Cinemax Private Limited- Disappointment

Having read the industry recently, I started with a hope that this would be a good one. It definetely is, but couple of transactions that the company has undertaken last year make me feel uncomfortable on the nature of the company policies. Anyways, here is a brief of the IPO

Issue Details

• Issue Size: Rs. 120.42 to 138 crores
• Fresh Issue: 94.5 crores to 108.5 crores
• Existing Shareholders: 25.92 to 29.5
• Price: Rs.135 to Rs.155
• Post Issue Dilution : 31.86% of the paid-up capital
• Book Running Lead Managers : Enam Financial Services, Eidelweiss Capital, JM Morgan Stanley and Ambit Corporate Finance
• Issue Period : January 18, 2007 to January 24, 2007

Company Analysis

The company has revenues coming from diverse streams. Theatres or Movie screening, construction (commercial and retail) and also in gaming.The income from construction is not regular. The company has a history in construction with more than 5 million square feet constructed space till date. In movie screening they have more than 9000 seats across 10 theatres. They have a very significant presence in Mumbai with 9 theatres and 21 screens. The company has two important subsidiaries that is involved in constructing and the other in maintaining multiplexes.

Objects of the Issue:

The company is raising the money for funding its expansion and also an exit option to its existing shareholders. The total cost of expansion of new theatres is expected to be Rs. 110 crores with close to 140 screens in the next two years. There is hardly any investment made from existing capital. Probably, since most of the reserves have been converted to bonus shares, they found it difficult to raise cheap money!

The company technically could raise more money if it gets subscription at the higher end of the price band. Now, it is quite disappointing as most of the expansion is happening from new shareholders. The company will utilize all the funds by 2008.

SWOT Analysis

Strengths

• The company is focussed in increasing multiplexes across the country with close to 100 screens in the next couple of years from the current 33 screens. This will increase the seat size by 3 times.
• The biggest strong point for the company is the current location of its theatres. They are mostly centrally located. Also, unlike its competitors, they have 8 properties with 7 in Mumbai giving free rental cost (only opportunity cost involved).
• The company has a strong experince in building and construction. Also, there is a brand of 'Cinemax' to be considered. I do not know if can be translated into revenues. They have a premium theatre too. The utilisation of this could probably indicate the pricing power for the company.
• The companys's average ticket size is still above Rs. 100 but with the introduction of cheaper tickets, this is bound to reduce.

Weakness

• High dependance on distributor for showing films in every theatre and for every film. This gives a very unstable business model when one compares with Adlabs which are in the other end of the value chain.
• The biggest weakness for any investor, which is mentioned rightly in the risk factors is the capital structure. It is so unfair for the retail investor. The bonus issue last year has diluted the earnings in a very big game.Further, there is also an issue of a preference share issue at no cost. This has diluted the earnings even further.
• The promoters have been investing in multiple business' streams. This is an area of concern as it looks like the promoters' are willing to enter into many areas with a motive of profit. The promoters have more than 25 different companies, partnerships etc and only 4 are operational. There are too many construction/building companies. I do not understand the existance of such companies.
• Alternate mediums like DTH, DVD or VCDs can become popular making the business unattractive.
• Existing competition is with Adlabs, Inox, PVR cinemas and Shringar. Adlabs is expected to be the largest player with a strong backward integration. Given this level of competition, efficiency or utilization rate is one of the key parameters for success. There is no strong pricing power with any of these competitors. Given, that they can't reduce the price to a 'non multiplex' rate, the downside pricing to increase volumes is lost too. Also, the competitors are expanding very aggressively. Incase, they are represented in most areas, specially in prime areas, that Cinemax is operating, this can lead to loss of business.
• Currently, the projection medium is traditional. Newer digital forms can force the company to incur substantial capital expenditure.
• The issue size exceeds the current networth by 5 times. That is a lot of funding under the present capital structure.

Opportunity

• There is a big demand for theatres across the country given the poor quality currently in existance across places. Also, most theatres are willing to open in Sec B and C cities and move into small towns too.
• They are willing to work on different model for pricing tickets depending on time/day
• The contribution of Multiplexes has been increasing constantly and is close to 20%

Threat

• Success of theatres are movie specific and this can tilt towards failure with poor movie scripts.
• Alternate sources of entertainment such as DTH, DVD can lead to lower sales.
• Removal of entertainment tax benefits can risk profitabilty if lower pricing power is not passed to the customer.

Financial Structure

• On the capital structure : The capital contribution by the promoters has been for 70 Lakh shares. The rest 1.5 crore shares has been in the form of bonus shares. This has been issued quite recently-July and August 2006. With the current issue of 89 lakh shares, 70 lakh shares represents a fresh issue. This will be 25% of the post issue of the share capital.The preference share issue to the promoters and persons acting in concert is a source of concern as this was issued at no cost to the promoters.
• There is a small taxshield available in the form of goodwill in the balace sheet created out of amalgamation of group companies. This is to the extent of approximately 5 crores across years.
• D/E of the company is on the higher side : 2.2 ( Tax provisions benefits taken as a part of equity)
• The working capital requirements for the company is increasing at more than 55% CAGR. Given the nature of business (cash from tickets) the company's has a huge growth in working capital requirements.
• As with any other multiplex, there are primarily three sources of income: Ticket Sales (60-70%),Food and Beverage(15-20%), Advertisement. In the case of Cinemax, this works to 80% (on the higher side), and the rest is with food and beverage. Advertisement revenues is very marginal(~5% but contribution is increasing). The sales from tickets has been growing at 30% p.a.
• Project income is something erratic for the company and hence difficult to estimate revenues from this business. It contributed to 55% of the revenues last year. However, this year it is less than 20%. Gaming income is still insignificant for the company (~1%)
• However, on the cost structure of the company, the distributor cost contribution is about 25% and this has reduced from last year at 40%. Entertainment tax has reduced for the company mainly due to tax benefits enjoyed by multiplex.Employee costs have risen in the last six months (~8% of the cost)
• The company has not declared any dividend till date. However, it has compensated with a huge bonus issue.
• The ROCE is about 40% significantly higher than its peers. This will fall down to 28% after the issue.
• The current EPS is at Rs. 2.02(annualised). This has dropped from 3.57 last year. The only reason for it being the huge dilution of equity in the month of August. If one removes project income and depreciation written back, the current EPS is at 1.56 wherars it was 4.07 last year.
• Given the erratic nature of the project income, the Cash from operations is highly irregular. However, the current business is generating strong cash for the business.

IPO Pricing

Relative Valuation : (Taken Post Issue Capital and on the lower price band)

Price/Sales :6.46 and Net Profit Margin : 20%. Inox is trading at 6.34,Adlabs is at 12.5 and PVR cinemas is at 19.01

Price/Book Value : 10.58 and ROE:28% Inox is trading at 4.2, Adlabs is at 5.23 and PVR cinemas is at 2.95

Price/Equity : 66 times. This can go as high as 89 times if the benefits from the new theatres do not accrue to the shareholder in the next year.
Inbox is trading at 39, Adlabs is at 37 and PVR cinemas is at 61.86.


Managment

The management of the company is headed by the Kanakia family. A family held business from 1984. The other members are quite impressive. They have a CA who is also a key director in other companies including Ashok Leyland, Gulf Oil Corporation, Ennore Foundaries etc. Another director is an independent director at L&T, Hindustan Motors, India Infoline etc.


Interesting Facts

It is interesting to note that the issue of 1.5 crore shares through a 'bonus issue' to the promoters. The lead managers have rated this as a risk factor, possibly on the basis of concern on management. Apart from this, the directors have a monthly salary of Rs. 2.5 Lakhs per month as salary and perks.

Each principal promoter will have a networth of close to Rs. 130 crores on the lower side. These promoters have increased their networth by 3 times from approximately 40 crores to 130 crores merely by issuance of bonus shares.

The company is pretty expensively valued when compared to its peers. I have not valued two of its important subsidiary because of the nature of disclosure. However, this could impact the pricing in a significant way. A big let down was on the pricing and also on the bonus issue by the company. I would not buy this stock inspite of the business being attractive.

Autoline Industries IPO - Go Ahead

After more than a week IPO is back in action. The first for the year is Autoline Industries Limited. For once, reading the IPO was very refreshing. A good insight into the automobile industry.

Some of the key issues for the IPO
Issue Size : 75 Crores
Period : January 8 to January 12, 2007
Price Band : Rs. 200 to Rs.225
Lead Runner: BoB Capital Markets
The company has been extended loans by BoB, a prime reason for being the lead managers for the issue.

Objective of the Issue

• The company is planning to upgrade, expand and modernise its existing facilities and desgn centre in Pune.
• The company is planning to enter into new products such as door assembly and contract manufacturing for heavy vehicles
• Building a new corporate office
• 'Long Term' working capital requirements

Sourcing of Funds

• The company is looking at an investment of Rs. 104 crores. The funding has been done as follows.
• 75% of the funding is done from this IPO. 8% through private placement. 17% from raising debt.

Utilisation of Funds

• Expenses on Construction / Upgradation / Modernisation : 72%
• Joint Ventures and Acquisition : 11%
• Working Capital : 11%
• Others: 6%

Strengths and Weakness for the Industry

• The industry is moving up in the value chain and also there is some element of scaling of business by existing players. This would help in driving the cost of manufacturing down.
• The after market is mostly held with unorganised players, with more than 65% share. This is a good opportunity for companies with scaling business to take advantage of price. However, increase in scale can lead to differential taxation nulling such benefits.
• Cost and quality advantage, esp in the export market, where India's contribution is increasing every year (CAGR >25% in the past 5 years).
• The industry is moving towards e-auction. This is a big danger for companies that are in contract manufacturing.
• There is a huge demand for cost reduction from suppliers. Also suppliers are engaged in active designing and the risk of performance is falling on automotive component suppliers.
• Consolidation in the industry leading to fewer players in the market. The same should start occurring in the component supplier in which scale is giving key benefits.

Strengths and Weakness for the Company

• The company is committed with this IPO fund deployment. The funding which is to be raised from debt has already been raised or commitment received from BoB and Kotak Mahindra Bank.
• 25% of the cost of the plan requirements has already been implemented with existing source of funds. The promoters have contributed to this significantly. This might be reduced with the money raised. However, I like the promoters commitment to the venture.
• The company has made some really strong predictions on its sales figures. 95% (almost on track 54% of the target sales figure reached in 7 months) for the current year. 140% for the next year and 20% the following year.
• The company is also looking at mass production as a method to reduce its cost. This will make them competitive and can increase volume in the long run. This would increase the dependence of its customers on the company.
• The company is moving up the value chain from being a mere manufacturer to be a part of the design team. The downside risk is the inherent problem with quality manpower. Its subsidiary company is involved in this venture and it is a reseller of a software and does CAD/CAM. The subsidiary company is planning to increase manpower. However, for a company which does not have a clear focus in this area, I still am not sure of the success of this venture. The company has a tie up with Detroit Engineered Products. This MOU seems to be a more successful idea than having a separate venture of its own.
• The company is also setting a state of art control tool room that provides testing facilities. The customers are unclear and though this contributes only 5% of the cost of funds required, utilisation is under doubt.
• The project expansion has taken the customer requirement in mind. The company has entered into some kind of contract manufacturing with the Indian subsidiary of Stokota, Belgium.
• The biggest weakness for the company would be client segmentation. With more than 80% of the business coming from a single client Tata Motors, the company is running a big risk.Though the company has a small benefit being a sole supplier to Tata Motors, this however is product dependant.
• The company's owners were more than willing to have the entire IPO handled by BoB, given that they have had very few issues last year. Merely being the bankers to the company, BoB was able to influence them quite easily for a complete issue.
• The company has been given a covenant of not declaring a dividend till it has an adequate current ratio of 1.33:1 and also the bank's permission.

Financial Aspects of the company

Networth of the company before the issue : Rs. 298 million
Net worth of the company before the issue : Rs. 373 million
Book Value : 42.49
EPS (Latest) : 15.95 (Annualised)
RoE : 25%
RoC : 8.4%

• The company has a employee manpower of 1588 and this is expected to increase by another 72. The incremental sales per employee is expected to increase by more than 75%
• The company has just started declaring dividends over the past two years (18% last year).
• The inventory is close to 15% of the sales, on the higher side.
• Significant cost include: Raw Material and Manufacturing Expenses: 90%
• In spite of huge investment in machinery to create scale benefits the depreciation cost contributes <2%>
• The interest coverage ratio is now close to 6 times and this can go down further with increased sales.
• The current CEPS for the company is around Rs. 14

The future financial projections can give the following EPS and the forward P/E for the company:



Relative Valuation

1. Price/Earnings: 14 times on the higher side and 12.5 times on the lower side. Rasandik is at 12, Jay Bharat Maruti is at 12 and Automotive Stampings is at 20
2. Price/Book Value : 5.29 times on the higher side and 4.7 times on the lower side Jay Bharat Maruti is trading at 2.5 times(RoE : >20%) and Automotive Stampings is trading at 2.7 Times (RoE : 9%) and Rasandik Engineering is at just 0.49 times (RoE : >20%)
3. Price/Sales: 1.19 one the lower side and 1.33 on the higher side Net Profit Margin of the company is 6.3% while that of competitors are Rasandik is at 6%, Jay Bharat Maruti is at 2% and Automotive Stampings is at 1.5%

Others

• The company has been receiving some funding from different entities in the past. The most recent one in August was at Rs. 130, a steep discount of 30% (lock in period is 20% 3 years and 80% 1 year)at the lower end of the issue for a company that is doing really well for the year and with clear plans for an IPO in place giving sight of exit options to the investor. Yet such a discount to the issue.
• Mr.Vikram Bhat, the chairman of the company has strong credential with the Monitor Group, Mahindra British Telecom and other entities of the Mahindra Group. Also the board is largely filled with non technical people and also a marketing professor from IIM A.
• The promoters networth would be close to 11 crores (on the lower side) with this IPO listing.One of the promoters of the company is a sitting MLA and also a former mayor of Pune. Surprisingly, the company does not look bureaucratic as a government institution The group has not ventured beyond this company. No company is sick though two companies of the two promoters are not doing any more business.
• The company is not facing any major litigation and also the contingent liability is on the lower side and more on export obligation commitment.

Pricing of the IPO

The company has priced its IPO between Rs. 200 and Rs. 225. On a relative basis and given sales projection the forward P/E looks very attractive for an investment in this company. However, the profits are dependant on two key factors: ability to meet its sales projection and its pricing power. With the product it has and the success of Tata Ace and Indica, the volume looks plausible. However, pricing and profit margins is still under threat. I have made some downward correction to the future margins. Given the strong RoE the Price/Book Value is attractive comparatively attractive to its peers. I would give a 'go ahead' to this IPO and a good investment for the future. There is a possibility of listing gains in this scheme. However, I would look at this stock for a long term rather than a short term story.