January 20, 2007

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.

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