"A brazen fraud"

Late last month, H.I.G. Capital sued Audax Group over its 2021 purchase of Mobileum, a provider of enterprise analytics and network services for telecom companies.

H.I.G. says Audax and their management team artificially inflated Mobileum’s revenue and earnings, conning them into paying around $250 million more for the asset than it was actually worth.

Mobileum Inc.

Audax bought Mobileum, originally called Roamware, in 2016, and continued with co-founder and CEO Bobby Srinivasan in the same role post-acquisition. Through their hold, the team completed a series of six add-on acquisitions before hiring Jefferies to lead a sale process that launched in early 2021.

According to H.I.G., Mobileum’s process fell flat. With no credible offers from initial outreach, H.I.G. was brought into the fold in September following a preliminary call with Jefferies that sparked their interest.

The group kicked off their diligence and submitted an IOI in November, before blowing up deal team holidays with the signing of a $915 million purchase agreement on December 25th.

Based on marketed 2021 EBITDA of $84 million, the 10.9x multiple was a relative bargain as valuations peaked, particularly for a business that was supposedly growing 15% year-over-year.

Not the Company They Thought

Now, H.I.G. says more than $20 million of that EBITDA was fabricated in what they’re calling a “carefully coordinated, systemic effort intended to deceive.”

Their lawsuit alleges a series of financial misrepresentations, discovered after completing what they’ve characterized as a full post-acquisition forensic investigation.

The accusations take two primary forms…

1. Prematurely recognized revenues (and thus earnings) from long-term projects: In 2020, Mobileum updated its accounting procedures to use a “percentage of completion” methodology (POC), estimating the portion of a project completed at any given point in time and recognizing that amount of revenue as a proportion of the total contract value.

For clarity, a project that is 50% complete will have 50% of its total value recognized as revenue.

This presented an attractive opening for POC manipulation. A tempting target in a sale process, most private equity owners would do as much as they could around the edges to front-load their earnings.

Audax, however, is accused of going overboard. Portfolio company Mobileum dramatically shifted forward its project completion rates in order to artificially pad revenue through the sale process. H.I.G. says customer relationships had deteriorated in recent months, and the deception was Mobileum’s solution to avoid downward forecast revisions.

The complaint cites an example of a 490 employee-days project, which Mobileum restated to just 81 employee-days of work, before recognizing the entirety of its revenue in September (the start of H.I.G.’s interest). On the back end, they were forced to book 3,800 hours on a non-billable code to hide the real labor required for the project.

The breadth of the alleged deception reached a point that members of the finance team internally questioned its feasibility, with one remarking that “taking the full quarter revenue in the first month is not right. Auditors will catch it for sure.”

Second-order consequences of the alleged manipulation created other problems to mop up — confused by the revenue acceleration directives, some Mobileum employees asked “how customers might react if and when they receive invoices for milestones not yet completed.”

To avoid that problem, CFO Andrew Warner and his team opted to maintain an invoicing schedule commensurate with original project timelines (and real work completion). That, however, created an abnormal build-up of unbilled revenue balances.

Per H.I.G., the growth in unbilled balances appeared out of the ordinary and became a diligence focus. Questions from both H.I.G. and another interested party pressured Mobileum to find a solution for what was rapidly becoming a sticking point.

The practice created internal friction as well. The complaint quotes a Mobileum employee raising concerns over a “mismatch” between bookings and revenue, calling into question the accuracy of financials: “I don’t know what [the] numbers are and they’re certainly not correct.” Another employee responded, “It’s all bullshit.”

Warner’s response to the situation was to create a set of falsified internal invoices. The company continued to bill clients in normal course, while dating internal invoices in line with the fraudulently accelerated revenue recognition — including falsified time logs.

Often, their internal invoices showed dates that were a month or more before when the invoice was actually sent. This provided cover to shift the unbilled balance to billed (accounts receivable) and alleviated the mounting pressure from prospective acquirers.

Referencing the growing complexities of the suspect operation, a member of the Mobileum finance team was quoted as saying, “My God … Get me out of this nightmare,” but was told, per the complaint, “You already know what it takes to do this.”

A quote tailor-made for inclusion in a lawsuit, though, to be fair, most portfolio company employees would share similar sentiments in the middle of a sponsor-to-sponsor sale process.

Regardless of management’s thoughts, Audax and Mobileum senior leadership felt the problem was averted, seeing off the final hurdle in the way of a transaction.

After hearing of the reduction in unbilled revenue, CEO Srinivasan emailed Audax on December 15 (ten days before signing): “Frankly, this should be game, set and match for both [the other bidder] and H.I.G.”

2. H.I.G. contends Audax went a step further and also created fake bookings to support the appearance of a rapidly growing business. In reality, H.I.G. believes the supposedly double-digit growth company was actually shrinking by more than 5 percent per year.

The complaint alleges Mobileum falsified hundreds of booked transactions, though centers its narrative around $12 million of signed contract value with a business known as Kibott.

Per H.I.G., Mobileum’s CFO introduced the company to the upstart hospitality vendor, which, it claims, was controlled by two of Warner’s friends. They maintain Kibott was not incorporated, had no customers, no funding, no revenue, and clearly had no prospect of ever paying Mobileum for its services.

They also say those services made no sense — why did a hospitality business need specialized enterprise analytics meant for telecom infrastructure providers?

H.I.G. says Kibott was clearly nothing more than a sham to help Mobileum “cook the books.” An opportunity to freely fabricate bookings and revenue to ensure the company hit its targets as the sale process progressed. Less than 0.5% of the claimed revenue was ever collected.

Backing up their argument, Warner is quoted as directing a Mobileum staffer to “think of this as a blank canvas” and a way to “maximize revenue.” Per the complaint, Kibott first began utilizing Mobileum services in September, just as H.I.G.’s interest heated up.

Liaising through a consultant that was engaged by both Kibott and Mobileum, Warner arranged various engagements and projects to build up to the $12 million headline value.

H.I.G. says the consultant in question received “commissions” for each fraudulent purchase order signed—whether or not Mobileum ever actually collected any payment.

In partnership with Warner, the two were said to have strategized on how to “squeeze” as much out of Kibott as they could, “carefully selecting numbers that would push Mobileum just over its targeted [forecast].”

H.I.G. also says that a portion of these payments made their way back to Kibott and its principals.

Supposedly referencing the Kibott arrangement, Warner explained the task to a direct report: “The reality is we have a target number from Bobby [Srinivasan], then build the support that makes the number seem reasonable, but we can not say that!!”

An approach not dissimilar from the reality of many budgeting processes. Benefit of the doubt does, however, become difficult to maintain:

H.I.G.’s Kibott allegations make for interesting reading, but they do contain a number of inconsistencies compared to a March 2023 breach of contract suit that H.I.G.-owned Mobileum filed against Kibott in the Northern District of California.

In that filing, H.I.G. contradicts its own narrative around Kibott’s role as Audax’s last-minute fake revenue "blank canvas." Instead, H.I.G. says Mobileum was actually introduced to Kibott in November 2019, more than 24 months before their current timeline.

They also claimed that the 2019 initial meeting was facilitated by software development agency owner Peter McNamara, not Audax-installed CFO Warner. Mobileum's relationship with McNamara dates to 2017. Detail is redacted, though it’s likely McNamara is the unnamed consultant in H.I.G.’s current suit.

The companies then held a series of discussions through 2020, including product pitches from Mobileum and negotiations over a potential engagement. All evidence of a longer-term relationship that doesn’t fit the last-minute sale process scam that H.I.G. now says it was.

They go on to claim that the relationship proceeded only after Mobileum reviewed and got comfortable with Kibott’s business plan, credit-worthiness, and “commitment to meeting its customers’ and potential customers’ needs,” even though it was a hospitality startup in stealth mode. This included a proof of funds analysis completed by a third-party auditor. A very different portrayal than the current line of questioning around Kibott’s suitability as a customer.

Per Mobileum v. Kibott, the parties signed a 12-month Framework Services Agreement in June 2021. Much of the detail is redacted, though the agreement included a full scope of work.

It’s a different story than H.I.G.’s current portrayal. Their complaint briefly mentions the June agreement, though, throughout the filing, positions the Kibott engagement as having started only in September, explicitly tying it to the beginnings of H.I.G.’s interest.

Now, H.I.G. claims “Kibott was not a bona fide customer, but instead a third-party controlled by friends of Warner who were happy to enter into millions of euros worth of sham contracts.”

Even so, Mobileum continued to provide services to Kibott through at least November 2022, including an additional June 2022 statement of work that reaffirmed the relationship and was sanctioned by what was then an H.I.G.-backed management team.

H.I.G. now says its own post-close management team (many of which continued in their roles) perpetuated the fraud, seeking to cover up what was really happening. As part of their evidence, they point to an internal post-close admonishment from one Mobileum employee to another: “Please don’t send emails detailing things out … will land you in lot of trouble.”

Diligence Breakdown

If H.I.G.’s claims are proven true, the decision to proceed with a deal for Mobileum reads as a significant diligence miss — none of the alleged fraudulent activities were particularly sophisticated.

At least one other sponsor avoided the mess. H.I.G.’s complaint references a second buyer in the late-stage process that ultimately walked after receiving their quality of earnings readout, completed by KPMG. That report, H.I.G. says, noted “numerous inconsistencies in data and information” provided, as well as “a general lack of controls.”

According to H.I.G.’s account of events, their PwC-led buy-side QoE didn’t provide cause for concern. They say PwC investigated Mobileum’s revenue recognition only after the H.I.G. deal team specifically directed them to review abnormalities.

It’s difficult to believe a competent team from a reputable financial due diligence provider would miss something so blatant.

The Kibott situation is equally confusing. Kirkland-led legal diligence would have immediately flagged any agreements signed with a counterparty that wasn’t incorporated, operated in an entirely different industry, and for which there were supposedly questionable consulting or sales relationships (as is now all claimed).

The contract also wouldn’t have been lost in the shuffle, relative to larger clients, given that updates to its scope came in the middle of H.I.G.’s diligence and, according to H.I.G., had a material impact on whether or not Mobileum could hit its numbers.

With existing concerns over revenue recognition and unbilled balances, scrutiny of last-minute financial updates and contract changes must have been high.

H.I.G. maintains its U.S. financial due diligence relationship with PwC and, at least through mid-2023, continues to actively engage Kirkland & Ellis on Mobileum matters, including their legal proceedings with Kibott.

A purely speculative explanation is that H.I.G. knew something was up, but decided to turn a blind eye in hopes of landing a bargain. Even without the fraud, they came into the process looking for a deal on an undesired asset, knowing that Jefferies’ initial outreach failed and there were relatively limited alternatives.

For its part, Jefferies may have had misgivings of its own. As the deal neared its conclusion, the Mobileum finance team shot off telling chat messages:

Though, fraud or not, any banker would be concerned about their client blowing the deal with a revenue miss.

What’s the Full Story?

A case of window dressing gone too far, or a concerted effort to defraud H.I.G.? The plaintiff certainly has its view, but Audax’s investment mandate probably does not include a strategic focus on cooking the books.

Audax filed a countersuit last week — it remains sealed but should provide additional color on the situation (and entertainment) when it becomes publicly available.

 DEALS, DEALS, DEALS

• Saudi Arabia is considering the purchase of a stake in the Indian Premier League, a leading cricket competition that could be valued at around $30 billion.

• The Walt Disney Co. (NYSE: DIS) announced an agreement to purchase NBC Universal’s 33% stake in Hulu for around $8.6 billion.

• Core Industrial Partners invested in Century Box, a manufacturer of folding cartons for private-label food and consumer goods.

• EagleTree Capital acquired MMGY Global, a marketing agency specializing in travel and hospitality., from Peninsula Capital Partners.

• EQT has resumed its interest in Global Switch, a London-based data center provider that could sell for around $6.5 billion.

• Greenbelt Capital Partners acquired electrical infrastructure services firm Saber Power Services from Oaktree Capital Management.

• RedBird Capital Partners is evaluating exit options for French soccer club Toulouse FC, a soccer club in France’s top flight.

• Six Flags (NYSE: SIX) and Cedar Fair (NYSE: FUN) have reached an agreement to merge into a consolidated theme park operator in a $2 billion deal.

• Ascendant Capital Partners may restart efforts to acquire Hollysys Automation Technologies (Nasdaq: HOLI), a provider of industrial automation and control systems trading at around a $1.3 billion market cap.

• GIC acquired a 35% stake in Southern European resort management company Hotel Investment Partners, owned by Blackstone.

• Graycliff Partners acquired Xcel NDT, a provider of non-destructive testing service for essential infrastructure.

• Accenture (NYSE: ACN) has agreed to buy digital consultancy 6point6 from ICG.

• Cytokinetics (Nasdaq: CYTK), a $3.3 billion market cap biotech focused on muscle disorders, is considering a sale process after fielding inbound offers.

• MRC Global (NYSE: MRC), a supplier of pipe, valve, and fitting products is considering a sale following activist involvement from Engine Capital.

• Treasury Wine Estates has agreed to acquire California-based Daou Vineyards for more than $1 billion.

• Blackstone and Vista Equity Partners agreed to acquire Energy Exemplar, an Australian developer of energy market modeling software, from The Riverside Co.

• Carlyle launched Farmfront Group as a new irrigation platform formed via the combination of portfolio companies Ocmis Group, Irrimec, Otech, and RKD.

• Madison Dearborn Partners acquired Shaw Development, a developer of fluid management systems and sensors for diesel engines, from Monomoy Capital Partners.

• Percheron Capital acquired SafeBasements, a basement waterproofing and foundation repair service.

• TT Capital Partners acquired a majority stake in Cantata Health Solutions, a provider of electronic health records for behavioral health.

• American Securities agreed to sell medical instruments manufacturer Paragon Medical to AMETEK (NYSE: AME) for around $1.9 billion.

• BuzzFeed (Nasdaq: BZFD) may be nearing a deal to sell Complex Media to lifestream shopping platform NTWRK, backed by Goldman Sachs and Kering.

• Reality Income (NYSE: O) agreed to acquire Spirit Realty Capital (NYSE: SRC) for $5.3 billion.

• Western Digital (Nasdaq: WDC) announced plans to spin out its flash memory business after negotiations fell apart with Japan’s Kioxia over a deal for the unit.

• Apax Partners agreed to acquire Ascential (LSE: ASCI)’s consumer research unit for up to £700 million.

• Bernhard Capital Partners agreed to acquire Entergy (NYSE: ETR)’s gas distribution business for $484 million.

• Blue Owl Capital agreed to acquire funds managed by Cowen Healthcare Investments, picking up around $1 billion in assets.

• Madison Industries, a Sequoia Heritage-backed industrials platform, agreed to buy CAE (TSX: CAE)’s healthcare unit for C$311 million.

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