| HONG KONG
HONG KONG May 18 Last September, less than two
weeks after an IPO plan was approved, the private equity owners
of India's Lilliput Kidswear got a call that set off a chain of
events that could wipe out their investment.
According to sources with knowledge of the matter, an
anonymous caller phoned Lilliput's accountants on Sept. 22 with
information that revenue figures might be inflated.
The next day, executives at the Mumbai offices of private
equity firm Bain Capital got the same call. They quickly told
their partners in Lilliput, TPG Capital.
What followed is an ordeal symbolic of both India's rapidly
sagging private equity market and a reminder of the perils that
await foreign investors there.
It also highlights the broader souring of hopes for India,
where policy paralysis, corruption scandals, flagging growth and
high inflation have sapped investor confidence, prompting net
foreign fund outflows of $540 million in March and April.
Bain and TPG have accused India's largest kidswear company
of accounting fraud, in a case filed with the Delhi High Court.
The court in November appointed SS Kothari Mehta & Co. to
conduct an independent audit of Lilliput's accounts, but the
report remains incomplete.
Lilliput's founder, Sanjeev Narula initially cooperated with
the audit but then stopped, according to court documents, saying
the probe went too far. At a High Court hearing on Wednesday,
the court ordered that the audit dispute be settled by an
While details of the case are unique, including accusations
of threatening text messages and inciting protests, the failure
of an Indian entrepreneur to successfully team up with a Western
private equity group is common in Asia's third largest economy.
The dollar figure involved for the private equity firms,
which oversee around $110 billion combined, is not large. Bain
invested $60 million and TPG put up $26 million for the 45
percent Lilliput stake, which sources familiar with the matter
say the two firms have written down to zero as the company
teeters on the brink.
What's at stake for Bain and TPG is their reputation in
India, with Narula accusing the firms of crippling the company.
For the Indian private equity market the danger is that,
should an accounting fraud be proven, it would be another red
flag to investors, according to industry insiders.
The excitement of private equity opportunities in India,
which reached fever pitch in 2007-2008, has crumbled.
"India has given almost zero returns in absolute terms in
the past decade, despite high economic growth," said Anubha
Srivastava, Asia managing director for CDC Partners, which has
backed 24 private equity firms in the country.
In 2008, 49 private equity funds with a focus on India
raised $13.9 billion, according to Preqin, an industry data
provider. Last year the number of funds dropped to 27, raising
just $5.3 billion.
For India specific funds, the number of companies invested
in dropped to 38 last year from 155 in 2007, according to
Thomson Reuters data.
The reasons for the drop are varied, industry players say,
among them archaic rules that foreign investors thought would be
updated but never were.
India's complex M&A rules effectively rule out leverage
finance, which makes deals less profitable for foreign firms by
discouraging them from borrowing money to make acquisitions,
forcing them to use more cash.
The so-called "floor price" rule means that when a foreign
investor puts money into a company it has to pay above the
average price of the stock within a six-month range.
Private equity firms have a track record of job cutting and
over-levering companies with debt. But they also have a record
of success too, and in the case of foreign firms, they have
much-needed capital to spend in a place like India, which could
help fuel parts of India's lagging corporate sector.
That isn't happening, and now India's economic slowdown is
only making the situation worse.
"India portfolios in the 2006-2008 cycle are probably worth,
on average, around 40 to 50 cents on the dollar," said one
Western private equity executive investing in India, who did not
want to be named.
Major buyout firms that flocked to Asia in the last five
years saw opportunities in both India and China. The China
market was viewed as high risk and high reward, while India
offered steady growth and a more transparent market.
With a few exceptions, India corporate governance was not
viewed as a major hindrance for foreign private equity firms.
But as the Indian economy slows, some worry that a few other
cases of companies accused of cooking the books will go from a
trickle to a stream.
"As things slow down, these things come more to the
forefront," said Reshmi Khurana, India country head for Kroll,
which specialises in due diligence for investors.
In the Lilliput case, sources close to Bain and TPG
acknowledge that their due diligence failed to find
irregularities prior to the investment.
The sources say the buyout firms were encouraged by the fact
Lilliput had an independent board, a reputable auditor - the
local affiliate of Ernst & Young, S.R. Batliboi & Co - and prior
ownership by an established, large, local private equity firm.
A Feb. 6 letter sent to Lilliput and the independent
auditors from the attorneys representing Bain and TPG says
Lilliput sales may have been inflated and profits overstated,
and "direct or indirect transactions with related parties may
have been consummated for the purpose of furthering the
Court documents also allege Narula organised a mob of as
many as 100 demonstrators who went to the offices of Bain and
TPG's lawyers in Delhi after the court battle surfaced, waving
placards and shouting slogans, an incident captured on CCTV
footage and filed with the High Court.
Narula has also sent "unsolicited and unwarranted text
messages (SMSs) that contain oblique and hidden threats", the
Reached by phone, Narula denied the allegations and said the
whole situation could have been resolved through face-to-face
talks with Bain Capital.
"These things cannot be settled by the court. These things
have to be sorted out between Bain and me," Narula said.
After some early success stories with firms such as Warburg
Pincus, private equity appetite for India is fading. Investment
returns have fallen far below expectations after a strong
initial run in the mid-1990s to around 2004.
By comparison, returns from private equity investments in
China in the last five years are, on average, more impressive.
"From 2004-2009, most investors have generated low single
digit returns, compared to China which gave 20 percent," said
Bain and TPG, who declined to comment for this article,
invested in Lilliput in March 2010.
Lilliput, based in New Delhi, makes and sells branded
kidswear in India and exports finished goods to international
companies including Gap Inc, Mothercare,
Wrangler and Macy's.
According to sources, Bain and TPG's plan was to help the
company expand production to tap the new middle class consumer
in India's booming first and second tier cities, and boost
exports to international markets at the same time.
Narula says total retail space at the company, grew from
220,000 sq ft to 800,000 sq ft in the 18 months after Bain and
The buyout firms' plan to grow the company appeared to have
a positive start, and nearly resulted in an IPO, which the board
approved just before the fraud allegations erupted.
Now, Lilliput's debt load - around $47 million according to
a pre-IPO business plan seen by coupled with the court
battle that has resulted in bank credit lines being frozen since
October last year, is strangling the company.
"We have shut down 25 shops because of financial strains, we
have sacked around 10,000 people," said Narula. "Twenty years of
my efforts have gone down the drain."