Piramal Enterprises Ltd

Stock Opportunities
83

Hi Prasanna,

You are very right. I think it’s the “noise” and extraneous factors surrounding the PEL that makes it tricky to arrive at valuation. Of course, company’s entry into some new businesses has further compounded the complexity. Let me share my thought process here if at all it can be of help. As they say, price is what you pay; value is what you get! Let me start by weeding out the “noise” and separating financing and investment angle from intrinsic business valuation.

Market cap: 9400 crores

Total outstanding debt: 9500 crores ( Q3, FY 14 analyst presentation)

Total investment:

Current investment: 900 odd crores in debentures and liquid MF

Vodafone investment: 5864 crore (book value); Now Vodafone will buy out PEL’s stake

at9000 crores. So net of capital gain of 20% on 3000 crores, this

investment is worth 8400 crores

Other investments: 1000 crores in equity/quasi equity in various

infrastructure/housing projects

STFC Investment: 1600 crores

In all investment of around 12,000 crores.

Receivables + Cash: 2221 crores + 379 crores = **2600 crores **

So business is available at (9400+9500-12000-2600) = 4300 crores

Mcap + Debt - Investment - (Receivables + Cash)

Now let’s look at business side

Pharma solutions + Critical care + OTC business Annualized top line (based on extrapolation of 9M estimates): 2757 crores (Typically, for valuation we can assign Avg. multiple range 3 -4 times sales based on peer valuation)

Financial Service business: 748 crores (Avg. multiple range 2-3 times sales based on peers’ valuation)

DRG business : 1000 crores (Avg. multiple range 3-4 times sales considering the combination of moat and growth of the business)

If we apply the lower range of this multiples total business valuation should be

27573 + 7482 + 1000*3 = (8271+1496+3000) = 12700 odd crores

While market is assigning only @4300 crore value to PEL business. There is steep discount applied to PEL just because of the complexity of the PEL structure and uncertainty associated with cash deployment and future returns on investment made

In addition to the operating businesses, one is getting an option on upside on new NCE fructifying and AP weaving his magic wound again to generate returns similar to the one he has generated in the past.

So, to me it looks a very favourable opportunity as an investor. Hope this may be of help gain better handle on valuation of PEL.

3 Likes
84

Fantastic analysis Dhanwil. Thank you for sharing your insights. It is because of people like you, valuepickrs don’t lose money.

Just to highlight the cons side of the above thesis, (as Hitesh points out elsewhere) Ajay Piramal is pursuing investment opportunities that yield him 18-20%/year. At his level of capital at hand, perhaps those kinds of yields are fantastic. We at valuepickr apply discount rates much higher than that. Perhaps Piramal’s investments in these mezzanine loans are short-term till he finds Pharma opportunities to deploy capital, but without it, as such the net growth rate after discounting is -ve.

So yes, the business is attractively valued as you mention at 33% of fair value conservatively estimated. But the longer it takes to reach closer to fair value, the more the opportunity cost we have to bear.

To put things in perspective, certainly a 2/3 discount should be good enough to bear that pain.

Is there something you would like to add? How fast do you see the underlying fair value growing? What in your mind are the triggers that might help the market fairly value this company. The trigger might be when the Pharma solutions business goes from investment mode to operation mode. I chose that division since that was the largest component of fair value in your assessment. (DRG business growth is fairly set in stone at 20%/year in revenue - does the profits grow faster? Piramal had acquired it for almost 3.5x the fair price you mentioned.)

I understand that I’m might be over-thinking a no-brainer buy. But given that I’m new to investing, can I ask you about how one goes about comparing this opportunity with another one where one sees a 40+%/year upside from CMP (Can Fin, Ajanta); Just wanted to see how you think about portfolio allocation.

Thanks you for the teaching,

-Prasanna

85

Excellent analysis Dhwanil. Also to add to the discount in the valuation which I suppose you have conservatively avoided, is the zero valuation given to the decade of R&D Expenditure of the Company.

Co. is already successful in getting European permission for its BST Cargel medical device which is a 1000 cr market in Europe alone. Also its Florbetaben drug is awaiting final permission from the FDA and European authority. AP is highly positive in getting this approval, the market for which is 10000 cr.

86

Hi Prasanna,

Thanks for your kind words. On the specific points that you raised

)- AP getting 18-20% ROCE is different from what you mentioned about the discount rate applied at valuepickr. The discount rate that you are alluding to is, to the best of my knowledge, the opportunity cost that one incurs by “waiting out” to bridge the gap between price and fair value. So, the primary question for us is, Is it really worth “waiting out”? Here, two factors are important which can tell whether to wait out or get out! I think you have captured them both in subsequent questions

  1. discount to intrinsic value

  2. Growth in intrinsic value over a period of time.

For discount to intrinsic value, it is highly favourable. What is phenomenal in case of PEL, which no one seems to be talking about is that it’s business is growing at breakneck pace. It’s will more than double its topline (from 2100 crore in 2011-12 to around 4500 crores in 2013-14) in two years. This is very good growth by any standards. To further put this in perspective, before sale to Abbott, its topline was 3600 crores. So, PEL has definitely grown bigger than what it used to be before Abott deal. Similarly, on EBIDTA level also, PEL will most likely equal its 2010 numbers this year. Also look at the operating margins. They are expanding almost every quarter.

So, personally, I feel that even if one ignores the upsides from R&D spend and NCE launches, steep discount and very decent growth and profitability in existing business makes it a very good value proposition.

In terms of timing for price-value differential to close, your guess is as good as mine! But eventually, in next couple of years, I expect the gap should reduce considerably. Having said this, I would like to put one caveat here, that if AP decides to make this a holding company or the market continues to perceive this as holding company, there will be holding company discount of 30-40% shall be applied.

On your query on portfolio allocation, over a period of time I have learnt to apply two tests. If it does not pass any of them with high probability,I give it a pass

  1. Can the EV double from here in next 3 years? (these are my medium term bets)

  2. Can EV become 10 times in 10 years? (these are my long term bets)

I try to allocate capital to both type of businesses in my portfolio judiciously.

87

You are right Vinay. I have not considered any value for R&D pipeline. The only reason is to err on the side of conservatism.

One flag that I want to raise here though is

Numbers on market size which is being talked about does not give true picture about revenue generation potential due to following reasons

  1. There are number of products/competition in the product segment which means the market is divided amongst all the players

  2. Typically, it takes many years before the product reaches peak sales (most aggressively 8-9 years from launch) due to time taken to establish efficacy, distribution network and market penetration.

So, let’s be conservative and keep that as upside, as and when it fructifies!

88

Hi Dhwanil

Excellent analysis on the valuation. However, one question remains unanswered for me. Why should we not apply the holding co discount to the valuation? For example Bajaj Holdings is presently available at roughly 35% of the market value of its holdings. Many other holding cos are available at varying discounts to the value of their holdings. Why should a different metric be applied to Piramal?

89

Ajit - from my understanding a holding company discount is applied when a holding company ‘H’ holds shares of another company ‘C’, and C’s dividends that flow to H get taxed at 35%; Another issue is, C’s dividend payout ratio is not 100% and money is stuck in the system at several parts. Fully owned subsidiaries rarely experience that discount. Stand to be corrected…

90

Though Piramal is not exactly like a holding company but it has invested in various different businesses so there is going to some discount in the valuation. Also why is the company pharma / OTC segment is still making losses. They sold off the formulation business in 2009 (I hope I remember correctly ) so by now they should be posting some profits.

91

Prasanna - The reason holding cos are valued at a discount is that the value of their investments usually do not get unlocked unless there are exceptional circumstances. So the co has to be valued on the basis of its expected future cash flows which is mostly dividends from its subsidiaries. While I agree that Piramal is not exactly a holding co, it has many similarities with its cash getting invested into a diverse set of investments with varying cash flows.

92

Does this looks feasible to do 5 X in 6 years?

âOur immediate goal is to consolidate the efforts on the business plans in each of the shortlisted areas and to grow them vertically to help transform the group into a diversified conglomerate that should ideally have a turnover of at least Rs.20,000 crore in the next six years,â says chairman Ajay Piramal.

To be sure, it is not going to be an easy journey for the group, which has a consolidated revenue of $650 million (about Rs.4,100 crore) as of December 2013.

93

FDA approves Piramal Imaging’s Neuraceq

http://www.piramal.com/sites/default/files/pdf/FDA-approval-pr.pdf

Piramal Imaging has partnered with IBA Molecular for Mfg. & Distribution of Neuraceq. IBA owns and operates a network of 49 PET Isotype Facilities worldwide, a network which is unique in both size and scope.

94

Piramal invest more into financial services…Buy 20% of shriram capital…

95

The shares are up 5% today. There are two catalysts unlocking, and I’d love to understand them more.

(1) Dividend of 9% has been announced. @Dhanwil or other seniors: How likely is it, this would be continued over the next few years? Is there any reason to suspect this as a one time thing? Does the underlying business support such recurrent cash generation?

(2) Subsidiaries are merging with the parent. This should not be a big deal, but would it remove the holding co discount?

Thanks,

-Prasanna

96

Actually I stand corrected - Yield is 3% added with a one time dividend of 6%, giving a 9% dividend. Regarding growth - It looks like the company is growing at 20-30%, which is amazing for it’s size.

97

Hi Prasanna,

As you mentioned, yield is 3% while 6% is coming from one time dividend mainly because of the gain generated on Vodafone investment. Broadly, they shared 30 of the profit generated from Vodafone investment with shareholders while remaining are kept with the company. So, I do not expect similar rate of dividend payout. However, there may be some buy back in future, if company does not find opportunities to deploy such large amount of cash. So in short, I do not expect similar level of dividend in future unless the company receievs some significant profit from short-term investment (As in the case of Vodafone). Few broad things one should keep in mind while looking at PHL

)- It is definitely a stock ONLY for long term investors and one is largely relying on extraordinary skills of AP to deploy capital efficiently as he has demonstrated in the past. So, it will take time for the whole story to unfold and yield returns. Here, one should keep in mind that extrapolating past track record for future has its own risk and hence monitoring of events as they unfold is important to minimize risk.

)- Clearly, AP is on the way to build a niche financial service business through partnership with Shriram. I personally have very high regards for both the groups and hence see good chances of this working out beautifully as Shriram has assiduously built some highly differentiated business models in financial service industry over the years. PHL’s access to capital and deal making ability will be handy to scale up this business from here. Having said this, the downside is that from what it looks like, at least for short term, PHL is not going to be majority partner and at best an equal partner. So, the deal is based on mutual trust. Secondly, since, the investment made in these companies may not be treated as subsidiaries for the time being, the proportionate share of earnings of Shriram group investments may not be reflected in EPS of PHL thus keeping the EPS under recognized.

)- Thirdly, PHL is spending roughly 250-300 crores a year on R&D. As of now, the value of these investment is zero. Though under all reasonable circumstances, the value will be higher than zero in case of out-licensing some of the products or one of the product getting commercialized (a positive black swan). However, worst case scenario is the money going down the drain and may be sunk capital if AP decides to not to continue burning such cash

)- What is going unnoticed by the market is that in mere 4 years, PHL has reached the same topline as before the sale of formulation business and has been growing @ 20-30% and expanding margins at EBIDTA level for last 4 years in spite of entering into entirely new businesses.

So to sum it up, at currently valuations, I feel this is a great opportunity for ONLY long term investors to generate some very decent returns without bearing much of risk.

Discl: invested in PEL @ average price of 450: capital allocation 10%

98

Latest annual report is available for download on the company’s website.

At first look Management appears to preparing to carve up PEL into three businesses: health care, financial services and information management.

In healthcare PEL is concentrating on consumer health care where threat of regulation is low. Growth would be both organic and unorganic with management continuing to look at acquisitions. Buzz is that the company may sell its imaging business in which case it will add some neat profits to the consolidated account.

In financial services, management is showing signs of integrating the Shriram group with itself over time. Here also the business is slowly and steadily looking at newer opportunities. Growth appears to be cautious and reading between the lines it appears that management appears to be veering towards safety instead of growth.

The real joker in the pack will be the information management business based in the US. There is a lot of information on data analytics and how it is important for companies and the size of opportunity, etc.

All three business are showing signs of improving margins and becoming profitable. I am expecting operating leverage to sharply accelerate net profits in the coming quarters.

disclosure: holding and hence views may be considered biased.

Shiv Kumar

99

Hi Shiv,

Similar views. But my only concern why is Pharma business growing at just 12%…when they claim that they have dominance in segments.

Actually found the commentary on Pharma section quite complacent.

Regards,
PS- Invested.

100

After going through the PEL AR, I can say that it is one of the most detailed report to have come out from Piramal group in recent times. For the first time I am able to get an glimpse (though not the full picture, as I would have liked!) in to the each business stream up close! However, few observations, though very high level, that caught my attention in the AR (many of them are mere re-reinforcement of earlier belief/hypothesis)

  • The dominant theme, the common denominator, through the AR, is the efficient capital allocation! To me, it is truly remarkable. Till now, I have not come across any AR that has given so much prominence to “capital allocation”! As WB says, capital allocation is one of the most important function of the management. The focus on efficient capital allocation by management and demonstrated track record is quite satisfying for a shareholder
  • Another observation after running through AR and analysis of the business streams is that most of the businesses owned by company are either operating in a niche or have some edge over its competitors. In addition, the company is taking steps (as alluded to in AR) to make its position stronger.

Take for example the focus of the company on ADC (Antibody drug conjugates) contract manufacturing. It is a world leader in this field with more than 30% market share. After doing some research, I found out that there are hardly 10 major players across the world who do contract manufacturing of ADC. Moreover, there are only select few among the 10, who can provide end to end CMO services. Piramal’s tie-up with Fujifilm and it’s acquisition of cold stream laboratories (which has significant expertise in ADC CMO across life-cycle) will make it one of the few players who can provide end to end CMO for ADC.

There is similar case in Critical Care. It is, slowly but surely, acquiring market share in various markets, bridging the gap in product lines through new product launches (Sevofluorane, desflurane planned) thus inching up to improve its market position with respect to leaders Bexter and Abbvie.

  • Company is leveraging immense power of collaboration and complimentary skill. This is demonstrated through, its focus on growing through partnership in all the business streams be it real estate finance (CPPIB), infrastructure finance (APG), ADC (Fujifilm), Imaging (partnering with various entities for manufacturing and distribution), OTC (partnership with Marisant for sales and distribution of “Equal”; JV with Allergen- world leader in ophthalmic medicine) .

  • There is a very good articulation of risk management framework followed by PEL. If the same is followed in letter and spirit at PEL, it can surely contain risk for the company for each of the business. Company at few places talks about its objective of efficiently allocating capital to consistently generate higher profitability while undertaking controlled risk. This, again, is a rare site where management talk about risk-adjusted returns!

Disclosure: I am Invested in Piramal from much lower levels and have significant capital allocation. Hence my views can be biased. Please do your own due diligence before making an investment decision.

7 Likes
101

Hi Dhwanil,

Agree on capital allocation part, but cant understand why they have been growing at this rate in Pharma. Especially with such dominant position.

ur thoughts

Regards,

102

I went through the report too. There was very little discussion on what is going on to improve pharma profitability. Also on the financial side, it was not clear how much levered it was, CAR, NPA’s etc. I was a little disappointed that I could not decipher the segments.

Diclosure: invested