~~ Beginning of the Case ~~
A LOT IS HAPPENING OVER A COFFEE..!!!
(Case Study – Valuing IPO of Café Coffee Day)
Swarup prefers to spend his Sundays as dull as possible. The Sunday of October 11thof 2015 was going to be different for him. On any other weekday he would’ve commenced the day with getting a global market update from the Bloomberg app on his iPad. Being an investment broker for several HNI investors of Equate Advisors, Swarup is a much sought after relationship manager by his clients. His clients feel Swarup is one such adviser, whose stock picks rarely go wrong. His boss at Equate Advisors is generally happy with his performance in terms of delivering numbers and maintaining satisfied customer relations, but, he feels Swarup sometimes contradicts the stock advises of central research team. Swarup argues that’s precisely the reason for his success. He does not blindly recommend a stock to his clients, instead, with every such recommendation that comes to him from his research team in Mumbai, he does his own valuation of the stock before he arrives at his conclusion. He strongly believes this always works.
By the time he woke up on this Sunday it was already 9.30 am. He stepped out of his apartment after a short work-out module at the club-house. The generally-residential area that it is, Sahakar Nagar in Bangalore, was semi-urban in landscape. Less than 200 meters from his apartment complex was an outlet of Café Coffee Day (popularly called CCD), to which Swarup was a regular visitor. He had an emotional connect with CCD, as most of his successful client meets happen in CCD outlets, thanks to widespread presence across Bangalore; he spends most of his leisure and he feels rejuvenated after every visit in CCD; and more than anything, it is in this CCD that he proposed his girlfriend (and she accepted..!!). Truly a lot happened to Swarup over Coffees in CCD…!!!
screen, while still being amused at the young crowd at the shop already barged in. The moneycontrol.comwebsite that he had open yesterday was still on the first screen. As if it was usual, Swarup reluctantly glanced through news stream, and he found a news item – “Café Coffee Day to go Public”. He also recalled grapevine download from his chitchat with his research team that Equate Advisors are going to recommend CCD for a buy at IPO aggressively. His hot espresso was served and he could just smile at the thought of how hot CCD’s IPO going to be. He decided to be better prepared. And this Sunday was to become a working Sunday for him.
Swarup believes valuing a stock means valuing a business. It’s important to understand the fundamental business model of the company. He browsed through the red herring prospectus (RHP) of the company and few websites to gather relevant information and made notes as below, as he usually does:
i. Stakeholders: CCD’s parent company Coffee Day Enterprises Limited (CDEL) is held by V G Siddarth-led promoter group upto 93%, whereas private equity firm KKR, Infosys co-founder Nandan Nilekani and Rakesh Jhunjhunwala’s Rare Enterprises make it to the list of major shareholders with 3.43%, 1.77% and 0.24% equity stakes respectively.
ii. Businesses: CDEL classify themselves into mainly food service market, as their primary business is into coffee products. In addition to having the largest chain of cafés in India, CDEL also operates in procuring, processing and roasting of coffee beans and retailing coffee products across various formats. Their diversification into non-coffee businesses include technology park development, logistics solutions, financial services, Resorts & Hospitality and ownership stakes in IT-ITES companies like MindTree.
iii. Environment: Their claims about the growth in coffee vending business gets justified with the changing consumption pattern of northern and western Indian tea drinking population also preferring to coffee consumption. Added by strong economic and demographic aggregates like increasing percapita income, rising urbanisation, discretionary spending, out-of-home food consumption trends, corporatisation etc., coffee outlets today are in demand more than ever.
Indian QSR (Quick Service Restaurants) market is expected to grow exponentially in the coming years. The same (in Rs. Billion) is shown in the below graph. (Source: Techopark, March 2015)
iv. Strengths: CDEL’s strengths are strong home-grown brand, first-mover advantage, substantial market presence, established network of franchises and dealers, multiple consumption points, disorganised competition, scalability of the business, diversified businesses focusing in India growth story and professional management.
v. Strategic View: Currently, CDEL’s strategic outlook is to further deepen the existing chain of cafés; increase café revenues by generating higher footfalls and driving increased consumption; leverage brand equity of “Coffee Day” and “Café Coffee Day”; constantly augur product range; and also develop non-coffee business.
vi. Financials: A simplified set of consolidated financial statements for the previous five years were also prepared like this:
Consolidated Multi-Step Income Statement (Simplified) | |||||
Rs. in millions | |||||
Particulars | For the year ended 31st March | ||||
2011 | 2012 | 2013 | 2014 | 2015 | |
Revenue from Operations | 10244.04 | 15652.79 | 20995.60 | 22870.08 | 24793.55 |
Other Income | 725.15 | 685.92 | 495.84 | 657.63 | 693.60 |
Total Income | 10969.19 | 16338.71 | 21491.44 | 23527.71 | 25487.15 |
Cost of Goods Sold | 6727.64 | 7075.02 | 7205.34 | 7076.89 | 7751.94 |
Other Expenses | 1994.49 | 2150.65 | 2355.52 | 2570.32 | 2983.10 |
EBITDA | 2247.06 | 7113.04 | 11930.58 | 13880.50 | 14752.11 |
Depreciation | 792.45 | 935.69 | 1208.55 | 1540.76 | 1579.54 |
EBIT | 1454.61 | 6177.35 | 10722.03 | 12339.74 | 13172.57 |
Finance Costs | 464.56 | 431.90 | 399.80 | 449.40 | 554.98 |
EBT | 990.05 | 5745.45 | 10322.23 | 11890.34 | 12617.59 |
Tax Expenses | 101.18 | 104.78 | 93.55 | -1.37 | 44.46 |
EAT | 888.87 | 5640.67 | 10228.68 | 11891.71 | 12573.13 |
Extracts of Consolidated Balance Sheet | |||||
Rs. in millions | |||||
Particulars | For the year ended 31st March | ||||
2011 | 2012 | 2013 | 2014 | 2015 | |
Non-Current Assets | 7384.3 | 9302.07 | 10700.71 | 11251.42 | 10794.61 |
Shareholders’ Funds | 7566.96 | 7369.69 | 7344.04 | 7281.88 | 7693.05 |
Interest-bearing Non-Current Borrowings | 4355.66 | 4226.63 | 3713.46 | 3937.66 | 2844.03 |
Current Assets | 7627.30 | 5860.35 | 4172.2 | 3984.27 | 4546.98 |
Current Liabilities | 2735.78 | 3076.19 | 3146.95 | 3292.07 | 4092.01 |
Total Assets | 15011.60 | 15162.42 | 14872.19 | 15235.69 | 15341.59 |
Extracts of Cash Flow Statement | |||||
Rs. in millions | |||||
Particulars | For the year ended 31st March | ||||
2011 | 2012 | 2013 | 2014 | 2015 | |
Cash Flows from Operating Activities | 103.78 | 1520.04 | 1600.01 | 2304.60 | 3131.45 |
Cash Flows from Investing Activities | (2121.22) | (54.01) | (1078.10) | (1492.73) | (1147.97) |
Cash Flows from Financing Activities | 2646.03 | (611.97) | (852.16) | (803.87) | (1354.25) |
Purchase of Fixed Assets | (2005.80) | (2689.87) | (2452.10) | (1650.63) | (1460.67) |
vii. IPO: The current issue was to raise Rs. 11500 million with a price band of Rs. 316 to Rs. 328 per share using book building process. Currently, the number of shares held by owners is 170,940,744 with a face value of Rs. 10
The issue proceeds are planned to be utilised towards repaying of existing debt to the tune of Rs. 6328 million (in FY16); financing for expansion of coffee business to the tune of Rs. 2875.10 million (in FY16 – Rs. 1241.08 million; in FY17 – Rs. 1634.02 million) and rest to be used for general corporate purposes (evenly in the coming two years)
viii. Market & Competition: Key players in the coffee outlets include Starbucks, Dunkin, CCD, Barista, Cost Coffee and other minor operators. Their respective market shares are given in the below table:
CDEL’s competitors include the coffee outlets businesses as above; QSR operators such as McDonalds (WestLife), Dominos (Jubiliant Foodworks) and KFC, Pizza Hut (YUM); food and grocery businesses Nestle and HUL.
Swarup uses Enterprise DCF approach to arrive at the valuation. He decided to use some modifications in the process, as he normally does and calls it Midas Touch of Swarup..!!:
ü He has decided to use CAPM approach to compute cost of capital. Considering that this company do not have historical data of prices, he wonders how to compute the beta. He has anyways collected below information relating to industry players (those which are listed):
Jubiliant Foodworks | Nestle India | HUL | |
Beta | 0.14 | 0.62 | 0.11 |
Debt Equity Ratio | 0 | 0.37 | 0 |
Risk-Free Rate = 7.20% (RBI 10-year GOI yield) | |||
Nifty Monthly Returns annualised for the period 2011-2015 = 14.2% | |||
ü The marginal tax rate for the corporate is 30%, and Swarup prefers to use this, instead of effective tax rate, which is negative in many years for CDEL
ü He also wants use a growth rate estimate as below. These rates are based on his discussions with few of his friends in the equity research industry and also few industry experts he keeps interacting on social n
etworking platforms: From 2016 to 2025 – 17% p.a; After 2025 – 3.50% p.a infinitely. He consciously avoids using the sustainable growth rate as this is the case of IPO, which is expected to be a turnaround event and company’s prospects will be way different from its past.
etworking platforms: From 2016 to 2025 – 17% p.a; After 2025 – 3.50% p.a infinitely. He consciously avoids using the sustainable growth rate as this is the case of IPO, which is expected to be a turnaround event and company’s prospects will be way different from its past.
ü He wants to assign weights to cash flows of last five years as below, for forecasting purposes, so that he is giving higher importance to latest cash flows:
2011 | 2012 | 2013 | 2014 | 2015 | |
Weights | 0.10 | 0.10 | 0.20 | 0.30 | 0.30 |
ü He decides to compute FCFF first and then reduce the debt component to arrive at FCF for equity shareholders.
ü Swarup also wants to conduct a sensitivity analysis using Monte-Carlo simulation for changes in above growth rates.
Questions:
(1) Discuss the possible valuation biases Swarup is exposed to in valuing CDEL.
(2) How do you compute the beta for an unlisted company?
(3) Compute the post-issue cost of capital for CDEL.
(4) Do you agree with Swarup that sustainable growth rate of past cannot be applied in the case of valuing an IPO?
(5) What will be the projected FCFF for CDEL for the next 10 years and the terminal FCFF?
(6) What will be post-issue intrinsic value per share of CDEL?
(7) Conduct a simulation using MS-Excel for varying rates of growth of next 10 years from 12% to 24% (changing interval of 1%) and terminal growth rate from 0% to 6% (changing interval of 0.50%). What will be the expected post-issue intrinsic value per share of CDEL
(8) Discuss the areas of subjectivity involved in the entire CDEL valuation exercise of Swarup and what other alternatives were skipped in the process.
~~ End of Case ~~
INSTRUCTOR REFERENCES:
I. What courses are intended to be using this case?
The case can be used as part finance courses like Financial Management, Security Analysis, M&A, Investment Banking, Corporate Valuation, Financial Modeling/Analytics/Engineering
II. What concepts/models/theories can be explained through this case?
This case can be used to demonstrate the below concepts/theories/models/applications:
i) Corporate Objective – Shareholder Wealth maximisation to Intrinsic Value Maximisation
ii) Concept of Intrinsic Value
iii) Valuation biases, subjectivity and Challenges
iv) Accounting Profit Vs. FCFF, FCFE
v) Cost of Capital (WACC); CAPM; Cost of Equity for unlisted company
vi) IPO Process
vii) Enterprise DCF Technique
viii) Financial Modelling using MS-Excel for corporate valuation
ix) Sensitivity Analysis using Monte-Carlo Simulation using MS-Excel
III. What main issue/problem is addressed in the case?
The case addresses the problem of valuing an unlisted company during its IPO that is already a household name, and hence, has ample scope for pre-valuation bias
IV. Teaching Notes:
1) The anchor books for the above case would be,
ü “Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, 2ndEdition” (Author: Aswath Damodaran) by Wiley Publishing
ü “Corporate Valuati
on and value Creation” (Author: Prasanna Chandra) by McGraw Hill
on and value Creation” (Author: Prasanna Chandra) by McGraw Hill
ü “Financial Management: A Step-by-Step Approach” (Author: N R Parasuraman) by Cengage Learning
2) This case can best be solved using MS-Excel. Student should be comfortable in entering formulas, using functions and using What-if Analysis feature in MS-Excel.
3) A total for 4 sessions (approximately 5 hours of classroom discussion with demonstration is required). Ideal if the students are grouped into groups of 3-4 members in each.
4) Possible Approaches for solving the key issues: (Explained Question-wise)
Question-(1) : Discuss the possible valuation biases Swarup is exposed to in valuing CDEL.
As Swarup is already having positive impression of CCD (as a customer), he might be biased while using some inputs, like, the growth rate, overlooking of past performance etc. (Input Bias); He may also revisit his assumptions after valuation if his value differs from the Band Price of Rs. 316 to Rs. 328 (Post-Valuation Tinkering Bias); He may also dedicate the distance between his value and the price band to qualitative factors, like strategic consideration etc.(qualitative factor bias). (Refer Damodaran – Chapter-1)
Question-(2) : How do you compute the beta for an unlisted company?
Step-1: Compute the asset betas of listed competitors – HUL, Nestle & JFW
Step-2: Compute the equity betas using the above asset betas.
Step-3: Compute the average equity beta
Step-4: Compute the equity beta of CDEL using proposed capital structure
(Refer Prasanna Chandra – Chapter-3)
Question-(3) Compute the post-issue cost of capital for CDEL
Compute WACC using post-issue weights
(Refer Prasanna Chandra – Chapter-3)
Question-(4) Do you agree with Swarup that sustainable growth rate of past cannot beapplied in the case of valuing an IPO?
Yes. CDEL has incurred losses in two out of last 4 years. The purpose of IPO is primarily to clear the debt. The financial performances will turnaround once the debt is cleared and planned expansion take place. This will not be reflected if we consider sustainable growth rate (ROE X Retention Ratio) of past years.
(Refer Damodaran – Chapter-3 & 4)
Question-(5) What will be the projected FCFF for CDEL for the next 10 years and theterminal FCFF?; Question-(6) What will be post-issue intrinsic value per share of CD
EL?
EL?
Step-1: Prepare projected income statements for next 10 years, applying the growth rate given in the case on the sales numbers. Using common size approach, project the other numbers.
Step-2: Compute projected FCFF for next 10 years
Step-3: Compute the terminal cash flow using Gordon’s model and compute the present value
Step-4: Compute the present value of all cash flows = FCFF or Value of the Firm
Step-5: Deduct the debt component = FCFE or Value of Firm for Equity Shareholders
Step-6: Divide FCFE by number of equity shares post-issue = Intrinsic Value per Share
(Refer Damodaran – Chapters – 4,5 & 6; Prasanna Chandra – Chapter -2)
Question-(7) Conduct a simulation using MS-Excel for varying rates of growth of next 10 years from 12% to 24% (changing interval of 1%) and terminal growth rate from 0% to 6% (changing interval of 0.50%). What will be the expected post-issue intrinsic value per share of CDEL
Use MS-Excel>>Data>>What-if Analysis>>Scenario Manager
Use MS-Excel>>Data Analysis>>Random Number Generation>>Conduct Simulation
(Refer Parasuraman – Chapter-17)
Question-(8) Discuss the areas of subjectivity involved in the entire CDEL valuation exercise of Swarup and what other alternatives were skipped in the process
Areas | Swarup’s Action | Possible Alternatives |
Growth Rate | Expert Opinion | Regress with Economic Numbers Sustainable Growth Rate (ROE X RR) |
Competitors | HUL, Nestle, JFW | Other Hotel Stocks |
Forecast Period | 10 years | Can consider the Business Cycle and Decide |
Risk-free rate | 7.20% | Could’ve adjusted for long-term interest rate expectation |
Cost of equity | CAPM | Dividend Discount Model; Bon-Yield Plus Risk Premium; APT; FF Five Factor Model |
Tax Rate | Marginal Tax Rate | Effective Tax Rate |
Capital Structure Weights | Current | Long-term Target Capital Structure |
