Initial Disclosure: After extensive research, we have taken a short position in shares of EROS. We stand to benefit financially if the stock price declines. This report represents our opinion, and we encourage every reader to do their own due-diligence. Please see our full disclaimer at the bottom of the report.
The last couple of days has seen a dramatic series of events for Eros, a company that has been dogged by allegations of accounting irregularities for years (including in several articles written by us: 1, 2).
India’s second largest credit ratings agency, CARE ratings, suddenly lowered the rating on Eros’s key Indian operating subsidiary by 10 notches to “Default”, catalyzing a wave of intense selling pressure across Eros’s entire capital structure.
Eros’s Bombay Stock Exchange-listed subsidiary subsequently cratered limit-down, along with Eros’s unsecured bonds trading -43%, followed by its NYSE-listed stock which finished the day down about 50%.
Eros initially responded to the default news with a morning press release stating:
Eros International PLC and all of its subsidiaries have met and continue to meet all debt service commitments.
The story already shifted by mid-day however when a follow-up press release acknowledged that its subsidiary was actually late on two loan payments:
(the subsidiary) was late on two loan interest payments for April and May 2019. These interest payments total less than $2 million and are currently in process of remittance.
The release then reiterated the company’s strong cash and liquidity position, although this seemed to do little to allay investor concerns (the stock remained roughly flat from the time of announcement until end of day).
The implosion of Eros’s capital structure seems to have caught many market participants off-guard. Macquarie analysts covering the stock put out a research note entitled “Hard to Explain“, with their best guess being that Eros defaulted due to a “clerical error”.
For us, this unraveling couldn’t have been more expected. We have been tracking Eros’s rapidly deteriorating financial condition closely and were in the process of finalizing this investigation which sought to understand these very issues in more depth.
With Eros’s high short-term debt balance, its recent failure to raise an onshore bond, and its failure to collect on its suspiciously high receivables balance, a liquidity event seemed to border on inevitable.
The reasoning cited by CARE for the default rating was a “slowdown in collection from debtors” which led to cash flow issues at the company. Per the report synopsis:
The “slowdown in collection” echoes the criticism of multiple short-sellers over the past several years (including us) who had identified patterns of suspicious related-party entities and large amounts of revenue that the company has had persistent difficulty in collecting.
Quite frankly, our belief is that Eros is having a hard time collecting on its receivables and advances because we think a significant portion of them do not actually exist.
When faced with past questions about revenue and receivables from skeptics Eros chose to sue them all, including us, alleging a massive “short and distort” conspiracy. The lawsuit was recently dismissed against all moving defendants.
Instead of cowering to Eros’s bullying tactics, we instead decided to take our research to the next level.
In this report, we will share findings from our on-the-ground investigation to Mumbai, and from interviews conducted with multiple former employees globally.
Our primary goal was to learn more about Eros’s mysterious and growing uncollected receivables balance, which appears to be at the core of its current liquidity situation.
As we will show, we think Eros’s collapse is an egregious failure of its auditors, Grant Thornton, to apply even basic scrutiny to the company’s financial condition. This comes as no surprise: In the wake of another ‘mysterious’ financial collapse at one of its other clients last year, the CEO of Grant Thornton said (quite infamously):
We are not doing what the market thinks. We are not looking for fraud and we are not looking at the future and we are not giving a statement that the accounts are correct…we are not set up to look for fraud.
You can say that again Grant Thornton.
We will dive into what we believe are accounting irregularities in the reported financials, but a quick analysis of Eros’s reported numbers showed a poor liquidity position as-is:
At a glance, a company with high short-term debt, historically negative free cash flow, and low available liquidity represents an obvious credit risk. It is for these reasons that a large number of companies decide to get supply chain financial risk mitigation. Ultimately, mitigating financial risk is all about lowering the level of risk by eliminating or reducing risk factors that could leave a business in financial ruin.
Going one level deeper, Eros has been the subject of multiple historical articles identifying accounting irregularities (1,2,3,4,5,6,7,8). Many of these articles have focused on red flags like Eros’s large uncollected receivables balance and consistent lack of positive free cash flow.
Eros’s days sales outstanding (DSO) indicate that almost a year’s worth of revenue has been booked but never collected. It is this lack of collection that seems to be contributing to Eros’s current liquidity meltdown.
(Note that large, growing receivables balances and a consistent lack of positive free cash flow generation are two common red flags often associated with revenue falsification):
We will next explore Eros’s relationship with a variety of questionable entities that we believe are contributing to its current situation.
Next Gen is one example of a related-party entity that we think Eros may have trouble “collecting” from.
Next Gen is a film production company owned by the brother-in-law of Sunil and Kishore Lulla, Eros’s Chairman & CEO respectively. [Pg. 98] The entity has received $153 million in net payments and advances since 2012 (the earliest year reported in Eros’s SEC filings.)
According to its website, Next Gen has produced only 5 films since 2012, all of which were co-produced and/or distributed with Eros. We find this odd: Why fund Next Gen with hundreds of millions of dollars only to then co-produce/distribute all of their films?
Again, these films were largely co-produced by Eros which means that Next Gen likely hadn’t even shouldered all of these production costs itself:
If production costs totaled only $19.3 million, where did the other $133+ million go?
Next Gen also claims to buy and sell catalogue film rights, yet its website shows no films purchased or distributed. This doesn’t seem to explain the massive amount of money sent into the entity either. It also raises the same question-why would Eros send money to Next Gen only to buy catalogue films from it?
We visited Next Gen’s offices and found it to be far from what you would expect out of a supposed high-end Bollywood production company allocating hundreds of millions of dollars to movie projects.
Next Gen’s website doesn’t list an address, so we had to dig through the entity’s Indian private company filings to find its headquarters. The address is listed as ‘6-A/10, Junu Sangeeta Apartment, Santacruz (West), Mumbai.’
The offices are located in the Juhu Beach area and, more precisely, in a small enclosed area called “Sangeeta Apartments”. As the name suggests, and unsurprisingly for the location of a suspected shell company, the area is largely residential. Here we are at the Sangeeta Apartment complex on May 4th of this year:
And here is the Indian investigator in front of Next Gen’s offices (you can see the Next Gen sign in the background):
The company is located on the ground floor of what has been identified by one of our Indian advisors as an SRA building. SRA stands for “slum rehabilitation authority”, a government institution in charge of taking slum constructions and, with minimal modifications, turning them into buildings safe for living. This is clear from the photograph, which shows metal bars at the exterior of the building — typical signs of SRA intervention.
Our Indian consultant explained that many “dodgy” businesses tend to be located in slums or former slum locations because the authorities are less likely to check the premises and interfere with their activities.
We were able to briefly enter the Next Gen offices and accessed what seemed to be the main area. It was a small room with a desk and a couple of posters. We saw little to no commercial activity going on at the premises.
Immediately upon entrance, a middle-aged man with a mustache approached us with a worried and suspicious disposition. This person, as far as we could tell, was the only employee present during our three visits to the premises, and was unable to communicate in English.
The impression we got from this visit is that of a sham office where little to no real activity is going on at a location totally unsuitable for movie production; an industry most would associate with a nice building, well-stocked offices, and plenty of high-level employees.
A 2016 class action lawsuit against Eros included witness testimony alleging that Eros uses Next Gen as a means of funneling money to the company’s insiders. Per the amended complaint [Pg. 22]:
Confidential Witness (“CW”) 2 is an Indian film producer with personal knowledge of the Company’s business practices in the period immediately leading up to the Class Period, as a result of his work co-producing films with Eros, including at least one film released in 2011. According to CW2, Eros channels money to family members through dummy production deals.
According to CW2, 30-40% of Eros’s acquisition and production occurs through Next Gen, owned by Kishore Lulla’s brother-in-law Puja Rajami. Further, according to CW2, NextGen signs the co-production agreements with EIM, and Eros makes payments to EIM, which, in turn, makes payments to NextGen to produce the films.
Thus, NextGen collects money on films but provides no added value, according to CW2. CW2 also avers that NextGen employees use Eros’s offices and do little other than make a margin on the film. CW2 also avers that Lulla’s wife also receives advances as a producer.
The lawsuit was dismissed, likely due to a lack of additional evidence. In light of our latest findings on Next Gen, however, we view the witness testimony as highly prescient.
We think investors deserve to know:
Aside from Next Gen, and guided by our interviews with former employees, we explored other entities related to Eros’s Lulla family for clues to what is happening with Eros’s receivables balance. As alluded to earlier, we think the reason Eros has been unable to collect on its receivables is because it may be circulating them through its myriad related-party entities.
Our research led us to an entity called InfraDigital Technologies that operates out of a different suite at the same address as Next Gen.
The entity is clearly a related party of Eros. Its two directors are (1) Anand Shankar, Eros’s finance controller and (2) Sagar Surender Sadhwani. (Surender Sadhwani is Eros’s director of Middle East operations and the cousin of Eros’s Chairman and CEO, Kishore Lulla and Sunil Lulla.)
Per the latest director’s report we can see both the directors and the address:
From the latest financials for the entity we see that it generated only about $90,000 USD in operating revenue yet had “Long term borrowings” and “Long term advances” of about 5x that amount, $427,000 and $482,000 respectively.
The borrowings come from related-parties Next Gen and Eros Labs:
And the advances go right out to related-party Eros Television:
If this is all starting to look very circular it’s likely because it is all very circular.
From the same audit we see that 99.99% of the shares of Infradigital are held by a Singaporean entity called Eroslabs Pte, revealing that the entity is not part of Eros’s corporate structure:
We wonder, why do Eros’s principles have multiple entities engaging in numerous related party transactions based out of a small apartment in what appears to be a rehabilitated Mumbai slum? What legitimate business could be taking place here?
InfraDigital looks to be just one of multiple entities that exhibit similar characteristics.
Eros Television is an entity based out of the same address as Eros’s Indian registered office, yet which falls outside of Eros’s corporate structure. From the entity’s recent directors report we see its address:
And from the Eros website we see the registered office matches:
In other words, this entity falls outside of the Eros corporate structure but is clearly a related party that exists at Eros’s own address.
As we see from its latest audit, Eros Television has generated zero operating revenue for the prior 2 years, had zero inventory, no fixed assets, and no investments, yet its balance sheet is laden with large, suspicious advances and payables:
We see that the advances largely consist of “advances given for film”, suggesting that the entity lends out a massive amount of capital to procure films.
As we had noted earlier, Eros sued us in 2017 after we had identified that the company appeared to be engaging in undisclosed related-party transactions. We had initially emailed Eros to ask about such transactions, but rather than respond to our questions they instead filed a lawsuit against us and dozens of others in an effort to silence criticism.
Despite the lawsuit, Eros eventually admitted in its 2017 financials that it had taken a $6.4 million loan from Eros Television, one of the very entities we had identified as suspicious. [Pg. 98]
While we were pleased to see that Eros eventually disclosed its dealings with Eros Television in its 2017 financials, we see that no related party transactions with Eros Television were disclosed in 2018:
(Note that Eros Television was mentioned 3 other times in the 2018 financials, but similarly disclosed no other transactions aside from the 2017 transaction.)
We found this incredibly surprising. We see that Eros Television in fact engaged in plenty of related party transactions in 2018 according to the entity’s own audit:
As you can see from the above, the large transfers have gone through this entity both to and from Eros’s subsidiaries and its key individuals. Aside from this apparent system of advances and payables we were unable to identify any other operations or purpose for this entity.
We view this as another major failure of Eros’s auditor, Grant Thornton, to monitor an entity with a documented history of engaging in undisclosed related-party transactions. There is simply no excuse for this repeated failure.
Given that Grant Thornton seems to have exercised virtually zero oversight over Eros’s financial controls we sought to see if anyone else was monitoring the situation.
We see from Eros Television’s latest audit that the entity is audited by a firm called R.R. Gawande & Co. The proprietor can be reached by email at either his Hotmail account or his Yahoo account:
We visited Gawande’s offices in May 2019. The office is located in a humble neighborhood in Mumbai called Goregaon and within a commercial building called “Express Zone”. To enter we first walked past a few cows lounging under a tent at the gate:
On the inside, the facility was poorly-lit and run-down. Most of the commercial space looked vacant.
Gawande’s office was clearly marked with a sign on the second floor. The office was tiny, barely enough for a single desk and a table with a mug of coffee.
When we entered, Mr. Gawande was sitting with a younger co-worker. Although we entered the office on the pretense of being a potential client, the staff was clearly suspicious (they probably do not get many walk-ins).
Needless to say, the staff’s disposition and the lack of office infrastructure is not what we would have expected for an establishment that audits entities associated with Eros and the Lulla family.
Shortly after our meeting, Mr. Gawande, possibly advised by Eros to behave cautiously with curious strangers, discontinued all communications with us despite our repeated attempts to contact him again.
All told, we do not think Gawande is a credible auditor, though he strikes us as a perfect auditor for an entity with virtually no operations aside from suspect receivables and payables.
As early as 2009, Eros’s principles had been credibly accused of engaging in related-party transactions to help a company inflate revenue and earnings following an investigation by audit firm BDO.
From the article:
A probe has discovered Eros has been used in an apparent effort by a Soho-based special effects group to embellish its financial results.
Senior company insiders say a confidential report two years ago by BDO, the accountant, found a pair of questionable transactions between Eros and Prime Focus, which is run by Namit Malhotra and best known for its special effects work on Avatar.
Prime Focus’ independent auditor disputes BDO’s findings.
Insiders at Prime Focus claim the deals artificially inflated the turnover of its London subsidiary, helping the loss-making operation return to profit.
There should be no surprises about what is happening now.
Speaking of ‘now’, the equity bull case for Eros has generally relied on a belief that ErosNow would be a massive success. In a liquidation scenario, creditors would also want to know what the value of the platform could be.
In its last earnings release, Eros touted that ErosNow reached 15.9 million paying subscribers, an impressive milestone.
Despite the rosy headline, Eros’s accounting around ErosNow revenue looks muddled. Rather than simply reporting revenue from the platform, last quarter’s release (for example) just vaguely declared that revenue growth was “fueled primarily by Eros Now” without stating clearly how much was generated from the platform.
Understanding true usage and adoption is also a challenge based on Eros’s reported numbers. The “paying subscribers” metric, for example, seems to consist largely of users that have simply bought new phones that come with pre-paid content bundles. Such numbers say nothing about usage or user engagement.
The platform’s active users are minimal, according to independent metrics provided by KalaGato, a service regularly cited by Indian media that tracks over-the-top (OTT) content app usage and downloads.
According to KalaGato, ErosNow barely registers as a player in the space, ranking 15th with a market share of about 0.16% as of December 2018.
By all measures ErosNow’s usage seems minimal, despite years of company suggestions that the platform represents the future of Eros.
For those who have followed the Eros saga closely, the latest news looks to be the culmination of the inevitable:
Our prediction is that the company will repeatedly attempt to re-assure bond and equity holders that ‘everything will be fine and we are well-capitalized’ all the way down.
Good luck and safe investing to all.
Disclosure: I am/we are short EROS.
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 The first 5 people who are able to positively identify the Indian investigator will win a free Hindenburg mug, a quintessential addition to any kitchen cabinet.