes
In Apr '08, Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC)
began the process of inviting and collecting subscriptions from the general public. Over a span of 3 years these
companies collected ~Rs177bn from 30mn investors. The invitation to subscribe was in the form of “Optionally
Sahara Aug-12 Fully Convertible Debentures”. On investigation by SEBI, it concluded that SIREC and SHIC violated the
Companies Act by collecting money through optionally fully convertible unsecured debentures (OFCDs) and
ordered the company not to raise any further funds using these instruments. Further, in Aug '12, the SC
ordered the Sahara Group to return ~Rs240bn, plus 15% interest, to millions of investors, within three months.
R Subramaniam, also the founder of defunct store chain Subhiksha, was arrested in Sep '15 for allegedly
Vishwapriya Sep-15
duping over 4,000 depositors in the Vishwapriya group of companies to the tune of Rs1.5bn
Earlier this year, the promoters of PACL were arrested by the CBI over allegations that the property company
PACL Jan-16
cheated investors of Rs450bn (US$6.8 bn).
Source: Various press articles, Ambit Capital research
Given how widely prevalent instances of alleged accounting malpractices have been, Instances of alleged accounting
for an investor contemplating whether or not to invest funds in India, it only becomes malpractices are aplenty in India…
imperative to gauge the accounting quality of any company before investing.
Against that backdrop, five years ago we started out building our proprietary forensic
accounting model with the sole objective of helping investors navigate camouflaged
annual reports. Over the years, we have built from scratch and refined our now well-
established forensic accounting model to help provide investors with a first-level …and hence at Ambit we have
assessment of their portfolio’s health. In addition to this, through a plethora of built our proprietary forensic model
bespoke accounting projects, we helped several clients dig deeper into corporates to help investors navigate through
with glaring accounting issues that were masked using various accounting gimmicks. camouflaged annual reports
Note that our bespoke projects are not just restricted to an analysis of the reported
annual accounts for the company, but also on extensive primary data checks, analysis
of relevant press articles on the firm and/or its promoters, comparison with peers,
and analysis of various statutory filings of the firm. To illustrate this, towards the end
of this note (see page 38) we have provided a forensic bespoke that we did on an
emerging IT Solutions provider earlier this year.
Further, we have always believed that the degree of conservativeness exercised by
the auditor/audit firm auditing the books of accounts is as much important as the
accounting quality of the underlying listed company itself. In that context, a sample
bespoke that we did on the top Indian auditors too has been attached towards the
end of the note (see page 37).

Strategy
Accounting quality matters! (over long periods of time)

That accounting quality matters is a point we have often highlighted over the past few
years. Exhibit 2 below plots the long-term (six years to be precise; measured over Nov
’10 - Nov ‘16) share price performance of the ten deciles created on the basis of our
accounting model.
Exhibit 2: Performance of accounting deciles over long periods of time
30%
'Zone of Safety'
performance (Nov '10 to
25%
'Zone of
Median share price
20%
Pain'
15%
'Zone of
Nov '16)
10%
Darkness'
5%
0%
-5% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
-10%
Accounting score based deciles
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual
financials over FY11-FY16; stock price performance is from November 2010 to November 2016. Shaded areas
denote the three zones on accounting quality. Universe for this exhibit is BSE500 (ex-financials).
From exhibit 2 above, we note that an analysis of deciles constructed on the basis of
accounting quality (quantified using our model) brings out the following interesting
observations:
 The top 5 deciles on accounting do not seem to be materially different from each
other on investment performance (we label these deciles the ‘Zone of Safety’);
 The next two deciles - D6 and D7 have been slight underperformers (and hence
we categorise them as the ‘Zone of Pain’); but
 The bottom three deciles have been massive underperformers (and hence we Bottom three deciles on accounting
categorise this as the ‘Zone of Darkness’). have been massive
The key takeaway from exhibit 2 above is that beyond D7, i.e. in the ‘Zone of underperformers over long periods
Darkness’, the performance slumps dramatically, suggesting that this is the zone that of time…
has to be avoided at all costs.
Accounting quality matters! (on a live basis too)
Even on a live basis, accounting quality has remained relevant over the past year. An
analysis of the performance of accounting deciles created on the basis of last year’s …as they have been over the last
iteration of this note suggests that whilst the top 5 deciles on accounting quality (and twelve months
within these deciles, ‘D3’ and ‘D4’) have done reasonably well, the bottom three
deciles on accounting quality (especially ‘D10’) have been massive underperformers.
Exhibit 3: Performance of the accounting deciles over the last 12 months (for the
BSE500 universe)
20%
15%
Median share price
performance* (%)
10%
5%
0%
-5% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
-10%
-15%
-20%
Source: Bloomberg, Capitaline, Ambit Capital research. Note: Universe for this exhibit is the BSE500 (ex-
financials) as of 31 October 2015. Price performance has been measured over the period 16 December 2015 to
14 December 2016.

Strategy
In exhibit 4 below, we illustrate the performance over the same period for the sub- Gauging accounting quality
BSE500 universe. Note the sharp underperformance for the bottom three deciles on especially becomes crucial for the
accounting. less discovered space
Exhibit 4: Performance of the accounting deciles over the last 12 months (for the
sub-BSE500 universe)
15%
10%
Median share price
performance* (%)
5%
0%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
-5%
-10%
-15%
Source: Bloomberg, Capitaline, Ambit Capital research. Note: Universe for this exhibit is the sub-BSE500 (ex-
financials) as of 31 October 2015. Price performance has been measured over the period 16 December 2015 to
14 December 2016.
Exhibits 2, 3 and 4 above bring out a very interesting observation about accounting
quality in India. Thinking about accounting quality as just one of the many factors
affecting investment returns isn’t appropriate. It is, in fact, a critical hygiene factor,
the lack of which can be seriously detrimental to portfolio returns.
Launching our proprietary accounting model for FY16

With FY16 annual reports out for nearly all the major listed Indian companies, this With this note we bring to you this
note brings to you this year’s edition of our annual accounting thematic extended to year’s edition of our annual
all companies with market-cap greater than Rs1,000mn. accounting thematic
In the next section, we will discuss the methodology used to rank the entire universe
of listed companies (excluding banks and financial services firms) with market-cap
greater than Rs1,000mn on the basis of their accounting quality. All our accounting
analysis is based on data sets taken from Ace Equity, Capitaline and Bloomberg. We
triangulate our data across three data sets to ensure that we minimise data-driven
errors in our analysis.

Strategy
Our ‘forensic’ model: Methodology

We use 11 objective, quantifiable ratios to rank the universe based on We use 11 quantifiable ratios
accounting quality in this year’s iteration. These ratios can be broadly across four categories of
categorised into four key areas of accounting checks as shown in Exhibit 5 accounting checks
below:
Exhibit 5: Key categories of accounting checks - Universe (excluding Financials)
Category Ratios Rationale
Check on a firm's revenue recognition policy; a low ratio may be
Cum. CFO/cum. EBITDA
indicative of aggressive revenue recognition practices
Volatility in depreciation rate* Penalise firms where volatility in depreciation rate is unusually high
Penalise firms where volatility in NoI is unusually high, as this could
P&L mis-statement checks Volatility in non-operating income (NoI) (as a
imply intent to inflate profitability in years of low profits by resorting to
percentage of net revenues)
such means as sale of assets, investments, and so on
Check on a firm's debtor provisioning policy; a low ratio raises
Provisioning for doubtful debts as a proportion of
concerns regarding earnings being boosted through aggressive
debtors more than six months
provisioning practices
A low cash yield may either imply balance sheet misstatement or that
Cash yield
the cash is not being used in the best interests of the firm
Balance sheet mis-
Change in reserves (excluding share premium) to
statement checks A ratio of less than 1 may denote direct knock-offs from equity
net income excluding dividends
Contingent liability as a proportion of net worth Indicative of the extent of off-balance-sheet risk
Miscellaneous expenses as a proportion of total Check on a firm's expenditure policy; a high ratio raises concerns
revenues regarding the authenticity of such expenses
A high CWIP to Gross Block ratio could either indicate unsubstantiated
Pilferage checks CWIP to Gross Block
capex or delay in commissioning
Check on whether the firm has historically been able to generate
Cumulative CFO plus CFI to median revenues
positive cash flows after investing activities
CAGR in auditors remuneration to CAGR in Check on the audit quality; ideally growth in auditors remuneration
Audit quality checks
consolidated revenues should be consistent with growth in consolidated revenues
Source: Bloomberg, Ambit Capital research. Note: *Depreciation accounting has undergone significant changes in FY15 (due to the requirements of the
Companies Act, 2013 that became applicable w.e.f. 01.04.2014). This has resulted in inherent volatility in the depreciation rate in FY15 across the universe.
However, given that we are looking at a 6-year median in our model, this change in depreciation accounting does not materially impact the scores for companies
in the universe.
In the subsequent sections, we provide a brief description of these accounting ratios

along with illustrative case studies.
Note: These case studies are for illustrative purposes only. The objective is to
demonstrate the working of our framework and not to imply any ill-intent on
the part of the company in question.

Strategy
I - P&L mis-statement checks

Several companies use aggressive revenue recognition policies to boost their book
profits. Often, however, these book profits do not necessarily translate into cash
profits for the firm. Further, in several cases, these book profits often appear higher
due to use of less conservative policies such as lower provisioning for doubtful
debtors, use of several one-offs such as sale of investments, assets etc. to artificially
inflate profitability and so on.
We thus seek to penalise such firms in our model using the following ratios:
1 Cumulative CFO/cumulative EBITDA: This ratio is a check on a company’s
ability to convert EBITDA (which can be relatively easily manipulated) into
operating cash flows (which is relatively difficult to manipulate).
A low CFO/EBITDA could be
Over long periods of time, a company’s book profits should ideally translate into
indicative of aggressive revenue
cash profits. A low ratio (i.e. CFO/EBITDA that is significantly less than one) thus
recognition policies
raises concerns about the company’s revenue recognition policy (as this may
imply aggressive revenue recognition through methods such as channel stuffing,
elevated credit period offered to customers etc.).
To arrive at the scores for the universe on this measure, we first cumulate CFO
and EBITDA over the last six years. We then sort companies on this ratio and
penalise firms where this ratio is abysmally low.
Case study: 8K Miles (KMSS IN, US$ 0.3bn, Not Rated)
8K Miles has had a stellar run over the last few years. The company’s revenues
have compounded at an impressive 90% CAGR over the last four years. As a
result, the company has been reporting healthy book profits. That said, a closer
look at 8K Miles’ annual accounts suggests not all of these profits are getting
translated into cash profits for the firm (see exhibit 6 below):
Exhibit 6: 8K Miles - rising investment in working capital has led to a low score on
cumulative CFO/cumulative EBITDA
Particulars (Rs mn) FY12 FY13 FY14 FY15 FY16 Cumulative
CFO (before changes in W/C) (A) 50 52 138 386 887 1,513
W/C investment (B) (84) (120) 1 (66) (548) (817)
CFO (after changes in W/C) (A-B) (34) (69) 139 320 339 696
EBITDA* 50 54 138 383 885 1,510
CFO/EBITDA -67% -126% 101% 84% 38% 46%
Revenue 211 262 441 1,249 2,719
Revenue growth 24% 68% 183% 118%
Source: Company filings, Ambit Capital research. Note: *EBITDA excludes other income. CFO is pre-tax.
Exhibit 6 above also suggests the company’s cash flows have been fairly volatile
over the years. This could partly be explained by its unstable working capital cycle
(see exhibit 7 below). Whilst 8K Miles’ has historically had a much longer working
capital cycle than its peers, it seems to have improved in FY15 (when the cash
conversion cycle improved to 55 days from 103 days in FY14). However, in FY16,
the company’s working capital cycle again seems to have deteriorated (to 110
days). Further, even in FY15, when the working capital scenario appeared to be
improving, the company still lagged its peers.
Exhibit 7: 8K Miles’ cash conversion cycle is the highest among its peers
FY12 FY13 FY14 FY15 FY16
8K Miles 84 145 103 55 110
Take Solutions 30 51 65 85 68
Accelya Kale 59 46 33 40 49
MPS 8 3 28 43 47
Persistent Systems 21 28 23 24 16
eClerx 55 55 68 72 34
Peer Median 30 46 33 43 47
Source: Company, Ambit Capital research; Note: Following reclassification of reporting structure, 8K Miles has
been reporting zero payables since FY13.

Strategy
Given the rising investment in its working capital and the volatile nature of its
cash flows, 8K Miles fares poorly on our accounting model on cumulative
CFO/cumulative EBITDA.
2 Volatility in depreciation rate: Rather than looking at the absolute
depreciation rate (i.e. whether it is high or low), we believe undue volatility in the
depreciation rate warrants further investigation and, hence, we first calculate the Our model penalises high volatility
depreciation rate for each of the last seven years (FY10-FY16). We then calculate in depreciation rate
the change in depreciation rate for each year (giving us a set of six observations).
We then calculate the median of absolute changes and then sort the companies
on this ratio such that the company with the smallest change in its depreciation
rate receives the best score. The rationale is to penalise companies that have high
volatility in their depreciation rate on a YoY basis.
Note: Depreciation accounting has undergone significant changes in FY15 owing
to the requirements of the Companies Act, 2013 that became applicable with
effect from 1 April 2014. This has resulted in inherent volatility in the depreciation
rate in FY15 across the universe.
However, for the purpose of our analysis, we use a six-year median of the
volatility in the depreciation rate. Consequently, this change in depreciation
accounting does not materially impact the accounting scores for companies in the
universe.
Case study: Omkar Speciality Chemicals (OSCL IN, US$ 0.1bn, Not Rated)
Omkar Speciality Chemical’s depreciation rate has historically been fairly volatile
vis-à-vis its peers (see exhibit 8 below):
Exhibit 8: Depreciation rate analysis - Omkar Speciality Chemicals vs peers
Depreciation rate YoY change in depreciation rate (in bps)
Company/metric
FY12 FY13 FY14 FY15 FY16 FY13 FY14 FY15 FY16
Omkar Spl.Chem. 15.6% 8.8% 10.9% 6.6% 4.4% 680 212 433 214
Navin Fluo.Intl. 6.0% 5.7% 5.8% 5.2% 5.3% 25 7 58 7
Sequent Scien. 8.6% 9.5% 8.9% 7.7% 8.8% 92 65 119 108
Aarti Inds. 6.7% 8.0% 6.6% 5.2% 5.3% 125 139 135 5
Vinati Organics 4.2% 3.8% 4.3% 4.5% 4.1% 41 55 21 38
Atul 4.4% 4.6% 4.8% 4.7% 4.6% 24 16 4 10
Peer group median (ex Omkar) 41 55 58 10
Divergence with median 639 157 375 204
Source: Company, Ambit Capital research
One plausible reason for such major volatility in depreciation rate could be the
continuous additions to its gross block. However, if we see the gross block
breakup directionally, the depreciation rates should move up as the share of
buildings/premises (which attract a lower depreciation rate) has come down
whilst the share of plants and machinery (which attract a higher depreciation
rate) has moved up (see exhibit 9 below:)
Exhibit 9: Omkar Specialty Chemicals’ gross block breakup
Gross block breakup
Gross block
Goodwill 6% 4% 4% 2% 0%
Freehold Land 0% 0% 0% 0% 0%
Buildings / Premises 22% 22% 20% 20% 20%
Plant& Machinery 59% 60% 60% 66% 68%
Leasehold Land 10% 12% 13% 8% 8%
Furniture & Equipment 3% 2% 2% 2% 2%
Patents, trademarks and designs 0% 0% 0% 2% 3%
Other Assets 0% 1% 1% 0% 0%
Source: Company filings, Ambit Capital research

Strategy
In Omkar’s case, the blended average depreciation rate has gone down from
~15.6% in FY12 to ~4.6% in FY16. Overall, given the volatility in its depreciation
rate as well as the directional trend in its depreciation rate; Omkar Speciality
Chemicals gets a low score on volatility in depreciation rate on our model.
3 Volatility in non-operating income: Just like the previous measure, high
volatility in non-operating income (NoI) is a cause for concern as this could imply High volatility in non-operating
intent to inflate profitability in years of low profits by resorting to such means as income too is a cause for concern!
sale of assets and investments and booking exceptional items.
We thus calculate the non-operating income (as a percentage of net revenues)
for each of the last seven years (FY10-FY16). Next, we calculate the change in the
non-operating income (as a percentage of revenues) for each year (giving us a
set of six observations). We then calculate the median of absolute changes and
finally sort the firms on this ratio such that the company with the least volatility
receives the best score. The rationale is to penalise firms where volatility in non-
operating income is unusually high.
Case study: Biocon (BIOS IN, US$ 2.7bn, Not Rated)
Biocon’s non-operating income (as a percentage of net revenues) has historically
been fairly high versus its peers (see Exhibit 10 below). Whilst Biocon’s non-
operating income has averaged at ~7% of its revenues over the last few years,
the same stood at ~1% for its peers.
Further, not only has it been fairly high, it has also remained quite volatile over
the period. For instance, NoI (as a percentage of net revenues) was 5.8% in FY15
vs 1.9% in FY14, implying a ~388bps YoY change. The high volatility in FY15 (as
well as in FY16) could be attributed to gains on sale of shares in subsidiary.
Similarly, Biocon’s non-operating income saw significant volatility in FY13 (and
more recently in FY16) primarily due to exceptional income recognised in its
books pertaining to deferred revenues allocated to Biosimilar Insulin Analogs.
Exhibit 10: Volatility in non-operating income - Biocon vs peers
NoI* as a % of net revenues Volatility in NoI (as a % of net revenues) in bps
Company/metric
FY12 FY13 FY14 FY15 FY16 FY13 FY14 FY15 FY16
Biocon 2.6% 10.8% 1.9% 5.8% 22.0% 818 883 388 1,620
Glenmark Pharma 0.5% 0.2% 0.2% 0.3% 0.5% 24 2 14 14
Dr Reddy's Labs 0.6% 1.0% 1.0% 1.2% 1.4% 36 1 20 23
Cadila Health. 1.0% 0.6% 0.5% 0.5% 0.9% 39 12 6 41
Median (ex-Biocon) 0.6% 0.6% 0.5% 0.5% 0.9% 36 2 14 23
Divergence 2.0% 10.2% 1.5% 5.3% 21.1% 783 881 374 1,597
Source: Company filings, Ambit Capital research. Note: *This includes exceptional items
4 Provision for doubtful debts as a proportion of debtors more than six Low provisioning raises the spectre
months: This ratio is a check on the conservativeness of a company’s of earnings being boosted through
provisioning policy. Debtors more than six months have a greater probability of aggressive provisioning practices
defaulting and, hence, best practices would require higher provisioning for such
debtors.
A low ratio, on the other hand, raises the spectre of earnings being boosted
through aggressive provisioning practices. We use a six-year median for this
measure and penalise firms where this ratio is abysmally low.
Note: We agree that in case of several companies, given their nature of business
operations, debtors more than six months are not material (vis-à-vis the size of
the business). Thus, in such cases, to avoid unduly penalising firms where debtors
more than six months are a small fraction of the consolidated revenues (our
threshold for this is 0.20% of consolidated revenues), we assign an average score
to the firm on this parameter.

Strategy
Case study: Tata Chemicals (TTCH IN, US$ 1.8bn, Not Rated); Linde India
(LIIL IN, US$ 0.5bn, Not Rated)
Historically, Tata Chemicals’ debtors outstanding for more than six months (as a
percentage of gross debtors) have ranged from 15% to 25%, which is
substantially higher than that of its chemicals sector peers.
Further, for Linde India, the proportion of debtors outstanding for more than six
months has been much higher (having ranged from 45% to 60%).
However, in spite of the higher share of debtors more than six months, as a
percentage of gross debtors, the provisioning for old debtors (i.e. provisioning for
debtors as a percentage of debtors more than six months) is materially below that
of its peers for both these companies (see Exhibit 11 below):
Exhibit 11: Provisioning for old debtors - Tata Chemicals and Linde India vs peers
PFD as a % of Debtors more than Debtors more than six months as a % of Gross
Company/metric six months Debtors
FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16
Tata Chemicals 9% 4% 5% 6% 12% 16% 25% 21% 18% 15%
Guj Alkalies 69% 67% 64% 73% 78% 7% 7% 7% 6% 5%
BASF India 87% 73% 74% 76% 83% 4% 4% 4% 4% 4%
Coromandel Inter 44% 30% 11% 26% 52% 2% 5% 20% 12% 8%
Atul 16% 32% 27% 47% 45% 2% 2% 2% 1% 2%
Linde India 9% 10% 13% 7% 9% 44% 60% 60% 59% 60%
Median(ex-Tata Chemicals) 44% 32% 27% 47% 52% 4% 5% 7% 6% 5%
Divergence (Tata Chemicals vs peers) -35% -28% -23% -41% -41% 12% 20% 14% 12% 10%
Median(ex-Linde India) 44% 32% 27% 47% 52% 4% 5% 7% 6% 5%
Divergence (Linde India vs peers) -35% -22% -15% -40% -43% 41% 55% 53% 53% 54%
A study of Tata Chemicals’ annual accounts for FY16 suggests provisioning for
old debtors has, in fact, increased from ~6% in FY15 to ~12% in FY16. Note,
however, that a look at the provisioning policies followed by its peers suggests
Tata Chemicals’ peers’ provisioning for old debtors stood at ~52% in FY16 and,
hence, Tata Chemicals’ FY16 provisioning is still quite low versus peers.
Had the company’s provisioning for debts more than six months been in line with
that of its peers (i.e. 52%), consolidated PBT for FY16 would have been lower by
~17%.
In Linde India’s case, had the company’s provisioning for debtors more than six
months been in line with that of its peers (i.e. 52%), the excess provisioning
required translates into ~9.1x FY16 profit before exceptional items and taxes.
II - Balance sheet mis-statement checks

Direct write-offs from equity without routing it through the P&L account, high levels of
off-balance sheet risks, low investment income (as a percentage of cash and
marketable investments) etc. are some of the key areas that need to be scrutinised
further in order to assess the sanctity of a company’s balance sheet.
In that context, following are the ratios that we use to penalise such firms:
5 Cash yield: Cash yield denotes the yield that is being earned on cash and
marketable investments. A low cash yield may either imply
balance sheet mis-statement or
With the risk free rate in India being closer to 6-8%, one would expect idle cash that the cash is not being used for
and marketable investments to generate at least 5-6% returns. A low cash yield the firm’s best interests
could thus be a cause for concern as it could mean that either the balance sheet
has been mis-stated or cash is not being used in the best interests of the firm.
We calculate the cash yield for each of the last six years. We then sort the firms
on this ratio using the last six-year median such that companies with relatively
high cash yields get a high score while companies with lower cash yields get
penalised the most.

Strategy
Case study: Tanla Solutions (TANS IN, US$ 0.1bn, Not Rated)
Historically, Tanla Solutions has been earning a significantly lower yield on cash
and marketable investments as compared to its peers.
Whilst its competitors such as Info Edge have been earning cash yields in the
range of 6-9%, Tanla Solutions has been earning much lower returns. In fact, in
FY16, the cash yield was as low as 1.1% (see exhibit 12 below):
Exhibit 12: Tanla Solutions’ investment income yield vs Info Edge
Investment income yield
Company/metric
FY13 FY14 FY15 FY16 Average
Tanla Solutions 2.6% 3.4% 0.1% 1.1% 1.8%
Info Edge* 9.0% 6.4% 7.5% 6.8% 7.4%
Source: Company filings, Ambit Capital research. Note: *In FY13, detailed break up of proceeds from sale of
investments (current and non-current) is not available. Hence we have considered the total proceeds from sale of
investments in FY13.
As noted earlier, with risk free rate in India being closer to 7-8%, cash and liquid
investments would be expected to generate at least 5-6% yield. In Tanla
Solutions’ case, however, the cash yield has averaged a dismal 1.8% over the last
few years and, hence, raises red flags.
6 Change in reserves (excluding share premium) to net income excluding
A ratio of less than one on change
dividends: Under the erstwhile accounting practices that were prevalent in India
until FY16, there were several provisions that allowed direct write-offs to equity in reserves, ex-share premium to
without reflecting these adjustments in the P&L account. Further, through various net income, ex-dividends, may
Court Schemes, several companies (such as the company discussed in the case denote direct write-offs through the
study below) have taken direct write-offs from the reserves without routing it balance sheet
through the P&L account.
In order to penalise such firms that have historically taken direct knock-offs from
equity, we calculate the change in reserves (excluding share premium) on a YoY
basis and divide it by that year’s PAT excluding dividends. We then take a six-year
median of this ratio. A ratio of less than one indicates direct write-offs to equity
without routing these through the profit & loss (P&L) account and may indicate
aggressive accounting policies.
Case study: Godrej Consumer (GCPL IN, US$ 7.3bn, SELL)
Godrej Consumer is an example of a firm that has historically taken direct write-
offs from equity. Whilst these direct write-offs were in accordance with the
accounting treatment prescribed under various Court Schemes, they were not in
accordance with the generally accepted accounting practices in India.
For example, according to the Scheme of Amalgamation of the erstwhile GHPL
with the company sanctioned by the Bombay High Court, GCPL directly routes the
amortisation expense (of ~Rs527.50mn) pertaining to the Goodknight and HIT
brands through its General Reserve (instead of the P&L account). Similarly, in
accordance with various other Court Schemes, Godrej Consumer has taken
several other write-offs directly from its equity.
Had Godrej Consumer routed these expenses through the P&L, its restated
earnings would have been very different (as shown in the exhibit below).
Exhibit 13: Godrej Consumer - restated earnings if amortisation of Goodwill and Hit Brands as well as other direct
write-offs from equity were routed through the P&L
(Rs mn) FY12 FY13 FY14 FY15 FY16
Profit before taxes [A] 9,773 10,246 10,297 12,487 14,760
Amortisation of Goodknight and Hit Brands directly debited to General reserve/other direct write-
904 528 923 777 528
offs from equity [B]
Profit before taxes (had these direct write-offs been charged to the P&L) [C=A-B] 8,869 9,719 9,374 11,711 14,232
Impact on profit before taxes (as a % of stated profit) [(C-A)/A)] -9% -5% -9% -6% -4%

Strategy
Note that the company has always made appropriate disclosures in its notes to
accounts. We are highlighting Godrej Consumer as an example primarily to show
how a few changes in accounting policies as well as a few court approvals may
cause a significant change to the reported bottom-line.
In fact, the auditors of Godrej Consumer too have been highlighting this in the
audit report. For example, in the FY16 annual report, the auditors have made the
following comments:
“We draw attention to Note 13(b) to the Consolidated Financial Statements
regarding the Scheme of Amalgamation of the erstwhile Godrej Household
Products Limited with the Company approved by The Hon’ble High Court of
Judicature at Bombay, whereby an amount of Rs52.75 crore, for the year ended on
March 31, 2016, equivalent to the amortisation of the Goodknight and Hit Brands
is directly debited to the General Reserve Account instead of debiting the same to
the Statement of Profit and Loss as per the provisions of AS 26. The said accounting
treatment is in accordance with the accounting treatment prescribed in the Order
of the High Court of Mumbai dated February 28, 2011 under section 394 of the
Companies Act, 1956. Had this amount been charged to the Statement of Profit
and Loss, the profit for the year ended March 31, 2016 would have been lower by
Rs52.75 crore and the General Reserve would have been higher by Rs52.75 crore.
Our opinion is not modified in respect of this matter.”
7 Contingent liabilities as a proportion of net worth: This is indicative of the
extent of off-balance-sheet risk. A high ratio raises concerns regarding the
strength of the company’s balance sheet in the event that these contingent
liabilities materialise.
Given that contingent liabilities also include genuine items such as letters of A very high proportion of
credit, bill discounting and capital commitments, we seek to eliminate as many of contingent liabilities to net worth
these items whilst computing the figure for contingent liabilities. We use a six- indicates disproportionately high
year median for this measure and penalise firms with a very high proportion of off-balance sheet risk
contingent liabilities.
Case study: UPL (UPLL IN, US$ 4.9bn, Not Rated)
UPL is an example of a firm that gets penalised in our framework due to relatively
high contingent liabilities as a proportion of net worth.
Contingent liabilities accounted for 18% and 14% of UPL’s net worth in FY15 and
FY16 (see exhibit 14 below):
Exhibit 14: Contingent liabilities - UPL vs its peers
Contingent Liabilities* as a % of net worth
Company/metric
UPL 17% 13% 17% 18% 14%
P I Inds. 3% 2% 2% 2% 1%
Rallis India 18% 16% 14% 14% 11%
Dhanuka Agritech 1% 2% 2% 3% 2%
Bayer Crop Sci. 17% 8% 8% 6% 7%
Median (ex-UPL) 10% 5% 5% 4% 4%
Divergence with median 7% 8% 12% 13% 10%
Source: Company filings, Ambit Capital research. Note: *Contingent Liabilities excluding LCs, Bills discounted and
capital commitments.
These contingent liabilities mainly relate to tax payables, penalty claim on

cartelisation claim by CCI, and claims related to associates (see exhibit 15 below).
The cartelisation penalty was imposed by CCI in April 2012 for an anticompetitive
agreement among the manufacturers of ALP (material used for preserving food
grains in the central pool).

Strategy
Exhibit 15: UPL’s contingent liabilities breakup (Rs mn)

Nature of contingent liability FY12 FY13 FY14 FY15 FY16
Statutory payable (Direct & Indirect taxes) 2,111 2,345 2,252 2,281 2,679
Penalty on cancellation of licenses 335 335 335 335 335
Penalty on cartelisation 2,524 2,524 2,524 2,524 2,524
Guarantees (incl guarantees by bankers) 428 13 3,024 4,727 3,356
Claims not acknowledged as debt 361 416 469 220 244
For associates 1,215 533 212 142 456
Others - - - 67 68
Total 6,975 6,167 8,816 10,298 9,662
Overall, given the relatively high proportion of contingent liabilities and the
nature of these liabilities, UPL gets penalised on contingent liabilities (as a
proportion of net worth) on our model.
III - Cash pilferage checks

Cash pilferage is the third category of checks that we analyse. High amount of
miscellaneous expenditure (for which no further disclosures are available),
unsubstantiated capex and negative free cash flows over long periods of time are
some of the key categories of checks that should raise eyebrows and, hence, need to
be scrutinised further.
We use the following ratios:
8 Miscellaneous expenses as a proportion of total revenues: This ratio is a
check on a company’s expenditure policy. Miscellaneous expenses, by their very A high proportion of miscellaneous
nature, do not require any further disclosure. A high ratio thus raises concerns expenses raises concerns regarding
regarding the authenticity of such expenses. the genuineness of such expenses
Thus, in order to penalise firms with high miscellaneous expenses, we calculate
miscellaneous expenses as a proportion of total revenues for the last six years
and then use a six-year median for this measure.
Case study: Wockhardt (WPL IN, US$ 1.1bn, Not Rated)
An analysis of Wockhardt’s miscellaneous expenses (as a percentage of net sales)
suggests the company’s miscellaneous expenses have historically been
significantly higher than those of peers (see exhibit 16 below):
Exhibit 16: Miscellaneous expenditure analysis - Wockhardt vs peers
Misc. expenses* as a % of total revenues
Company/metric
FY12 FY13 FY14 FY15 FY16 Median
Wockhardt 4.1% 5.3% 6.2% 8.2% 8.2% 6.2%
Dr Lal Pathlabs 2.2% 2.2% 2.1% 2.0% 2.3% 2.2%
Fortis Health. 0.2% 0.5% 0.7% 0.6% 0.4% 0.5%
Apollo Hospitals 0.2% 0.2% 0.2% 0.2% 0.2% 0.2%
Median (ex-Wockhardt) 0.2% 0.5% 0.7% 0.6% 0.4% 0.5%
Divergence 3.9% 4.9% 5.5% 7.6% 7.8% 5.7%
Source: Company filings, Ambit Capital research. Note: *Misc. expenses include Donation and CSR expenses.
Note that not only has this ratio been fairly high versus its peers, it has also been
increasing over time. Whilst sales for the company have only compounded at less
than 1% over the last four years, miscellaneous expenses have compounded at a
staggering 20% over the period.
Note further that this ratio was ~570bps higher versus its peers in FY16. In terms
of magnitude, it is worth highlighting that miscellaneous expenses were nearly
the same as Wockhardt’s PBT in FY15, and hence raises red flags.

Strategy
9 CWIP to gross block: The idea here is to penalise firms that show consistently
high CWIP relative to the gross block as this may either indicate unsubstantiated A high CWIP relative to gross block
capital expenditure or a delay in commissioning (which may in turn be motivated may either indicate
by a delay in the recognition of the related depreciation expense). We calculate unsubstantiated capex or delay in
the proportion of capital work in progress to gross block for each of the last six commissioning
years and then take the 25th percentile observation (instead of a simple six-year
median like in most other ratios).
The reason for using the 25th percentile over the last six years for this measure as
opposed to the median (which would be the 50th percentile observation) is to
allow the benefit of doubt to firms that have invested wisely during the ensuing
downturn. Hence, we are penalising companies only if the ratio has been
consistently high over most of the last six-year period.
Case study: Balkrishna Industries (BIL IN, US$ 1.7bn, SELL)
One firm that gets penalised on CWIP-gross block versus its peers is Balkrishna
Industries.
Whilst the company’s CWIP relative to its gross block was broadly in line with that
of its peers in FY11, the ratio had remained at elevated levels over the last few
years until FY15. This seems to be on account of the capex incurred in connection
with its greenfield tyre project at Bhuj in Gujarat, which had only been partly
commissioned so far.
In its FY14 annual report, the company highlighted that this plant will be fully
commissioned by end-FY15. However, as can be seen in exhibit 17 below, this
does not appear to be the case (given its CWIP-gross block ratio still remained at
elevated levels in FY15). Note that in FY16 the company appears to have fully
commissioned the plant and, hence, the FY16 CWIP-gross block ratio is in-line
with its peers.
Exhibit 17: Balkrishna Industries – capex analysis vs peers
CWIP*-Gross Block
Company/metric
FY-11 FY-12 FY-13 FY-14 FY-15 FY-16
Balkrishna Inds 0.15 0.55 0.67 0.23 0.21 0.08
Apollo Tyres 0.07 0.05 0.05 0.01 0.03 0.16
MRF# 0.30 0.09 0.08 0.12 N/A 0.14
JK Tyre 0.06 0.22 0.02 0.04 0.17 0.02
Ceat 0.07 0.01 0.01 0.04 0.11 0.11
Median (ex-Balkrishna) 0.07 0.07 0.03 0.04 0.11 0.13
Divergence (Balkrishna) 0.08 0.48 0.64 0.19 0.10 (0.05)
Source: Company, Ambit Capital research; Note: Note: *CWIP includes Capital Advances. #N/A since MRF has
changes its year end.
10 Cumulative CFO plus CFI to median revenues: We calculate the cumulative Our model penalises firms that
CFO (cash flow from operations) plus cumulative CFI (cash flow from investing have not generated positive free
activities) over the last six years. Next, we divide this by the last six-year median cash flows even on a six-year basis
revenues for the company to normalise it for the size of a company. The higher
the ratio, the better our perception of the company’s accounts.
The idea is to penalise firms which over such long periods have been unable to
either generate positive cash flows from operations or alternatively where cash
flow from investments have consistently eaten away the cash generated from
operations.
Case study: Sequent Scientific (SEQ IN, US$ 0.4bn, Not Rated)
An analysis of Sequent Scientific’s asset turns suggests the company’s gross block
turnover has historically remained significantly below its peers. In spite of the
lower gross block turnover (suggesting inefficiencies in sweating the assets),
Sequent Scientific’s cumulative CFI over the last five years has consistently eaten
away the cash generated from operations, raising questions regarding the
wisdom of the capex (see exhibits 18 and 19 below).

Strategy
Exhibit 18: In spite of the lowest gross block turnover vs Exhibit 19: …Sequent Scientific’s free cash flows have been
its peers… negative (Rs mn)
Gross Block Turnover Cum. CFO plus
Cum. CFO plus Median
Company/metric CFI to median
FY14 FY15 FY16 Company/metric CFI revenues
revenues
Sequent Scien. 1.2 1.0 1.1 (FY14-FY16) (FY14-FY16) (FY14-FY16)
Omkar Spl.Chem. 2.1 1.6 2.0 Sequent Scien. (6,189) 4,432 (1.40)
Omkar Spl.Chem. (233) 2,651 (0.09)
Navin Fluo.Intl. 1.2 1.4 1.4
Navin Fluo.Intl. 755 5,915 0.13
Aarti Inds. 1.9 1.8 1.5
Aarti Inds. 1,876 27,796 0.07
Vinati Organics 2.0 2.0 1.4
Atul 2,421 26,014 0.09
Atul 2.0 2.1 1.8
Vinati Organics 2,768 6,961 0.40
Median (ex-Sequent) 2.0 1.8 1.5 Median (ex-Sequent) 0.09
Divergence (0.8) (0.8) (0.4) Divergence (1.49)
Source: Company, Ambit Capital research Source: Company, Ambit Capital research
Given the negative free cash flows on a cumulative basis over the past few years,
Sequent Scientific gets a low score on free cash flows to median revenues on our
model.
IV - Audit quality checks

Having looked at the reported financial statements, the auditor and the auditor’s
report are the next most important sections of the annual report that need attention.
Any qualifications made or issues raised by the auditor imply that something is amiss
and that the books of accounts, as presented by the management, do not reflect the
actual state of the firm’s business. Likewise, investors should watch out for frequent
changes in the statutory auditor as this would imply frequent disagreements between
the auditor and the management, which eventually resulted in the auditor leaving.
On the other hand, a disproportionate increase in audit fees versus the increase in
top-line calls for caution as well.
We use the following ratio to evaluate the quality of the audit and the auditors:
11 CAGR in auditor’s remuneration to CAGR in consolidated revenues: We

calculate the CAGR in standalone auditor’s remuneration and the CAGR in We penalise firms where growth in
consolidated revenues over FY10-FY16. A lower ratio of CAGR in auditor’s auditor’s remuneration has been
remuneration relative to CAGR in consolidated revenues receives a high score. exorbitantly high vis-à-vis growth
The rationale is to penalise companies where the growth in auditor’s in the firm’s revenues
remuneration has exceeded the growth in the firm’s revenues.
Case study: Unitech (UT IN, US$ 0.2bn, Not Rated)
Unitech’s standalone auditor’s remuneration (Rs27.3mn) in FY16 and
consolidated auditor’s remuneration (Rs42.7mn) were far higher than the
auditor’s remuneration paid by peers. Even as a proportion of consolidated
revenues, remuneration paid to the auditors was significantly higher than its
peers (see exhibit 20 below). Furthermore, whilst the company’s consolidated
revenues have witnessed a decline over the last six years (on a CAGR basis
revenues have declined by 6% over FY10-16); the auditor’s remuneration (on a
standalone basis) has grown at 10% over the same period.

Strategy
Exhibit 20: Unitech - auditor’s remuneration vis-à-vis peers

FY13 FY14 FY15 FY16
Unitech
Consolidated Net Sales (Rs mn) 24,405 29,534 34,312 20,075
Consolidated auditor’s remuneration (Rs mn) 38.5 46.2 44.7 42.7
Standalone auditor’s remuneration (Rs mn) 24.3 27.7 27.2 27.3
Consolidated auditor’s remuneration as a % of Total revenues (%) 0.16 0.16 0.13 0.21
Standalone auditor’s remuneration as a % of Total revenues (%) 0.10 0.09 0.08 0.14
Sobha
Oberoi Realty
Omaxe
Overall, given the high proportion of auditor’s remuneration vs the consolidated

revenues and given that growth in auditor’s remuneration has exceeded growth
in overall revenues for the firm, Unitech is an example of a company that gets
penalised on our model on this measure.

Strategy
Cumulating scores: We first assign scores to all the firms in the universe on each of Table 1: Sub-BSE500 firms that
the 11 parameters discussed above. Next, we cumulate the scores across the 11 have been included in the BSE500
parameters to arrive at the final blended accounting score for each firm. screen
Company Name Ticker
Based on these parameters, we rank 411 BSE500 firms and 893 sub-BSE500 firms on
accounting quality in this year’s forensic exercise. Note that from the sub-BSE500 Cairn India CAIR IN
universe, four firms have been included in the BSE500 screen given the sheer size of L & T Infotech LTI IN
these companies (see Table 1 on the right). As with all our forensic checks, from the Mahanagar Gas MAHGL IN
BSE500 universe, we have excluded 72 banks and financial services firms. A further
Sundaram Clayton SDC IN
17 firms have been excluded due to sketchy data availability, corporate restructuring
and limited listed history.
Note that five firms have been included based on their financials over FY10-FY15 as
their FY16 annual reports had not been published at the time of running this exercise Table 2: Firms included based on
(see Table 2 on the right). Further, six firms have been included based on their FY10-FY15 financials
standalone financials as their consolidated financials would include the results of Company
Ticker
Fiscal Year
their financial arm and hence would not have been comparable with the rest of the Name End
universe (see Table 3 on the right). Siemens SIEM IN Sept.
Jet Airways JETIN IN Mar.
Just like last year, we have extended this year’s forensic accounting exercise
SpiceJet SJET IN Mar.
to include all firms with a market-cap above Rs1,000mn. The exhibits and
discussion that you find in the subsequent sections, however, are only for the HMT HMT IN Mar.
BSE500 universe (excluding financial services firms). Lycos Internet LYIL IN Mar.
Data sources: We have used Ace Equity and Capitaline as data sources for the
underlying financial data whilst stock price data has been sourced from Bloomberg. Table 3: Firms included based on
We had to use Ace Equity for some data items and Capitaline for some others in standalone financials
order to minimise data errors. Unfortunately, neither of these databases (nor any Company Name Ticker
other database in India) is entirely reliable by itself. Aditya Bir. Nuv. ABNL IN
Please note, however, that several adjustments need to be made to each of the Ashok Leyland AL IN
individual variables which we have not detailed here. For further details on these Larsen & Toubro LT IN
adjustments, kindly email the authors of this note. M&M MM IN
PTC India PTCIN IN
Tube Investments TI IN

Strategy
Link between accounting quality and

investment returns
In this section of the note, we seek to answer the following question: ‘Does We explore the link between
accounting quality, as measured by our model, have any link with stock accounting quality and stock
market performance?’ To answer this, we assess the link between the returns
blended accounting score for the BE500 ex-financials universe, derived using
the methodology discussed above (i.e. using six years of consolidated
financials), and the share price performance over the last six years (i.e. Nov
2010 to Nov 2016). We note the following key takeaways from our analysis:
 Decile-level analysis points to a strong link between accounting quality and
investment returns;
 There is a strong link between accounting quality and investment performance
even after controlling for sector effects; and
 Large-cap firms have better accounting quality vis-à-vis mid/small-cap firms.
Universe level
At the universe level (i.e. BSE500), we do not find any significant relationship
between accounting quality and share price performance. This could partly be
explained by the fact that at the stock level, there are several other factors that
influence share price returns (such as the underlying fundamental performance of the
company, company-specific and industry-specific factors and so on).
Exhibit 21: Scatter plot does not reflect any significant relationship between
accounting scores and share price performance for the BSE500 stocks
140% R² = 9% Stock-level noise leads to a weak

120% relationship between accounting
Share price performance
scores and stock returns at the

(Nov '10 to Nov '16)
100%
universe level …
80%
60%
40%
20%
0%
-20% 50 100 150 200 250 300
-40%
-60%
Accounting score
Source: Bloomberg, Ace Equity, Capitaline, Ambit Capital research. Note: Accounting score is based on annual
financials over FY11-FY16; stock price performance is from November 2010 to November 2016 on a CAGR
basis. Universe for this exhibit is BSE500 (ex-financials).
Decile level
To control the noise around individual stocks, we now construct deciles on the basis
of accounting scores for the companies. A decile-level analysis is revealing and
demonstrates the power of accounting quality in shaping investment returns.
An R-squared of ~84% suggests that accounting quality is a significant driver of stock
returns.

Strategy
Exhibit 22: Decile-level analysis, however, reveals the strong link between accounting
quality and share price performance
30% R² = 84% …however, deciles constructed on

accounting scores demonstrate the
25% power of accounting quality in
D1
Median share price
20% D4 shaping stock returns

performance
D7 D5
15% D2
D3
10% D8 D6
5%
D9
0%
-5%150.0 200.0 250.0 300.0
D10
-10%
Accounting score based deciles (FY11-FY16)
basis. Universe for this exhibit is BSE500 (ex-financials).
In terms of individual decile performances, the first decile (D1) has delivered stock
price returns of 24% CAGR since November 2010. In contrast, the last decile (D10)
has delivered returns of -4% CAGR over this period, thus implying a 28% CAGR
outperformance for D1 vs D10. The performance differential across deciles becomes
more evident from the exhibit below.
Exhibit 23: Decile-level analysis suggests accounting quality is important
Top accounting decile outperforms
30%
the bottom decile by 28% on a
'Zone of Safety'
25% CAGR basis

'Zone of
Median share price
20%
Pain'
15%
Nov '16)
'Zone of
10% Darkness'
5%
0%
-5% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
-10%
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accouting score is based on annual
financials over FY11-16; stock price performance is from November 2010 to November 2016. Shaded areas
denote the three zones on accounting quality. Universe for this exhibit is BSE500 (ex-financials).
The most crucial takeaway from the above exhibit is that the market can be divided
into three different ‘Zones’ on accounting quality on the basis of investment
performance – the ‘Zone of Safety’, the ‘Zone of Pain’ and the ‘Zone of Darkness’.
The top 5 deciles on accounting do not seem to be materially different from each
other on investment performance and hence we label it the ‘Zone of Safety’. The
performance drops in the next two deciles (D6 and D7), suggesting that such stocks
need to be scrutinised carefully to deliver investment performance and hence such
stocks can be categorised as the ‘Zone of Pain’. Beyond D7, however, the
performance slumps significantly, suggesting that this is the ‘Zone of Darkness’, one
to be avoided at all costs.
Exhibit 23 above therefore suggests that thinking about accounting quality as just one
of the many factors affecting investment returns isn’t appropriate. It is, in fact, a
critical hygiene factor, the lack of which can be seriously detrimental to portfolio
returns.

Strategy
Sector-agnostic buckets
One may argue that in the decile construction above, sector effects have not been
nullified and some sectors may do better than others on our accounting model by
virtue of the nature of their businesses. The decile performances thus might reflect
serendipitous sector effects. To control the sector effects, we now construct four
sector-agnostic buckets such that ‘bucket A’ comprises the first quartile of each sector
on accounting scores, ’bucket B’ comprises the second quartile of each sector, ‘bucket
C’ comprises the third quartile of each sector and ‘bucket D’ comprises the last
quartile of each sector. Hence, every bucket has an equal number of stocks from
each sector, implying that the buckets are sector-agnostic.
Each bucket in this case will have similar sectoral compositions and, hence, a
performance assessment of these buckets should enable one to assess the impact of
accounting quality on stock price performance in a sector-agnostic manner. Exhibit 24
below displays these four buckets with their respective stock price performances.
Clearly, the performance differential points to a strong link between accounting
quality and stock price performances even after controlling for sector effects.
Exhibit 24: Strong link between accounting quality and stock performance even after
controlling for sector effects
Sector-agnostic buckets constructed
20%
with homogenous sectoral make
and differentiated only on

Median share price
252, 15.4% accounting quality show

15% accounting quality drives
222, 12.8%
Nov '16)
investment performance even after

202, 10.5%
controlling for sector effects
10%
175, 6.4%
5%
Bucket A Bucket B Bucket C Bucket D
Sector-agnostic accounting buckets
financials over FY11-16; stock price performance is from November 2010 to November 2016 on a CAGR basis.
Universe for this exhibit is BSE500 (ex-financials). The first entry is the accounting score over FY11-FY16; the
second entry is the median CAGR stock returns in that bucket from November 2010 to November 2016.
The above exhibit again highlights the importance of avoiding the lowest quality firms
on accounting quality regardless of how cheap they are.

Strategy
Sector level
Next, arranging the BSE500 firms into sectors and assessing the link between the
average accounting scores of these sectors and the average stock price performance
of their constituent stocks suggest that accounting quality makes a difference at the
sector level as well (i.e. sectors with higher accounting quality, such as Consumer
Discretionary, Home Building and Consumer Durable perform better than sectors
with poor accounting quality such as E&C, Utilities and Realty).
Exhibit 25: At a sector level, link between accounting quality and stock price performance is relatively modest
60%
R² = 28%
50% Cons. Disc.

Median share price performance
40%
30% Textiles Auto Anc Cons. Durable Home Building

Pharma Chemicals
20%
Healthcare Agri Inputs IT FMCG
Srvcs. Auto Cement Misc.
10% E&C Retail Light Engg.
Conglomerate Infra. Media
Heavy Engg. Oil & Gas
Travel &
0% Telecom
Metals & Leisure
150 170 Realty 190 Mining 210 230 250 270
Aviation
-10% Utilities
Sugar Shipping
-20% Median accounting score
Source: Bloomberg, Ace Equity, Capitaline, Ambit Capital research. Note: Accounting score is based on annual financials over FY11-16; stock price performance is
from November 2010 to November 2016 on a CAGR basis. Universe for this exhibit is BSE500 (ex-financials).
With a median score of 247, the ‘Home Buildings’ sector is amongst the best
sectors in our accounting model. The sector has generated median stock price At a sector level, link between
returns of 27% CAGR over the last six-year period (Nov ’10 to Nov’ 16). On the accounting scores and price
other hand, Utilities is amongst the worst sectors on accounting on our model performance is relatively modest…
with a median score of 184. The median stock price performance in the sector
has been -8% CAGR over the last six-year period.
Also, stocks within the same sector exhibit a significant link between accounting
scores and stock price returns in many cases. Three sectors which show strong
links are Media, Heavy Engineering and Infrastructure.
Exhibit 26: Within the sector, the link between accounting and price performance for
the Media sector
40% R² = 28%
30%
20%
…within a sector however stock
10% returns show significant
0% dependence on accounting scores
50 100 150 200 250 300
-10%
-20%
-30%
Accounting score
basis. Universe for this exhibit is stocks from the Media sector in the BSE500 index.

Strategy
Exhibit 27: Within the sector, the link between accounting and price performance for
the Heavy Engineering sector
30% R² = 42%
20%
10%
0%
50 100 150 200 250 300
-10%
-20%
-30%
-40%
Accounting score
basis. Universe for this exhibit is stocks from the Heavy Engineering sector in the BSE500 index.
Exhibit 28: Within the sector, link between accounting and price performance for the
Infrastructure sector
30% R² = 21%
20%
10%
0%
50 100 150 200 250 300
-10%
-20%
-30%
-40%
Accounting score
basis. Universe for this exhibit is stocks from the Infrastructure sector in the BSE500 index.

Strategy
Size buckets
Finally, to address the size dimension, we split our universe of stocks into four sizes of
buckets as shown below. Bucket 1 comprises the largest 50 stocks in terms of market- Accounting quality is better for
cap, Bucket 2, the next 100, Bucket 3, the next 100 and Bucket 4, the lowest 161 larger caps on an average
stocks in terms of market-cap (thus, taking the total to 411 firms).
Exhibit 29: Larger capitalisation firms have better accounting scores on average
Number of Average share
Market cap range (USD Average % stocks in 'Zone of
firms Bucket Market cap range (Rs bn) price
bn) accounting score darkness'
in the bucket performance
top 50 Bucket 1 Rs 360bn- Rs 4187bn US$ 5.3bn-US$62bn 216 13.2% 28%
next 100 Bucket 2 Rs 82bn- Rs 348bn US$ 1.2bn-US$5.1bn 221 18.8% 21%
next 100 Bucket 3 Rs 37bn- Rs 82bn US$ 0.55bn-US$1.2bn 212 15.5% 26%
bottom 161 Bucket 4 Rs 3.7bn- Rs 36.9bn US$ 0.05bn-US$0.55bn 204 11.7% 39%
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY11-16; stock price performance is
from November 2010 to November 2016 (on a CAGR basis). Universe for this exhibit is BSE500.
As one would expect, we find that the average accounting score as well as the stock
price performance varies directly with market cap, i.e. the larger market-cap buckets
(i.e. Buckets 1 and 2) have better accounting scores as well as better stock price
performance whilst the smallest market-cap bucket has the worst accounting score as
well as the worst stock price performance.
Further, the proportion of stocks in the ‘Zone of Darkness’ (i.e. stocks that fall in D8,
D9 and D10) too varies with market cap. Whilst 28% of firms belonging to the largest
market cap bucket fall in the ‘Zone of Darkness’, ~39% of the firms belonging to the
smallest market cap bucket fall in this zone.
Delving further into the stocks that fall in Bucket 4 of market cap, we note that ~35%
of these names also fall in Bucket ‘D’ discussed earlier (i.e. the bottom quartile stocks
from each sector). In contrast, the remaining ~65% stocks are evenly distributed
amongst Buckets ‘A’ to ‘C’ (see Exhibit 30 below). This suggests that a significant
proportion of firms from Bucket 4 on market cap, also fall in the bottom quartile on
accounting quality in their respective sectors.
Exhibit 30: Distribution of the smallest market-cap firms across the four accounting
quality buckets
Number of As a % of total number of firms in Bucket '4' (i.e. the
Accounting quality bucket
firms smallest 161 firms in the BSE500)
Bucket A (best quality) 36 22%
Bucket B 36 22%
Bucket C 33 20%
Bucket D (worst quality) 56 35%
Total 161 100%
Source: Company, Ambit Capital research. Universe for this exhibit is BSE500 (ex-financials).

Strategy
Why we think accounting quality especially

merits attention at this critical juncture
As ‘business as usual’ gets severely hampered owing to the ongoing Given the demonetization-driven
demonetisation-driven disruption, we believe several promoters are likely to disruption, accounting quality
resort to more and more creative ways to flatter their books. So, we believe especially merits attention at this
at such a critical juncture investors need to be much more vigilant whilst critical juncture
investigating the quality of accounts of any company. Our forensic model
should be helpful to investors in this regard. We highlight two instances
below where our forensic model helped investors discover accounting
irregularities well in advance.
Case study: Amtek Auto
In our 22 December 2014 thematic: “Forensic accounting: Identifying the ‘Zone of
Trouble’”, we had highlighted certain accounting issues in Amtek Auto. Amtek Auto’s
stock had rallied by ~156% in the year before. In Aug 2015, however, the company
had failed to honour its debenture obligations. Since its Aug 2015 highs, the stock is
now down nearly 74% (see Exhibit 31 below):
Exhibit 31: Amtek Auto’s share price performance vs Sensex
Ambit's annual forensic

400 thematic highlighting certain
350 accounting issues in the
300 company Amtek Auto fails to
250 honour its debt
200 obligations
150
100
50
-
Dec-13
Feb-14
Apr-14
Jun-14
Aug-14
Oct-14
Dec-14
Feb-15
Apr-15
Jun-15
Aug-15
Oct-15
Dec-15
Feb-16
Apr-16
Jun-16
Aug-16
Amtek Auto Sensex

Source: Company, Press articles, Bloomberg, Ambit Capital research; Note: Amtek Auto’ share price as well as
Sensex have been rebased to 100 at the beginning of 2014
The following exhibit provides a brief snapshot of Amtek Auto on our ‘HAWK’
platform:
Exhibit 32: Amtek Auto’s forensic and greatness score evolution using ‘HAWK’
Source: Ambit ‘HAWK’, Ambit Capital research

Strategy
Case study: Arshiya

Arshiya is another example of a company where our research team had highlighted
several accounting irregularities. Exhibit 33 below provides a snapshot of the key
accounting concerns raised by our Head of Research Nitin Bhasin (see our
25 February 2014 report: “How Accounting, Politics and Capital Allocation Drive Alpha
in India”).
Exhibit 33: Arshiya’s accounting practices vs peers
Source: Company, Ambit Capital research. Note: This exhibit has been reproduced without any changes from our 25 February 2014 report: “How Accounting,
Politics and Capital Allocation Drive Alpha in India”

Strategy
In Jan 2013, certain employees of the company alleged financial irregularities in the company
and non-payment of salaries to the staff since Sep 2014. Since then, Arshiya’s shares have
corrected by ~75% (see Exhibit 34 below):
Exhibit 34: Arshiya’s share price performance vs peers and Sensex
600 Ambit's forensic

500 bespoke on the
company Employees allege
400 financial irregularities;
300 non-payment of salaries
to staff since Sep
200
100
-
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Apr-09
Aug-09
Apr-10
Aug-10
Apr-11
Aug-11
Apr-12
Aug-12
Apr-13
Aug-13
Apr-14
Aug-14
Apr-15
Aug-15
Apr-16
Aug-16
Arshiya Gateway Distriparks Sensex
Source: Company, Press articles, Bloomberg, Ambit Capital research; Note: Arshiya and Gateway Distriparks’
share price as well as Sensex have been rebased to 100 at the beginning of 2009
The following exhibit provides a brief snapshot of Arshiya on our ‘HAWK’ platform:
Exhibit 35: Arshiya’s forensic and greatness score evolution using ‘HAWK’
Source: Ambit ‘HAWK’, Ambit Capital research
Whilst we agree that it requires a lot of time for these accounting issues to
materialise, when they do, the events tend to be a binary event for the stock price.
Having discussed the crucial role that accounting quality plays in shaping investment
returns, we now move to a discussion on popular myths about accounting quality.

Strategy
Debunking myths about accounting quality

That the market knows and properly discounts firms with poor accounting is
one of the popular myths around accounting quality that we have
encountered over the years. Similarly, accounting quality does not matter in
an uptrend is another popular myth about accounting. In this section of the
note, we refute these (and some other) popular myths about accounting
quality.
Myth #1: Accounting quality is already priced in
Satyam did trade at a valuation discount to Infosys and Wipro even before the
promoter owned up to aggressive accounting. That said, its share price crashed by
over 90% within two days of the fraud being made public. Thus, the market does not
already know and properly discount firms that have poor accounting quality.
Similarly, more recently, Ricoh India is another firm where its auditors, KPMG, alleged
certain financial irregularities in the company’s books. On the day the announcement
was made public (in May ’16), the stock crashed by 5% and is down 38% since then.
Even our analysis of trailing/forward P/E for the BSE500 firms and their accounting Accounting quality is not already
scores points to a zero correlation between the two variables. This further augments priced in!
the argument that accounting quality is not already priced in (making it even
worthwhile to investigate and assess further!).
Exhibit 36: At the market level, we find no correlation Exhibit 37: …nor between accounting quality and forward
between accounting quality and trailing P/E… P/E
120.0 R² = 0% 120.0 R² = 3%
100.0 100.0
FY17 P/E
Trailing P/E
80.0 80.0
60.0 60.0
40.0 40.0
20.0 20.0
- -
50 150 250 50 150 250
Accounting score Accounting score
Source: Company, Ambit Capital research; Note: Trailing P/E has been Source: Company, Ambit Capital research; Note: Forward P/E has been
restricted to 100. Universe for this exhibit is BSE500 (ex-financials). restricted to 100. Universe for this exhibit is BSE500 (ex-financials).
Myth #2: Accounting quality does not matter in an uptrend

That accounting quality matters during bear markets is a point we have observed as
well as often highlighted over the past few years.
Further, contrary to popular belief, accounting quality had remained relevant even Accounting quality remained
during the most recent uptrend (i.e. in CY14), with the bottom two deciles (i.e. D9 relevant even in the most recent
and D10) on accounting massively underperforming the rest of the deciles. uptrend

Strategy
Exhibit 38: Accounting quality stayed relevant even in the most recent uptrend (CY14)
75%
Median share price
60%
performance
45%
30%
15%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Source: Bloomberg, Ambit Capital research. Note: Price performance has been measured over the period 21
November 2013 to 19 December 2014.
Myth #3: All Nifty firms have good quality accounts

From our discussions in the preceding sections (see exhibit 29 on page 25 above), we
note that the top size bucket (i.e. Bucket 1) has the best accounting quality. Whilst we
Not all firms from the Nifty have
agree that large caps on an average have superior accounting quality vis-à-vis
clean accounting
small/mid-caps, this overall average hides a great deal of variations.
A look at the Nifty (ex-financials) universe suggests as many as 46% of Nifty firms (i.e.
19 firms) have accounting scores below the universe (BSE500) average. Further, for
the weakest 19 of these firms, the accounting scores are actually so low that these
firms fall in the bottom three deciles of accounting quality for the BSE500. In other
words, 12 Nifty firms feature in the ‘Zone of Darkness’ on our model.
Myth #4: In sectors such as E&C, Utilities and Heavy Engineering, weak
accounting quality is a certainty
Exhibit 25 on page 23 above suggests that for sectors such as E&C, Utilities and
Heavy Engineering, weak accounting quality is a given.
Within these sectors, however, several firms such as Bharat Electronics, Techno Not all firms in sectors such as
Electric and Thermax have accounting scores that are far superior to the market E&C, Utilities and Heavy Engg.
average. have weak accounting
Myth #5: It takes too much time and effort to assess accounting quality for a
firm
Contrary to popular belief, it does not take too much time and effort to assess It is now easy for clients to access
accounting quality for a firm. As we will discuss in the next section, there are several our models to assess the
ways in which interested clients can use our forensic model, not just to assess the accounting quality for any firm
first-level health of their portfolio but also to screen the entire spectrum of listed
companies ex-financials (with market-cap greater than Rs1,000mn) on the basis of
their accounting quality.

Strategy
How can clients access our forensic model?

We discuss three distinct ways in which clients can access our forensic model.
Clients can now use our ‘HAWK’ platform to screen the entire listed universe
(~1,300 firms) on the basis of their accounting quality. For clients interested
in their portfolio heatmaps, we can also provide an accounting heatmap of
their portfolio within five working days of receiving it if the constituent stocks
are in our accounting model. Finally, for a more detailed analysis, we also
conduct extensive bottom-up company-specific bespoke research for clients.
Access our ‘HAWK’ platform

In the wake of several clients requesting access to both our ‘forensic’ and ‘greatness’ Clients can access our ‘HAWK’
models, in July this year, we launched our ‘HAWK’ platform giving clients access to platform to screen ~1,300 firms on
Ambit’s proprietary ‘forensic’ and ‘greatness’ models in an easy to use and intuitive their accounting quality
format (click here for the User Guide).
Our ‘HAWK’ platform allows clients to screen the entire universe ex-financials
(~1,300 listed Indian companies) on the basis of their accounting quality (quantified
using our ‘forensic’ model) and capital allocation track record (quantified using our
‘greatness’ framework’) over the last ten years. Whilst the platform currently has the
accounting scores for all the companies updated until FY15, in a couple of weeks
from now, we will refresh our platform to incorporate FY16 financials as well.
As an example, the following exhibit illustrates how clients can use our ‘HAWK’
platform to identify the more conservative or the more aggressive sectors – both on
capital allocation as well as the quality of financial reporting.
Exhibit 39: Sector level heatmap analysis using ‘HAWK’
Source: Ambit ‘HAWK’, Ambit Capital research. Note: Each block represents a sector – block size represents either free float or market cap, block color represents
either forensic score or greatness score. Clients can use the toggle buttons to switch the representations. Click on any sector to see the constituent stocks – this also
changes current selection to all stocks in that sector. The other charts update automatically. Data for the above exhibit pertains to FY10-15.
Please contact your relevant sales representatives at Ambit if you have not yet
received the login credentials for ‘HAWK’ or if you would like a demo on how to use
the product.

Strategy
Portfolio heatmaps
We can give interested clients an accounting heatmap of their portfolio within five Clients can also request accounting
working days of receiving it if the constituent stocks are in our accounting model. This heatmaps for their portfolio
will enable clients to identify if any of their holdings are in the ‘Zone of Darkness’. A
sample screenshot of what such a diagnostic looks like is presented below.
Exhibit 40: Indicative portfolio heatmap
Scores
Companies Ambit sector CAGR in PFD-% of Change in

Cont Change Vol. in Misc. Cum. FCF/
CFO- auditor’s remn Cash debtors reserves/ Overall
|Liab-% in depr NoI (as a exps-% of median
EBITDA to CAGR in yield more than (PAT ex Score
of NW rate % of sales) total revs revs
consol revs six months dividend)
ABC Industrials 11 12 13 8 2 13 6 13 11 3 9.2
XYZ Utilities 13 8 12 9 5 12 2 7 7 3 7.8
PPP Utilities 1 5 8 10 8 8 11 11 6 3 7.1
RRR IT 3 2 10 12 7 10 8 10 5 3 7.0
DEF Metals 12 10 4 5 6 3 3 6 13 3 6.5
GHI Metals 10 6 7 6 1 2 12 5 12 3 6.4
TTT Oil & Gas 6 11 5 4 4 7 1 1 10 2 5.1
PQR Oil & Gas 7 13 3 2 3 1 4 1 2 3 3.9
Note: ORANGE denotes sub-par accounting quality relative to the sector average; Red denotes that the stock falls in the ‘Zone of Darkness’
In-depth bespoke analysis

From our discussions above, we note that our accounting model uses 11 objective,
quantifiable parameters to assess the overall quality of a firm’s accounts. That said, it
has certain limitations too. For example, as we will see in the next section of the note,
certain subjective assessments on governance standards cannot be quantified and
can only be made after going through the annual reports. Our bottom-up analysis,
therefore, plays a vital role in helping our clients identify these parameters.
Thus, for clients interested in a more detailed analysis, we also conduct extensive For interested clients we also
bottom-up company-specific bespoke research. A couple of our sample bespoke conduct in-depth bespoke research
reports have been attached towards the end of the note in this regards.

Strategy
Subjective checks: Can be gauged only

with a careful reading of the annual report
Our discussions above suggest that whilst our accounting model uses 11
objective, quantifiable ratios to assess the accounting quality for a firm, it
has certain inherent limitations too. Certain subjective assessments
regarding corporate governance can only be made through a detailed
analysis of the annual report. We discuss some of these subjective checks
that investors should be on the lookout for whilst analysing annual reports.
Subjective check #1 – Proportion of assets not audited by the statutory
auditor
An important parameter that cannot be captured on our forensic screen, but which
needs to be scrutinised carefully is the proportion of assets not audited by the
statutory auditor.
In several cases in his auditor report, the statutory auditor clearly gives a disclaimer
that a certain proportion of assets have not been audited by it but have been audited
by another auditor and that it has relied on the reports (of the other auditor)
furnished to it by the management.
Thus, the higher the proportion of assets not audited by the statutory auditor, the Investors should keep an eye out to
weaker is the audit framework given to the extent to which these numbers fall outside note the proportion of assets not
the ambit of the audited consolidated numbers. audited by the statutory auditor …
Glenmark Pharma is an example of a firm where the proportion of assets not audited
by the statutory auditor is fairly high.
(Note: Glenmark Pharma falls in the ‘D7’ in the BSE500 universe on our accounting
model).
Case study: Glenmark Pharma (GNP IN, US$ US$ 3.8bn, Not Rated)
A relevant extract from Glenmark Pharma’s FY16 auditor’s report has been presented
in Exhibit 41 below:
Exhibit 41: Glenmark Pharma - extract from its FY16 auditor’s report (Pgs. 195 and
196 of the annual report)
Source: Company filings
Exhibit 41 above suggests that the auditors have not audited total assets to the tune
of ~Rs53bn but have relied on the statement furnished by the other auditors. In
percentage terms, this translates into ~53% of Glenmark Pharma’s FY16
consolidated assets.

Strategy
Subjective check #2 – Frequent changes in the auditor

Investors should keep an eye out for frequent changes in the statutory auditor as this
could imply frequent disagreements between the auditor and the management,
which eventually results in the auditor leaving.
This can be better understood by looking at the changes in Arshiya’s auditor in FY10.
(Note: Arshiya falls in ‘D10’ of the sub-BSE500 universe on our accounting model).
Case study: Arshiya (ARSL IN, US$ 0.1bn, Not Rated)
In August 2009 (FY10), based on company filings, PwC expressed unwillingness to be
reappointed as auditors of Arshiya (see Exhibit 42 below).
Exhibit 42: Extract of Arshiya’s BSE filings (from Aug ’09)
Source: BSE filings

Consequently, Arshiya changed its auditor in FY10 (August 2009) from PwC to MGB
& Co. MGB & Co. in India is a member firm of MGI International, which is
headquartered in London, UK, since 1947. MGB & Co. also audits the accounts of
Zee Group and Welspun Corp (a flagship company of the Welspun Group).
Subjective check #3 - Issues raised by the auditor

Amongst the first things to look for whilst analysing an auditor’s report is to keep an
eye out for any qualifications made by the statutory auditor. Whilst there are several … as also any qualifications made
reasons why an auditor may qualify his reports, one common reason is when the by the statutory auditor
accounts have not been drawn up according to the generally accepted accounting
principles.
This can be better understood by looking at the issues raised by Lanco Infratech’s
auditors, PwC, in the auditor’s report in FY07 and FY08.
(Note: Lanco Infratech falls in the ‘D9’ of the sub-BSE500 universe on our accounting
model).
Case study: Lanco Infratech (LANCI IN, US$ 0.1bn, Not Rated)
In FY07, the auditors of Lanco Infra had raised the following issues with respect to the
consolidated financial statements:
 Profits were higher by Rs169.29mn (or 9% of consolidated profits for FY07) due
to non-elimination of intra-group transactions and unrealised profits pending
clarification from ICAI.
 The consolidated financial statements were presented considering M/s Lanco
Kondapalli Power Private Limited (LKPPL) as a subsidiary with effect from 1 April
2006 when in fact LKPPL became a subsidiary of the company with effect from 15
November 2006. As a result, profits were higher by Rs242.94mn (or 13% of
consolidated profits in FY07).
Not only did the company not meet the requirements of AS-21 on the consolidated
financial statements (given that according to AS-21 issued by the ICAI, consolidation
should have been carried out from 15 November 2006, the date on which holding
subsidiary relationship came into existence), the above treatment resulted in the
profits for FY07 being higher by Rs412.23mn (or 22% of consolidated profits for that
year).
The excess profit of Rs412.23mn, which was recognised in the P&L account of Lanco
Infra in FY07, had to be reversed in FY08. According to the generally accepted
accounting principles, such a reversal should have been made against current-year

Strategy
profits (i.e. FY08 profits in this case) as a prior-period adjustment. Lanco Infra instead
chose to adjust these excess profits against the balance of profit brought forward
from the previous year. Consequently, the correction to FY08 profits was not made as
required. The auditors too had raised their issues on such a treatment in their report
on the consolidated financial statements for FY08.
Issues raised by Lanco’s auditors in FY07 Annual Report (on Page 63)
“Attention is drawn to the following:
 As detailed in note 4(xvi) of Schedule 19, pending clarification from the ICAI on
non-elimination of intra group transactions and unrealised profits arising out of
construction of projects under Build Operate Own and Transfer basis, the Company
has not eliminated revenues and unrealised profits in the consolidated financial
statements. As a result the consolidated revenue and net profit after minority
interest are higher by Rs1692.97 millions and Rs169.29 millions respectively.
 M/s Lanco Kondapalli Power Private Limited (LKPPL) has become a subsidiary of
the Company with effect from November 15, 2006. However the consolidated
financial statements have been presented considering LKPPL as a subsidiary with
effect from April 01, 2006. As a result the consolidated revenues and net profit
after minority interest are higher by Rs3270.90 and Rs242.94 millions
respectively.”
Issues raised by Lanco’s auditors in FY08 Annual Report (on Page 71)
“Attention is drawn to Note 4.viii on Schedule 19 to the consolidated financial
statements regarding the adjustment of excess profits recognised in the previous year
aggregating to Rs412.23 million against the balance of profit brought forward from
the previous year, which in our opinion and according to the generally accepted
accounting principles in India should have been adjusted against the current year’s
profit as a prior period adjustment. Consequently the net profit after tax and minority
interest for the current year has been overstated by the above amount.”
Subjective check #4 - Related party transactions

Investors should look out for suspicious related-party transactions undertaken by
listed entities. At its simplest, the extent of related-party transactions and the trend in Suspicious related party
these transactions are important; a sudden increase can be bad news. However, it is transactions would merit further
often trickier than this, as shown in instances illustrated here. attention
Parties would be considered ‘related’ if at any time during the financial year, one
party is able to either control the other party or can exercise significant influence over
the other. Thus, related parties would include subsidiaries, associates, joint ventures,
key management personnel and their relatives etc. Ideally, transactions between
related parties should be at arm’s length. An arm’s length transaction would mean
that both the parties seek to execute the transaction in their best interests. However,
in several cases, related-party transactions are conducted in a manner that is not in
the best interests of one party. Overpaying for an asset purchased from a related
party, sale of goods or other assets to related parties at a significant discount to their
fair market values, loans given to related parties at exceptionally concessional rates
or loans taken from related parties at exorbitant interest rates are just a few
examples of how these transactions might not be in the best interests of the minority
shareholders. Likewise, unwarranted transactions with related parties should raise a
red flag.
This point can be better understood by analysing certain related-party transactions
that Crompton Greaves has undertaken over the last few years.
(Note: Crompton Greaves does not feature in our accounting model due to corporate
actions).

Strategy
Case study: Crompton Greaves (CRG IN, US$ 0.6bn, Not Rated)
In FY08, Crompton Greaves purchased co-ownership rights in an aircraft from a
related party, M/s Asia Aviation Ltd, for Rs562.5mn. Mr. Gautam Thapar, MD & CEO
of Crompton Greaves, was also a director of M/s Asia Aviation Ltd, a company in the
business of providing air charter services.
Whilst it is arguable that the aircraft purchase was unwarranted, the fact that it had
been executed with a related party in the business of providing aircrafts on a lease
basis also raises concerns regarding the appropriateness of such a transaction, given
that Crompton Greaves could have simply hired the aircraft.
This transaction was followed by the purchase of another aircraft during FY11 for
Rs2700mn. However, no disclosures were made by the company in its annual report
for FY11 as to whether or not this was a related-party transaction. When these issues
were raised by investors with the management in 2QFY12, the management
transferred the entire block of aircrafts at book value to its unlisted related parties,
M/s Asia Aviation Ltd (Rs411.7mn) and M/s Avantha Holdings Ltd (Rs2,405mn). This
last point can be detected from the FY12 annual report.
The nature of these subjective checks further augments the need for an in-
depth bespoke analysis
Given the nature of the subjective assessments on corporate governance discussed
above, the need for a detailed investigative bottom-up company-specific bespoke
analysis only becomes much more imperative for an investor.
Against that backdrop, in the final section of the note, we look into our forensic
bespoke knowledge bank and dig out two of the most interesting bespokes that we
did during the year. Whilst one of the bespokes pertains to an emerging IT Solutions
provider the other bespoke pertains to the top audit firms in India where we have
evaluated these firms on the basis of the accounting quality of their auditee firms.

December 16, 2016
Analysing top Indian auditors

The accounting quality of India Inc. remains lower than its global peers.
Our analysis of the top 13 auditors in India suggests that the “Big Four”
(Deloitte, KPMG, E&Y and PwC) are more conservative than the mid-sized
Indian audit firms. Even within the “Big Four” there is a wide level of
disparity; KPMG and E&Y are the more conservative firms. Amongst the
mid-sized Indian audit firms, V Sankar Aiyar & Co and Kalyaniwalla &
Mistry are the more conservative auditors. The most unexpected
observation, however, is that versus last year, the median accounting
quality (basis our model) of top-10 auditee firms for the top 5-6 auditors
has witnessed a decline. This could be in light of the auditor rotation
which has gained momentum in the last one year.
Mapping accounting quality of the top audit engagements of the top Indian
auditors
Free float mcap of
Median Forensic Median Forensic
the auditee firms
deciles for the top deciles for the
Name of the firm (as a % of overall
10 auditee top 10 auditee
market’s free float
firms# (2016) firms# (2015)
mcap)*
Deloitte group 37% D6 D6
KPMG group 12% D6 D4
EY group 12% D6 D3
Price Waterhouse group 7% D8 D8
Chaturvedi & Shah 4% D8 D6
V Sankar Aiyar & Co 3% D7 D7
Sharp & Tannan 3% D9 D6
Lodha & Co 2% D7 D7
Haribhakti & Co 1% D10 D9
Walker Chandiok & Co LLP 1% D8 D10
Kalyaniwalla & Mistry 1% D8 D5
Brahmayya & Co 0% D4 D5
B K Khare & Co 0% D5 D5
Total 84%
Source: Prime database, Bloomberg, Capitaline, Ambit Capital research. Note: *Free float market-cap as of
Nov ’16. There is some degree of overlap in this calculation given some of the audit assignments are jointly
audited by one or more auditors. That said, given these overlaps are more of an exception than the rule, the
above exhibit should give a fair indication of the free float market cap audited by these firms. # Using six
years of consolidated financials for BSE500 and sub-BSE500 companies (ex-financials), we assign
accounting scores to the companies. We perceive firms with a high score on our model to have superior
quality of accounts and vice-versa.
Research Analysts
Nitin Bhasin
+91 22 3043 3241
nitinbhasin@ambitcapital.com
Karan Khanna, CFA
+91 22 3043 3251
karankhanna@ambitcapital.com
Thousands of Miles
NOT RATED
September 26, 2016
Too good to be true!

“If something sounds too good to be true, it probably is” – Thousands
of Miles is a classic fit for this adage with a supernormal revenue/PAT
CAGR of 90%/83% over FY12-16. While most of the early stage growth
companies have high growth rates, Thousands of Miles differs from
them in its aggressive accounting policies (amortization rate of 2.1% vs
normative of 10%/unbilled revenues of 36 days vs 13 days for peers),
frequent reclassification of line items (sometimes resulting in a
difference up to 30% of PAT) without adequate disclosures, sketchy cash
flows and irreconcilable line items. Issue of preferential warrants to
promoters at a discount (~Rs399 vs Rs419, calculated as per SEBI
norms), inadequate disclosures on management remuneration (Rs0 as
per annual report) and related party transactions, and non-rotation of
auditors for 9 years are key corporate governance concerns. Our
bespoke analysis of the company raise more questions than answers!
Highly aggressive and inconsistent accounting

Key examples of aggressive accounting: (1) Receivables (including unbilled
revenue) have increased to 144 days in FY16 vs 80 days in FY15, group
median of 77 days, likely indicating an aggressive revenue recognition policy,
and (2) certain intangible assets have an assumed life of 47 years.
Further, several actions appear to be undertaken just to obfuscate analysis. Key
examples: (1) frequent re-classification of expense buckets so that a time-series
analysis is not possible, (2) intangible assets clubbed with goodwill, (3) reserves
and surplus (~42% of net-worth, FY16) in cash flow statement does not tally
with that in the balance sheet.
Lower than peer median tax rates (22% vs 25% peer group median) despite
lower proportion of other income in PBT (0.3% vs 8.5% for peers), volatile
working capital cycle (103 to 55 to 110 days over FY14-16), discrepancies and
errors in annual reports are relatively minor concerns for us.
Poor corporate governance practices

The salaries of the key management personnel are not disclosed. The company
secretary earns Rs300,000 lower than even a fresher at TCS. Inadequate
disclosures regarding related party transactions, issue of warrants to promoters
ahead of 4x jump in stock price, discrepancies in pricing of warrants, non-
rotation of auditors for an extended period of time remain key corporate
governance issues.
Summary of flags
Checks on FLAGS Research Analysts

RED FLAG for ad hoc and often aggressive depreciation policy, Sagar Rastogi
Accounting unconventional cash flow accounting, numbers not tallying +9122 3043 3291
across statements. sagar.rastogi@ambit.co
RED FLAG for low proportion of independent directors, lack of
Sudheer Guntupalli
disclosure on management compensation, the appointment of
Corporate governance +9122 3043 3203
the same auditor until FY21, issue of warrants ahead of 4x
jump in stock price and discrepancy in pricing of warrants. sudheer.guntupalli@ambit.co
Thousands of Miles
DuPont analysis
Thousands of Miles’ RoE has been lower than its peers due to lower PAT margin (15%
vs 24% peer group median, FY16) and asset turnover vs its peers. Consummation of
acquisitions like SERJ (acquired at an EV/sales =0.35), Cintel systems (acquired at an
EV/sales = 0.5), NexAge (acquired at an EV/Sales = 0.6) and Mind print (acquired at
approximate EV/sales = 0.8) resulted in an improvement in Asset Turnover ratio in
FY15-16.
The company’s RoEs improved significantly to 26% in FY16 vs 14% two years ago
(FY14). As seen in the DuPont analysis exhibit below, the improvement in RoE was
mainly explained by improvement in asset turnover as the company grew its sales by
118% in FY16. PAT margin, however, remained flat in FY16.
Exhibit 1: Lower ROE compared to peers
Thousands of Miles 15% 15% 14% 23% 26%
Peers
Take Solutions 32% 23% 14% 16% 22%
Accelya Kale 29% 70% 82% 60% 73%
MPS 16% 42% 48% 35% 27%
Persistent Systems 18% 20% 22% 22% 20%
eClerx 55% 44% 50% 35% 40%
Peer group median 29% 42% 48% 35% 27%
Source: Company, Ambit Capital research; Note: MPS had reported a loss in FY11 and has been excluded from
the ROE exhibit
Exhibit 2: DuPont analysis

PAT margin Asset Turnover Leverage
FY11 FY12 FY13 FY14 FY15 FY16 FY11 FY12 FY13 FY14 FY15 FY16 FY11 FY12 FY13 FY14 FY15 FY16
Thousands of
13% 17% 15% 14% 15% 15% 1.1 0.6 0.7 0.7 1.1 1.3 0.7 1.4 1.4 1.5 1.4 1.4
Miles
Peers
Take
15% 13% 11% 8% 11% 12% 1.1 1.3 1.3 1.1 0.9 1.1 1.4 1.8 1.7 1.6 1.6 1.6
Solutions
Accelya Kale 9% 19% 28% 27% 22% 24% 2.8 1.4 2.4 2.9 2.6 2.9 0.6 1.1 1.1 1.0 1.0 1.0
MPS -65% 5% 19% 21% 26% 26% 1.7 2.5 2.1 2.3 1.3 1.0 1.2 1.1 1.1 1.0 1.0 1.0
Persistent
18% 14% 14% 15% 15% 13% 1.1 1.3 1.3 1.4 1.4 1.5 1.0 1.0 1.0 1.0 1.0 1.0
Systems
eClerx 36% 34% 26% 30% 24% 28% 1.6 1.6 1.7 1.6 1.4 1.4 1.0 1.0 1.0 1.0 1.0 1.0
Peer group
15% 14% 19% 21% 22% 24% 1.6 1.4 1.7 1.6 1.4 1.4 1.0 1.1 1.1 1.0 1.0 1.0
median
September 26, 2016 Ambit Capital Pvt. Ltd. Page 39

Thousands of Miles
Inconsistent accounting policies

In the exhibit below, we present a common-size income statement of the company for
a better understanding of the drivers behind the company’s profit margins. We notice
that the company’s employee expense (as a percentage of revenue) has come down
significantly over the years (from 62% in FY12 to 47% in FY16). However, the drop in
employee expense was somewhat offset by the rise in other expenses (14% in FY12 to
21% in FY16).
Whilst the company’s EBITDA margin has improved significantly (24% in FY12 to 33%
in FY16), we observe that this has not led to an improvement in the company’s net
profit margins (net profit margin declined from 17% in FY12 to 15% in FY16). This is
explained by four factors: (1) Increase in depreciation as a percentage of revenue
(discussed in detail in later parts of the report), (2) higher tax expense as a
percentage of revenue due to higher PBT margins, (3) increase in the share of
minority income, (4) acquisition of companies like Cintel (~10% net profit margin vs
15% net profit margin of Thousands of Miles) and Mind print (negative net profit
margin vs 15% net profit margin of Thousands of Miles) with lower net profit margin
profile.
Exhibit 3: Excerpt from common size income statement
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
Total Revenue 100% 100% 100% 100% 100%
Employee benefit expenses 62% 60% 53% 45% 47%
Other expenses 14% 19% 16% 24% 21%
EBITDA 24% 21% 31% 31% 33%
Finance costs 0% 1% 1% 0% 0%
Depreciation and amortisation expenses 4% 3% 10% 7% 7%
Profit before tax 20% 17% 21% 23% 25%
Tax expenses 3% 2% 4% 5% 6%
Profit from continuing operations 17% 15% 17% 18% 20%
Minority Interest - - 3% 3% 5%
Net profit attributable to shareholders 17% 15% 14% 15% 15%
Frequent reclassifications
Other expenses
In the exhibit below, we benchmark the other expenses reported by Thousands of
Miles with non-operating expense reported by peers. We find that Thousands of
Miles’ other expenses were below peers in FY12 but increased over the years, peaked
in FY15 and remained in line with peer group median in FY16.
Exhibit 4: Thousands of Miles’ other expenses as compared to peers
as % of revenue FY12 FY13 FY14 FY15 FY16
Take Solutions 19% 22% 23% 24% 23%
Accelya Kale 30% 21% 20% 20% 21%
MPS 32% 26% 24% 21% 21%
eClerx 17% 17% 17% 20% 19%
Peer group median 19% 21% 20% 20% 21%
Source: Company, Ambit Capital research; Note that different companies have different ways of reporting other
income, this comparison is meant for a broad check
In the exhibit below we dig deeper into why the ‘other expenses’ reported by the
company have increased in recent years (FY15-16) as a percentage of revenues. We
notice that the company’s spending on ‘travelling and business promotion expenses’

Thousands of Miles
has gone up substantially and peaked out during FY14-15 (14-16% of revenues for
FY14 and FY15). Though this has come down sharply in FY16, we are of the view that
this decrease may be because of the change in classification of other expenses rather
than the actual decrease in such expenses.
The classification of other expenses reporting has changed considerably over time, The classification of other expenses
rendering it difficult to compare time series data on a like to like basis. For instance, reporting has changed
in FY15 annual report, ‘travelling and business promotion expenses’, for FY15 are considerably over time rendering it
reported as single line item (Rs195mn) while in FY16 annual report they seem to be difficult to compare time series
reported as three different line items - travelling & logistics (FY15-Rs27.4mn), data on a like to like basis.
business promotion related (FY15-19.6mn), immigration expenses (FY15-Rs25.6mn).
Surprisingly summation of these three line items (Rs72.6mn) would not result in
reconciliation of numbers reported in the two annual reports. The difference amounts
to 30% of FY16 PAT. There are similar discrepancies even in other line items like
Rent, Rates & Taxes. While companies change/reclassify their line items, appropriate
and adequate disclosures and reconciliations regarding the same are expected by the
investors for making comparisons across time and across peer group.
Exhibit 5: Breakup of ‘other expenses’
expressed as % of revenue FY12 FY13 FY14 FY15 FY16
Auditors Remuneration 0.1% 0.1% 0.0% 0.4% 0.3%
Professional and Consultancy Fee 1.4% 0.1% 0.0% 2.1% 2.4%
Travelling and Business Promotion Expenses 0.2% 0.0% 14.5% 15.6% 4.0%
Communication 0.2% 0.1% 0.1% 0.8% 1.7%
Rent 0.7% 0.5% 0.3% 1.1% 1.6%
Non-classified expenses (mainly other general
11.3% 18.5% 0.7% 4.0% 10.6%
and administration expenses)
Total Other Expenses 13.9% 19.4% 15.6% 23.9% 20.6%
Exhibit 6: Other expenses as reported in FY16 AR Exhibit 7: Other expenses as reported in FY15 AR
Source: company Source: company
Depreciation & Amortization

Discrepancies in reporting
We noticed the following discrepancies in the company’s reporting related to fixed
assets and depreciation:
 In the FY14 annual report, the company has reported its FY13 intangible assets
as Rs14,354 on the balance sheet (page 78). However in the financial schedule
for breakup of fixed assets, the total of intangible assets is shown as Rs57.4mn
(page 88).
 In its FY13 annual report, the company reported Rs54.5mn as goodwill on
consolidation on the balance sheet for FY12 and FY13. However this goodwill

Thousands of Miles
amount for FY13 does not appear in balance sheet and financial schedules of
FY14 annual report.
 In the FY12 annual report, the company’s total gross fixed assets increased from
Rs0.3mn to Rs9.5mn (page 70) due to consolidation of Mentorminds. The
numbers for net fixed assets were re-stated accordingly but the number for gross
fixed assets were not re-stated.
 In the FY13 annual report, the company added some new entries to FY13 gross
block (page 67) related to consolidation and re-stated net fixed assets for FY12
but not the gross fixed assets. The table of breakup of fixed assets in the FY13
annual report is not easily readable because the table is probably a scanned
image. For one of the consolidation entries (item 6 in the table) the company
added Rs8.2mn to the gross block but depreciated it by Rs7.0mn in the same
year.
Depreciation rate analysis
Given the nature of the business, the company invests in lot of intangible assets (like
software products) on an ongoing basis. Certain assets that are not yet ready for
intended use are recognized as ‘intangible assets under development’ and are not
depreciated. These assets as a percentage of total net assets have come down over
the years and in FY16 accounted for 11% of total net block.
The company’s overall depreciation rates look more or less stable over the past three
years. We divided the depreciation rates into two sections, one for tangible assets (as
a percentage of net block as the company uses WDV method) and other for
intangible assets. Due to discrepancies in reporting discussed above, we get outlier
values for depreciation rates for FY12 and FY13. We find the reporting for FY14-16 to
be more reliable and put higher weight on depreciation rates for these two years for
further analysis.
Exhibit 8: Thousands of Miles’ depreciation rate overview
FY12** FY13 FY14 FY15 FY16
Income statement depreciation as
13.5% 9.8% 13.7% 13.9% 15.3%
% of total gross block
Depreciation rate based on footnotes
for tangible Assets* (as % of net block) 2.5% 130.7% 26.4% 22.9% 25.3%
for intangible Assets 26.3% 0.2% 11.4% 9.1% 17.4%
Intangible assets under development
73.3% 96.0% 27.3% 20.1% 11.0%
as % of total net block
Source: Company, Ambit Capital research; Note: depreciation rate is calculated as depreciation expense for the
year divided by average gross block at the beginning and end of that year; *depreciation rate for tangibles is
calculated on WDV basis, hence depreciation rate is considered as % of net block;** the gross block for FY12
includes Rs54.5mn of goodwill disclosed on the balance sheet
We point out that prior to FY16 there are some differences in total depreciation
expense disclosed in the income statement and the breakup of tangible asset
depreciation and intangible asset depreciation given in financial schedules.
Exhibit 9: Breakup of depreciation expense
Rs mn FY13 FY14 FY15 FY16
Total Depreciation (from income statement) 8.1 43.1 91.2 202.3
Tangible assets depreciation (from footnotes) 8.1 2.1 4.3 17.4
Intangible assets depreciation (from footnotes) 0.1 35.7 62.4 184.8
Total tangible and intangible 8.2 37.7 66.7 202.3
% difference 1% -12% -27% 0%
In the exhibit below, we compare Thousands of Miles’ intangible assets depreciation

rates with peers (not comparable for tangible assets of peers as the company uses
WDV method). We notice that intangible asset depreciation rate is also volatile for
peers.

Thousands of Miles
Exhibit 10: Intangible assets depreciation rate comparison

Depreciation as % of gross block
Intangibles
Thousands of Miles 26.3% 0.2% 11.4% 9.1% 15.0%
Take Solutions 14.7% 19.4% 21.7% 15.0% 15.3%
Accelya Kale 9.7% 10.0% 8.7% 9.0% 9.4%
MPS 28.0% 16.9% 10.6% 6.6% 1.9%
Persistent Systems 11.0% 20.5% 17.4% 7.6% 14.7%
eClerx 19.1% 19.6% 13.9% 12.7% 4.1%
Peer Median 14.7% 19.4% 13.9% 9.0% 9.4%

Thousands of Miles
Aggressive accounting - amortization rate

Thousands of Miles’ Depreciation and Amortisation Policy
Depreciation is provided on tangible fixed assets on the written down value (WDV)
method over useful life of the assets as estimated by the management.
Intangible assets are amortised on a straight line basis over their respective individual
estimated useful lives as determined by the management.
We take a closer look at the breakup of depreciation data provided by the company
for intangible assets to understand the policy better. We notice that the company
records depreciation (not impairment) on the goodwill on its balance sheet without
specifying the reason behind it. We also notice that for intangible assets under its
~63% held subsidiary “Thousands of Miles Software Services Inc (USA)” the company
has recorded a very aggressive 2.1% amortization rate. The company has a policy of
amortizing intangible assets on a straight line basis based on the useful lives
determined by the management. A 2.1% amortization rate (or 2.6% on taking FY14
gross assets) implies that the assumed life of the intangible asset is ~47 years (39
years using FY14 gross assets) which seems aggressive.
We note that intangible assets related to Thousands of Miles Software Services Inc
(USA) are of substantial size and had the depreciation for them been 10% for FY15
(still lower than depreciation rate for other reported intangible assets) the reported
depreciation would have increased by Rs.41mn and led to a reduction in reported
FY15 net profit of Rs.190mn by ~21%.
There are discrepancies in reported numbers of Gross Carrying Value (GCV),
Accumulated amortization, Net Carrying Value (NCV) as on 31st March 2015.
Reported numbers in FY16 annual report do not tally with those in FY15 annual
report. On further analysis, we discover that the company clubbed intangible assets
of Thousands of Miles software services Inc (USA) (~63% held subsidiary) with the
goodwill on balance sheet starting from FY16. Intangible assets of another 100%
held subsidiary, Thousands of Miles software services Inc (FZE) are clubbed with
internally generated intangible assets. We are highly critical of the accounting
treatment of goodwill recognition/transfer during consolidation of subsidiary’s
intangible assets without adequate disclosures. This accounting treatment will only
mask the aggressive amortization rate that the company has adopted on the
intangible assets of the subsidiary by making the FY16 numbers incomparable to
those of previous years on a like to like basis.
We find many discrepancies in the company’s reporting of depreciation and also the
depreciation policy looks ad hoc to us in the absence of sufficient disclosures. We
highlight this as a RED FLAG.
Exhibit 11: Intangible Assets Depreciation Rate for FY15
FY14 end gross FY15 end gross FY15 depreciation FY15 depreciation
Rs mn
intangible assets* intangible assets* expense as % of gross block**
Computer Software (Acquired) 0.04 0.04 0.01 15.2%
Computer Software (Internally Generated) 30.9 79.4 9.5 17.2%
Goodwill 74.0 74.0 29.6 40.0%
Thousands of Miles Software Services Inc (USA) 426.5 604.4 10.9 2.1%
Thousands of Miles Software Services Inc (FZE) 0.0 84.4 12.4 29.4%
Total 531.4 842.3 62.4 9.1%
Source: Company, Ambit Capital research; Note: *The gross intangible assets data given here excludes intangible assets under development; ** depreciation as %
of gross block is calculated by dividing depreciation expense for FY15 by average of gross block for FY14 and FY15.

Thousands of Miles
Exhibit 12: Intangible gross block classification in FY16 annual report
Source: company
Exhibit 13: Intangible gross block classification in FY15 annual report
Source: company

Thousands of Miles
Unclear items – Lower Tax rates

The company’s tax expenses as a percentage of revenues increased partially due to
improvement in PBT margins. In the exhibit below, we take a closer look at the
company’s effective tax rate. We find that Thousands of Miles’ tax rate is volatile and
has climbed since FY13. The disclosure on taxes is not detailed enough to make
sense of why the tax rate is volatile. For the recent years (FY14-16), the effective tax
rate is lower than peers. We raise an AMBER FLAG for the tax rate being lower than
peers despite lower proportion of other income and also for being volatile.
Exhibit 14: Effective tax rate of Thousands of Miles is lower than pees despite…
Effective Tax Rate (%) FY12 FY13 FY14 FY15 FY16
Take Solutions 18% 17% 2% 6% 14%
Accelya Kale 32% 31% 33% 37% 35%
MPS 26% 22% 34% 34% 32%
eClerx 20% 19% 23% 23% 24%
Peer Median 26% 22% 27% 25% 25%
Exhibit 15: …other income as percentage of PBT is lower for Thousands of Miles
Other income as % of PBT FY12 FY13 FY14 FY15 FY16
Take solutions 0.0% 0.0% 0.0% 0.0% 1.9%
Accelya Kale 3.8% -2.4% 3.4% 5.4% 7.2%
MPS 46.0% 12.5% 10.1% 11.6% 17.5%
Persistent Systems 13.0% 2.3% 4.4% 23.9% 19.0%
eClerx 11.2% -8.6% 3.3% 10.9% 8.5%
Peer group median 11.2% 0.0% 3.4% 10.9% 8.5%
Source: Ambit Capital research, company

Thousands of Miles
Volatile cash flows

As shown in the exhibit below, Thousands of Miles’ cash conversion ratio is highly
volatile. In FY12 and FY13, the company generated healthy EBITDA but reported
negative CFO mainly due to allocation of cash towards working capital. In FY14 and
FY15, the company’s cash generation has been healthy as compared to its peers
before deteriorating again in FY16.
Exhibit 16: Thousands of Miles’ cash generation has been volatile
Pre Tax CFO/ EBITDA (%)
FY11 FY12 FY13 FY14 FY15 FY16
Thousands of Miles 367% -52% -124% 97% 83% 24%
Take Solutions 60% 83% 76% 71% 55% 71%
Accelya Kale 73% 110% 110% 105% 82% 96%
MPS - 33% 84% 82% 77% 59%
Persistent Systems 121% 78% 83% 88% 106% 99%
eClerx 88% 111% 76% 77% 98% 79%
Peer Median 80% 83% 83% 82% 82% 79%
Source: Company, Ambit Capital research Note: MPS had reported a loss in FY11 and has been excluded from
the above exhibit
Unstable working capital cycle

Thousands of Miles’ working capital cycle has improved over FY14-15 before
deteriorating again in FY16. The company started reporting unbilled revenues in
FY16 which resulted in almost a 100% jump in working capital days. Even during
FY14-15 when working capital scenario appeared to be improving, the company still
lagged the peer group with longer working capital cycle. We assign an AMBER FLAG
due to volatility in the cash conversion cycle
Exhibit 17: Net working capital cycle days
Thousands of Miles 84 145 103 55 110
Take Solutions 30 51 65 85 68
Accelya Kale 59 46 33 40 49
MPS 8 3 28 43 47
Persistent Systems 21 28 23 24 16
eClerx 55 55 68 72 34
Peer Median 30 46 33 43 47
Source: Company, Ambit Capital research; Note: Following reclassification of reporting structure, Thousands of
Miles has reporting been zero payables since FY13.
In the exhibit below, we break down the components of Thousands of Miles’ working
capital cycle and compare it with peers. The biggest driver of the increase in the
company’s working capital cycle in FY16 has been in unbilled revenue (increased to
36 days from zero days in FY15). While fixed price contracts contributed 40% of FY16
revenues, unbilled revenue days of 36 days are much higher than peer group median
of 13 days. Here, we are concerned that the company might have switched to more
aggressive revenue recognition policies. Improvement in creditor days (33 days from
25 days in FY15) scenario is more than offset by worsening of receivable days (108
days from 80 days in FY15) and unbilled revenue days.

Thousands of Miles
Exhibit 18: Breakup of cash conversion cycle as compared to peers

Receivable days Unbilled revenue days Creditor days Cash conversion cycle
FY14 FY15 FY16 FY14 FY15 FY16 FY14 FY15 FY16 FY14 FY15 FY16
Thousands of Miles 112 80 108 - - 36 9 25 33 103 55 110
Peers
Take Solutions 101 117 107 13 17 20 49 50 58 65 85 68
Accelya Kale 45 44 42 21 23 28 33 26 21 33 40 49
MPS 58 61 64 14 14 13 43 32 30 28 43 47
Persistent Systems 66 69 67 7 8 - 18 17 52 56 60 16
eClerx 43 48 52 36 38 - 11 14 18 68 72 34
Peer group median 58 61 64 14 17 13 33 26 30 56 60 47
Source: Company, Ambit Capital Research
Weak free cash flow conversion

In the exhibit below, we compare free cash flow (CFO+CFI) yield generated by the
company over the last five years vs peers. The company has generated high negative
free cash flow during this period whilst its peers have fared better. Thousands of Miles
has been making many acquisitions in the past and this has contributed to cash
outflow (CFI) whilst its benefits (CFO) will accrue over time. In the later parts of this
report, we highlight that Thousands of Miles has been using an unconventional
accounting practice for its cash flow statement. We believe this could have also led
outflows related to investments (CFI) reported by the company to be overstated. We
assign an AMBER FLAG.
Exhibit 19: Free cash flow conversion of the company has been week and volatile as well
Cumulative Cumulative Cumulative Median
Company name CFO CFI (CFO+CFI) revenues Cum (CFO+CFI)/median rev
FY12-FY16 FY12-FY16 FY12-FY16 FY12-FY16
Thousands of Miles 464 (1,857) (1,394) 441 (3.2)
Take Solutions 5,918 (5,179) 740 8,155 0.1
Accelya Kale 4,272 (660) 3,612 3,038 1.2
MPS 1,749 (1,784) (35) 2,040 (0.0)
Persistent Systems 12,635 (8,139) 4,496 16,692 0.3
eClerx 11,333 (7,110) 4,223 8,410 0.5
Peer group median 5,918 (5,179) 3,612 8,155 0.3
Sketchy cash flow accounting

Thousands of Miles is following an unconventional accounting practice with respect to
its cash flow from financing activities. It is difficult to understand how the company is
funding its financing needs by looking at the cash flow statement. In FY14, the
company reported Rs481mn (78% of FY14 net worth) as cash inflow related to
‘Reserves and Surplus’ although the company did not issue any new shares during
that period. In FY15/16, the company reported Rs185mn/Rs859mn (19%/42% of
FY15/16 net worth) as cash inflows related to ‘Reserves and surplus’ (proceeds from
preferential share allotment out of conversion of 0.3mn/0.55mn warrants during
FY15/FY16 could not be reconciled with cash inflows related to ‘Reserves and
Surplus’). We notice the following other issues with the cash flow reporting:
 The cash flow item in ‘Reserves and Surplus’ item does not tally (for FY14 & FY16)
with the breakup of reserves and surplus given by the company in its financial
schedules for consolidated balance sheet. Based on FY15 data, we ‘assume’ that
this cash flow entry mainly pertains to two things shown in the breakup of
reserves and surplus: 1) addition to capital reserves (including to securities
premium account) during the year; 2) foreign currency translation effects.

Thousands of Miles
 Pages 96 and 97 of FY15 annual report shows that the company has reported
Rs418m as addition and Rs54m as deduction from capital reserves for FY14 and
FY15 respectively. There is no disclosure on how these numbers were arrived at
or what the underlying reasons behind it were. Surprisingly, page 120 of FY16
annual report paints a different picture. Opening and closing balances for FY15
capital reserves and securities premium account do not reconcile with each other
(based on FY15 and FY16 annual reports). We expect further clarity and
disclosures regarding this from the management.
Given that the company reported Rs859mn in FY16 cash flow statement related to
reserves and surplus there ‘might’ also be an offsetting entry in investing cash flow
section so that there is no impact on change in cash for the year. This ‘could’ lead to
overstatement of cash outflow related to investments made by the company.
We also noticed that the individual line items for FY15 financing cash flow do not add
up to the total financing cash flow of Rs436mn disclosed by the company. This is
likely a typographical error and the correct number should have been Rs205mn. This
way the individual line items add up to the total financing cash flow and total change
in cash equals sum of operating, investing and financing cash flows.
Due to above issues, we assign a RED FLAG.
Exhibit 20: Cash flow statement of the company is a black box
Cash used in financing activities Mar-14 Mar-15 Mar-16
Share Capital - 3.0 5.5
Application money pending allotment - 115.0 (57.5)
In Reserves & Surplus 481.1 185.1 859.6
Deferred Tax liabilities 4.3 1.2
Interest Paid (3.7) (4.5) (2.1)
Increase in Non-Current Liabilities 5.6 (94.7) 0.4
Net Cash Used In Financing Activities (3) 487.3 436.1 805.9
Net Increase in Cash and Cash Equivalents (1+2+3) 33.9 99.5 137.7
Cash and Cash Equivalents at the beginning of the year 14.5 48.3 147.8
Cash and Cash Equivalents at the end of the year 48.3 147.8 285.5
Reserves and surplus as % of net worth 78% 19% 42%
Source: Annual report
Exhibit 21: FY16 annual report of the company… Exhibit 22: …contradicts data present in FY15 annual report
Source: company Source: company
Capital allocation
Getting insights on Thousands of Miles’ capital allocation is challenging given that we
don’t fully understand where the financing cash flow is coming from and there is no
granular breakup on where the investing cash flow is being spent. In the exhibit
below we take a deeper look at how the company has allocated its capital from
FY12-FY16.
Out of total inflows of Rs2.9bn, 57% have come from financing cash flows and the
rest came from operating cash flows (before working capital adjustments). Out of

Thousands of Miles
total cash outflows of Rs2.6bn, 69% was used towards investment activities while the
rest was used for investing in working capital.
Exhibit 23: Getting insights into capital allocation is challenging
Inflows: FY12-16: Rs2.9bn Outflows: FY12-16: Rs2.6bn
Operating
Cash Flow
Working
(before
Capital
WC
31%
changes)
43% Financing
cash flow
57%
Investing
cash flow
69%
Source: Company, Ambit Capital research; Note: For Financing cash flow we have used RS205m as the number for FY15 instead of Rs436m due to a typo in the
company’s annual report

Thousands of Miles
Corporate governance
Company’s CEO serves on nomination and
remuneration committee
Thousands of Miles had a close-knit Board comprising only five people till FY15.
However, the strength of the board has expanded to seven members by the close of
FY16. The Board includes four independent directors (only two till FY15) whilst the
other three Board members are promoters/part of the management team (CEO, CFO
and COO). The company’s Nomination and Remuneration committee consists of
three non-independent directors and only one independent director. Thus, we have a
situation where a company’s top management is a part of the committee that
oversees policies related to its own compensation. Hence, we assign an AMBER
FLAG.
Exhibit 24: Board of directors
Name Background
 CEO , Chairman and Promoter of the company (held 55.25% stake as of September 2015)
 Has more than 26+ years of experience in the IT solutions & consulting industry
Suresh Venkatachari
 Has founded four IT companies over the past 14 years
 Previously served as Head of Electronic Banking at Deutsche Bank, Singapore
 Other Directorship: SolutionNet (Asia Pacific) Pte Ltd; Mentor Minds Solutions and Services Pvt. Ltd.;
Imogo Tech Solutions Pvt Ltd
Gurumurthi Jayaraman
(Independent)  Other Directorships: Nova Human Resources Outsourcing Pvt. Ltd.
 Serving as CFO of the company
 Owns 6.14% shares of the company (as of March 2015)
Ramani RS  27+ years of experience in finance roles; key areas of focus for Mr. Ramani is Finance, Accounting,
Auditing and operations in IT, Education and Trading Industries
 Other Directorships: Mentor Minds Solutions and Services Pvt. Ltd.; Imogo Tech Solutions Pvt Ltd
Padmini Ravichandran
(Independent)
 Other Directorships: Sreyes Communetwork Pvt. Ltd; Sudesi Infomedia Pvt. Ltd.
 COO and Head of Cloud IAM business for 8KMiles
 Founder of FuGen Solutions which was acquired by 8KMiles
Lakshmanan Kannappan  One of the original founders of SAML 2.0 protocol and Federated Identity Management model for the
industry while at Orange-France Telecom, which changed the way Identity Information is shared
between Service Providers and enabled the huge success of SaaS, Cloud and Social Networking
Dinesh R Punniamurthy (Independent)  Over 14 years of experience in service industry predominantly in India and a few years in Australia
Babita Singaram (Independent)  Ardent marketing professional with a Post Graduate in Business Administration from SRM university
Source: Company, Media Sources; Note that Mr. Dinesh R Punniamurthy and Ms. Babita Singaram were appointed as additional directors under independent and
non-executive category w.e.f 31st March 2016
Attendance of the members (especially independent) in the Board meetings in FY16

has been satisfactory.
Exhibit 25: Attendance and joining date details of the board members
FY16 Attendance Appointment Date
Suresh Venkatachari 5/7 Aug-2010
Gurumurthi Jayaraman 7/7 Feb-2014
RS Ramani 7/7 Aug-2011
Padmini Ravichandran 7/7 Aug-2010
Lakshmanan Kannappan* 4/7 Mar-2015
Dinesh R Punniamurthy 1/7 Mar-2016
Babita Singaram 1/7 Mar-2016
Source: Company, Media Sources; Note that Dinesh RP and Babita S are appointed as independent directors
w.e.f 31st March 2016 and hence their attendance does not reflect full year meetings

Thousands of Miles
Inadequate disclosures on management compensation

In its FY16 annual report (pages 63, 64), the company has left the sections on
remuneration for CEO, CFO and independent directors blank, suggesting that they
are not getting any compensation from the company. We believe that the company’s
disclosure regarding its compensation for top leadership is incomplete and assign an
AMBER FLAG.
Strategic Advisory Board

On 9th October 2015, the company announced that it has appointed a strategic
advisory board consisting of people with domain expertise in cloud, digital
transformation, mobile and security. The aim of this initiative is to strengthen
Thousands of Miles’ offerings and provide access to previously untapped business
opportunities. This is an encouraging initiative by the company.
Exhibit 26: Composition of the strategic advisory board
Name Background
John Cuny
 Senior health system developer & manager with 30 years of managed care experience in hospitals & major health plans
 Previously served as advisor / manager to select healthcare organizations in US, Britain, Argentina, Saudi Arabia etc
 A global IT executive with 20+ years of proven leadership in professional services and operational end-to-end
Reza Nazleman accountability with EUnet, France Telecom, McKinsey & Co., KPMG, BearingPoint, Bank of Scotland, and Microsoft.
 Former Head of Global IT Transformation, Microsoft
 Senior Director of Engineering at Time Warner Cable; responsible for the ongoing development, operation, and support
Jason Rouault of the TWC OpenStack Cloud
 Previously worked as CTO of the Hewlett-Packard’s Identity Management business
Jeff Nigriny
 Founder and President of CertiPath, a trust framework provider that certifies authentication and access control devices
with a focus on high assurance for aerospace and defense industries and government agencies
Dinesh Yadav  Responsible for sales, channel and go-to-market for IBM’s security solutions
Suja Chandrasekaran  CIO of Kimberly-Clark corporation, Suja leads all technology, digital, data and application capabilities globally
Rajan Natarajan  President of TechnoGen Inc. and serving on the Maryland cybersecurity council, board of directors of Maryland chamber
of commerce
Source: Company
Company secretary’s remuneration is extremely low

The company secretary, Ms. Jayashree Jagannathan earns just Rs300,000 p.a., which
we note is lower than even a fresher at TCS. At best, this indicates poor importance
given to the role of a company secretary.
Inadequate disclosures on related party transactions

As per the annual reports of the company, there were no materially significant
transactions with related parties during FY16/FY15 but there were some in FY14. We
find the company’s disclosures related to RPTs to be inadequate and flag it as a cause
of concern.
The company reports RPTs for only the standalone entity whereas the RPTs for
consolidated entity are not disclosed. In FY14, the company reported following
related party transactions in the schedules to financial statements without disclosing
the same in the RPT schedule.
Exhibit 27: Thousands of Miles’ notable related party transactions in FY14
FY14 Related party transactions Amount (Rs mn) % of net worth
Standalone
Short term loans and advances from related party 10.2 1.3%
Long term loans and advances from related party 4.9 0.6%
Consolidated
Loans and advances from directors 11.6 1.4%
Long term loans and advances to related parties (asset) 1.7 0.2%
Source: FY14 annual report

Thousands of Miles
Issues around warrant pricing

On 20th December 2014, the company allotted 1.4mn warrants (equivalent to ~14%
of shares outstanding) on a preferential basis to promoters and other non-promoter
investors. The relevant shareholder resolution was passed at an extraordinary general
meeting held on 28th Oct 2014. The warrants were allotted at a price of Rs398.6 per
share.
In a BSE release dated 6th Oct 2015, Thousands of Miles disclosed the policy it was
following for calculation of warrant price.
Calculation of Warrant Price

The price of the Securities to be issued is being calculated in accordance with the
provisions for preferential issue as laid under Chapter VII of the SEBI ICDR Regulations
which inter alia provides that the equity shares and Warrants shall be allotted at a price
not less than higher of the following:-
(a) The average of the weekly high and low of the closing prices of the Company’s equity
shares quoted on the Stock Exchange(s) during the twenty six (26) weeks preceding the
relevant date; or
(b) The average of the weekly high and low of the closing prices of the Company’s equity
shares quoted on the Stock Exchange(s) during the two (2) weeks preceding the relevant
date.
On 25th Aug 2014, the SEBI had released an amendment following which the warrant
price calculation was to be based on volume weighted average price (VWAP) vs THE
old rule of using closing price. The stock prices are to be considered for the exchange
where higher number of shares of the company trade. In the exhibit below, we
calculate the SEBI mandated floor price for the warrant using old and amended rules
and using both BSE and NSE stock prices. Note that we are not including the previous
26 week average because it is much lower than the previous 2 week average and is
inconsequential given that higher of the two prices is considered as the floor price.
Exhibit 28: Calculation of warrant floor price as per SEBI rules
NSE BSE
Date
Closing Price VWAP Closing Price VWAP
26-Sep-14 469.9 465.5 468.8 465.9
25-Sep-14 447.6 452.4 446.5 452.9
Week 1
24-Sep-14 452.4 447.2 449.4 443.3
23-Sep-14 452.2 454.2 448.4 452.4
22-Sep-14 451.0 445.8 449.5 443.6
19-Sep-14 429.6 423.6 428.1 420.7
18-Sep-14 390.5 381.1 389.2 382.6
Week 2 17-Sep-14 355.0 345.9 353.9 336.0
16-Sep-14 326.0 338.3 327.2 337.3
15-Sep-14 347.6 347.0 347.3 346.9
Week 1 min 447.6 445.8 446.5 443.3
Week 1 max 469.9 465.5 468.8 465.9
Week 2 min 326.0 338.3 327.2 336.0
Week 2 max 429.6 423.6 428.1 420.7
Average Price 418.2 418.3 417.7 416.5
Source: Company, BSE, NSE, SEBI
Our calculations suggest that the SEBI mandated warrant floor price should have
been in Rs416-419 range compared to the price of Rs398.6 at which the company
allotted warrants. The management stated in a TV interview that there was no
discount in the price at which these warrants were allotted without giving further
information. We assign a RED FLAG.

Thousands of Miles
This issuance came ahead of a 4x jump in stock price. Minority shareholders were
worse off because the company preferred issuing warrants instead of common equity.
The company does not have a usual practice of issuing warrants and the issuance in
Dec-14 was one-off. We assign an additional AMBER FLAG for this reason.
Exhibit 29: List of shareholders to whom warrants were issued
Name of the allottee Category No of securities
Suresh Venkatachari Promoter 450,000
Ramani Rama Subramani Promoter 150,000
Sandeep Tandon - HUF Non-Promoter 400,000
Sarojini Tandon Non-Promoter 300,000
Karthik Ramakrishnan - HUF Non-Promoter 100,000
Total 1,400,000
Source: Company, BSE
During FY16, holders of 0.55mn (0.3mn during FY15) warrants have exercised their
rights and converted their warrants to shares.
Exhibit 30: Conversion of warrants to shares
Date Name of the Allottee Category No of securities
8 Oct 2015 Ramani Rama Subramani Promoter 150,000
20 Apr 2015 Sandeep Tandon - HUF Non-Promoter 400,000
28 Jan, 30 Mar 2015 Sarojini Tandon Non-Promoter 300,000
Total 850,000
Source: Company, BSE

Thousands of Miles
Auditor checks
Auditor’s Remuneration
Higher growth in auditor’s remuneration relative to company’s consolidated revenues
remains a cause of concern for us.
Exhibit 31: Growth in company’s revenues vs auditor’s remuneration
CAGR in auditor's remuneration CAGR in consolidated revenues
FY12-FY16 FY12-FY16
Thousands of Miles 162% 90%
Exhibit 32: However, auditor’s remuneration as % of cons. revenues remained low

Source: Company
Auditor rotation
The company had last changed its auditor in FY12 to GHG Associates. The Board has
recently passed a resolution that seeks to appoint GHG Associates as auditors of the
company until FY21 (subject to ratification of their appointment at every AGM). We
view this as a lack of intent towards rotating the auditors and raise a RED FLAG.
Insider trading
As per Bloomberg, there were only two major transactions in Thousands of Miles’
shares and none of them involved insiders.
Exhibit 33: Insider trading grab from Bloomberg
Source: Bloomberg, Ambit Capital research
Pledging of shares by promoters

From Mar-2012 to Mar-2014, the company had disclosed that its promoters had
pledged 3.56mn of company’s shares (representing 33.1% of shares outstanding as
of Sep-2015). However, from Jun-2014, the company disclosed that none of its
promoters had pledged their shares. We see no signs of concern here.

Institutional Equities Team
Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 saurabh.mukherjea@ambit.co
Pramod Gubbi, CFA Head of Equities (022) 30433124 pramod.gubbi@ambit.co
Research Analysts
Name Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 nitin.bhasin@ambit.co
Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 aadesh.mehta@ambit.co
Abhishek Ranganathan, CFA Retail (022) 30433085 abhishek.r@ambit.co
Anuj Bansal Mid-caps (022) 30433122 anuj.bansal@ambit.co
Aditi Singh Economy / Strategy (022) 30433284 aditi.singh@ambit.co
Ashvin Shetty, CFA Automobile (022) 30433285 ashvin.shetty@ambit.co
Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 bhargav.buddhadev@ambit.co
Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 deepesh.agarwal@ambit.co
Dhiraj Mistry, CFA Consumer (022) 30433264 dhiraj.mistry@ambit.co
Gaurav Khandelwal, CFA Automobile (022) 30433132 gaurav.khandelwal@ambit.co
Girisha Saraf Mid-caps / Small-caps (022) 30433211 girisha.saraf@ambit.co
Karan Khanna, CFA Strategy (022) 30433251 karan.khanna@ambit.co
Mayank Porwal Retail (022) 30433214 mayank.porwal@ambit.co
Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 pankaj.agarwal@ambit.co
Paresh Dave, CFA Healthcare (022) 30433212 paresh.dave@ambit.co
Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 parita.ashar@ambit.co
Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 prashant.mittal@ambit.co
Rahil Shah Banking / Financial Services (022) 30433217 rahil.shah@ambit.co
Rakshit Ranjan, CFA Consumer (022) 30433201 rakshit.ranjan@ambit.co
Ravi Singh Banking / Financial Services (022) 30433181 ravi.singh@ambit.co
Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 ritesh.gupta@ambit.co
Ritesh Vaidya, CFA Consumer (022) 30433246 ritesh.vaidya@ambit.co
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritika.mankar@ambit.co
Ritu Modi Automobile (022) 30433292 ritu.modi@ambit.co
Sagar Rastogi Technology (022) 30433291 sagar.rastogi@ambit.co
Sudheer Guntupalli Technology (022) 30433203 sudheer.guntupalli@ambit.co
Sumit Shekhar Economy / Strategy (022) 30433229 sumit.shekhar@ambit.co
Utsav Mehta, CFA E&C / Industrials (022) 30433209 utsav.mehta@ambit.co
Vivekanand Subbaraman, CFA Media (022) 30433261 vivekanand.s@ambit.co
Sales
Name Regions Desk-Phone E-mail
Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7886 2740 sarojini.r@ambit.co
Dharmen Shah India / Asia (022) 30433289 dharmen.shah@ambit.co
Dipti Mehta India (022) 30433053 dipti.mehta@ambit.co
Krishnan V India / Asia (022) 30433295 krishnanv@ambit.co
Nityam Shah, CFA Europe (022) 30433259 nityam.shah@ambit.co
Parees Purohit, CFA UK (022) 30433169 parees.purohit@ambit.co
Punitraj Mehra, CFA India / Asia (022) 30433198 punitraj.mehra@ambit.co
Shaleen Silori India (022) 30433256 shaleen.silori@ambit.co
Singapore
Praveena Pattabiraman Singapore +65 6536 0481 praveena.pattabiraman@ambit.co
Shashank Abhisheik Singapore +65 6536 1935 shashankabhisheik@ambitpte.com
USA / Canada
Ravilochan Pola – CEO Americas +1(646) 793 6001 ravi.pola@ambitamerica.co
Hitakshi Mehra Americas +1(646) 793 6002 hitakshi.mehra@ambitamerica.co
Production
Sajid Merchant Production (022) 30433247 sajid.merchant@ambit.co
Sharoz G Hussain Production (022) 30433183 sharoz.hussain@ambit.co
Jestin George Editor (022) 30433272 jestin.george@ambit.co
Richard Mugutmal Editor (022) 30433273 richard.mugutmal@ambit.co
Nikhil Pillai Database (022) 30433265 nikhil.pillai@ambit.co

Biocon Ltd (BIOS IN, NOT RATED)
600
500
400
300
200
100
0
Apr-13
Apr-14
Apr-15
Dec-12
Dec-13
Dec-14
Aug-13
Aug-14
Aug-15
Jun-13
Jun-14
Jun-15
Feb-13
Oct-13
Feb-14
Oct-14
Feb-15
Oct-15
BIOCON LTD
8K Miles Software Services Ltd (KMSS IN, NOT RATED)

1,000
800
600
400
200
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
8K Miles Software Services Ltd
Omkar Speciality Chemicals Ltd (OSCL IN, NOT RATED)

300
250
200
150
100
50
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Omkar Speciality Chemicals Ltd
Tata Chemicals Ltd (TTCH IN, NOT RATED)

700
600
500
400
300
200
100
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Tata Chemicals Ltd

Linde India Ltd (LIIL IN, NOT RATED)
500
400
300
200
100
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Linde India Ltd
Tanla Solutions Ltd (TANS IN, NOT RATED)

70
60
50
40
30
20
10
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Tanla Solutions Ltd Oct-16
UPL Ltd (UPLL IN, NOT RATED)

800
700
600
500
400
300
200
100
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
UPL Ltd
Sequent Scientific Ltd (SEQ IN, NOT RATED)

300
250
200
150
100
50
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Sequent Scientific Ltd

Unitech Ltd (UT IN, NOT RATED)
40
30
20
10
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Unitech Ltd
Arshiya Ltd (ARSL IN IN, NOT RATED)

60
50
40
30
20
10
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Arshiya Ltd
Lanco Infratech Ltd (LANCI IN, NOT RATED)

16
14
12
10
8
6
4
2
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Lanco Infratech Ltd
Crompton Greaves Ltd (CRG IN, NOT RATED)
100
80
60
40
20
0
Mar-14
Mar-15
Mar-16
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Sep-14
Sep-15
Sep-16
Nov-13
May-14
Nov-14
May-15
Nov-15
May-16
Crompton Greaves Ltd

Glenmark Pharmaceuticals Ltd (GNP IN, NOT RATED)
1,400
1,200
1,000
800
600
400
200
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Glenmark Pharmaceuticals Ltd
Balkrishna Industries Ltd (BIL IN, SELL)
1,400
1,200
1,000
800
600
400
200
0
Mar-14
Mar-15
Mar-16
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Sep-14
Sep-15
Sep-16
Nov-13
May-14
Nov-14
May-15
Nov-15
May-16
Balkrishna Industries Ltd
Wockhardt Ltd (WPL IN, NOT RATED)

2,500
2,000
1,500
1,000
500
0
Apr-14
Apr-15
Apr-16
Dec-13
Dec-14
Dec-15
Aug-14
Aug-15
Aug-16
Jun-14
Jun-15
Jun-16
Feb-14
Oct-14
Feb-15
Oct-15
Feb-16
Oct-16
Wockhardt Ltd
Godrej Consumer Products Ltd (GCPL IN, SELL)
2,000
1,500
1,000
500
0
Mar-14
Mar-15
Mar-16
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Sep-14
Sep-15
Sep-16
Nov-13
May-14
Nov-14
May-15
Nov-15
May-16
Godrej Consumer Products Ltd

Explanation of Investment Rating
Investment Rating Expected return (over 12-month)
BUY >10%
SELL <10%
NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock
POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs
NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs
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STRATEGY

Median share price

Forensic Accounting: Beware of the 'Zone of Darkness'!

Executive summary ……………………………………………………………………4

Our ‘forensic’ model: Methodology ………………………………………………..8

Link between accounting quality and investment returns ……………………..20

Why we think accounting quality especially merits ……………………………26

Debunking myths about accounting quality …………………………………….29

How can clients access our forensic model? …………………........................31

Subjective checks: Can be gauged only with a careful ………………………..33

Sample bespoke: Analysing top Indian auditors ……………………………….37

Sample bespoke: Thousands of Miles …………………………………………...38

Analysing top Indian auditors ………………………………………………..37

Thousands of Miles (NOT RATED): Too good to be true! ………………..38

December 16, 2016 Ambit Capital Pvt. Ltd. Page 2

Beware of the ‘Zone of Darkness’! Case studies featured in this report

'Zone of THIS NOTE CANNOT BE USED BY THE MEDIA

Accounting quality especially merits attention at this critical juncture

16 December, 2016 Ambit Capital Pvt. Ltd. Page 4

Name of company Year and month Brief description

16 December, 2016 Ambit Capital Pvt. Ltd. Page 5

Accounting quality matters! (over long periods of time)

Accounting score based deciles

16 December, 2016 Ambit Capital Pvt. Ltd. Page 6

Launching our proprietary accounting model for FY16

16 December, 2016 Ambit Capital Pvt. Ltd. Page 7

Our ‘forensic’ model: Methodology

In the subsequent sections, we provide a brief description of these accounting ratios

16 December, 2016 Ambit Capital Pvt. Ltd. Page 8

I - P&L mis-statement checks

16 December, 2016 Ambit Capital Pvt. Ltd. Page 9

16 December, 2016 Ambit Capital Pvt. Ltd. Page 10

16 December, 2016 Ambit Capital Pvt. Ltd. Page 11

II - Balance sheet mis-statement checks

16 December, 2016 Ambit Capital Pvt. Ltd. Page 12

16 December, 2016 Ambit Capital Pvt. Ltd. Page 13

These contingent liabilities mainly relate to tax payables, penalty claim on

16 December, 2016 Ambit Capital Pvt. Ltd. Page 14

Exhibit 15: UPL’s contingent liabilities breakup (Rs mn)

III - Cash pilferage checks

16 December, 2016 Ambit Capital Pvt. Ltd. Page 15

16 December, 2016 Ambit Capital Pvt. Ltd. Page 16

IV - Audit quality checks

11 CAGR in auditor’s remuneration to CAGR in consolidated revenues: We

16 December, 2016 Ambit Capital Pvt. Ltd. Page 17

Exhibit 20: Unitech - auditor’s remuneration vis-à-vis peers

Overall, given the high proportion of auditor’s remuneration vs the consolidated

16 December, 2016 Ambit Capital Pvt. Ltd. Page 18

16 December, 2016 Ambit Capital Pvt. Ltd. Page 19

Link between accounting quality and

140% R² = 9% Stock-level noise leads to a weak

scores and stock returns at the

16 December, 2016 Ambit Capital Pvt. Ltd. Page 20

30% R² = 84% …however, deciles constructed on

20% D4 shaping stock returns

25% CAGR basis

Accounting score based deciles

16 December, 2016 Ambit Capital Pvt. Ltd. Page 21

and differentiated only on

252, 15.4% accounting quality show

investment performance even after

16 December, 2016 Ambit Capital Pvt. Ltd. Page 22

50% Cons. Disc.