Eros struggles to fend off heat from investors

Doubts over Eros's strategic focus and its accounting practices have hurt its share price despite several attempts by the company to assuage investor concerns

Before Wells Fargo downgraded Bollywood film maker and distributor Eros International's stock to 'market perform' last week, citing lack of clarity in its books of account, there were other investor groups which seemed uncomfortable with the company best known for this year's blockbusters Bajrangi Bhaijaan and Tanu Weds Manu Returns.

In May, London-based activist investor Knight Assets, which owns around 2 per cent of Eros, had written to the company's chairman, Kishore Lulla, that he should simplify the holding structure and get future-ready. Knights Assets said in its letter that Eros should swap shares in its Indian subsidiary for American Depository Receipts, thereby reducing transfer pricing issues, and allowing American investors to better participate in the Bollywood story.

Knight Assets claimed the company needed to get its strategic focus back, clean up its books, leverage its balance sheet and focus hard on platforms such as ErosNow, a video-streaming service billed as an answer to Netflix.

The objective, the investor group said, was to help Eros unlock shareholder value.

From then to now, though, shareholder value of Eros International, which is listed on the New York Stock Exchange, has only eroded: its share price has fallen 22 per cent since May.

The company has tried from time to time to assuage investor concerns including stating in June this year that it would delay its TV channel launch by a year as part of its endeavour to focus on its key business of film production and distribution, and also to be able to leverage it better on newer platforms such as digital.

On Monday, the share price of Eros's Indian subsidiary, Eros International Media, fell nearly 10 per cent on the Bombay Stock Exchange as investors reacted to the news of the three US law firms launching a probe into alleged accounting fraud by the company. The stock has since recovered, and it traded up 7 per cent on the BSE on Wednesday. But Monday's concerns prompted the parent to issue a statement to clarify its position for the second time in a week. In the statement, Eros said it was confident of its business fundamentals. To defend itself against possible class-action suites, Eros said its audit committee had appointed US-based law firm Skadden, Arps, Slate, Meagher & Flom LLP to conduct an independent review of its accounting practices.

Is it too little, too late?

While Lulla was not available for comment, the company has come down hard on allegations of financial mismanagement in its latest statement, and has said there is a "vicious campaign" to damage its credibility.

"No new facts about the company have come to light since the filing of the FY2015 financials or its Q1 FY2016 financials at which time the market sentiment was extremely positive," it said.

Responding specifically to the issue of increasing trade receivables (amounts owed to the company by customers), Eros said that a 21 per cent increase in its FY15 revenues accounted for nearly $50 million of the overall increase in receivables.

For a film producer, receivables are dues from the distributors and exhibitors. Typically, receivables in the Indian film industry are due when a movie is a hit. That is because producers and distributors/exhibitors work on an agreement that the excess amount (called income overflow in film industry parlance) after deducting costs (such as minimum guarantee, publicity and commission) will be shared between the two. In most cases, there is a delay on the part of distributors/exhibitors in making these payments, resulting in trade receivables.

In the case of a flop movie, the question of an income overflow does not arise. Producers typically have to be satisfied with the minimum guarantee amount they have got from distributors/exhibitors.

Wells Fargo pointed to UAE being a trouble spot for Eros in terms of receivables, stating that it had not disclosed the full liability there. It added that the contribution of the UAE market had increased sharply to 36 per cent of consolidated FY15 revenues against 10-12 per cent in the previous year. Eros denied that was the case.

The company claimed in its latest statement that it had in FY15 disclosed a possible increase in receivables after it had renegotiated and given extended payment terms to customers amounting to $31.2 million. This had caused the spike in trade receivables that year, it said.

Meanwhile, investment blog Alpha Exposure noted in its post a few days ago that due to aggressive accounting practices, Eros's reported earnings were significantly overstating the economic reality of its business model and that its subsidiary's financials raised many questions.

ErosNow, the company claimed on September 30, had over 30 million users, which Wells Fargo and a number of analysts have contested, saying it was difficult to ascertain whether this number was true or not.

"Public websites that track app downloads (i.e. App Annie) show relatively low rankings for ErosNow versus other Indian streaming services with lower user counts (such as Saavn had 14 million users of July 2015, yet ranks higher on App Annie). We can't reconcile the disparity and it's a red flag for investors," Well Fargo said in its October 23 report.