Financial Shenanigans

The Forensic Verdict

Sagility's reported numbers pass the most important forensic stress-tests: five-year operating cash flow runs at roughly 1.8x net income, accruals are persistently negative (CFO above NI), and there is no restatement, auditor change, regulatory enforcement, or short-seller dossier on the public record. The accounting risk that does exist is structural — a giant goodwill/intangible block from the 2022 HGS carve-out, an aggressive adjusted-EBITDA stack that strips out earn-outs, SARs, forex and "exceptional" labour-code charges, and a control structure where EQT-owned Sagility B.V. still controls the company, prices the share-based pay, and has been the active seller of stock. The single data point that would most change the grade is a reversal in cash conversion — if CFO/NI falls below 1.0x while DSO climbs above 95 days, the "earnings quality is conservative" thesis breaks.

Grade: Watch (21-40). The verdict is "underwrite the structure, trust the numbers" — not the other way round.

Thirteen-Shenanigan Scorecard

Breeding Ground

The structural breeding ground is elevated but mitigated. Sagility is a recent (Nov-2024) IPO carve-out from Hinduja Global Solutions, still controlled (50.95%) by EQT-owned Sagility B.V., and the parent has been actively selling down. The board has more independence than typical promoter-controlled Indian listings (5 of 9 directors independent), the auditor is BSR & Co LLP (KPMG India network) with no qualifications, and the internal auditor is EY — all standard institutional quality. What we cannot ignore: the parent prices, awards and settles share-based pay outside the listed entity, the chairman is a parent-appointed non-independent, and management compensation is heavily weighted to variable pay.

The breeding ground is where Sagility looks materially different from a regular listed Indian IT-services peer. Institutional protections (Big-4-affiliate auditor, independent board majority, no auditor change, clean Sec 143(12) report) keep the risk in yellow rather than red, but three caveats matter when reading the financials: (1) the parent still sets the rules on share-based pay, (2) EQT has been an active seller and likely remains one, and (3) the P&L sits on top of ₹60B+ of acquisition-sourced goodwill that did not arise inside the listed entity.

Earnings Quality

Earnings quality is good in substance but optically inflated by an aggressive adjusted stack. The four most important tests pass: (a) operating margins are stable at 23-25% across five years, (b) reported PAT is consistently lower than CFO, (c) FY25 net income jumped 136% but the entire jump is explained by lower amortisation (HGS intangibles fully amortised) and lower interest (promoter debt repaid), and (d) FY24's 6% effective tax rate normalised to 25-29% by FY26 without any reserve release lifting reported PAT. The problem is what management highlights — Adjusted PAT margins run 280-500 bps above GAAP because they strip out items that recur (earn-outs, SARs, intangible amortisation, exceptional labour-code charges).

Revenue, receivables, and unbilled

DSO is the single most-watched accounting metric in BPO/BPM. It dropped to 83 days in FY25 (collections tightened ahead of and post-IPO) and rose to 93 days in FY26. Management attributed the Q4 FY26 climb to "a reclassification from unbilled to financial liabilities" worth about 4 days, plus seasonal H2 mix from the AEP/OE peak. Both explanations are plausible, but a mid-year reclassification of DSO definition belongs on the watch list — Genpact and EXL did not need a reclassification footnote to explain their FY26 DSO trajectory.

Margins, amortisation roll-off, and tax volatility

Two earnings-quality points jump out. First, the post-amortisation margin nearly doubled from FY24 (8.5%) to FY26 (17.7%) — not from operating improvement but because the HGS carve-out intangibles fully amortised by FY24 and acquisition-related intangibles are smaller. This is mechanically correct, not a shenanigan, but it means FY25-26 GAAP earnings growth is partly a base-effect of amortisation roll-off, not pure operating leverage. Second, the FY24 6% effective tax rate is an outlier — a deferred-tax credit and India employment-generation incentive temporarily lifted net income. The FY24 PAT base is therefore not a clean comparator for FY25's 136% growth.

Soft assets and goodwill weight

The "Fixed Assets" line in Indian reporting includes goodwill and other intangibles. At FY25, goodwill alone is ~₹60B (₹51.7B from HGS, ₹4.9B from DCI/BirchAI/BroadPath, ₹3.8B from FX translation), against total assets of ₹109B. The balance sheet is more than half goodwill. This is not a red flag in itself — it correctly reflects the purchase price paid by EQT to acquire the healthcare BPM business from HGS in January 2022 — but it means GAAP ROE/ROCE will permanently look low, which is exactly why management built "Adjusted ROCE" excluding goodwill and reports 50%+ versus 13% on the GAAP basis.

Cash Flow Quality

Cash flow quality is the strongest piece of the forensic picture. CFO has tracked or exceeded reported operating profit for four consecutive years (99%, 101%, 106%, 90% cash conversion), there is no evidence of receivable sales / factoring / supplier finance, and acquisitions have been cash-funded from operations rather than from working-capital lifelines. The number to underwrite is whether 90% cash conversion in FY26 (down from 106%) marks a return to baseline or the start of a slide — management said FY26's lower conversion reflects a one-time FY25 India tax refund that did not repeat, higher non-cash forex gains, and the working-capital absorption of BroadPath.

The shrinking CFO/NI ratio is good news disguised as bad news: net income is rising faster than CFO because the HGS amortisation that depressed reported earnings has run off. Pre-FY25, every rupee of net income generated 4-5 rupees of CFO because amortisation was the dominant non-cash item. FY26's 1.30x is approaching a "normal" services-company ratio. A move below 1.0x would be the first genuine red flag in this stack.

Acquisition-adjusted free cash flow

Estimates of acquisition outflow are derived from disclosed deal values (DCI April-2023, BirchAI March-2024, BroadPath ₹5,020M January-2025 plus pending HGS consideration) — exact splits across years are approximate. After accounting for acquisitions, FY25's standout 10.9B reported FCF shrinks to ~3.0B — still positive, but a fraction of headline. Sagility self-funded BroadPath without raising debt, which is genuinely impressive; readers underwriting "self-funded compounder" should still apply this haircut.

Working capital contribution

The cash-flow statement does not break out working-capital movements in the data we have access to, but the DSO trajectory (83 → 93 days FY25→FY26) implies a working-capital headwind of ~₹2,000M in FY26 — i.e., absent the seasonal-mix and reclassification effect, headline CFO would have been higher. No evidence of payables stretching (CFO did not get an obvious lift from suppressed inventory or extended payables), but the absence of a detailed working-capital schedule is itself a disclosure gap.

Metric Hygiene

Metric hygiene is the weakest area of the forensic file. Sagility runs a five-step adjusted stack — Adjusted EBITDA, Adjusted PAT, Adjusted EPS, Adjusted ROCE, and constant-currency revenue — and each adjustment is individually defensible but the cumulative effect is a 280-500 bps overstatement of margin versus GAAP. The most aggressive single adjustment is Adjusted ROCE at 50%+, which excludes goodwill and intangibles from the capital base; the GAAP equivalent is ~13%. Management discloses the calculation in footnotes, but the headline is the 50% number, not the 13% one.

The PAT gap narrows from 760 bps in FY24 to 280 bps in FY26 as the amortisation that adjustments strip out mechanically rolls off. On current trajectory, the GAAP-vs-Adjusted gap could fall under 200 bps by FY28, making the adjusted stack less load-bearing. Today it still matters: anchoring on 15.7% Adjusted PAT versus 12.9% GAAP changes what a peer-multiple application implies for fair value.

What to Underwrite Next

The forensic risk here is real but bounded, and translates to a valuation haircut (anchor on GAAP PAT, not Adjusted) and a position-sizing limiter (until cash conversion stabilises), not a thesis breaker. Concretely:

Track every quarter:

1. DSO ex-reclassification. Sagility moved ~4 days from unbilled to financial liabilities in Q4 FY26. The Q1 FY27 print should let analysts re-compute clean DSO. If DSO ex-reclass exceeds 95 days, the H2-seasonality story breaks.
2. CFO/NI conversion. FY26 came in at 1.30x (down from 2.25x). 1.0x is the line in the sand. Below that, the company is generating accruals, not cash.
3. Adjusted ROCE versus GAAP ROCE. Adjusted is 50%+, GAAP is 13%. Watch whether management continues to lead with the adjusted figure as the goodwill block compounds with more deals.
4. Earn-out recurrence. DCI, BirchAI and BroadPath earn-outs are still being expensed. Each future M&A deal adds another earn-out stream that will be tagged "non-recurring" again. Count the cumulative "non-recurring" earn-out add-backs over a five-year window — that is the recurring cost of the M&A strategy.
5. Promoter (Sagility B.V.) sell-down. EQT moved from 82.39% to 50.95% in one fiscal year. Further selling is likely; alignment between selling promoter and minority shareholders weakens as the holding shrinks.

What would downgrade the grade to Elevated (41-60):

• DSO above 100 days without a clear collection issue
• CFO/NI below 0.8x for two consecutive periods
• A new "exceptional" line item that reverses last year's exceptional
• An auditor change, late filing, or material weakness disclosure
• Reduction in independent director count or audit committee composition

What would upgrade the grade to Clean (0-20):

• Two consecutive years of cash conversion above 95% post-amortisation roll-off
• Convergence of Adjusted PAT to within 100 bps of GAAP PAT (likely by FY28 on current trajectory)
• Completion of promoter sell-down and stabilisation of share register
• Disclosure of receivable composition (billed vs unbilled vs reclassified) on a comparable historical basis

Bottom line: the accounting risk at Sagility is presentation-driven, not reality-driven. The cash is there, the auditor is clean, the customer base is verifiable, and the principal issues are an aggressive adjusted-metric stack and a balance sheet weighed down by goodwill that arose before the company was listed. Anchor on GAAP, consider a valuation haircut for the adjusted-stack optics and promoter overhang, and re-test next quarter once the DSO reclassification has comparable history. Watch, not avoid.