Nesco Ltd

We value investors are a funny breed. I have over the past couple of years experienced that though we might share the same framework and thought process for some explicable reasons the portfolio of value investors rarely seem to match beyond maybe 20 – 30% of stocks. I regularly compare notes with my fellow friends and value investors Rohit Chauhan and Neeraj Marathe ( and a few more ) and funnily I have found that all of us have different stocks that we are comfortable with.

So it was a interesting that during the last week of December it transpired out of conversations/emails that all three of us have been independently looking at a company - Nesco Ltd. So we decided that post the year end break without discussing individual thought processes or our view on the company, we will put out posts on our blogs with our perspective on this investment opportunity. We thought it would be an interesting exercise for us as well as the readers of our blogs to have a post on the same company at the same time. The idea is not to see who is right or who is wrong. All three of us know that even if we reach a consensus, all three of us could be very wrong and even if all of us have different conclusions, all three could be very right! Well thats the best thing about investing, there is no one way of doing things.

You can check out Neeraj Marathe’s post at  http://neerajmarathe.blogspot.com/  and Rohit Chauhan's post at  http://valueinvestorindia.blogspot.com/ 

So here goes my side of the story 

Nesco Ltd was established in 1939 as New Std Engg and operated in the capital goods business. The company had plants in multiple locations in Mumbai which it finally consolidated at a single location in Goregaon on the Western suburbs of Mumbai with a 70 acre plot.

The company started incurring losses in its capital goods business and gradually shifted to the business to Gujarat and converted the Mumbai land bank into a exhibition and convention centre. The size of the land bank coupled with close proximity to the airports and the national highway has enabled it to become one of the premier exhibition centres in the country and has conducted over 500 exhibitions and events at the location. The closest competitor in Mumbai, Nehru Centre is less than 1/15^th the size in terms of exhibition space.

The company has also converted its old plant sheds into IT parks and is in the process of constructing a large IT park ( IT park 3). IT park III will have nearly 8,00,000 sq feet of space and the company has leased  out a significant chunk of this project which is under construction and should be ready for fit outs in the next couple of months. 

The management has been conservative and has repaid the debt on the books and has used the internal accrual route to fund expansion for the IT park that it is setting up. The management has clearly stated plans for IT park IV and IT park V where it intends to use the cash flow generated out of the exhibition business and rental income to fund construction of the remaining IT parks.

Financials

FY 2011

a) Income

1)       Convention Business -  65.62 crores ( up 21% over previous year)

2)       IT Park ( rent Income ) – 51.61 crores

3)       Capital Goods business -  16.82 crores ( Down from 24.8 crores in the previous year)

4)       Income from investments and other income -  10 crores

b) Cash/ Investments on Balance sheet -  168 crores

c) Net Profit -  68 crores

d) Cashflow from operations -  78 crores

HY -  2011 -2012

a) Income

1) Convention Business -  25 crores ( HY 2011 -  21 crores )

2)       IT Park ( rent Income ) – 51.61 crores

3)       Capital Goods business -  15.29 crores (HY 2011 -  6.61 crores )

4)       Income from investments and other income -  3.15 crores (  HY 2011 -  3.63 crores )

b) Cash/ Investments on Balance sheet -  215 crores

c) Net Profit -  25 crores

Dividend policy

The dividend payout ratio has been poor because the management has chosen to reinvest the cashflow in construction of the new IT building. The management intends to maintain the same as it is averse to taking debt and will use internal accrual to fund further construction over the next four to five years. One can’t argue against this thought process of the management considering the high operating margin and ROCE.

Valuation

The company is currently available at a market cap of Rs 800 crores with no debt on books. Against which we have

Cash / Investment on Books -  215 crores

Net Profit – 68 crores ( Last year) 

IT Park III should start contributing from next year and on a conservative estimate of Rs 80 per sq feet should generate an additional Rs 50 crores of revenue in FY12-13. 

So net cash of the company is available at 5-6 times and which would appear low for a company with high ROE and with steady cashflow and huge entry barrier to the business.

Risks

1)       Though cashflows over the next 4- 5 years are slated to be lined up for construction of IT park IV and V, subsequent to which there is lack of clarity on what the management intends to do with the cashflow going forward. The bladder problem of management either earmarking the cash for its capital good business or blowing it up into unrelated diversifications exists.

2)       The historical low dividend payout ratio though can be argued as logically correct at this stage of the business could however turn out to be a constant thought process for the management.

3)       The biggest risk that I perceive is that the entire business model is constructed around a piece of land in a single location in Mumbai. Mumbai is currently the most expensive city in this country with respect to real estate prices. There is a situation of oversupply of commercial property in Mumbai. The company stands exposed to not just a generic correction in real estate prices ( hence associated rent income )  but more importantly derating of the Mumbai real estate market. There is a increasing trend of companies shifting their IT / ITES operations out of Mumbai to other locations like Bangalore/ Pune/ Gurgaon etc. Case in point is that Intelenet which occupies one of the building did shift a significantly large process of over 2000 ppl to Aurangabad. TCS Eserve which occupies one of the other buildings is expanding its operations in Ahmedabad and other Tier II cities. Considering the 4- 5 year window when shareholders could possibly look at actual cashflow, this is a large risk that the business carries.

 My viewpoint

Prima facie the company appears to be cheap with relatively steady cashflows. I intend to look at company from a different angle.

Is Nesco a cash bargain / holding company and hence should be valued accordingly?

Lets examine the management competency variables

1)       The biggest achievement of NESCO is the piece of land at Goregaon which it fortuitously acquired a long time back.

2)       The current business model and cashflows are dependent on this piece of land.

3)       Can we say the management has competency in the real estate business and can take up more projects beyond this piece of land like any other real estate developer. 

4)       Is the same true about the Convention business? Do we think the management has competency to set up x more convention centres across the country and run it?

5)   The only operating business that management is running which is the capital good business has a chequered past track record.

So lets flip the coin and look at NESCO as a holding company / cash bargain opportunity.  We have a plot of land which on a conservative basis can be valued at RS 2000 crores + 200 crores ( Cash on balance sheet) = Rs 2200 crores.

This piece of land through rent and the convention centre generated about  68 crores of net profit last year . (I m keeping the calculations simple at this point of time without valuing the capital goods business separately) 

Effective yield of 3.4%. This yield should go up to about 5 % with the IT building III coming to play.

The market today values

Holding companies -  25% of intrinsic value

Cash bargains  -  40-50% of cash on balance sheet

 ( One can argue on the merits and demerits of these discounts but if one feels otherwise clearly there are better managements who could  be looked at for cash bargains)

 Considering the relatively lower yield being earned as compared to other cash bargains and management risk we can value the company at about 40% holding value.

 Value of the company -  40%* Rs 2200 crores -  880 crores

Current market cap  - Rs 800 crores.

Conclusion

Considering the lack of visibility of cashflow payout to the shareholders over the next 4- 5 years, I would like to look at this opportunity a couple of years down the line as clarity emerges on the management’s thought process and visibility on dividend payout and deployment of future cashflows.

Wordsworth

Like women’s fashion, there are words and phrases which come into our daily lives at light speed and disappear equally fast. Very few stick around to become part of our long term vocabulary. I have experienced this in all facets of life over the years whether in College/Corporate world/ Indian movies or in the investing space.

I of course rue words and phrases which are dear to me disappear gradually from the popular vocabulary. For Ex the word “Zulf” was so intrinsic to Hindi romantic songs but has been gradually replaced by the crude “Baal”.

When I was in management school the word “ Paradigm” had just emerged as the new paradigm of corporate lingo and everything kept moving to newer paradigms. Paradigm though still used fairly extensively has now been replaced by a more easy to pronounce “ Plane”. We all now seem to moving onto different planes and of course try to land on the “Same Page”.

The investing world also has its fair share of words and phrases that come and go like flavours of the month. It was with much amusement that I was recollecting just about 6 – 12 months back one of the most popular pair of words that most TVanchors and pink newspapers were mouthing was “ Coupling” and “ Decoupling”. I am sure most of you have a wry smile about this one.

Readers would recollect we used to be “Coupled” one week and miraculously used to get “Decoupled” the next week and again get coupled the next week. It was like speed dating and I thought it would have been easier to track Liz Taylor’s everchanging marital status than figuring out where our markets were in their love affair with global markets.

I of course am not so sure whether we are currently coupled or decoupled though our correlation or the lack of it with the global markets remain the same.

A new phrase that I m increasingly hearing for the last 6 months and has entered the Tv anchors lingo is “Risk Aversion”. It would be interesting to see how long “ Risk Aversion” lasts or will it also disappear gradually if markets go up.

To end, a nice phrase from the English romantic poet William Wordsworth

The mind that is wise mourns less for what age takes away; than what it leaves behind.

Interesting Accounting - Jyothy Laboratories

I was listening to the current quarter concall of Jyothy Laboratories and came across some interesting accounting.

In the month of May 11, Jyothy Laboratories announced the acquisition of Henkel’s stake in its Indian subsidiary Henkel India, gaining a foothold in the detergent market. Henkel India has been losing money for sometime and Jyothy has initiated action in turning the business around. As part of the exercise Jyothy has borrowed money on its balance sheet and lent that money to Henkel to manage debt on its books.

In the current quarter Jyothy has borrowed over Rs 460 crores ( 4600 Rated Taxable Zero Coupon Non Convertible Debentures  of a face value of Rs 10 lacs) by issuing short term debentures to the bank and lent the same to Henkel India. The debenture has been issued for a period of 91 days and will be redeemable at a premium of Rs 26,801.47 per debenture.

Now comes the interesting part. Jyothy in its current quarters results has booked other income of 14.82 crores. Nearly about 12 crores of it is interest paid by Henkel India to the parent for the money that Jyothy has lent to it. It is a significant amount considering the fact that Jyothy’s PBT for the quarter is Rs 16.93 crores.

But guess what, there is no corresponding interest expense booked in Jyothy’s accounts against the income that they are booking. On the concall the management said that since it is a zero coupon debenture which is being redeemed at a premium, the company is allowed to write of the redemption premium ( which is essentially interest) from the reserve and surplus. So magically they are booking interest income in the profit and loss account and expensing it out in the balance sheet.

Not really Ujjala bright and clean I must admit 

Endowment Bias and our wives – Interesting paradox

I have been besieged with increasing demand from my fans ( Fan club of two people - My pet frog and my pet rock) to start writing on the blog again. So here goes …

I m sure most of you have read about endowment bias on multiple blogs. Prof Bakshi has written on it and so have my friends Rohit and Neeraj commented on it.

Endowment bias or effect is the phenomenon where people start valuing something more after they own it. It is the effect where people would demand a considerable higher price for a product that they own as opposed to what they would be prepared to pay for it before they own it.

A practical example is that people will always expect a higher amount for their home when they are selling as compared to what the prevalent market rate. In case of the house part of the value ascribed comes from the effort put in over the years in converting the house to a home at a emotional level. The buyer of course has no such emotional attachment to the house. A car once purchased, miraculously seems to better features than the neighbours car and so does our television or tablet etc

Endowment bias seeps into our stockpicking when suddenly the company we buy transforms from a ugly duckling into a white swan. It begins to look very precious with great business opportunity, great management, ability to increase marketshare, ability to increase margins etc. This flaw also plays out in our decision to sell the business when we always perceive it to be more valuable than what the market is willing to pay for it.

The paradox of course is that we suddenly don’t find our wives more beautiful or more precious after we marry them ( hopefully my wife is not reading this). I haven’t encountered men (even women) paying glowing tributes to their spouses like saying “ How good a cook my wife is or how beautiful/ intelligent she is or how caring my husband is etc

One way of looking at the paradox is that we really don’t own our wives :-). A lovely song by the Beatles called the “Norwegian Wood” comes to my mind immediately

“I once had a girl, or should I say, she once had me …"

Punjab Alkalis Update

I had earlier written on the opportunity arising out of the possible disinvestment of Punjab Alkalis by the Punjab state government.
The opportunity seems to have taken a ominous turn with an update that I read on the website which states that no bids have been received before the due date. The link is enclosed below
http://www.pbdisinvest.nic.in/html/approver_current_status_PSU.htm
Though I cant make out whether this is a old update when initial interest for the disinvestment was called for or a fresh update for the financial bids. Part of it could originate from the floor price that the government has defined or structure of the deal.
There could be fresh round of bids called with some concession from the government, I would rather err on the side of caution. Considering there is no valuation comfort, it makes sense to exit the situation without having to live thru the risk.

Humour in Results

It is my honest belief that there is a lot of humour all around us if we look at things with a slightly open mind.

As I was browsing through announcements on the BSE site, I came across a interesting announcement made by Gujarat Alkalies and Chemicals ltd regarding their results.

http://www.bseindia.com/xml-data/corpfiling/AttachHis/Gujarat_Alkalies_and_Chemicals_Ltd_140211.pdf

In the Press release Shri Guruprasad Mohapatra, IAS, MD of the company announced that financial ratios have improved significantly at the end of the third quarter as compared to year end March 10

1) Price Earning Ratio - 13.15 times from 5.37 times

2) Current Ratio - 1.68 times to 1.56 times

3) Debt Equity Ratio - 0.13 times to 0.17:1 times

4) Book Value - Rs 193 from Rs 185

Now you would wonder what magic did the management did to improve PE ratio. It is news to me that management’s are now beginning to be judged by how well they can talk to the markets and improve their PE ratios.

Coming down to the magic that the management did to improve this PE ratio. It was a goal that they achieved by reducing the nine months profits of the company from 86 crores to 58 crores. Forget the price just reduce the earnings. I m waiting for the day they bring down the profits to zero and increase the PE ratio to infinity :-).

Midday / Nirma Update

Midday

I had initially written about the midday demerger opportunity and followed it up with a subsequent post when I exited the trade. Links to the post are enclosed below

1) http://investingvalues.blogspot.com/2011/01/take-midday-break.html

2) http://investingvalues.blogspot.com/2011/01/midday-update.html

The stock went Ex on the 20th and the market finally valued the radio business at Rs 8.60 per share on the closing of the day. This was in sync with my estimates of Rs 8-10 per share with 10 bucks on the outside.

Nirma

I had written earlier on the Nirma Delisting opportunity and the structure of the transaction. Link of the post is enclosed below

http://investingvalues.blogspot.com/2011/01/nirma-delisting.html

The reverse bookbuilding closed and the company has garnered enough shares to make the delisting successful at a price of Rs260. The management has till Feb 02nd to announce its acceptance / rejection of this discovered price.

There is a side trade that can be done now that the book has closed. Typically in the event of the management accepting the price, the stock will move towards the Rs 255 mark with the arbitrageurs sealing the gap. At the current price of Rs 248 there is Rs 6-7 bucks on the table in a 10 day period. However in case the management decides otherwise and rejects the offer then the stock could settle 25% lower from here. To quote Buffett/Munger this is the classic “Picking pennies in front of the roadroller” :-) and I for sure don’t have the appetite for it.