Quess Corp' Rs 664-cr impairment loss - Cost of Covid or shopping spree?

In over 25 acquisitions the past 13 years, India's largest staffing firm mopped up Rs 1,335 cr in goodwill assets and Rs 278 cr in intangibles. A one-time write-off wiped out 40% of its investments

Quess Corp, India’s largest staffing company, posted one of its worst financial results in 2019-20, reporting a net loss of Rs 422 crore on a top line of Rs 11,043 crore.
 
For Quess, Rs 664 crore worth of assets, most of which were goodwill, were written off from its balance sheet during the March quarter. The write-off saw the company’s bottom line turn red for the first time since its listing in July 2016.
 
A one-time write-off wiped out a fifth of the company’s consolidated net worth and more than two-fifths of the value of its investment in various subsidiaries.
 
Quess Corp attributed this write-off to the global pandemic that caused a slowdown in economic activity. The management also indicated that there might be further impairment soon.
 
Post listing, Quess focused on inorganic growth, acquiring several targets at a premium to the net asset value. In many of them now, the entire goodwill amount has been written off.
 
“At the time of closure of books for March 2020, the pandemic situation had just set in, but it looked like it would last for a while, affecting the overall economy. There was no visibility of the end date and some of our businesses had zero revenue for the initial period of the pandemic,” S Ramakrishnan, chief financial officer at Quess Corp, told Business Standard.
 
“Under the circumstances, we were advised by professional consultants to relook at the projections used for goodwill, which resulted in write-offs,” he added.
 
But was it the Covid impact alone or is it the company’s bad capital allocation strategy?
 
How a mammoth deal machine called Quess was created
 
Founded by Ajit Abraham Issac, Quess was incorporated as IKYA Human Capital Solutions in 2007 in Bengaluru. It was Issac’s second entrepreneurial project after he sold his first venture, HR staffing firm PeopleOne, to Adecco in 2004.
 
IKYA Human Capital Solutions became Quess Corp when Canadian billionaire Prem Watsa acquired 74 per cent in the company through Thomas Cook (India) Limited. Currently, Watsa owns 32.3 per cent stake in Quess Corp through two of his entities — Fairbridge Capital Mauritius and HWIC Asia Fund. Issac owns 23 per cent in the company, as on June 30, 2020.
 
On its market debut, Quess was subscribed 144 times, the highest for an Indian IPO in at least the nine years prior to listing.
 
The stock was listed at Rs 500, a premium of 58 per cent against an issue price of Rs 317 a share. Its market capitalisation was Rs 17,656 crore at its peak on June 15, 2018, almost a three-fold increase since listing. The stock has since tanked and is currently trading below its listing price at Rs 346.5, valuing the company at sub-Rs 5,000 crore.
 
The company raised Rs 400 crore from its IPO and twice the amount — Rs 874 crore — through an institutional placement programme (IPP) in the next one year.
 
Quess is currently India’s largest private-sector employer with 385,000 staffers on its payroll — even ahead of TCS' India headcount. However, TCS is the largest overall employer with 448,464 employees on its payroll, including around 90,000 employees based abroad.
 
 During the past five year, revenues tripled to Rs 11,043 crore in 2019-20. The net profits witnessed similar growth, to Rs 257 crore in 2018-19, before posting a loss in the subsequent year.
 
Binge–buying
 
The acquisition spree began within a year of Quess’ incorporation.
 
In 2008, it acquired Bengaluru-based Avon Facility Management Services, entering facility management. In 2010-2011, it acquired Coachieve, an HR compliance and background verification services firm, and IT staffing solutions company Magna Infotech, among others.
 
The most notable acquisition in the pre-IPO years was that of the Sri Lankan arms of rival Randstad India, marking Quess’ expansion into the Asia Pacific and Sri Lankan markets. Quess also acquired a 49 per cent stake in US-based IT outsourcing solutions firm MFXchange Holdings Inc, a subsidiary of Fairfax Financial Holdings — the new owner of Quess Corp. It acquired the remaining stake in 2016.
 
Out of the IPO proceeds, Rs 80 crore and over 70 per cent IPP — Rs.705 crore worth of dry powder were set aside to be spent only for acquisitions and investments.
 
Naturally, the 15 post-IPO acquisitions were of a much higher value than the 10 small-ticket deals done pre-IPO.
 
According to Ramakrishnan, “The general investment philosophy of Quess is to look for businesses that are accretive to our existing lines of businesses and we have been paying valuations between 5-8x of profits of the target companies. Some assets take a longer time to turn around due to some special situations like the nature of project.”
 
In November 2016, Quess Corp acquired the facility management and catering business from Manipal Integrated Services. In the same deal, it acquired two of its subsidiary companies — Master Staffing Solutions and Golden Star Facilities and Services for an additional consideration.
 
A year later, it acquired a 51 per cent stake in Tata Business Support Services, a customer lifecycle management and BPO firm and renamed it Conneqt Business Solutions. It expanded its IT staffing solutions business by taking over Singapore-based Comtel Solutions.
 
Quess made its foray into the online job portal business when it acquired Monster.com’s India, Middle East and South-East Asia businesses from Randstad in the subsequent year.
 
In 2018-19, Quess also inked an intriguing partnership deal in a completely unrelated business. It entered a JV with almost a century-old Kolkata-based football club — East Bengal — leading to the formation of a new entity named Quess East Bengal FC. Quess bought a 70 per cent stake in the new entity for Rs 10 crore, while the rest was held by the East Bengal club.
 
Key managerial reshuffle
 
While the company was on a shopping spree, it was also going through rapid changes in its key managerial positions since its listing, with four CFOs in the past four years.
 
Company veteran Subrata Nag was the CFO of the company when it got listed. In January 2017, Balasubramanian S joined as the group CFO and Nag became the executive & whole-time director. After three months, Balasubramanian resigned from his position and Nag was again re-instated as CFO.
 
In December 2017, the company hired Manoj Jain as the new group CFO and Nag was elevated to the role of CEO. In June 2019, Jain was re-designated as business head and his deputy, Subramanian Ramakrishnan became the CFO. The company also has had three compliance officers since listing.
 
“The role of a CFO in a company is very crucial, especially for a company that has been raising funds and acquiring. Frequent changes in such a critical position are not a good sign,” said Amit Tandon, founder & managing director of proxy advisory firm, IiAS.
 
“The company has been in existence for the past 13 years and in such a time span there would be changes in key managerial positions. We believe in the right man for the right job and these decisions were taken in the best interest of the company and the individuals,” said Ramakrishnan.
 
How Quess gained, and then lost, goodwill
 
In over 25 acquisitions in its 13-year, the company accumulated goodwill assets worth Rs 1,335 crores and intangible assets worth Rs 278 crore on its books, as on March 31, 2019, together accounting for more than half the company’s total long-term assets.
 
Quess bought companies at a high premium to their fair value of net assets. Thus, the difference between the purchase consideration and the fair value, which is added up as goodwill, kept on increasing. 
 
For instance, Manipal Integrated Services, the biggest acquisition by Quess — acquired at a consideration of Rs 708.5 crore — was done at 85 per cent premium, deriving a goodwill asset worth Rs 601 crore and creating an intangible asset of Rs 115 crore.
 
Similarly, Comptel Solutions was bought at a 72 per cent premium of its fair value of Rs 70 crore. The deal generated goodwill assets worth Rs 119 crore and an intangible asset — customer relationships worth Rs 80 crore.
 
It acquired Mumbai-based telecom network operations and maintenance services provider Vedang Cellular in October 2017. Quess paid around Rs 58 crore for a 70 per cent stake on a net asset value of mere Rs 15.66 crore, accumulating goodwill and intangibles worth Rs 44 crore. In 2019, Quess further acquired the remaining stake in the company to make it a wholly-owned subsidiary.
 
The fair value of some of these target companies was negative, and Quess still bought them at a high premium. Take the example of MFXchange. The company had more liabilities than its assets and, therefore, a negative fair value of Rs 61 crore. Quess paid Rs 29 crore to acquire it and added Rs 90 crore worth goodwill on its books.
 
Similarly, it acquired Bengaluru-based Greenpiece Landscapes India for a consideration of Rs 24.5 crore and Dubai-based Styracorp Management Services for Rs 1.43 crores. Both firms had  negative net asset values, and thus goodwill accumulated was higher than the purchase price.
 
MFXchange and Styrop Corp were related-party deals. MFXchange was acquired from Fairfax Financial Holdings, while Styracorp was earlier owned by Issac himself.
 
The management’s rationale behind the series of acquisition deals was to diversify into different business verticals and geographies. In some cases, the intention was to turn around those companies.
 
Cut to March 2020, company management wrote off more than half the goodwill and other intangible assets it had accumulated through these acquisitions.
 
 The biggest write-off happened in the integrated facility business acquired from Manipal Integrated Services. The company wrote off over half the entire goodwill and two-thirds of the intangible assets acquired through this business.
 
MFXchange, the subsidiary acquired from Fairfax, also faced a 60 per cent write-off in goodwill.
 
Three of the acquired companies lost almost all the goodwill value. Goodwill acquired through Greenpiece Landscapes India faced complete a write-off. Quess had acquired a 90 per cent stake in it in March 2018 and bought the remaining stake in May 2019. The company lost its entire value within a year.
 
In Vedang Cellular, Quess acquired a 70 per cent stake in March 2018, and bought the remaining stake in the subsequent year, again at a premium. The entire goodwill and a major chunk of the intangible assets acquired from the acquisition got impaired in March 2020.
 
In November 2017, Quess bought a 51 per cent stake in Trimax Smart Infraprojects, a JV with Trimax IT Infrastructure & Services, for Rs 51,000 for its entry into the government’s smart city project in Ahmedabad. Quess also advanced a loan worth Rs 135 crore to the company, even though the JV partner, Trimax IT Infrastructure & Services, has been dragged to NCLT.
 
In June 2019, Quess further invested Rs 13 crore in the JV to acquire the remaining stake, again with a negative net worth. Within a year it wrote off Rs 40 crore of goodwill accrued by acquiring the company, higher than the total consideration paid.
 
“We acquired the remaining stake in the JV since Trimax IT Infrastructure & Services was facing NCLT proceedings and the cash flows of the JV would have also gone into the escrow account. Quess is now sole owner of the project and the project is now under complete control of Quess,” said Ramakrishnan.
 
Quess’ sporting ambitions with East Bengal FC also turned sour. It had an outstanding loan accrued in the JV of Rs 7.7 crore, as on March 31, 2019. This year, Quess wrote off Rs 24.3 crore of total equity investment and loans given to the sports club, citing lack of economic viability. The write-off is more than the total investments made and loans provided during 2018-19, all within a single financial year.
 
“East Bengal FC was purely a branding exercise for Quess. We have looked at other forms of branding after a couple of seasons with the club and hence decided to terminate our JV with the club,” Ramakrishnan said.
 
How goodwill turns bad
 
Various factors are considered while buying a target company: brand value, synergies with existing businesses, client-base, future cash flows. The greater such long-term benefits, the higher the premium paid for acquiring the company.
 
The accrued goodwill does not depreciate or get amortised regularly, like other assets. It has to be written off only when an impairment is found. But it does need to be tested to find an impairment if any, at least once a year.
 
“An impairment of goodwill takes place if there is a trigger event which can impact future cash flows that were expected to be generated from that asset. The trigger event could be a technological advancement, losing a major client, an economic crisis and so on. A company has to test these assets for impairment at least once every year to check for these trigger events,” said Santosh N, a valuation expert and managing partner at Duff & Phelps, a global management advisory firm.
 
A global pandemic such as Covid certainly qualifies to be a trigger event for companies to test their goodwill and other intangible assets for possible impairments.
 
The March quarter witnessed various such write-offs by India Inc. Vedanta Ltd, metals & mining conglomerate, wrote off Rs 16,576 crore worth of goodwill in its oil & gas, copper & iron ore business, resulting in a net loss of around Rs 20,000 crore in the March ending quarter—the biggest quarterly loss by any Indian company so far.
 

While goodwill impairment is a non-cash charge and has no current impact on the company's cash flows, it represents lost capital. Put to alternative use, it could have improved the company’s return on assets and shareholder value.
 
Masking bad calls?
 
Quess’ core staffing business is asset-light and non-capital intensive. The company’s cash flows indicate that funds spent on investments are 8x higher than its operating cash flows.
 
But did the capital allocation for investments generate desired returns? The return on capital employed (RoCE) ratio of Quess shows a different picture.
 
For Quess, since it started focusing on inorganic growth, its RoCE has been showing signs of deterioration. RoCE gauges a company's efficiency at which the capital is utilised — a higher ratio implies more economical use of capital. The same metric for Quess shows a consistent fall from 33 per cent in 2015-16, to 12 per cent in 2018-19.
 
The higher proportion of accrued goodwill due to high premium acquisitions has consequently lowered its RoCE. But after writing off part of the goodwill and intangibles, there has been a marginal increase in RoCE to 15 per cent in 2019-20.
 
Operating margins (EBIT) on a standalone basis — which represents the core staffing business — have been stable. However, the consolidated operating margins are declining. The consolidated margins include all the acquired businesses and a decline indicates poor performance by the acquired businesses.
 
For Quess, the entire goodwill amount from two of its investments — Vedang Cellular and Greenpiece Landscapes —  became zero within a year of acquisition.
 

“It is highly unlikely that a company will lose its entire value in such a short period. There can be some decline in the value triggered by a few events, but things cannot go so bad in just one quarter to write off the entire goodwill accrued from a particular acquisition. For instance, even a company like Askmebazaar, which went completely bust, might still hold a certain brand value,” says Anul Bali, founder of AnBac Advisors, a Delhi-based valuation & deal advisory firm.
 
“Greenpiece was the entry point for Quess into the landscaping vertical which was complementary to our facility management segment. Vedang provided enhanced footprints in networking and managed services vertical,” said Ramakrishnan.
 
The Greenpiece write-off was mainly due to the fact that the construction industry has been going through a rough patch for the past one year or so, and landscaping business also took a beating and the pandemic further worsened the situation.
 
“In the case of Vedang, the entire industry [telecom] is going through a change due to technology enhancements from 4G to 5G and numbers of operators reducing from eight to three, hence the opportunities in the vertical were quite low,” explains Ramakrishnan.
 
Apart from these write-offs, Quess has earlier sold two of its acquired businesses in a slump sale.
 
Coachieve Solutions was sold last year to Allsec Technologies, an indirect subsidiary of Quess, for about Rs 16 crore. Similarly, VJP Advance Systems, acquired in 2016, was sold within two years for a profit of a mere Rs 19 lakh — another example of their investment decisions not generating desired returns.
 
As per the company management, the sale of Coacheive to Allsec was part of internal reorganisation, as the business units were complementary in nature. VJP, on the other hand, was disposed off for arresting further cash burn.
 
The deterioration in the company’s margins and RoCE has been consistent for the past three fiscals. This seems to suggest that the company’s investments were underperforming even before the pandemic hit across the globe, with the Covid-19 outbreak throwing light on the company’s capital allocation woes.
 

 

 
The company management opines that the reduction in RoCE is mainly due to expansion of its capital base owing to funds raised through IPO and IPP.
 
“Every company goes through a life cycle with different phases. We are now moving from a phase where we have spent capital on acquisitions to a phase where we are digesting these acquisitions, so RoCE will gradually go up again. We are working towards an RoE target of 20 per cent and increasing operating cash flows,” said Ramakrishnan
 
“The fact that our chairman and managing director, Ajit Isaac, has been increasing his stake in the company for the past one year or so, further strengthens our commitment,” he added.