Srinivas with Suneera Tandon
Sanjeev Narula could say his fight with private equity (PE) investors
Bain Capital and TPG is a Lilliput versus Gulliver saga. The managing
director of Lilliput Kidswear, an apparel retailer that until
recently was a success story, got into a fight with his principal
investors over the veracity of the companys audited accounts
that were presented at a board meeting on 28 September.
Details are scant, but what appears to be a whistleblower call
about fudged accounting, just as the company was readying to file
a draft red herring prospectus (DRHP) ahead of a planned initial
public offering (IPO), has driven a wedge between the two parties.
Narula has 55 per cent of the stake, and the PE firms, 45.
A re-audit was suggested, but Narula did not agree to it. Instead,
he appears to have taken umbrage at the suggestion, refused to
agree to a re-audit and moved the courts.
The fight prompted many resignations from the companys
board: by the representatives of Bain Capital and TPG, four independent
directors, and just days later, by the auditors S.R. Batliboi
and Ernst & Young (Lilliputs advisors).
In an appeal filed by Lilliput in the Delhi High Court on 3 October
2011 against Bain Capital India, the company has restrained
the respondents from selling, alienating, transferring or creating
third party rights in any manner dealing with their shares of
petitioner (Lilliput) and hence, the respondents are restrained,
directly or indirectly, from acting contrary to the minutes of
the Board Meeting dated 28.09.2011 and they are further restrained
from giving adverse publicity to Lilliput. The petition also restrains
the respondents, its associates, affiliates, servants, and employees
directly or indirectly, from interfering with and obstructing
the operations of the petitioner.
After the company filed an injunction in the high court restraining
its investors and related parties from exiting the company or
taking matters further, no one Narula, the PE firms, or
the auditors is willing to go public on anything. BWs
attempts to talk to them were unsuccessful; they claim the matter
is sub judice.
The PE investors concerns stem from what is standard operating
procedure. In US firms, any suggestion of wrongdoing in
an investee company is always reported by the managing partner
to his fund, says a PE expert. That prompts a set
on questions, checks and inquiries that ultimately are taken back
to the investee companys management.
The opportunities for litigation against the PE firms general
partnership make a firm very cautious. Occasionally, the general
counsel gets involved. All too often that ignores the realities
on the ground in India, like very sensitive promoters, the
expert adds. That could have driven Lilliputs promoters
over the edge.
We talked to more than a dozen analysts, experts and retail consultants
to try and piece together some answers. None of them, however,
was willing to go on record.
The Beginnings Of A Clash
Both Bain and TPG competed fiercely to get a piece of Lilliput
in 2009, says a leading investment banker. At that time,
35 per cent of the company was held by PE investor Indivision
Fund (now Everstone Capital), with Narula holding about 65 per
Other investment bankers say Narula was unwilling to give up
control, so Everstone, which had invested in the company in late-2006,
sold its stake, and Narula sold a small part of his. After the
deal was completed, the company was valued at about Rs 775 crore.
S.R. Batliboi and E&Y have worked with the company for over
three years, and helped conduct the due diligence necessary for
the PE investors. That was followed up by another due diligence
exercise by KPMG, another global consultancy, before Bain and
TPG paid about $86 million to buy in, closing the deal in January
2010. Lilliputs revenues, say market observers, was then
more than Rs 300 crore.
The company then embarked on a rapid expansion spree. It added
four manufacturing plants to its existing six. In 2010, the company
had about 225,000 sq. ft retail space; by September 2011, that
had gone up to 700,000 sq. ft, with another 200,000 being fitted
out. It also took on a lot of debt. All of this cannot be
done without at least the strategic approval of Bain and TPG,
says another investment banker. July to September have been
hard on retail, and such rapid growth implies huge inventory.
That may have scared Bain and TPG. Perhaps, but where does
the alleged fudging come in?
The Lilliput story highlights a critical issue that investors
in organised retail have been facing for some time: inventory
management and accounting. Stores do not do any annual stocktaking,
says one analyst. In most cases, there is no policy for
markdowns, or writing off for losses.
That, he says, leaves the door open for accounting gaps. Other
analysts say that sometimes stock from existing stores is moved
to new stores without accounting for them properly. But they add
that a lot of it could be because of inadequate management information
systems (MIS) at the end of the year, these transactions
and markdowns are rounded off. This could have
prompted the whistle-blowing, says a retail consultant.
Rapid expansion could exacerbate the effects of slack inventory
accounting. Analysts say there is usually a benchmark of unaccounted
inventory-to-sales ratios. It is something that auditors
are aware of, or should be, says an analyst with a brokerage
There is constant pressure on the company to show sustained
growth, top-line progress and a sizeable foot-print, adds
Devangshu Dutta, CEO of Third Eyesight, a retail consultancy.
Other instances have illustrated the consequences of very rapid
With investor interest one can create turnover in ways
you would not use otherwise, says Dutta. This is partly
driven by stockmarket movements, by the exit window of PE investors
who want sizeable returns, and by human aspiration.
No End In Sight?
Reports say that Narula has agreed with his creditor commercial
banks to allow a re-audit; he wants them to pick the auditors
(something he had disagreed to earlier). This may suggest that
he is confident that there is no substance to the allegations
of fudged financials.
By taking the matter to court, however, Narula may have tied
the hands of his PE investors. Once things move into the
legal arena, there usually is no going back to the negotiating
table, says an investment banker. So chances of a settlement
or understanding between the two parties have weakened.
The clash has also dented reputations: Narulas, the PE
firms, the auditors, and the advisors. When
the smoke clears after the re-audit, which people estimate should
be in about six months, it might well turn out that the spat was
ill-advised. If nothing else, the value that the promoter
and investors would have realised (through an IPO) is unlikely
now, says an investment banker. As one put it, what a tragedy
(This story was published in the Businessworld