Forensics and the art of triangulation

A few months back I had written a note on Vakrangee highlighting the red flags. The note was based on the reported financials and some management claims regarding biz economics which were too good to be true. (some of the data may be a few months old)

1. No Free Cash Flow – While the Company has demonstrated strong earnings growth, the Company has not generated any free cash flow. High earnings growth with continuously -ve FCF is a red flag suggesting that earnings may not be real. Debt reduction that has happened over the last 1 year was also through equity issuance and not internal cash flows.

2. Increasing Working Capital requirements – Over the last 5 years, Vakrangee’s net current assets have increased from 55 crs to 750 crs (13.5x increase) while sales have gone up from 295 cr to 1950 cr (6.5x increase). WC requirements increasing substantially faster than Sales is a red flag suggesting Sales may not be real.

3. High capex on government business
   -Vakrangee incurred 228 crs in capex in FY14 (of which 197 crs is for Computers & Printers) towards the e-governance business. Vakrangee continuing to incur high capex for the government business does not make business sense considering the poor economics of the segment and low growth expected by the management.
   -197 crs in capex for computers and printers suggests the purchase of over 20,000 computers in a 1 year period. This number would significantly exceed the company’s employee count (permanent and contracted – Vakrangee incurred 31 crs in employee costs in FY14 and as per the opex breakup does not have significant sub-contracting expenses). The high capex does not match with the current scale of the company’s operations and this is probably opex classified as capex to boost earnings.

4. Vakrangee Kendra (VK) economics – too good to be true
   -As per management, a typical VK requires very little upfront investment by the company with franchise bearing most of the capex and working capital costs. And a typical VK generates 10 lakhs in annual revenues with the franchise getting 70% share leading to 3 lakhs revenues per VK for Vakrangee. These numbers seem too high and are inconsistent with the realized economics of other companies such as FINO and ALW which have struggled in the BC business.
   -In March 2014, Vakrangee had 3,853 VKs which generated approx. 900 crs in Revenue in the full year. This implies Revenue/VK of 23 lakhs which is substantially higher than the management estimate of 10 lakhs per VK. If we consider that the VK rollout would have happened over the year, the average revenue/VK number would be even higher. These numbers are staggeringly high and hence in all likelihood fictitious.

5. Exaggerated claims on White Label ATM (WLA) business –
   -Vakrangee has the license to install and operate 15,000 WLAs over a 3-year period (starting January 2014). Management claims the WLA ATM business will be extremely profitable. However, Vakrangee having installed less than a 100 ATMs over the last 14 months is contrary to management claims (http://www.npci.org.in/nfsatm.aspx). Management claims that they were trying to get RBI permission for new biometric ATM technology and hence the delay. This is difficult to believe considering all the other players (Tata, Prizm, BIT) have already started installing ATMs and now Vakrangee would have to make do with sub-par locations for their ATMs (location is the key driver of ATM transaction volumes). Vakrangee’s lack of progress on WLA ATM deployment is consistent with the market view that the WLA ATM business is economically unviable for most players (http://www.livemint.com/Industry/3YLmH9ZyWTIxjIchh8ed1K/White-Label-ATMs-struggle-to-stay-afloat.html)
   -Management has guided at installation of 5,000 ATMs over the next 3 months and another 5,000 over the next 9 months. Even the largest ATM players have been unable to achieve such a pace of ATM rollout. This number seems fairly exaggerated. Should be verified 3 months down the line if the company is anywhere close to even achieving its rollout target. (The company had made this claim 3 months back – they haven’t installed even 50 ATMs since then)

6. Employee count inconsistent with claimed size of operations
   -As per management, Vakrangee currently has 1064 employees (150-200 at the corporate-level, 800-900 at block level for managing 12,000 VKs and identification and deployment of new VKs). The employee count is inconsistent with their current pace of VK rollout (37 per day) and planned ATM rollout (50 per day) over and above their government business. This suggests that the overall scale of operations is much smaller than what the management claims.

The biggest red flag for me at that time was the company’s capex on computers and printers of approx 20 lakhs per employee !!!! A clear sign of opex being shown as capex.