coffee day

Coffee Day Enterprises operates in 6 segments: Coffee and related; Logistics; Financial services; Leasing of commercial office space; Hospitality services; and Investment operations. It operates Cafe Coffee Day chain across India. 

The total business had revenues of Rs.37 b in 2018, an increase of 21% over 2017. Revenues have been growing in double digits for the last 3 years, 2018 being the best year of growth. The financial services revenues were Rs.5.7 b and that of leasing were Rs.1.4 b. Investment operations were Rs.530 m. 

The company had book debt of Rs.50 b and operating lease debt of Rs.1.8 b in March 2018. Because it also operates in financial services business, I am not going to look at its operating profits. That will not be meaningful because for financial services, debt is like a raw material, and interest costs are part of its operations as opposed to other businesses.

Earnings for 2018 were Rs.1 b. But after adjustment for the exceptional item (sale of stake in Global Edge Software) of Rs.532 m, it is actually an increase of 13% over 2017. Earnings per share were Rs.2.51 excluding the exceptional item compared to Rs.2.28 of 2017. Return on equity is less than 5%. There aren't free cash flows generated by the business. 

But the stock is trading at Rs.291.75 implying over 100 times 2018 earnings. Who are its buyers? 

The company owned 28,056,012 shares in Mindtree representing 17.08% ownership as of December 2018.

Coffee Day Trading is a subsidiary of Coffee Day Enterprises. In March 2019, the news is that the company and its promoter have signed a definitive agreement to sell their entire stake (20.41%) to L&T for a consideration of Rs.32.69 b. The price per share works out to Rs.975; and the stock is currently trading at Rs.950. 

As per this report, the total investment in Mindtree was Rs.3.4 b: Rs.440 m in 1999 for 6.60% stake; Rs.850 m (5.57%) and Rs.400 m (2.05%) in 2011; Rs.1.71 b in 2012 (6.84%). 

If the transaction does go through, the company will have a cash flow of Rs.27 b, handy enough to reduce debt. And the promoter will reap over Rs.5 b.

Coffee Day came out with an IPO in October 2015 at Rs.328 per share, and the stock commenced listing in November 2015.

The stock is yet to recover from its IPO price. But the question is: Is the business worth Rs.62 b? 

lyft ipo

Lyft is coming up with an IPO at an expected valuation of $20 b to $25 b. Its previous private valuation was $15 b in June 2018. Now that it is coming out with a $2 b IPO, the market is going frenzy.

Here are the investors seeking a valuation as high as possible. 

And why not, when there are buyers at the price? But then pricing is a game played by the private equity and venture capitalists, and for the right reasons: They want to cash out. That's their compensation for taking risk.

What about investors who like looking at the business and numbers? I haven't got a story for Lyft, for it is beyond my imagination how far it can or cannot go. It could do very well, or it could falter. I am not sure. That's not my game. But I can lay down the numbers. 

Lyft had revenues of $343 m in 2016. They became $1 b in 2017, and $2.1 b in 2018. That's a massive increase. But the business incurred losses in operations: $693 m, $708 m, and $978 m. Markets say it is the nature of the business like any other high growth start-up. 

The business is not using much of capital. It had $3 b in cash, marketable securities, and restricted cash as of December 2018. But it will need a lot of capital going forward. Because it is losing cash every year: It has been losing over $500 m each year (2016 to 2018). For 2018, this is despite $625 m positive cash flows from changes in non-cash working capital.

We haven't got a firm hold of numbers since operating profits and earnings per share are both negative. It has had low capital spending: $71 m for 2018, and much lower during the previous two years. It acquired Bikeshare Holdings (Motivate) for $250 m, and spent $300 m on research and $352 m on advertising in 2018. That's a significant portion of revenues. There are no free cash flows yet. 

Where do we go? Easy, look at the pricing multiples. 

If we price Lyft based upon revenues: For $20 b valuation, it will be 10 times revenues. That will come down to 8x if revenues increase by 25% next year, or 6.67x if they increase by 50%, and so forth. Pricing always gets interesting.

If we choose riders: The price per rider will be $667 for the $20 b Lyft. The catch is Lyft had 18.6 m active riders. The the price per active rider will be $1,075.

How about pricing based upon bookings? 

Lyft at $20 b = 2.5 times its 2018 bookings. Cool.

There were 241.614 m shares outstanding after conversion of preferred shares as of December 2018. If we round off and consider 250 m shares, the expected IPO price will be $80 per share to get that $20 b value.

Then you can juggle, and include the options (6.828 m) and RSU (31.605 m) outstanding, and come up with 280 m shares; and the price per share will be about $70. If you include $2 b coming from IPO, the price will be $64 per share, with an additional 31 m shares being issued and totaling 311 m shares.

Lyft is a good business. But the question is at what price. That's the conundrum we face with every technology growth business, don't we?

real property, and tax

Here's the story. There was this ancestral land lingering for a long time. The house that was on the land was dilapidated. So the time was apt to do something about it. The family, finally after a long, long pause, decided to do something. 

They contacted a real estate developer, and agreed with the firm to release the land in their favor in exchange for a certain number of apartments. The developer would construct an apartment building both for residential and commercial purposes. Apart from the ones to be given away to the family all units would then belong to the developer. 

The family was keen to reduce tax, obviously. How the tax liability was to be estimated was a big question though. There was no specific reference to such transactions in the law. Neither was there any case study which was referenced in the past. At least this is what the tax consultants noted. Now what remained was how the transaction was actually interpreted: by the family, by the tax consultants, and most importantly, by the tax authorities for assessment. 

What occurred to be a simple and straightforward deal was made out to be complicated. What did actually take place? An implied sale of the land for the consideration of market value of the apartment units given in exchange. None would agree to this analysis, though, especially if the tax liability increased.

Let us elaborate. Cost of land after indexation was negligible. So the capital gain was almost equal to the consideration given. The market value of apartments given away was at Rs.3,000 per sqft. Meaning, if the apartments were sold immediately after possession, the family would get that rate. That's a deemed and implied sale. 

1) 3 apartments of 1000 sqft each: 3x1000x3000 = Rs.9 m;

2) 1 apartment of 5000 sqft: 1x5000x3000 = Rs.15 m;

3) 1 apartment of 3000 sqft: 1x3000x3000 = Rs.9 m.

That's a total market value of Rs.33 m; and a capital gain of Rs.33 m. At 20% rate, the tax liability would be Rs.6.6 m. Net cash flow to the family would be Rs.26.40 m.

Because the deal missed one step of the transaction, it appeared to be complicated. Consider this: Step 1 was sale of land; Step 2 was receipt of Rs.33 m towards sale of land; Step 3 was purchase of 5 apartments totaling 11000 sqft at the market price of Rs.3,000 per sqt; that is Rs.33 m. If these steps were carried out, the capital gains would be Rs.33 m. Just because Step 2 and Step 3 were bundled together, the fact does not change, does it? 

Of course, the family is eligible to take deductions on account of the purchase of one apartment to reduce the tax liability. Everything else should remain the same. 

No wonder there is this perverse human character that takes pleasure in making simple things difficult. 

coke and pepsi

Coke or Pepsi, which is better? Both are lousy as consumer products. But I mean, which is better as a stock? Coke is worth $191 b, and Pepsi, $161 b. The Coke stock implies nearly 30 times its earnings, the Pepsi stock, 13 times. Why should Coke trade at a higher multiple than Pepsi? Is Coke growing better than Pepsi? Which business has a better return on capital and return on equity? Or is there a bias?

Coke has a better operating margin (20%) compared to Pepsi (16%). But I don't care much about operating margin. What I do care is return on capital. Pretax return on capital for Coke is 25%, and that of Pepsi is 30%. These are long term averages. The most recent values are 36% for both Coke and Pepsi. 

And I care as much about sustainable growth rate. The 5-year average growth rate in revenues for Coke is negative 7.43%, and the 10-year average is 0%. It had revenues of $31 b in 2008, and they were $31 b in 2018. For Pepsi, the 5-year average growth rate in revenues is 0%, and the 10-year average is 4%. It had revenues of $66 b in 2013, and they were $64 b in 2018. Pepsi's revenues grew 1.79% in 2018, and Coke's fell 10%. So much for growth rates. 

They have products that are not healthful, and there is no growth in revenues. Do we really want to talk further? Both companies spend considerable amount on advertising. But it seems that Coke is more desperate, for its average ad spending is 10% of its revenues compared to Pepsi's 4%. Yeah, Pepsi has more diversified products. 

When we capitalize advertising costs, the pretax return on capital changes to 27% for Coke and 31% for Pepsi for 2018. I am using pretax return on capital because of strange things that have happened in tax rates recently. 

Both companies are mature businesses and payout significant dividends. The 5-year average growth rate for Coke dividends is 6% and 8% for Pepsi. The 10-year average is 7% for both. 

Let's look at free cash flows. Pepsi had $6.75 b pretax cash flows for 2018, and Coke had $6.1 b. The 5-year average for Pepsi is $9 b and $6.79 b for Coke. For both companies, free cash flows have not been growing. In fact, they are falling. 

So again, why should Coke be priced higher than Pepsi? Is it because a prominent investor holds it and backs it? That's appears to be a stupid idea. But then we are not dealing with rational people.

I will start with $6 b as aftertax free cash flows for Coke and $6.5 b for Pepsi. Never mind these are much higher for Coke compared to its historical numbers. With these assumptions and a growth rate of 5% leading to a cap on the growth rate after a decade, we get similar values ($85 b) for both at an expected rate of 10%. 

Based upon free cash flows at least, the market pricing for both companies appears to be on the higher side. But my point is that Coke should not be priced higher but lower than Pepsi. And this has not happened for a long time. In fact, most of the time, the yearly low market value of Coke has been higher than the yearly high market value of Pepsi. That is bias, Coke being accepted as a more prestigious brand. But then who cares for the brand when the cash flows behind it do not justify the price? 

I am no fan of either, for I don't like their products. But it is time that the market realizes the potential of these companies, and prices them accordingly. 

amazon march 2019

I have written about Amazon before, and as I have admired the company as a disruptive business, I have never been impressed with its lofty valuations. Value of a business, after all, is the sum of its cash flows discounted at an appropriate rate. It is not anything else. Markets may have been overwhelmed by Amazon, but at the end of it, its value is driven by its cash flows. 

In 2008, Amazon had free cash flows of $773 m. In 2012, they were negative $640 m due to higher capex. In 2015 and 2016, Amazon's free cash flows were over $4.5 b. Just when we thought the business will generate consistent cash flows, we had a surprise. In 2017, because of $13 b Whole Foods acquisition, cash flows were negative $11 b. For 2018, it had $9.8 b of free cash flows. They have been quite erratic as they usually are for a growing business. We have a conundrum: What are the sustainable free cash flows for Amazon? Last 3-year average is $1.1 b; 5-year average is $1.5 b. If we ignore 2017 as an exception, the 3-year average is $6.5 b. Heck, we at least need a starting point. 

I am not much of a story person. I need the business to tell me the story rather than me weaving one. The total market value of Amazon's equity is $820 b. Let's assume that investor's expected rate of return is 10%. I don't want that cost of equity shit. If I want 7% return, I will go to the S&P-500. With that out of the way, we need two more variables. One is the free cash flows, and the other is its growth rate. 

I will be an Amazon bull - which I am not - just for fun. Let's start with the beginning free cash flows of $9.8 b. Let's keep the growth rate high at 25% over each of the next 5 years, which means they will be about $30 b in year 5. I have estimated free cash flows aggregating to be $325 b over the next 10 years. For the record, they totaled $12 b in the last decade. Keeping the stable growth rate at 2.5% after year 10, I have put a break on optimism. Amazon had cash equivalents of $41 b and book debt of $32 b as of December 2018. But, it also had lease debt of $23 b which are off balance sheet because of some funny accounting rules. When I use these numbers as valuation input, I get a value of Amazon's equity much lower than its current market price. That's something to note because I have used high free cash flows as a starting point along with high growth rates.

May be one thing I missed was using high perpetual growth rate. Here's is the thing: If we used 6.5% as growth rate in free cash flows as perpetual, we get to its current market value of $820 b. The present value of Amazon's free cash flows at this growth rate is only 20% of its total value. The bulk of its value is coming from the stable growth (perpetual) period. If we start with lower cash flows as base, we will have lower value. Obviously if we keep the growth rates lower, we have lower value. 

I am amazed that Amazon continues to be priced by the market at such lofty expectations. You cannot buy an asset for its future price. The time value of money will tell you that. And yet...

Of course, when we do adjustments for lease debt, advertising costs, and technology costs, Amazon's operating margins, return on capital, and return on equity look good. But you need cash flows to value its business, and they aren't good enough at its current market price.

In March 2013, I thought long term thinking was doing good for Amazon (market value $120 b). But in February 2014, I asked, how long is long term ($160 b). In May 2015, the question was, when's the money ($200 b). In September 2015, I noted the price and value mismatch ($235 b). In July 2016, I compared Amazon with Berkshire Hathaway, and continued to ask, where's the cash ($347 b). In March 2017, I noted that when Amazon's market value hits $600 b Bezos will be the first $100 b person ($427 b). By August 2017, I talked about the hype ($474 b). In October 2017, I looked at Amazon's q3 numbers ($525 b). In February 2018, Amazon was worth $695 b, and Bezos $100 b. In August 2018, Amazon was worth $908 b as I compared it with Apple. 

Every time I try to value Amazon, I am far from meeting its market price, and I have been wrong in expecting its price to fall. Now Amazon is worth $820 b, and I say the same thing: that Amazon is expensive compared to its cash flows.

Amazon had revenues of $232 b for 2018, an increase of 30% over 2017. North America accounts for 60% of it, and Amazon Web Services, 11%. There was a marked improvement in operating profits for the North American (retail) segment though.

Nevertheless, AWS accounts for much of the operating profits, and the international segment continues to suffer operating losses. AWS has been very profitable and is growing faster than retail. As such, it would be better to look at AWS as a separate business, and value it independently.

There were 2 acquisitions in 2018: Ring for $839 m and PillPack for $753 m. Technology and content costs were $28 b. Amazon is still a growth company, and for that it needs a lot of capital. The key is how much free cash flows it will be able to generate in the next decade. It is a disruptive business, it is a fantastic business. But then it is also richly priced; and it has always been like that.