How to conduct your own due diligence on Indian IPOs from prospectus

Be it concession agreements, articles of association, prospectus, letter of offer etc, legal documents of any consequence usually have a default standard template or else statutorily mandated minimum disclosures. That 'boilerplate' is there for a reason but retail investors may tend to gloss over that, instead favoring the sexier details like business information/industry information etc. That is why I decided to list out some useful information mandated by the Indian securities regulator SEBI, for investors to ponder over. This is usually found in the section OTHER REGULATORY AND STATUTORY DISCLOSURES. Some factors are hygiene factors to ensure that the issue is authorized, promoters are not debarred from capital etc, financial eligibility for issue etc  but other factors for really meant for information purpose, and those are the factors I cover

1. Listed ventures of Promoters:-This information is needed to be disclosed, and if those companies are underperforming/in same line of business without non compete/have let down investors in the past, then prospective investors should beware
2. Previous issues of Equity Shares otherwise than for cash:-This allows the readers to assess the extent of 'sweat equity' or 'in kind' equity allotments of the company. Too much of that may mean asset valuation is suspect..
3. Promise vis-à-vis performance:- This data is needed in case company/promoter group companies made any previous rights or public issues. This data would help identify those promoter groups which have sick companies etc in their midst, or whose issues bombed in the recent past
4. Outstanding debentures or bonds and redeemable preference shares and other instruments:- Though the capital structure/balance sheet lists those instruments, this portion explicitly details the contingent capital securities. 
5. Changes in Auditors during the last three financial years:- This is a red flag, which might indicate that company wanted more pliant auditors to certify their IPO proforma statements. Of course, it may be that the company felt it had outgrown its existing auditors/for other genuine reasons. But any change here does warrant a closer look.
6. Revaluation of assets during the last five (5) years:- Any suspect looking revaluation(especially one done near the IPO time itself) may need adjustment while valuing the company. 

Under the section GOVERNMENT & OTHER APPROVALS, there is useful information as well. Despite the apparent liberalization, large portions of the ecosystem is still controlled by the Government. Hence, relevant permit raj information would be

1. Approvals applied for and pending:-Looking at the application dates would give a good idea of the company's foresight/planning. For example, filing for a trademark just months before an IPO smacks of negligence. But applications pending for too long(what is too long is professional judgement) are risky
2. Approvals to be applied for the Objects of the Issue:-To the extent major objects need approvals not yet applied for, that increases the risk. 

 Under the section OUTSTANDING LITIGATION AND MATERIAL DEVELOPMENTS, that gives a good idea of contingent liabilities and reputation risk(in case of group company/directors litigation). The company needs to give an undertaking that Except as stated herein, there are

1. no outstanding or pending litigation, suits, civil prosecution,criminal proceedings or tax liabilities against our Company, our Directors,  our Promoters and Promoter Group and 
2. there are no defaults, non-payment of statutory dues, over dues to banks and financial institutions, defaults against bank and financial institutions and there are no outstanding debentures, bonds, fixed deposits or preference shares issued by our Company; no default in creation of full security as per the terms of the issue, 
3. no proceedings initiated for economic or other offences

 Under the section MANAGEMENT DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, there is some useful information towards the end which includes

1. Unusual or infrequent events or transactions:-Though exceptional income have to be identified separately, the events must be identified separately as well.
2. Significant economic changes that materially affected or are likely to affect income from
   continuing operation:-While this is likely to be positively biased, merchant bankers might state even negative trends in fear of being hauled up by SEBI
3. Known trends or uncertainties:- This covers factors expected to have/have head a material adverse impact on sales, revenue or income from continuing operations.
4. Future changes in relationship between costs and revenues:-This helps for modelling if disclose given in useful/complete manner, which often it is not. 
5. Source of material increases in revenue:- The company must disclose the extent to which material increases in net sales / revenue is due to increase in sales volume, introduction of new products or services or increased sales prices. That allows investors to assess the strategy-margins, penetration
6. Status of any publicly announced new products or business segment;- This ensures that the company does not get away with fluff/vapourware. Of course, what is 'new product/business segment' is subjective, but SEBIs effort is commendable to seek this disclosure.
7. The extent to which  Company’s business is seasonal:-This helps interpret quarterly results in a correct manner, and also assess impact of climate change etc
8. Any significant dependence on a single or few suppliers or customers:-Concentration risk can be evaluated, thereby discounting the valuation accordingly.
9. Competitive conditions: No where else do companies have to disclose their competition explicitly. This requirement compels them to state their competition

Of course, if the merchant banker slips up on ensuring full disclosure, then even this can be gamed. But barring that, these are red flags which should be looked out for. 

The Caryle Group IPO governance/tax analysis

The above analysis is based on the Jan12 prospectus filed with the SEC(read it http://www.sec.gov/Archives/edgar/data/1527166/000095012312000638/w83442a2sv1za.htm), and the only reported amendment till then is that they have dropped the statutory arbitration for resolving disputes. But a host of other governance and valuation issues remain. My analysis on the IPO is as follows

1. As Seeking Alpha contributor Stone Street Advisors correctly points out in their post(http://seekingalpha.com/article/320660-carlyle-group-ipo-is-the-juice-worth-the-squeeze-glencore-redux), the fact that savvy investors are issuing stock itself indicates that they feel the market will overvalue them. One may contend that this is true for ALL issuers(maybe another reason why IPO returns are low), but looking at the post IPO records of financial service firms like Goldman Sachs and Blackstone, it does not inspire confidence. However, given that President Obama may treat hedge funds as a separate taxable entity instead of a pass-through partnership for tax purposes, Caryle may be in a hurry to raise funds before that proposal becomes law and leads to a steep hike in its tax bill. Hence, the market conditions timing argument may not hold water
2. Corporate governance limits typical to other PE firms:-Strictly speaking, Carlyle Group L.P is a limited partner, and as the name indicates, it has limited liability(and therefore limited rights). While it is but natural that limited partners cannot "remove" the general partner, the prospectus takes it to the other extreme and does not allow public shareholders to appoint directors on their own behalf of Carlyle Group L.P. Also, typical to the banking industry which prefers counterparties to clients, any fiduciary duty of the general partner towards the limited partners is eliminated. 
3. Unit holders have uncontrollable tax liabilities without assurance of compensating dividends: The Carlyle Group L.P. will be treated as a partnership for U.S. federal income tax purposes, and unitholders will be taxed on their pro-rata share of items of income, gain, loss and deduction in computing their U.S. federal income tax liability.  Yet, in the event of profits, they are not assured of adequate cash distributions to meet the same. While the company may yet declare to avoid unit price erosion, that is a material risk, especially for large unit holders.
4. Squeeze out provisions at market value without premium if declared as investment company under the U.S. Investment Company Act of 1940:-Besides the regular squeeze out provisions if public holding falls to 10% or less, there is another clause allowing the General Partner to purchase all public interests at the outstanding market price(or if greater, the highest price paid by it during last 90 days). This does not envisage takeover premium, and imposes a substantial tax risk on shareholders, for no rational reason without compensation. 

Hence, given the market timing concern, lack of control rights and possibility of potential tax issues like less dividends and squeezeout, the IPO seems risky for investors. Of course, the company's track record is impeccable, but the securities in their present form do not seem attractive as investments

Jawed Habib Saloons Rs 60Cr IPO_an analysis

A week ago, the famed hair stylist Mr Jawed Habib's company filed for an IPO. Investors following Peter Lynch's philosophy of 'investing in what you know' may feel that this is a lifestyle business and will grow as per the 'demographic dividend' hypothesis. But reading the prospectus is essential, and in this case throws up some nuggets.  The foll are the red flags I noticed in the prospectus

1. Unusual franchisee business model without adequate controls:- Usually, a franchisee operates on a royalty cum profit share basis. But the salons(majority of the company's salons) pass on their entire collections to the company which in turn pays them the agreed share. Though this may have the same economic effect, scope for fraud/embezzlement is more. And by the company's own admission, there is no foolproof mechanism to verify and ascertain the accuracy of reporting. However, their proposed ERP solution, if implemented right, promises to mitigate this risk.
2. Conflict of interest by promoters:- Group Companies( Habibs Hair & Beauty Studio
   Private Limited and Jawed Habib’s Hair Xpreso Private Limited) shall operate under the same or similar name with simillar objects and business activities. There is no 'non compete' agreement. 
3. Heavy promoter dependence:- While the company has standardized their training
   methodology and the franchisee operation, they still depend on Jawed Habib(as the name shows). Succession issues could be a problem here.
4. Unfathomable independent directors:- An auto OEM promoter(albeit with CA degree), a Padma Shri awarded political cartoonist and a Reliance Broadcasting COO-are the 3 independent directors. What value would they bring to the company, is difficult to fathom. And more importantly, will they be able to protect the shareholder's interest?
5. A 22 yr old compliance officer:- I'm not demeaning merely because of age but the company engaged a 22yr old ACS as its compliance officer. Considering the rapid expansion plans, and the possible related compliance issues, this decision is hard to stomach.
6. Neither Director, Finance nor Head, Accounts are CAs:-Despite the Satyam aftermath, a CA's guiding arm helps in a company's finance and accounts function. And this company has neither
7. Heavy pay disparity between non promoter director and others:- The Director(Franchising and Operations)-a 32yr old former consultant from ISB gets Rs 48 Lakh CTC but other senior management even 40-50yr olds get Rs 5Lakh-7Lakh. This disparity does not reflect well on the company and may induce attrition..

On the positive side, these are some good aspects

1. Own training academy for staff:- All the general hair-stylists and salon managers in  salons are mainly sourced from their academies.
2. Media promotion agreements:- Though ethically questionable, they have 'private treaties' with Brand Equity Treaties Limited(Times of India affiliate), which results in (more than deserved?) publicity for the brand. BETL gets Rs 18 crore worth advertising in return for Rs 6 crore cash & Rs 12 crore worth of equity.
3. Promoter routes his brand ambassadorship through the company(!):- In Dec-10, the Promoter in the capacity of Managing Director of the Company became Brand Ambassador of Panasonic’s hair drier products. This action reflects some generosity on his part. 

My take
 Given this company's lack of control systems and 'small company approach', be aware that you are basically investing in a one-man-show. Also, given that the promoter's average cost of acquisition is just 4.74 per Rs 10(face value) equity share, inducement to exit may be there Given the fragmented business model and risks with expansion, better avoid for the time being.

Tata Autocomp Systems IPO_qualitative concerns_AVOID

Like most Indians, I believe(rightly so) that the Tata brand stands for trust, loyalty, faith etc. So when I noticed the first(in a long time) IPO offer from the group in terms of Tata Autocomp Systems (TAC), I initially thought of subscribing to it w/o reading the prospectus. But remembering the RPower IPO fiasco, I decided to read the full DHRP available here And quite a few aspects of it are surprising, in a negative way.

• Entirely a stake sale by promoters:-The company will not receive anything from the IPO. It reflects on the confidence of the selling shareholders that they do not want to sell their sales in the secondary market but want an assured exit via IPO. This does not infuse funds into the company-and therefore is a risk factor when there are other opportunities out there that actually infuse funds into the firms.
• Qualified accounts;-To quote from the prospectus(risk factor 6), "The Company has not made provision for any possible diminution in the value of long-term investments aggregating Rs. 919 million in two of its joint venture companies, Tata AutoComp GY Batteries Limited and Tata Yazaki Autocomp Limited, whose net worth has each substantially eroded on account of losses". This IS a regrettable practice followed by several Indian companies-postpone write downs calling the investment 'strategic' etc but is hardly expected from a Tata Group company.
• Breach of covenants without renegotiating:-As per risk factor 8, the interest cover covenant on a   $23MM loan from HSBC  was breached in Oct-08. The default still continues with the only penalty being a higher interest rate. For such a small loan, it is surprising why the breach continues.

Despite all this, the company still remains a Tata Group company post IPO(with 75% majority holding) so may be considered as "Too Big to fail". But still, investing in better quality paper of the same group may be advisable from a fundamental aspect.

I have not considered the industry fundamentals or the pricing. This analysis is purely qualitative.