Future Enterprises Ltd (FEL) : Spin off with lot of hidden value


(SecretInvestor) #1

Hi everyone,

FEL (Future Enterprises) & FRL (Future Retail) were demerged some months ago.

Everyone knows FRL is the Retail business of the Future Group but a very few people understand FEL.

FEL basically has 2 standalone operating divisions : A) Lease rental biz. B) Manufacturing biz. They do the above businesses as a back end operation for FRL itself. Hence, they have solid & long term earnings.

Its interesting to note that FEL has done FY17 EBITDA of 1000cr rupees. Hence we have a strong core standalone business here. (Mkt cap is just 1400cr).

They also have debt of 5000cr approximately. This number sounds scary.

But here is the interesting thing - They have assets on their books which are currently valued at 5000cr too. Some of these are absolutely crown jewel assets such as stakes in Future Generali Insurance, Future Supply Chain (IPO expected this year according to Mr.Biyani), Prime mill land in the heart of Mumbai - Apollo & Goldmohar mills and some other stakes. A conservative valuation of the above assets on FEL books is 5000cr rupees.

*The management has indicated at the time of demerger that they plan to demerge all these assets in the coming quarters and make FEL a debt free company.

Valuations are very interesting:

Market cap of the company is about 1400cr. Debt is 5000cr. So, we have approx 6400cr EV.

We have FY17 Ebitda of 1000cr. Hence, we have EV/EBITDA of 6.4x on trailing numbers.

Now, if we believe that the management sells all their stakes as guided, we are going to have a debt free company and essentially have an ‘Adjusted EV/EBITDA’ of 1400/1000 = 1.4x.

*I have double and triple checked my numbers. FY17 reported EBITDA is 1000cr and this is rock solid and sustainable income because they are contracted through lease rentals and manufacturing for Future Group companies.

The company also has scary looking debt but its all entirely Long Term Debt via NCDs maturing after 5-6 years. The bonds too are trading above par. (Bond market thinks that the debt position is solid).

Forget everything else, the current trailing EV/EBITDA is 6.4x. That in itself deserves a 8-10x multiple due to the robustness of the income.

Also, according to me, their Future Generali & the Future Supply Chain businesses are doing very well and growing. With GST, the Supply Chain IPO will also be very strong.
The Apollo & Goldmohar mill land are absolutely coveted assets too. Their value has also risen since FY16 valuation.

Theoretically, if we assume the debt is canceled out by the investment sales, we will have a standalone company with 1000cr trailing ebitda and 1400cr market cap (debt free). Also to note is that, the standalone business is growing too.

Any feedback on my thesis will be very appreciated. If I am wrong in my thinking, please let me know. I have studied this over and over and I am baffled.

Disc- I own this stock.

S.I


(saurabhshares) #2

I see they have investment valued at 1500 Cr. So that is the max they could sell to clear debt.
I don’t think they can sell their core assets to pay their debt.
Please correct me if I am wrong.


(SecretInvestor) #3

Hi Saurabh,

The company had given a latest update on their investment values at the time of spin off.

Future Generali insurance stake itself is value between 2000-2200cr in FY17. (FY18 will have further growth).
Future Supply Chain IPO is expected in FY18 and its expected to be a hot IPO at very high valuation. Their stake can easily be valued at 1500cr.
They have 2 prime mill land parcels in Mumbai which I got some rough estimates done and I believe they are valued at minimum of 500-600cr and 800-850cr on upside.
Then they have small stakes in FCEL etc where the price has gone up a lot too.
All combined, it will easily fetch 5000odd crores at todays value according to me.

Best thing about FEL is that its not only a holding company, but its got a rock solid standalone business which is getting masked by depreciation and interest payments.

The standalone business has EBITDA of 1000cr in FY17 and mkt cap is 1400cr.


(ramakanth) #4

Hi,

I was going through the annual numbers of FEL on screener.in. Had a couple of questions:

  1. Why is the top line of the company going down from 2015? (Came down from 10K cr to 3K cr in TTM)
  2. The margin of the business has been phenomenal in the last twelve months. What has changed?
  3. Does the company have plan to reduce debt in the near future, considering that it is eating away most of the revenue.
    This looks like an interesting find, but might have to dig a lot deeper to understand the metrics of this business. Also at one point in time it was trading at 500+ now it is close to 35 level. Is it only that debt levels that is causing such a high discount to the company’s value?

(Subash Nayak) #5

One simple answer for all your queries. There has been demerger in Future group cos, (Now we have 4 Future group cos). So past data is of no use.


(Dayanand Deshpande) #6

Have you considered the non-current assets given such as property, plant and equipment (5974 Cr) mentioned in the consol balance sheet apart from the investments you mentioned?


#7

@SecretInvestor, thanks for starting this thread. I own this stock with similar thesis.

@saurabhshares, @daya555: The investments are held at book value, however the figure mentioned by @SecretInvestor is their market value or appraised value by the company. For more details, you can see slide 9 in this company presentation. The whole presentation is helpful in understanding the construct:
http://www.futuregroup.in/pdf/Future_Enterprise_9_May_16.pdf

The company has already sold 12.75% stake in Future Supply Chain Solutions and 16% stake in Future Lifestyle Fashions, which gives some comfort that management is going through with their plan of divesting investments.

Following are some questions / risks that I see and am keen to build more comfort on.

  1. Growth and maintenance capex: The company’s D&A spend is ~INR 160 Cr per quarter. How much is the real cash outflow based on maintenance capex in existing stores and growth capex for new stores? This will help us know how much free cash is expected to be generated over next 2-3 years that can be used to pare debt.

  2. What are concrete targets of debt reduction going forward? Debt increased slightly from Q3FY17 to Q4FY17 and we need to be watchful of increase in debt going forward.

  3. What are the contractual terms for each operating business (lease rental, garment manufacturing) with other Future Group entities? How long are the contracts for and are price escalations built in or not.

Overall, key monitorables for me are:

  • reported debt numbers
  • reported capex numbers
  • any decline in revenue in lease rental or garments business
  • progress on selling stakes in investments
  • insider selling

Please feel free to share other thoughts / insights.

Disclosure: I own this stock.


#8

There is news today that Future Enterprises is planning to sell its 50% stake in insurance company Future Generali General Insurance, and there are three bidders in line. This could result in debt reduction by ~INR 2000 Cr.

If true, this will be a positive development as it will show that the company is following its stated plan of deleveraging, and some of this debt in enterprise value should get converted to market cap.

Disclosure: I own this stock.


(SecretInvestor) #9

The company has a great EBITDA. Even if the company prints its cash EPS, the stock will come on many people’s radar for its extraordinary cheap valuation.


(shagun jain) #11

I have written a blog post. some problem in pasting here. hence the link attached.


(Raj Mehta) #12

What’s the difference between Future Enterprises Ltd. and Future Enterprises Ltd. (DVR)? Which is the right one, under discussion in this thread?


(vivtho) #13

That’s something I’ve been wondering too. I think there are two classes of shares, but I’d like someone with knowledge on the matter to confirm.


(Ankchandak) #14

Derivatives are also shares of company… But shareholders doesn’t get voting right for these shares. That’s why dvr usually trades on discount.
For more explanation you can read investopedia. It covers all the basics


(ASPN) #15

Very true. Only thing is that its not Derivative. DVR is Differential Voting Rights, which simply means that you can own the shares (just like ordinary shares) but may or may not have right to vote on various resolutions passed by the company. Pls refer below article for more info.


(8sarveshg) #16

@shaggyjo @SecretInvestor @subashnayak_19_
I have a question here, why are we focused on EBITDA and not PBT/PAT in a business where depreciation is very real. This is because this is organised retailing business - this is a business where one can’t hope to be competitive if the store is not nice and swanky at all times. I am not a retail expert and may be the boarders here can throw some light, but my sense is that today’s hyper-competitive retail environment it is not possible for a store to last for more than 10 years. That means my economic cost of replacement is huge in this business. Now coming to Future Enterprises, the segment assets in leasing as of FY17 is ~6000 cr. If I apply the logic that 1/10th of all my fixed asset base is going to go out of the business every year - 600 cr is a very real cost that I need to incur as fresh capex/store closing/maintannce capex etc.

This brings us to a very interesting conclusion - in FY17 the company earned a measly revenues of just 675 cr in leasing while if the economic cost of fast depreciating assets is itself 600 cr. This is before I have even counted the fact that I also need to pay the interest since I am heavily leveraged. And this is what FY17 numbers tell us, EBIT of just 45 cr on a asset base of 6000 cr - this is an RoCE of less than 1% - RoCE of 1% is a kind of business which has zero value because it is tremedously value destructive. So I think blindly working on EV/EBITDA model is not going to help here because depreciation is not a non-cash cost here, it is a significant cash cost. By the way even this EBIT of 45 cr doesnt take into account corporate cost etc. which if allocated can actually make this a loss making business.

The other business is manufacturing and trading, now this is a captive B2B apparel manufacturing and trading business which is available dime a dozen in a textile hyped country like us, the margins that this business is making is not on account of the standalone business merit but it is a function of what Mr biyani thinks they should earn in an any given year (correct me if I am wrong). I would not value this business at more than 1 times capital investment less debt excluding land value (because land value is being calculated separately anyways in the calculation of investment value). So if I do segment assets - segment liabilities for this business it comes to 1000 cr but I am not sure if land value is included here. So the best case valuation of this business is 1000 car and much less if land value is included in this. Can anyone enlighten us on whether the land cost is included here, please?

Overall because of extremely low EBIT with real cash expense occurring as depreciation (captured in Cash flow from investing), I feel that may be the market is right in valuing the overall business at 1500 cr because all other investments (I won’t get into details of investments value because that is anyways put forward by others and in total investments is approximately equal to debt.

Guys who have done a lot of work on this can please enlighten others on why this business should be valued at anything more than what it is.

Also the business has significantly high related party transactions with companies where Mr. Biyani has either far greater stake (Future Corporate, unlisted etc.) or far greater wealth (Future Retail). Why should Mr Biyani bother so much that this business should earn its rightful share of lease rents in an arms length way when this business has a market cap of just 10% of what Future Retail has. Isn’t it best to take out all the margins out of this business and park it in either unlisted related party (Future Corporate) or listed company where he has most of his wealth (future retail).

One more point, both future lifestyle stake and future consumer stake were sold at throwaway prices in the past few 7-8 months resulting in huge loss of potential realization from sale - Future lifestyle was sold at 1/3rd of the current price in December 16 to a 100% promoter owned entity and Future Consumer was sold at 2/3rd of current price just last month. Is this is series of mistake of omission or something else. The total loss to shareholders and benefit to promoters just on account of these trades is 1000 cr - in effect 500 cr of minority wealth (current minority market cap is just 750 cr till few days back) has been lost and transferred to the promoters. Is this is coincidence or deliberate.


(SecretInvestor) #17

Thanks for the thoughtful pushback. I have thought of most of these questions and am comfortable with them. Let me tell you why:

  1. Lease rental: You are being far too simplistic here. The capex is not a simple case of 6000cr divided by 10 years. Firstly, the routine maintenance capex is borne by Future Retail and not FEL. You are right that most of the furniture and fittings have a 10 year life and need to be replaced at the end of that. What you are missing is that (a) the end of life furniture has scrap value of 7-8% which FEL keeps and (b) FEL renews the contract at a spread to their cost of capital. FEL can borrow at 9-10% and then rent out the equipment at 12-13% annually in the new contracts. It’s a simple arbitrage business and I would venture that it has much more value than what you are implying, although clearly it is not a super high multiple business.

Management has suggested their runrate gross capex is 400-450cr. Net that out with salvage value and you get a decent business when the FY18 EBITDA is ~700cr (and growing). And btw, the revenue/ebitda is effectively contracted out for the next 6-7 years, so you have long recurring revenue and cash flow visibility.

Think of it this way. What happens if the company stopped doing growth capex for 2-3 years? They would generate 600-700cr in cash from this business and that would be enough for them to completely buy back the entire stock (market cap) from the market. And then you are still left with tonnes of contracted ebitda to come in the future years and still grow. Do you still think this business has zero value?

  1. Manufacturing business: Firstly, I do agree the margin here depends on Mr. Biyani. However, that can be said of any business. What happens to Future Consumer’s business if Future Retail stops buying from them? Do you value FCON based on invested capital? I suggest you short the stock and get a nice 90% downside on FCON then. The fact is that the manufacturing business is an in house manufacturer of apparel for the group and gets a certain margin, and has done for many years. I know how to value cash flows and I would value it based on cashflows with the appropriate discount you want to put on Mr. Biyani’s motives. Your call.

  2. The rest of your pushback essentially hinges on Mr. Biyani’s motives. To that, I would ask this question: if he really doesn’t care about FEL, why did he then leave all the crown jewel investments of the Future Group within FEL? Why didn’t he just spin them out with FRETAIL? The debt has no recourse to these assets, so there was really no need to keep the assets with FEL. Mr. Biyani is a smart man and would have known that the market will hate FEL when they look at it (for all the reasons you highlight: debt, depreciation, lack of ROCE, small market cap etc.). I don’t like to speculate publicly about things like this but just looking at the price action suggests this stock has been steadily cornered over the past 6-9 months or so once the foreign funds sold out.
    I take your point that minorities did get the wrong end of the stick in the FLFL and FCON transactions. I would paraphrase Munger here: tell me the incentives and I will tell you the outcome. Clearly the transactions favoured the promoters: they seem to have chosen to have 100% of the upside instead of 48%. But that did also give FEL cash to deleverage. Let’s be honest here… it was the rational thing for him to do and most promoters in India would have done it. Or maybe it’s just a coincidence. Only they know.

The key here is that you have a company trading at ~1.5x adjusted EV to EBITDA (once you adjust the debt for the investments). Btw the debt is mostly bonds with 6-7 year maturities so the chances of them defaulting is practically nil with their contracted cash flows. If you do not like to value based on EBITDA that’s fair enough. Neither do I. How about EBITDA minus capex? It is still trading at ~3.0-3.5x adj. EV/EBITDA-Capex.

Now clearly the fireworks here will be when they monetize their insurance and supply chain divisions. Till then, I would suggest you buy as much stock as you can get your hands on, because this is free money even at 40 (even though I bought at 16, for disclosure). Either that, or you go and short FCON with your above logic. Peace and sorry if I will be late to reply to any further questions; I am super busy these days. Those were smart questions you asked (I asked myself the same questions).

p.s. Do note that this business will benefit immensely from FDI in retail as they can cater to foreign cos looking for an asset light model while setting up in India. I also understand they got tonnes of requests for building out fittings and fixtures for bank ATM roll-outs post demonetization. There is a lot of growth there if they want it / can finance it… especially from non Future group entities.


(8sarveshg) #18

@shaggyjo @subashnayak_19_

@SecretInvestor Thanks for the long reply. While I will not speculate on the recent rally in all Future Group companies as well as many other stocks as thats the subject of speculation where I dont specialize, I will restrict however myself to lease business where after your reply I did some more work.

I now believe that I was wrong in assigning a ZERO value to lease rental business, the value will run into a large negative number. I take your point that in the case that they stop all their growth and don’t do any maintenance/replacement CapEx - they will still earn EBITDA which will be worth something - however that will be liquadation value and not as a ‘going concern’ but the essence of valuation here is to value it as a ‘going concern’.

  1. Lease rental yield - I don’t know how you have come up with the figure of 13-14%, please enlighten. Let me calculate the same here using some broad assumptions since we don’t have the FY17 annual report. The total Standalone opex is ~150 cr, lets assume 50% of that is related to lease rental business and rest is manufacturing business. This means given that the EBIT is just 45 cr, EBITDA is 45 cr + 75 cr = 130 cr. This means Depreciation for lease rental business is approx 675 cr - 130 cr = ~ 550 cr

Now, FY17 Net block is ~6000 cr (excluding CWIP). Given that inventories which should solely pertain to manufacturing business are ~900 cr while total segmental assets for manufacturing business is just ~1500 cr, we can conclude that ~90% of fixed assets are in the leasing business. So lets say the net block for lease rental business is ~5400 cr.

Also, gross block for FY16 is 6600 cr and this year Dep is ~600 cr, so this year gross block is ~7200 cr of which 90% is lease rental so gross block for lease rental business is ~6500 cr. (these are just simplified assumptions and doesnt take into account other minor stuff like store closing/sale etc.)

On this 6500 cr gross block, the company is earning a measly net rent of 675 cr (rental revenue) - 75 cr (opex) = 600 cr net rent - this is a ~9% net yield and not 13-14% as you implied in the post. Now at this step itself, one can say that this business is largely financed by debt at an average cost of upwards of 10.5% will be a perennial money losing business. This is common business sense.

Now, coming to the point of Capex that the company will incur, I think that the company has given guidance of 400-500 cr gross capex and you have mentioned the same in your post - I think this will be a significant understatement because FY17 number itself is looking like 1200 cr. This is because as I have said in my earlier post, this is how capex will look like in a typical year:

  1. Replacement capex - assuming 10% of stores have to be completely revamped every year = 10% of gross block = 650 cr
  2. Growth capex - assuming Future Retail wants to grow at 12% every year and wants to remain asset light so as it keep its high market cap where most of Mr Biyani wealth is = 12% of gross block = ~800 cr

3.Total capex = ~1500 cr (For FY17 this number has been 1200 cr assuming all capex done in lease rental business, as one will appreciate this number is likely to increase as stores age)

Total cash flow from operations = 600 cr

Total interest payments to be made = ~450 cr (assuming 90% of the present debt is related to lease rental)

Total cash suck up every year = 1350 cr (this is if Future retail decides to only grow at 12% and not higher). More importantly even if all the debt is paid, this will still be a yearly drag of 900 cr (excluding interest)

This is the simple economics of the lease rental business, it will keep sucking cash every year. Now if I do a DCF of such a business I am likely to get a very large negative value. I was being unnecessarily charitable in giving it a ZERO value. This commands a negative value. And the reason is very simple, management has loaded the dice heavily against it by accepting lowest possible lease rentals for this business thereby increasing FRL profits and decreasing FEL profits. This is why I am against using EBITDA metric in this case as large % of the EBITDA is yielding negative value. The reason why managment has done this is pretty simple - most of Promoter’s wealth is tied to FRL and not FEL. Charlie Munger will agree.


(SecretInvestor) #19

Poor ol’ Charlie. Let’s leave him out of this now. Let him enjoy his 90s.

What do I say, you have conveniently ignored everything I wrote and then made some further assumptions on top of your earlier ones to try and prove your point. To the man with a hammer, every problem looks like a nail. It feels like a waste of time debating with someone who has made up his mind but oh well. Here is my final reply.

You have conveniently ignored my comment that you are being too simplistic in your analysis of the lease rental business, and you are still working with the 6,000cr gross block to anchor your entire analysis. Do read what I wrote about salvage value again. Do read again my point that this is NOW a spread business. What is was earlier is another matter before the spinoff. If you know anything about spinoffs, you will know that pre and post spin agreements within companies are completely different. Obviously.

I prefer to look ahead, not behind. The 12-13% (not 13-14% as you wrote) net yield is a run-rate number on new leases. You also chose to ignore that the maintenance capex is borne by FRETAIL, not FEL. The ~3% spread on new leases is management guidance. On. New. Leases. The 400-450cr capex going forward is also management guidance. I suppose they are wrong and you know better that the actual capex going ahead will be 3x that. Never mind that they have a target of not net borrowing more in FY18 onwards and only spending within their EBITDA-interest accruals.

Now let’s extrapolate your argument further and assume that all of what I have said is nonsense and you alone are correct. Here are the likely outcomes:
1. The bond holders financing this are complete idiots, because with your assumption of the huge cashflow mismatch, clearly this is going to go bust. The fact the bonds trade above par is just a small detail I guess.
2. Mr. Biyani is not really that smart. By setting up FEL like the way you have mentioned, he is effectively writing off 5,000cr+ of investments in general insurance, life insurance, supply chain, Gold Mohur and Apollo mill land, Staples, etc. Because who cares about 5,000-6,000cr these days? Certainly not a shrewd businessman like Mr. Biyani it seems.
3. Mr. Biyani doesn’t really care much about FRETAIL either given that the only way FRETAIL can thrive is to have a healthy FEL. Perhaps given so much of his wealth is tied up in FRETAIL, he doesn’t want the business model to fall apart after a few years? Just a hunch, I guess.

If someone believes in the above three points, then they should wait up at midnight on Christmas Eve – they may just see Santa Claus.

Anyway, I must say that I congratulate you in your analysis that this business has negative value. A negative equity value! That’s a world first. Perhaps we should change the principle of limited liability to equity. Anyway I digress.

You have mentioned Mr. Biyani’s motives a few times but again conveniently ignored what I wrote earlier about the structuring of the spinoff. If FEL is a basket case, why does it have all the valuable real assets/investments? I am sure that you agree the spinoff could easily have been structured so that FRETAIL had all the upside from the investments and not FEL. Maybe it’s time to confer with Charlie again.

If you can’t see the upside here then clearly this type of special situation investing is not for you. Fair enough. Any sort of normalization of the capital structure here will mean an equity re-rating to 100rs+ per share.

Anyway, I have absolutely zero interest in going back and forth about this. Clearly, you have made up your mind. I thought I should point out parts of your analysis that I think are wrong. Time will tell who is correct.


(Subash Nayak) #20

Being a guy of lesser intellect, I would have liked better if you had given your calculation in the above table. This table is given at http://www.liberated-soul.com/2017/07/future-enterprises-ltd-value-beyond-debt.html and broadly match with what my thesis how FEL’s income statement is going to look like in future.


(8sarveshg) #22

My entire analysis is on FY17 numbers during which the company has existed as a spin-off entity. Since the entire business was one retail business earlier, there was no case of related party agreements before (correct me if I am wrong here). I have not used any numbers from FY16 or before when the company was one entity. So all rental agreements between related parties would have been made when there was a spin-off, just a year back - it is very likely those yields are going to remain like that. Even if rentals are being increased for new agreements going forward going forward but that wouldn’t change the mix of yield so rapidly that this business starts making sense.

All the numbers that I have taken are from FY17 and yes, in today’s age, you need to spend quite heavily if you wish to attract customers. Many of the future Group stores have been there for a while and they would need to incur significant replacement CapEx. The point is not whether they would be 600 cr or 400 cr - the number would be a significant number because the rental yield is just too low. Tell me one good reason why old stores wouldn’t need significant replacement CapEx (that too inflation linked).

Can you please mention the source of this info that you have on yield? The yield calculated - the net yield is just 9% as my calculations have shown. Do you have any support that the yield is going to be 12-13% and not 9-10% as calculated? And if this 12-13% is only for new leases, can you please tell us the overall mix of yield and how it will behave.

Can you please mention the source of management guidance. Anyways whatever their guidance, let us see what they have done in FY17.

Net block in FY16 (post spinoff number) - 5700 cr
Net block in FY17 (post spinoff number) - 6250 cr

Depreciation - 630 cr

Total cash flow from investments in FY17 - negative of ~1200 cr

Even if the management has given guidance of 400-450 cr they ended by spending 1200 cr instead.

Yes, a negative value which has reduced the positive value of the other businesses (manufacturing and investments) since all of us doing a SOTP. My analysis pertains to only lease rental business. A business which is just going to suck cash in the tune of hundreds of crores every year has a negative value.

Sorry I missed replying to this earlier.

That’s because IRDA would certainly not have agreed to listing of a soon to be sold second grade insurance company as India’s first. That’s because PE investors of Future Supply Chain wouldn’t agree to a premature IPO. That’s because these assets couldn’t have been parked with Future Retail because that would have defeated the biggest purpose of restructuring (increase Future retail market cap by showing it as an asset light pure play retail model). And most importantly Mr. Biyani whose group is saddled with a lot of debt had no money to de-list these businesses and pay off the existing shareholders (which would have anyways been difficult to get the shareholder/debt holders/regulatory approval).

PS - The markets are never rational. The stock price may go up and down in a volatile manner based on rumours/greed/fear. Only in the long run will the economics of the business bringforth the right valuation of the lease rental as well as other parts of the businesses. The sole point of painstakinly bringing forth this number based analysis is to say that their lease rental business in the present form is a dud - a big cash sucker rather than a cash giver.