Finlatics Investment Banking Experience Program

Project 4

Prepared by:
Souvik Roy
Premise:
The first emails about the potential purchase of one of its main competitors, Gini & Jony,
began to circulate at Lilliput Kidswear Ltd. on a hot June day last year. A partial share sale to
Lilliput was one of the possibilities the former considered after receiving an offer from a
strategic investor; this showed the world that Lilliput was on its path to becoming a
dominant force. Those were exciting times in Lilliput. Sanjeev Narula, the company's
founder, who owned 53.55 percent of its shares, had roughly quadrupled the size of the
business from Rs. 127 crore in 2007 to Rs. 560 crore in 2011. And with its first public
offering, which was projected to bring in Rs. 1000 crore, the business was quickly reaching a
key objective. For Narula, things couldn't have been worse. But as the saying goes, if
something seems too good to be true, it generally isn't.

Trouble comes Calling:

The descent was rapid.
From the exhilarating days through the IPO cancellation and, eventually, to today's legal
dispute between Lilliput and its investors in the Delhi High Court, it only took a few months.
Most people found it difficult and rapid to grasp the crash. For Lilliput, the earliest
indications of problems came from a surprising source: its private equity backers. And their
names are strong. In April 2010, for a combined $86 million, Bain Capital acquired a 30.99
percent stake through BC India Private Investors and TPG acquired a 14 percent share
through Star Markets Asia Inc. Despite repeated requests, Sanjeev Narula and Bain Capital
were unable to be reached for comment. However, court records obtained by Entrepreneur
help put together a tale that would befuddle and depress anybody betting on the India
development story.
According to the affidavits submitted by both parties, the Lilliput board, which included the
nominated directors for the investors, met on September 23, 2011, and at that meeting, it
was decided to proceed with an IPO as well as to adopt the draught red herring prospectus
(DRHP). The board also met the next day to go through the IPO in more depth.
But only two days later, on September 26, at around 6:25 am, nominated director Mathew
Levin sent a message to Narula that set off a chain of events that slammed Lilliput's
remarkable development tale. Levin claimed in the mail for the first time that Lilliput's
financial practises had been discovered to be improper. Levin requested that Narula
convene a board meeting to consider the issue and hire a third party to carry out a "forensic
examination" of Lilliput, its subsidiaries, and associated parties' financial statements, books,
and records. According to BC India's evidence to the court, Levin further noted in his mail
that Narula should make sure Lilliput does not take on additional debt or use existing
resources any further until the board meeting, where the issue would be discussed. Here,
Levin said that they had received an anonymous phone call alleging financial and associated
anomalies in Lilliput's financial reporting and business operations. According to the affidavit
Lilliput filed on its behalf, the decision made on the basis of a single anonymous phone call
was unexpected because Lilliput's financial decisions were made with the active knowledge
of the investor representatives who were also involved in the day-to-day management of its
finances.

IPO Woes:
A second letter from the investors withdrawing their support for the DRHP was received by
Narula on September 26. Following this, nominated directors for the investors requested
that S R Batliboi & Co. be asked to re-audit the company's annual accounts and that a
supervising independent agency be hired to handle the inquiry into Lilliput's financial
operations during a board meeting on September 28. According to Lilliput's declaration, "the
objective seems to be to halt the firm's expansion, which would be secured by an IPO on the
stock exchange since with financial injection, the company might reach globe corners with
its brand name and products."
Additionally, Narula believed that he should be permitted to conduct an internal
investigation and submit a report to the board within 15 to 30 days because having an
outside agency look into the company's financial operations just before an IPO would cause
chaos within the organisation and hinder work. However, his promise was disregarded. The
board decided to instruct S R Batliboi & Co. to conduct a new audit of the books and
designate Deloitte Haskins & Co. as the impartial agency to look into the accounts.
Additionally, it was determined to reject Lilliput's financial year 2010–11 accounts. The
investors also wanted to inform the banks and financial institutions about the
developments, but the proposal was struck down as it was seen to “destroy the company’s
reputation, hampering its operations and financial prospects”.

Situation Turned To Worse:

Things were unraveling fast at Lilliput now and getting worse by the day. On September 29,
2011 Narula was informed that the entire board had resigned barring him and another
board member from the company, Arun Jain. The dream run was now over.
Lilliput has argued that the investors worked in a manner which would destroy its
reputation and make it very hard for the company to raise funds. Terming them as buy-out
firms, Lilliput states that both the investors actively participated in the affairs of the
company, and that they “resorted to illegal and malafide measures to denigrate the image
of Lilliput so that the value of the company and its shares fall to such an extent that the
promoters have no option but to sell their shares to the investors at nominal price.” Pushed
to a corner, Narula and Lilliput took the case to the Delhi High Court in October 2011 and
filed a petition under Section 9 of The Arbitration and Conciliation Act, 1996 to restrain BC
India and Star Market from interfering in the business and working of Lilliput. Lilliput also
looked at restraining BC India and Star from taking any action that would harm the image of
the company, act contrary to the minutes of the meeting dated September 28, 2011 and
restrain BC India and Star from selling, alienating, transferring or creating third part rights in
any manner.

No Clarification to Certain Questions:

There are no doubts in the minds of many watching the current developments that some
pertinent questions remain unanswered. Firstly, who made that anonymous call to the
investors? Lilliput has maintained that the entire furor based on an anonymous call was
uncalled for, adding that the investors have not been able to provide any evidence on
financial irregularity as alleged in that phone call. The company also alleged that the
investors led the board to disapprove the financial statement for 2010-11 without any real
reason to do so. Some sections feel that the board of Lilliput, led by nominee directors of
the investors, may have erred in disapproving the books of accounts. According to
Accounting Standard 5, accounts once adopted in an annual general meeting (AGM) cannot
be reopened. It is normal for a mistake, fraud or any prior period error to be adjusted in the
next financial year. The investors, on the other hand, maintain that the books of accounts
had not been approved at an AGM in the first place

At the centre of controversy is the role of the investors in the day-to-day operations of the
company. The investors cite Clause 7.2.4 of the shareholder agreement which states that
“for avoidance of any doubt it is clarified that each of Bain Directors and the TPG directors
shall be non-executive Directors and shall have no responsibility for day-to-day
management of the company.” Lilliput, however, maintains that the directors were closely
involved with the working of the company. Documents with Entrepreneur show that the
investors were updated with monthly progress reports, on which they gave their feedback,
as well as data analysis, monthly results, business plans etc. However, all the statements
and data were presented by Lilliput and not obtained by the investors independently. The
real picture, therefore, is somewhere in the middle.

Why Was Lilliput Stonewalling?

Emails dated October 29, 2011 show that when a team from S R Batliboi went for a re-audit,
it was only provided with limited information and later, it was denied permission to enter
the premises of Lilliput altogether. Subsequently in an e-mail dated October 1, 2011, S R
Batliboi resigned as the statutory auditor of Lilliput. Lilliput, on the other hand, contests that
banks have an exposure of over Rs. 500 crore and they should be the ones to suggest the
name of the auditor for an investigating audit. After a meeting with the bankers on October
20, 2011, Anil Aggarwal & Associates were nominated to look into the books of accounts.
However, after many deliberations, S.S. Kothari Mehta and Co. was finally appointed. In the
courts, however, counsel for the investors argued that Narula was not supplying the
relevant papers to the auditors and submitted a communication dated January 3, 2012,
from the auditors to prove the point. Therein, both the parties agreed that all relevant
papers would be supplied to the auditors to enable them to conclude the audit in terms of
the order passed by the court. Questions remain on Lilliput’s reluctance for a re-audit. What
could have, perhaps, been a logical step for Lilliput to do would have been to go for a re-
audit, satisfy the investors and proceed with the IPO? While it resisted, fearing that its
reputation would be tarnished, today it stands to lose much more.

The Way Ahead: Present Status:

On the Delhi High Court’s order, the case has now gone to the arbitration panel, which will
be a long and expensive procedure. Arbitration can run for about six to nine years and each
arbitrator charges about Rs. 2.5 lakh from each party per sitting. Such proceedings can be
stretched across anywhere between 30 to 40 sittings. The auditors have filed their report in
a sealed cover and since the arbitral tribunal is seized of the matter, the auditors’ report has
been sent to the Presiding Arbitrator. The entire Lilliput case, however, raises several
serious issues, including some about the future of private equity in India. If two major PE
firms have been locked in a messy legal battle with a company which was once seen to be a
winner, what does the future hold for others betting on such companies? The case has been
in the courts for over nine months and the Company Law Board has also been involved. The
Lilliput case, PE circles say, has already dented sentiment and exposed the vulnerability of
investors in such situations. For Lilliput, the entire dream is now hanging by a thread. Banks
and financial institutions have stopped lending. There were talks of a possible deal with
French PE major L Capital, but according to sources, the PE firm is no longer interested in a
deal. But as the troubles mount, more than Bain and TPG, it is public sector banks like
Allahabad Bank, which has the maximum credit exposure to the company, who would have
a lot to lose. Tata Capital and China Trust Bank, two others which have exposure to the
company, have already filed separate cases in Delhi High Court against Lilliput to recover
their loans. Clearly, things are getting messier for Lilliput. For Bain, which has a sizeable
stake in Lilliput, this is certainly a body blow. But despite this, sources say it’s not the end of
the road for the PE major as it has other investments in the country and this one case is
unlikely to dampen its overall outlook for investments in Indian start-ups. For a PE investor,
when such a scenario takes place and corrective actions are too far in the future, it is a norm
to write off the investments made in a company. This may also be the case here. Recent
news reports say Lilliput is now seeking a bilateral or corporate debt recast of its Rs. 875
crore debt and is talking to its bankers. While both Narula and the PE investors will be
hoping for a resolution to this tangle, if Lilliput’s problems were to worsen, it could well be
an unfortunate blot on the otherwise exciting Indian entrepreneurial story which has caught
the imagination of some of the world’s biggest investors. To that extent, Lilliput’s
entrepreneur-PE faceoff will serve as a vital case study. The world will surely be watching
very closely