Practical analysis for investment professionals
19 May 2020

The NMC Health Debacle: Four Red Flags?

NMC Health (“NMC”) was founded in Abu Dhabi in 1975 and expanded to become the United Arab Emirates (UAE)’s largest health care company. Listed on the FTSE 100, NMC operated in 19 countries and employed 2,000 doctors and nearly 20,000 additional staff.

Then its fortunes took a turn.

Signs of trouble emerged in December 2019. Activist investor Muddy Waters published a report alleging that NMC had inflated cash balances, overpaid for assets, and understated its debt. This set off a chain of events that led NMC to reveal, inter alia, that its debt, at $6.6 billion, was over $4 billion more than the $2.1 billion it had declared in its 2018 financials.

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Abu Dhabi Commercial Bank (ADCB), NMC’s major creditor, applied to a UK court to place NMC in administration. A restructuring consultancy has taken over NMC’s management and replaced the entire board. ADCB has also filed a criminal complaint, citing “fraud and forgery” against half a dozen people, NMC’s founder BR Shetty and former CEO Prasanth Manghat, among them.

While the Muddy Waters report and subsequent investigative articles suggest that reverse factoring, related party transactions, and corporate governance may have contributed to the debacle, my analysis, which is documented in a detailed Excel file that is available to anyone on request, will focus solely on NMC’s financial statements, specifically its annual reports from 2015 to 2018.

My inquiry seeks to answer two key questions:

  • Were their red flags in NMC’s financial statements?
  • Could the predictive models have anticipated NMC’s earnings manipulation and bankruptcy risk?
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The Red Flags

1. Acquisitions

NMC went on a years-long shopping spree. Its total outlay on acquisitions from 2015 to 2018? Approximately $1.9 billion.

NMC had to keep acquiring in order to grow its revenue and profits. When a company relies so heavily on inorganic growth, it can create an incentive to fudge the numbers to ensure the revenue and profits stay strong.

NMC Aggregate Annual Purchase Considerations (US $1,000s)

Total2018 201720162015

2. Massive Goodwill

What is especially striking is how much NMC overpaid for its acquisitions.

NMC’s Goodwill Accounting

Average 201820172016 2015
Additional goodwill (US $1,000s) 390,329 471,573233,906 345,072
Fair value of net identifiable assets (“NA,” US $1,000s)221,777178,171 40,81989,049
Goodwill as % of PC79%69%74%91%80%
Goodwill as % of NA350%176%265%573%388%
Goodwill on balance sheet (US $1,000s) 1,440,2911,057,765567,338341,420
Goodwill as % of total non-current assets51%58%58%49%40%
Goodwill as % of total assets 30%37%36%24%23%
Profit after tax of acquirees for full year (US $1,000s) 16,47725,51343,938 28,638
Profit as a % of PC2.9%3.98% 17.15%6.68%

What percentage of the acquired subsidiaries’ net assets does goodwill account for? About 350%, on average, over the four years, with a high of 573% in 2016 and a low of 176% in 2018.

What does that mean? For a company whose balance sheet showed net assets worth $100, NMC paid $350. Or overpaid by $250.

Moreover, goodwill constitutes an unusually high proportion of total assets which is hardly surprising given such overpayments. As of 31 December 2018, goodwill accounted for a whopping 37% of NMC’s total assets! For most mature companies, goodwill rarely exceeds 10% of total assets. I have never seen a publicly listed company report numbers like these.

Of course, a natural response might be: So what? It’s just an accounting entry, after all. I’ll tell you what: Goodwill has a lot of issues here.

  • It is nothing but overpayment for subsidiaries. And NMC does not know why exactly it overpaid. Goodwill is a fancy way for accountants to account for this excess.
  • The size of the goodwill means the overpayment might be unjustified. Hence the goodwill may soon have to be written off in full or in part. And profits will suffer massively.
  • Another reason why a write-off is likely: Look at the post-tax profits of the acquiree companies as a percentage of the purchase price. It has been in steady decline since 2016, from 17% to 4% to 3%. So NMC is either desperately buying mediocre companies or paying exorbitant prices for good ones. Which is bad either way.
  • But the big question: Why such obscene overpayments? Was NMC desperate to grow revenues and profits?
  • The elevated goodwill could result from the deliberate undervaluation of tangible assets at the time of acquisition. Tangible assets like buildings and machines are depreciated, but goodwill never is. Given a fixed purchase consideration, undervaluing tangible assets means automatically overvaluing goodwill. If this is the case, NMC has saved millions in depreciation expenses over the years and hence overstated its net income.
  • A significant proportion of the acquisitions was financed through debt. So overvalued assets were basically financed through expensive debt.

3. Excessive Debt

NMC’s Debt and Debt Ratios

Adjusted 2018201720162015
Total debt (US millions)6,6001,9971,3991,049730
Debt to equity4.861.
Debt to capital0.830.60.550.530.59
Debt to FCF29979152

To be sure, hidden debt was what shoved NMC into the headlines. Debt-to-equity ratios (DERs) had been steadily increasing. But look at the “Adjusted” column. The shocker was the disclosure of up to $4 billion of hitherto undisclosed debt. That effectively revealed NMC for what it was: a massively indebted hospital chain.

The 4.86 to 1 DER and debt accounting for 83% of capital are scary enough. What’s scarier is the debt to free cash flow ratio of of 29. What does that mean? If the 2018 free cash flow held steady and ALL of it went to paying off the debt, the lenders would have to wait 29 years to be paid in full.

Why so much debt? Investigations are underway. But we know where a lot of it went. To financing acquisitions.

NMC Acquisition Financing

2018 201720162015
Financed by free cash flow47%34%49%1%
Financed by debt53%66%51%99%

4. Unusually High Margins

Gross, operating, and net margins have been higher than normal, and they have been growing:

NMC Margins

US Median201820172016 2015
Gross Profit Margin41%40%38%35%
Operating Profit Margin2.5%18%17%15%13%
Net Profit Margin12%13%12%10%

Why would the margins be high and rising? There are quite a few theories flying around, but what we can say is that there seems to be significant under provision for receivables.

NMC Receivables

2018 201720162015
Receivables Past Due (US $1,000s)197,113160,803103,75973,269
Percentage of Above Due to Total Receivables31%31%28%26%

Receivables past due increased by US $124 million, or 170%, over three years. Yet there is no mention of any provision for bad debts anywhere in the financial statements. That’s even more strange given how the macroeconomic situation in the UAE deteriorated over the same period.

Predictive Ratios

But could we have predicted anything? Could the famed Altman Z-score and the Beneish model have anticipated bankruptcy and earnings manipulation, respectively?

The Altman Z-Score Ratio

The Z-score formula predicts the probability that a firm will go into bankruptcy within two years. It is derived as follows:

Z-score = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5, where:

  • T1 = Working Capital / Total Assets (High = positive working capital)
    • T2 = Retained Earnings / Total Assets (High = profitable + less debt financing)
    • T3 = Earnings Before Interest and Taxes / Total Assets (High = high operating profits)
    • T4 = Market Value of Equity / Total Liabilities (High = more investor confidence)
    • T5 = Sales/ Total Assets (High = more sales efficiency)

The three Z-score categories are:

1. “Safe” = A Z-score over 2.99

2. “Grey” = A Z-score between 1.81 and 2.99

3. “Distress” = A Z-score below 1.81

Without going into the detailed calculations, in the lead-up to the revelations, NMC looked fine. It registered a Z-score of 2.93 in 2018 and an average Z-score of 3.18 from 2015 to 2018.

If we include the recently “uncovered” additional debt of approximately $5 billion, however, NMC’s Z-score for 2018 plummets to 1.83, which is awfully close to the distress zone. But this all comes with the benefit of hindsight and highlights two major weaknesses of this model: the inability to include off-balance-sheet liabilities and the dearth of independent variables.

The Beneish Model

The second predictive model is the Beneish model, or the so-called M-score. The M-Score is a multiple regression model with eight independent variables. It classifies a company as an earnings manipulator if its M-score is greater than -2.22.

The M-score is calculated as –4.84 + 0.920 (DSRI) + 0.528 (GMI) + 0.404 (AQI) + 0.892 (SGI) + 0.115 (DEPI) – 0.172 (SGAI) + 4.67 (Accruals) – 0.327 (LEVI)

NMC Beneish M-Scores


All M-scores for NMC exceeded the cut off of -2.22. Indeed, the model predicted earnings manipulation as early as 2016 with three of the eight indicators flashing red.

I am not surprised. A survey conducted by John MacCarthy demonstrated that the Beneish M-score used in tandem with the Altman Z-score could have successfully predicted Enron’s fraudulent behavior between 1997 and 2000.

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The Final Accounting

To return to the questions we posed at this article’s outset:

Were there red flags in the financials? Yes.

Could the existing models have anticipated the bankruptcy threat? Probably not.

Could earnings manipulation have been predicted early on? Probably.

Of course, many questions remain unanswered. Who was responsible for the manipulation and who failed to spot it will hopefully come to light before long.

But until then, a quote from Charles Scott is worth remembering:

“Creativity is great — but not in accounting.”

For more insight from Binod Shankar, CFA, visit The Real Finance Mentor.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Binod Shankar, CFA

Binod Shankar, CFA, is an executive coach and keynote speaker and appears regularly on CNBC Arabia and Asharq Bloomberg. He is also a Chartered Accountant and CFA charterholder with 30-plus years of experience in corporate and entrepreneurship and the author of the recently published Let's Get Real: 42 Tips for the Stuck Manager.

43 thoughts on “The NMC Health Debacle: Four Red Flags?”

  1. Zena says:

    Great article!! Can’t be explained better

    1. Thanks Zena! Worked hard to simplify some complex concepts… 🙂

  2. Alex says:

    Excelente te felicito muchas gracias por compartir tu conocimiento Dios te bendiga.crees que podrás regalar el excelente de esas fórmulas con el ejemplo dado

  3. Vivek says:

    Thanks Binod.

    What baffles me is how could a listed company be able to hide debt? How did the books balance and did the banks not see that their debt was not showing up on paper!

    1. Yes it is a mystery the huge amount of off balance sheet debt. I have some theories but we will have to wait for the results of the investigation. My analysis was based 100% on the published annual reports.

  4. Salman says:

    Great article.
    It is really strange that if the debt from banks is not completely reflected in the audited financials then what the relationship managers and risk managers doing at bank. They were not reviewing the financials! A lot to learn here for banks.

    Secondly, banks provide independent confirmations to external auditors about deposits, assets, and other facilities for the client as at the end of year.

    How the debt reported in the independent confirmation was reconciled with what reported in audited financials.

    1. Thanks Salman for the comments. Yes a lot of questions to be answered by the auditors and banks. I am not pointing fingers at these parties as it may not be collusion but incompetence. I will try and answer this and many other follow up questions that I received in a LinkedIn article soon.

  5. Gurpreet says:

    Superb analysis, can be a useful case study.

    1. Thanks Gurpreet. Its also a good example of the application of concepts from CFA Level I and II ( FRA). Shows that these are not mere theory and have a practical and highly useful side as well. I hope this relevance motivates students of finance to grasp financial reporting and analysis.

  6. Sanjiv Amar says:

    Excellent work, Binod!

    A very comprehensive financial Analysis – off-course could not have been thought to be done before NMC actually came into limelight after Muddy Waters report.

    As an auditor, a very simple question is how a UK listed company managed to not report such a massive debt on its balance sheet! The lenders usually keep a close eye on borrower’s results & numbers filed with Exchange but in this case, it doesn’t look to have followed the suite. May be a lesson to be learnt for Leders, Auditors & Regulators!

    1. Hi Sanjay excellent queries. I will try and clarify/answer these in a LinkedIn article soon. 🙂

  7. Vineet Yash says:

    Great article Binod – always adding unique perspective with lucid analysis!

    1. Thanks Vineet. Its fascinating the impact you can make if you are able and willing to use the many tools at your disposal. The CFA curriculum is a veritable repository of such tools and techniques. The CA background also helps. 🙂 🙂

  8. M.R. Raghu says:

    Good analysis Binod.

    1. Thanks Raghu. 🙂

  9. Hurez says:

    Thanks for a thoroughly data backed account of this whole fiasco. Brings some light on to this shocking development.

    1. Thanks Hurez. I hope it was clear even to a layman although there are some complex accounting practices and jargon involved!

  10. mike says:

    Is there a future for the stock holders?

    Is this worth buying at .40-.60 per share?

    1. No idea Mike. I haven’t run a valuation exercise so can’t say how overvalued or undervalued it is.

  11. Paul says:

    Nice work, Binod. But hindsight is 20-20. If the red flags were this obvious why had all the top buy side houses piled into this? You had capital group, Hermes, Wellington, just to name a few. Even sell side analysts almost unanimously had buy ratings. The most bearish was James @ jefferies and he himself never highlighted such red flags… how do you square this?

    1. Thanks Paul. I have no idea what process and what information they used so can’t comment. I’ll just say that its not unusual for analysts to miss accounting fraud.

  12. Samer Hamed says:

    But what is interesting is how could the company conceal this amount of debt and what accounting’s treatment helped them do that? I liked the models you presented but still they proved to be working because we now know the scale of the hidden debt.

    1. Thank you for the comment Samer. But the M score and the Beneish model were flashing alarm signals way before we became aware of the huge debt. So the model worked without the expose.

  13. Ashlay says:

    Thanks for the nice article.

    Every lenders rely on audited accounts for their credit assessment. Obviously if the audited reporting was not showing the correct figures, everything that follows will be incorrect as well.

  14. Boris C says:

    Thanks Binod for all your detail,

    Question, what happend with all share in the market. The traders lost the money?

    1. Hey Boris i don’t know as I am not a trader and havent invested in NMC securities but its quite possible that people who bought pre scandal are stuck with big paper losses. And its not just the shares. Anyone who bought NMC bonds in 2018 or earlier is also probably sitting on eye watering losses especially as the minimum investment amount for bonds ( USD 250,000?) is much higher than that for shares.

  15. Mohamed says:

    Good analysis, unfortunately these models are tested as a post-mortem exercise. The sad aspect of this entire saga is that some analysts sitting far away in NY with no local knowledge were able to catch the financial manipulation and expressed lack of trust.  None of the analysts with charters and degrees from prestigious institutions with expert local market knowledge employed by world class banks, insurance companies, IPO managers , lawyers and auditors could pick this up. We wonder why ? Is there a need for more regulation on lines of SOX or is it just the greed phenomenon across all industries ? I am afraid there are many more in the closet a!!

    1. Wadhwani says:

      I suppose this excercise should be thrusted by independent arm of the regulatory authorities accross the globe. There are many tools available that enable forensic accouting but the will is what remains feeble. And so the analysis post the event. As there is an element of greed behind all investments in general, in my opinion, I believe independent agencies just like audit firms that are part of government/regulatory agencies should provide these analysis on an ongoing basis for all listed companies and for the benefit of the investing society at large to keep a check on entities timely and trigger necessary actions when identifiying red flags. This concurrent activity coupled with regular investment reports should provide more advantange to the investment community and build confidence and avoid billions lost that are not easy to earn in form of money or reputation of the profession.

  16. Vikas says:

    Who were the auditors? EY I guess. Isn’t it a responsibility of auditors to give reasonable assurance of the financial position? Quite understandably the acquisitions have caused high goodwill ratios. Could that be a case where the management picked up the companies at a higher price than FV & pocketed some part of that excess payment. $4bn is a big amount but still how did it miss the auditors eyes is a big concern, you can’t even trust Big 4s fully.

  17. Rahul Notani says:

    Great article Binod! Analysis simplified.

    1. Thanks Rahul. 🙂

  18. Phil says:

    So what happens next for the company? Are they able to remain solvent and recover?

  19. Ratnakar says:

    Great article and lot of thinking required to evaluate published financials

    1. Thank you! Its nice to be recognised for all the research work. 🙂

  20. Mohd Siddique Mallick says:

    I have not extensively followed this case, but somebody needs to investigate the auditors?

    How did the firm get away with under reporting such massive debt??

  21. Yoann says:

    Excellent article !!
    Well done!
    Any chance we do the same for wirecard?

    1. I haven’t tried that. Good idea! 🙂

  22. A GREAT article, thanks. I added the Altman Z-Score to my monthly ‘CFO Report’ just so that I can keep an eye on how it is tracking. Much Appreciated. CHARLES ARNESTAD CA(SA), CFA

    1. Thx and do let me know what you find. I am always keen to get empirical evidence! 🙂 🙂

  23. Samer Babelli says:

    Thanks Binod, this is very insightful and provides analysts with interesting perspective for companies that experience inorganic growth.
    I would also not discount the impact of reverse factoring which historically contributed to high profile defaults like Abengoa S.A. and Carillion plc.
    It would be interesting to look into their accounting policies in reference to reverse factoring and disclosures provided.

    Commentary from Moody’s in March 2018 on the collapsed UK construction company Carillion illustrates the concern:
    “Carillion’s approach to its reverse factoring had two key shortcomings: the scale of the liability to banks was not evident from the balance sheet, and a key source of the cash generated by the business was not clear from the cash flow statement.” – Trevor Pijper, a Moody’s Vice President – Senior Credit Officer

    Under reverse factoring there should be careful consideration in determining whether the financial liability should be presented as a trade payable or whether it should be presented as part of borrowings. This could impact key performance ratios and influence users’ understanding of the company’s financial position, debt and cash flows.

    I would appreciate if you can share with me your detailed analysis in excel. ([email protected])

  24. Kavissen Senivassen says:

    Great article.

    I would appreciate if you could share your excel please.

    Mail : [email protected]

  25. Febina says:

    Thank you so much for this much needed article. Helped me to know these complex calculations in a much easier way.
    Is it possible for you to share the excel work with me? Would be much more helpful since I am doing a research on the NMC Fraud case for my studies.

  26. One issue that I noticed now that we are in the new financial year — I believe the Income Statement figures should be annualized — ?? — otherwise the T3 and T5 ratios drop off in a BIG way in January when you only have one month’s worth of Sales yet your total assets (denominator for T3 and T5) remains high.

    Also, other articles that I read online use “Net Sales” as the numerator for T5, i.e. sales less cost of sales, so I am confused as to which is the correct numerator.

    Bye, Charles.

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