January 19, 2010 [AQUA LOGISTICS IPO NOTE ]

Main Street Research

Avoid “fool poisoning”!
Clear evidences of creative accounting to spike up valuations of the firm where business itself is very unsustainable as compared to
other global 3PL firms:

Company follows so loose working capital management policy that it is almost acting like a financial services firm which fund
logistics operation of customers. In fact, more than half of PBIT (~14 cr. out of 21.86 cr) can be attribute to income which is
“in effect” interest income rather than income from logistics operations.
Despite of such loose credit policies company claims that it didn’t had any bad or doubtful debt for last 5 years (Refer
“Annexure 8”). If this is true, it’s a miracle. We haven’t come across any 3PL or for that matter any transportation company in
our global coverage universe which doesn’t have allowances for doubtful debt. There is a good chance that some of the
doubtful debts are not mentioned and others are artificially made good just to spike EPS & get higher valuations.
Employee costs have been artificially kept low by paying them via issuing equity at discounted price. Excluding promoters and
related parties, employees were paid ~8 cr via issuing equity at discounted rate (in Dec. 2008) which even if spread over 2
years and taken out along with “in effect” interest income would make company loss making.
Seems like this discounted equity issuance was not enough and a lot of employees were not even mentioned on company
books. They were just paid separately. DRHP of company filed with SEBI support this. For eg., Although the company has
mentioned that their “key managers” Mr. Prasanna R. Yedkar and Mr. Narendran Kochat have joined them in March 2009 and
February 2009, our checks indicate that they were working for the company even before that. DRHP of the company validates
that they were made significant payments via these discounted equity routes in Dec. 2008 along with other “on book”
employees. And it’s not just limited to top management. It’s quite widespread. Although, the company’s co-promoter and CEO
married his ex-assistant (who is almost half his age), even her salary is nowhere mentioned in related party transactions in
Annexure 18. [SEBI requires disclosing all related party transactions for last 5 years].
Promoters are raising cash like there is no tomorrow. Think about any possible reason and that’s there in promoters list. On
the one hand they say they are asset light and on the other plan to use significant part of issue proceeds to buy transportation
equipments. Then they are just thinking of buying some company (which they have not “thought” about) and are raising money
just based on that thought (reminds us of dot com days!). India, China, Hong Kong, Dubai… castles in the air!

We understand that in India it’s very rare to find a company which does not use creative accounting and sometimes it does make
sense to invest in such companies. However, in this case the complete intention for using creative accounting is to spike up
valuations as much as possible and to raise as much money as possible at those higher valuations. This IPO is nothing short of absurd
and an insult to investors' collective intelligence.

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Sensex and Nifty are up over 100% from their lows. Bull Market is back again and so is the action in Primary Markets. Last Bear Market, when the
tide went out, we saw a lot of companies swimming naked. Most notable being Satyam. Even Warren Buffet’s ‘analyze Cash Flow Statements
rather than P&L’ methodology is useless when such frauds occur. And the beauty of such frauds is no one ever notices them in a bull market. So
if you are a management looking to sell your ‘paper company’, it’s a good time to raise money in Initial phases of bull market. A typical bull
market of 3-5 years gives enough time to cover up the misdeeds; it’s only a bear market when anyone notices frauds.

Enough time to run away with investor money. Huh!

The Company

Aqua Logistics is an asset light third party logistics (3PL) provider. In very simple words, it is a transport broker. Usually companies need trucks
and other transports equipments to move their goods from one place to another. They can directly go to asset heavy transportation companies
(which own trucks and other transport equipments etc.) or they can go to 3PLs which in turn find them the deals available in the market and
charge a commission.

The concept is easy to sell when you cite some KPMG report saying overall logistics sector in India is likely to reach a size of $180 bn in 2012 and
when we look at share of 3PL it’s less than 10% in India as compared to 30% plus in Developed countries.

So, what’s the easy way to profit from it? Incorporate a company with main objective to provide 3PL services. Do some income statement and
balance sheet engineering, and show that you are running profitable 3PL operations. Tie up with stock operators. Come up with an IPO raising
enough cash to siphon off and simultaneously providing stock operators a route to profitable exit on listing. It’s not entirely impossible if that’s
what promoters of a transport broking company with less than 10 cr gross turnover and less than 2 cr net revenues decided to do a few years
back.

What does Aqua Logistics Do?

It’s a 3PL. Well, that’s what they say! Their balance sheet says that they provide working capital financing for the logistics needs of their
customers. In Exhibit 1 & 2, we have compared their current assets and liabilities with two other ‘true’ 3PL companies. (Since we wanted apple
to apple comparison and in Indian market there is not any pure play 3PL listed, we selected NASDAQ listed CH Robinson Worldwide Inc. and UTI
Worldwide Inc.)

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Exhibit 1: Current assets and Liabilities compared to annual gross revenues for CH Robinson & UTI Worldwide

CH Robinson (NASDAQ: UTI Worldwide (NASDAQ:

CHRW) for year ended UTIW) for year ended Jan 31, USD IN
Dec 31, 2008 USD IN Thousands 2009 Thousands
Current assets: Current assets:
Cash and cash
equivalents 494,743 Cash and cash equivalents 256,869
Available-for-sale
securities 2,644
Receivables, net of Trade Receivables (net of
allowance for doubtful allowance for doubtful Debtor days
accounts of $29,263 828,884 accounts of $15,118) 645,275
Deferred tax asset 5,413 Deferred income tax assets 19,192 ~1-1.5 months
Prepaid expenses and
other 16,187 Other current assets 79,869
Total current assets 1,347,871 Total current assets 1,001,205

Current liabilities: Current liabilities:

Trade payables and other Creditor days
Accounts payable 485,167 accrued liabilities 593,271
Outstanding checks 83,591 Bank lines of credit 69,978 ~3-6 weeks
Accrued expenses – Short-term bank borrowings 6,899
Compensation and
profit-sharing Current portion of long-term
contribution 93,431 bank borrowings 66,666
Current portion of capital lease
Income taxes and other 35,464 obligations 15,878
Total current liabilities 697,653 Income taxes payable 10,425
Deferred income tax liabilities 2,493
Total current liabilities 765,610

Annual Gross Revenue 8,578,614 Annual Gross Revenue 4,543,717

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Exhibit 2: Current assets and Liabilities compared to annual gross revenues for Aqua Logistics

Aqua Logistics (All Figure in Rs. Lakhs) 2007 2008 2009 What we found unusual about Aqua
Current Assets, Loans and Advances Logistics was large amount of sundry
Sundry Debtors 1,364 3,286 5,973 debtors (~Rs. 60 cr.) and virtually no
Cash and bank balances 55 830 1,149 sundry creditors (Account payable).
Loans and advances 492 740 2,397
While other 3PLs have debtor days of
Total (C) 1,910 4,856 9,519
1- 1.5 months, Aqua Logistics have
Liabilities and Provisions debtor days of ~ 3.5 months.
Secured loans 734 746 3,973
Unsecured loans 159 70 6
Deferred tax liability 11 76 309
Current liabilities 591 847 738
Provision for Taxes 97 37 389
Provision – Others 9 11 22
Total (D) 1,602 1,787 5,438

Annual Gross Revenue 4,302 10,899 21,340

This is more than just a working capital issue. If we assume unsecured ‘credit of ~ 60 cr towards sundry debtors’ equivalent to unsecured
working capital financing by banks which is usually at 15-17% rate of interest; a simple math will show half (~10 cr) of their PBIT (21.86 cr) is just
because of this financing services they are providing to their customers rather than logistics services. And this is without taking into account
‘interest income, on their Cash and bank balances of 11.5 cr plus loans and advances of 24 cr (at the end of FY2009). Including that, we can see
most of the PBIT (~14 cr) can actually be attributed to from ‘interest income’. (And this 60 cr is the reported number at the end of the year when
a lot of efforts are made to make balance sheet look good. There definitely is a case that it might be at higher levels during the year!)

Flowchart 1 on next page explains what going on in this case.

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Flowchart 1: What’s going on?

ABC is some company which needs to transport good

It usually takes unsecured working capital loan from bank (rate of which is usually 15-17%) for these kinds of activities. Banks usually have some
reasonable guidelines etc. they have to follow while issuing such credit.

Aqua Logistics which projects itself as 3PL comes to ABC and says don’t go to the banks, we will finance you, no guidelines. The only thing ABC
need to do is don’t pay interest as ‘interest’ but to pay it as ‘fees’ for 3PL’s logistics services.

Aqua Logistics extends credit for ABC for approx. 3.5 months & immediately pays the Asset Heavy transportation company

On this credit extended Aqua Logistics gets an interest + original amount it gave to the asset heavy transporter + some other expenses

Aqua logistics terms this complete revenue as income from its logistics services

Aqua logistics further follow some creative accounting in terms of salaries & wages, allowances for bad debt significantly understating them.
(There is a likely hood that money routed out of company in form of loans and advances is used for this purpose.)

With all these efforts Aqua Logistics is able to show profitable logistics operations, while in reality if we remove these interest income and other
financial engineering, its logistics operations wouldn’t even be profitable.

Now Aqua Logistics raises cash at high P/E multiple (~50 times FY2009 Earnings in terms of post issue diluted equity in this IPO) citing good
profitably growing logistics operation. While the actually business making money is the financial services.

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There are a couple of issues here:

1. First problem with this model is that company raises equity at high valuations projecting it as a profitable logistics company. However its
actual earnings are from financial services operations and its logistic operations sans financial engineering are not even profitable
Financial services companies are valued based on P/BV while Logistics companies get higher valuations as they are valued on high P/E
citing growth potential. In this case the actual growth is only coming from expanding balance sheet by raising equity cash at high
valuations and then in effect using that for giving loan to customers. And you can yourself look at RONW. You would see most of the
RONW is coming from new issue of stock at higher price rather than company’s operations.
2. Secondly, all their financial services operations are based on raising equity from the markets and then extending it as a loan to their
customers. We believe it is very questionable how this model of raising cash from equity route and then giving it as loan to customers
would work going forward. After all, cost of equity is greater than cost of debt!
3. Even if you look at company from financial service provider we find company’s practices very questionable. We haven’t seen any
company in global transportation sector which don’t have allowance for doubtful debts. And this company with so loose lending policies
which in essence makes it a financial services company don’t have any! We think they have deliberately not disclosed this so as to make
earnings look better (hence increasing overall valuation from P/E view point). And it is not entirely impossible that some of the doubtful
account were made good, even if that meant routing some of the cash from their own sources. After all, they are getting all the cash
from raising capital only and are cash flow negative at operating level. And the beauty of P/E valuation is, if you increase E by 1, you
increase P by 50 (Assuming P/E of ~50). It’s very difficult to get a real sense on their ‘actual’ bad debts. But a good starting point would
be to look at other companies in the space and then account for Aqua Logistics loose credit policies. Arshiya International with similar
revenue profile and relatively much better credit policies had it at more than 50 lakhs. And even as Aqua Logistics says it doesn’t have
any bad loans provision, it has over Rs. 4 cr tied to sundry debtors which haven’t paid for more than 6 months at the end last fiscal year.
And these are their “official numbers”. Real numbers might be even worse.

And if you are among those good guys who still have trust in auditors, merchant bankers, credit rating agencies we suggest you to take the "perp
walk" down the path that expires where Kenneth Lay and Ramalinga Raju now lies scattered in ashes.

One of the better gauges of company’s accounts is their counterparties which extends credit to the company. In this case they would be asset
heavy carriers which own transportation equipments. On accounts payable side while other “normal” 3PL companies have 3-6 weeks of
accounts payable, Aqua Logistics hardly have 13 days of accounts payable. It appears asset heavy companies which do business with them have
a good sense on doubtful financials of this company and are careful in collecting their dues as soon as possible. Banks are also doubly careful and

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they have securitized their loans completely with the assets as well as personal guarantees of promoters. Do whatever you want to but just first
allow us to exit!

And when we look at objectives of raising IPO money, the single biggest use of that money as company has mentioned is going to fund working
capital requirements (around 45 crores). If this company was having average credit ratings and its creditors wouldn’t have considered its
financial so doubtful, account payable would have been normal 3-6 weeks. And this company wouldn’t have required diluting equity and raising
cash for working capital needs. Yet Brickworks have assigned it IPO grade of 3 out of 5 indicating average fundamentals. Don’t understand how
someone can even remotely call this company’s rating average. Why God (or God’s agent SEBI) started mandatory grading of IPO? To make
mockery of ethics and help these credit ratings companies earn money by providing unreasonable and illogical IPO grading to investors!

It’s not that none of the credit rating agencies or auditors do their job properly. But there’s always a way out. If CRISIL or CARE doesn’t believe
you are worthy of 3 out of 5, you can always find some Brickwork who would happily give you that rating to get some business. Same for
accountants, if your earlier accountant is finding it difficult to justify income statement the way you like. Change to some new one and say that
the earlier auditors expressed their inability to continue in view of their preoccupations.

Also, if you want to have more sense on the financial skills of management of this company, just look at their long term investments. First, this
company which don’t even have funds for its working capital is speculating in stock markets. Second, they have “long term investments” in
stocks like Pyramid Samira and Himachal Futuristic. And this is nothing. They haven’t even provided for depreciation in values of these stocks
terming them as long term investment and have quoted them at cost price when they first filed their DRHP on 25 September 2009.

Overall, we believe there is a good chance that Greater fool’s theory working here. Keep spiking EPS, continue raising more and more cash.
Provide exit route to old investors and fool new investors to come in paying exorbitantly higher valuations only to realize going forward that they
are the victims of “fool poisoning”. Their current investors very likely know about company’s “real financials” and might be acting in concert.
Look at their agreement with Carwin Mecantiles (P) Ltd.: Carwin bought shares at the Rs. 100 per share and simultaneously entered into an
agreement that if company comes with an IPO for less than Rs. 200 per share, company would buy all shares of Carwin at Rs. 200 per share.
Where did we last come across such a risk free doubling of money? Some Ponzi scheme, we guess! And if you are aware of Equipment
Acquisition Resources Inc. case, you won’t be surprised that these days a lot of fraudsters take genuine looking businesses to lure peoples in
their Ponzi schemes. You need to take extra care to protect your or your investors’ hard earned money. Anyways’ in this case we won’t be
surprised if the IPO investors are proved to be greatest fools.

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The ‘actual’ employee costs

What would you do to make your earnings look better than they actually are? Two simple ways:

1. Instead of paying your staff in cash or as an ESOP which needs to be accounted in P&L, pay them by issuing equity discounted price which you
don’t need to show in P&L, hence artificially increasing earnings.

2. Don’t show people working for you as your employees. Pay them separately but just don’t show them as your workers. This may cost you a
couple of crores off balance sheet but if you plan to fund operations by raising cash again and again, you can get better valuations due to
increased EPS.

Well, the company has done both, it appears from their DRHP filed with SEBI.

We are actually not against the first way as such. Indeed it has helped a lot of troubled companies to survive. However, we have problem in case
equity issuance is done with the sole purpose of hiding loss making operation and to show them profitable. Further, if this method is used along
with other income and balance sheet engineering, its likely that you are also fooling your employees by giving them a paper worth nothing as
compared to what you are promising it to be worth. (Just for your knowledge, agreement with Carwin was cited to employees to justify
valuations of stocks which were given to them in lieu of salaries). However, the good thing here is there are no terms that employees have to
follow in terms of timeframe after which they can sell their stock. So, in case they are able to sell their equity before market realizes the truth
about the company, they can have an easy escape. Also, we think there is a slight issue with the regulations in India. If company issues equity at
significant discount, it should be accounted in P&L. Currently in India it is not, making things even easier for these guys.

If we look at their equity issues to promoters group, employees and others and try to figure out what impact that might have had on financials if
that would actually be included in P&L it is very significant. For time being let’s leave promoter group and just consider that of employees and
others. We found that employees and others were given 6,10,000 shares which at lower band of Rs. 220 means a whopping 13 cr plus. Lets also
remove 2,50,000 shares of Mrs. Lakshmi Sankarakrishnan who we believe is related to promoters but isn’t classified as promoter group (
something similar to benami, usually done to facilitate promoter group’s exit to some extent even during SEBI’s mandated holding period). Even
then payment to employees and others is ~ 8 cr. Even if we spread it over two years it would have significantly affected profitability if paid via
normal routes. Further, if we remove these payments made through equity and the ‘interest income’ as discussed earlier, company would be
having negative EPS.

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And it’s not just equity payment which bothers us on staff cost side. There are some surprising elements out there. Although the company has
mentioned that their managers Mr. Prasanna R. Yedkar and Mr. Narendran Kochat have joined them in March 2009 and February 2009. They
were made significant payments via these discounted equity issue routes in Dec 2008. Our checks suggests that these guys were working even
before that for the company but company just decided not to show them on books as their salaries would affect profitability in P&L and thus
effect valuations they would get while raising equity cash. Another funny thing is although their compliance officer (who is counted as one of
their key managerial person) joined before Dec. 2008, he has not taken any equity on Dec. 2008. Appears like he knows what is going around so
doesn’t want to get indulge in all this mess and prefers cash salary.

Another fact we believe supporting this staff cost discrepancy is if we look at their proposed Dubai office’s finance projections. They have
mentioned that Staff Cost there would be ~ Rs. 3.3 crores for 6 months which comes to ~Rs. 6.6 crores annualized. Aqua Logistics complete staff
cost for FY 2009 was shown ~10.5 crores. Doesn’t it seems odd that just a start up office in one new location has staff cost over 60% of total staff
cost of the overall company.

Also, although company’s co promoter and CEO’s wife is one of his former assistants, her name is nowhere mentioned in related party
transaction in Annexure 18 of DRHP. We believe that this “not showing salary on the company books” is much more widespread rather than
being limited to top management.

Don’t you get surprised when you see a first 6 months of FY10 has a number in staff cost which is less than half of last year for this growing firm.
There’s really much more here than what meets the eye.

Qualitative Aspects

After not being too satisfied with company’s Quantitative Numbers, we decided to do some qualitative analysis to find how they look.

Barriers to entry, Early Mover Advantage, Asset Light model etc…

We referred to company’s DRHP to find what they think are their strengths. Although there are no barriers to entry in this business, company
thinks early mover advantage would provide it a good lead.

Early mover advantage! We have heard this term before. Where? Where? Ya, got it! Remember, dot com boom. And even that was B2C industry
for most of the part. Here you are talking about B2B business. And if experience in US is anything to go by it doesn’t take more than a couple of
days for a company to change its logistics provider.

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And now coming to the first point company has mentioned in “Our Competitive Strengths”:- Asset Light Business model.

First, company is itself raising a significant part of their cash to buy transport equipment, thus going towards becoming asset heavy. ( They are
smart enough to know that they are getting way too high valuation for a business which might not really survive going forward, so it’s good to
have some trucks (bought on cash alone, no debt) to keep generating some cash flow and keep hiding the real fate of their 3PL business for as
long as possible.)

Second, we don’t understand what is this asset light model they are talking? Their working capital requirement is way too higher than even
capex requirement of similar sized companies.

Professional management team

Our preliminary research into the backgrounds of promoters and management has been tremendously disconcerting. Don’t get us wrong, we are
not talking about anyone’s colorful tastes here. If Former US president Bill Clinton, Oscar winner Roman Polanski, Italian Prime Minister Silvio
Berlusconi can have it why not Aqua Logistics’ CEO! We are talking about other things which we believe any good analyst or fund manager can
find out doing some channel checks with the firm’s employees (If anyone cares to do so). We are still in initial stages so would not disclose our
findings in this report. However, information already uncovered as part of our preliminary due diligence on the management may be made
available to certain clients upon request, and shall be made public when we disclose the results of its full investigation.

Franchise Strength

Half of their key managers have “officially” joined in past 15 months. It’s like a group of people who have come together with some clients from
their previous organizations in return of some equity stake to monetize. However, 3PL is a business with very low barriers to entry and is
extremely competitive. Client retention is a big issue and what if, after monetizing their stake in the company, some of these Key managers leave
with their client base to monetize them somewhere else. Asset light carrier, with no long history, which has suddenly added clients by luring
them on easy financing and hiring agents who can bring it to them, and having very high customer concentration: Do we need so say anything on
Franchise strength?

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The Real Story… What’s going to happen now?

Ok, so till now castle in the air is built. What next? Construct the base.

Raise a lot of money from the “greater fools” at exorbitant valuations. Present the business as a genuine one with excellent business model.
Best thing after sliced bread!

So, you are able to exchange your tulip in this “tulip mania” for 50 acres of land. What next?

Since you know the reality: - your castle, i.e., asset light business is not going to work; use 30 cr of cash to buy equipment. Complete cash, no
debt. (Investors won’t recall FIN 101, cost of capital optimization). Just leasing these equipments would provide some continuous cash flow to
make your business look genuine as long as possible to analysts. And unlike other asset heavy carriers you would not even have to worry about
any debt.

Hmmm… done. Anything more?

You are an asset light carrier. You can also raise money in name of buying some asset light company.

But which company?

That’s not important. We’ll think about that later. If markets are really good and buying a good company can help exit your equity holding at
better valuations, buy a decent one. Else go for the normal shady type where we can siphon off this money easily. Or we can just keep the
money on books. Anyways who cares? Don’t you know the story of that great Indian internet entrepreneur, who raised USD 48 mn by issuing
ADS on NASDAQ in the name of acquisitions in 2005. He is still keeping that on his books and is enjoying life. Occupying chairman seat in
prestigious management institute, planning to launch his football team, giving inspiring interviews on how to get ahead on his own internet
portal. So what if his ADS holders have lost 80% of their investment since they subscribed to the offer?

But would investors be willing to give money?

Dude! Again the same question. If those dot com bombs can get funded just on basis of a thought, why can’t our idea?

What an idea Sir ji!

Done! Good. What next?

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Incorporate subsidiary having almost the similar business line as our listed companies.

Oh that’s an old trick. We have already done that. And we have incorporated some of them like Aqua PCW and LEFWorld very recently, just
before filing our DRHP, as we got some more ideas for raising cash at the last moment. Plus, although we are raising equity cash to buy
equipment, we are very keen on giving loan advances to Aqua Specialized Transport Private Limited to buy the same. And forget about these big
things, just look at the rent of guest house we are charging. Our promoters are getting Rs. 45K for 1 bhk and 75K for 2 bhk as a rent from
company for using their property as guest house in Andheri East. Actual rates are even less than half. These are easy things; you don’t need to
teach us these.

Alright then, we are done.

Valuations

Aqua Logistics has mentioned in its resubmitted DRHP (Nov. 16, 2009) that it intends to buy a 3PL having estimated turnover of 125-175 crores
having estimated EV between 70-80 crores. Going by how Aqua Logistics itself values other 3PL firms in South East Asia region (with almost the
same kind of GDP growth rate), we get a decent 3PL can have EV around half of its yearly turnover (taking midpoint of both estimated turnover
and EV).

And, we assume this EV = 0.5 turnover would be for some company with at least decent financial. Aqua logistics would further need a huge
discount for its absurd financials and “in effect” loss making logistics operations (remove ~14 cr of interest income & ~8 cr of employee equity
cost from PBIT of 21.86 cr. And this is without considering bad debt allowances and “off book” employees). And how much valuation are they
asking for?

Recommendation

Do we still need to write something here? Well… we don’t mind this company listing. After all, it’s good to have some alpha shorts in the market!

Note: We are not negative on logistics sector as a whole. There are a lot of promising companies with sustainable business models: - from
startups to mega caps, listed and unlisted, in developing as well as developed world. And although we are a pure research firm and are not
involved in deals as such, we would be happy to introduce you to their managements. What we don’t want is you to have a bad investment in
this great sector.

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Disclaimer

This report is based on data which obtained from Aqua logistics’ DRHP filed with SEBI, other publically available data with additional information
from our own channel checks. Main street research does not represent that these are accurate or complete and hence, should not be relied
upon as such. In fact, we are not sure at all if Aqua Logistics Ltd. has provided totally correct and/or complete information in its DRHP. The data /
reports are subject to change without any prior notice. Opinions expressed herein are our current opinions as on the date of these reports.
Nothing in these report constitute investment, legal, accounting or tax advice or any solicitation, whatsoever. The subscriber / user assume the
entire risk of any use made of this data / reports. Main street research especially states that it has no financial liability, whatsoever, to the
subscribers / users of these reports. These reports are for the personal information only of the authorized clients of Main Street Research in
India & US only. These reports should not be reproduced or redistributed or communicated directly or indirectly in any form to any other person
especially outside India & US or published or copied in whole or in part, for any purpose.

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