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Kishore Lulla's <br> toughest hour </br>

Here’s why Eros International’s market cap has fallen 50% in the past month

Until last month, Kishore Lulla's Eros International Media was in focus as the production company’s ErosNow was being seen as India’s answer to Netflix. But, over the last few days, an unexpected twist has given this entrepreneurial success story, shades of a whodunnit. On October 23, Eric Katz, a Wells Fargo analyst, cut his rating on the NYSE-listed Eros International Plc to ‘market perform’ citing dissatisfaction from the explanation offered by the company’s management on its growing business in UAE. The company held a call with analysts after a Twitter post claimed that the company had manipulated its UAE sales figures. Katz’s chief concerns were: the continued increase in receivables, driven by a sudden spike in revenues booked in the UAE; whether Eros will actually be free cash flow positive by FY16, as previously guided; and validation of the actual ErosNow user count.

As on July 31, ErosNow’s user count stood at 26.5 million. According to Katz, the user count looks like a red-flag as websites tracking app downloads give a lower ranking to ErosNow versus other Indian streaming services with lower user counts. “We can’t reconcile the disparity and it’s a red flag for investors — so until we see some meaningful monetisation from ErosNow, we have a tough time giving credit for it in our valuation,” he says in the research note. Analysts are unable to understand the rise in company’s receivables despite the company’s explanation. “Management broke down the receivables in a very detailed manner, but quite frankly, it was still difficult for the analysts on the call to fully grasp the collection cycle and movement of funds (particularly deals booked in the UAE). We still don’t know the largest content buyers driving this increase, and we aren’t fully comfortable with the fact that nearly half of revenue originates outside of India,” reads the Wells Fargo note.

In a post on Seeking Alpha, an analyst who writes under the pseudonym of ‘Alpha Exposure’ says, “From 6/30/14 to 6/30/15, Eros booked revenue of $289 million. Over that same period, trade and other receivables increased $93 million. In other words, 32% of Eros' booked revenue wasn't actually received in cash. Days sales outstanding now stand at 403 days, which is an increase of 145 days from its level on 6/30/2014. As a result of the company's inability to collect receivables and its high capital investment, free cash flow has been negative for the past four years and fiscal-year 2016 looks to be no different.” The post adds that the company appears to be capitalising costs. “There has been a rapid and unexplained increased in capex in the last year. The company has only been able to stay afloat by issuing stock and taking on debt. This is not sustainable.”

UR Bhat of Dalton Capital Advisors feels that markets tend to look at cash and not so much at the capitalisation of costs. “While capitalisation of costs might not be a very good practice as long as it is within the framework of Indian accounting standards, investors may have their own view on cash flows.” As things stand currently, the locally-listed Eros International Media had a negative free cash flow to the extent of ₹621.65 crore in FY15.

Yesterday, Eros International Plc in a notice to exchanges tried to once again explain its case. “The company’s revenues from FY14 to FY15 increased by 20.7% (from $235 million in FY14 to $284.2 million in FY15). On its own, this increase in revenues accounts for approximately $50 million of the overall increase in receivables. Additionally, in FY15 the company disclosed that it had renegotiated and given extended payment terms to customers amounting to $31.2 million of receivables. The increase in revenues combined with receivables having extended payment terms, substantially explains the jump in overall receivables from FY14 to FY15.” The response was part of a clarification that was issued after media reported that three US law firms were launching investigations to check whether Eros and some of its officers and/or directors had violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The first section deals with position limits for an individual investors and the second section deals with insider trading.

Interestingly, the domestic arm of the financial services firm PhillipCapital has taken a slightly different stance and doesn’t see the receivables issue as a fresh concern. “Eros Plc’s receivables ballooned to 269 days at the end of FY15, partly explained by its aggressive accounting policy where it recognises revenue ahead of collecting payments due from TV and cable networks and partly because of library content distribution to international networks (can be up to one year). We believe this will be one of the key monitorables for the company’s financial health, but reiterate that it is not a fresh concern.”

Australian financial services firm Macquarie also takes comfort from management’s response. “The management has indicated it has made progress on collecting $35-40m in overdue receivables, which was the key element in the rise in receivables in FY15 (ended March). This implies that, if Eros meets our revenue forecast for F2Q (ended Sept) of $94m, and if there is no further step-up in new receivables, then the average receivables ratio of 0.4x and days sales outstanding of 269 days should decline in 2Q.” Despite brokerages like Philip Capital and Macquarie maintaining a bullish stance and the management trying its best to explain the situation, investors holding the stock seem to be unconvinced. After yesterday’s 10% fall to ₹250, today’s session did not see a meaningful bounce back and the stock gave up its gain for the day to close at ₹245.

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