Donald,
By taking the discount rate as 10% the Net Cash/share improves to 371. But in Prof. Bakshi’s post it has been mentioned that Net Cash is 517/share of which 374/share is from Cash to come over next 40 months.
Lets re-check the calculations.
Regards,
Ayush
Donald
What discounting rate we use could have significant impact on the PV of cash. Since this is not cash flows from business operations, would it be appropriate to use a lower discounting rate since there is lesser uncertainty ?
Also in your ealier post, you had said 150 Cr for Lifesciences Acq. Can you clarify what this is ?
Finally, number of shares will be around 17.4 Cr after dilution (allottment to existing Lifesciences shareholders in the ratio of 1 Piramal H share for every 4 Piramal L Sc share)
Sajan
HI Donald,
Great to see such active participation on the research of Piramal Healthcare. Couple of observations from my side.
On Cash :While valuing cash , one needs to keep in mind that all the cash that theyreceivedas upfront is already spent…so no newannouncementis going to come on any business plan. All the existing cash is gone. All that we are valuing is the future cash flows that will come in the next 4 years… how wise would be it for us to value something which is going to come staggered in the next 4 years and even though after discounting it, give it 1x value. in my opinion one wouldnt be unreasonable if he discounts furture cash flow by 15% also. Good Corporate FDs are offering 12%+ and mind it , its debt instrument while Piramal is equity.
But yes , one who has high riskappetite, Mr. Piramal is surely worth betting on. His past performance clearly speaks for it and i am sure he will do the same with the Piramal Healthcare as well.
Happy Investing
There is also a tax saving aspect due to merger of Pirama Life Sc. I dont know the exact quantum, from what I understand, if you spend X on R&D (and R&D related capex), you can deduct 2X from your taxable income. Have not been able to quantify this though.
What is the view on the way PLS was acquired by PHL? Valuation appear to be very high. Please check the below calculations.
Existing Lifesciences shareholders will be alotted shares in the ratio of 1 Piramal H share for every 4 Piramal L Sc share effective April 1, 2001. PHL Price crashed from 480 on 25th March to 420 1st April.
Total Shares of PLS = 2.54 Cr
Shares of PHL recieved by PLS shareholders = 2.54/4 = 0.63 Cr
Assuming Price of Rs 420 (As on April 1st 2011),
Effective price paid for equity right= 420 * 0.63 = Rs 267 Cr. (Earlier Donald mentioned 150 Cr in his calculations for PLS. So i am not sure what is wrong in my calculations)
Interest cost of PLS in Q4 2011 was approx 11.77 Cr.
Thissuggests a debt in the range of Rs 425 - 500 Cr.
Hence PHL valued PLS at an Enterprise Value = 450 + 267 = 717 Cr.
Sales of PLS in Q4 2011 = 0.69 Cr
Annualized Sales = Rs 2.8 Cr.
Annualized Net Loss = Rs 120 Cr
Valuation of PLS by PHL:
EV/Sales = 717/2.8 = 256 times sales
What kind of valuation is this for a company which has always been loss making and may not turn profitable for another couple of years?
One argument can be that even market values this at Rs 220 Cr market capitalization as on today hence Rs 267 Cr paid by PHL is not very high.
My view on it is that PLS had a debt of approx. Rs 450 Cr and with its unprofitable business it was almost impossible for it to pay down its debt withough diluting equity by more than 50 %. Hence the easiest way out was to merge it with a cash rich company PHL.
But is this not a quetionable corporate governance case?
Please share your views.
I think Ajay Piramal is using the cash kitty (partly owned by minority shareholders as well) to suit his own purposes and is getting good value for his own dud investments. At least that is what is apparent from the investments made till date in the NBFC and PLS venture. And that precisely is probably the reason why markets have given the stock a kick in the back.
Great to see so much participation so quickly into this stock opportunity. Went through the numerous posts and both sides arguments seem pretty strong.
I looked for what other research houses and media has been saying. Here are some recent reports for everyone’s benefit.
May 20, 2011 - ICICIDirect report on Piramal Heathcare post Q4 results
May 09, 2011 - PPFAS report on Piramal Heathcare
May 09, 2011 - Avendus report on Piramal Healthcare
May 04, 2011 - Outlook Money article )- Ajay Piralmal Plays
Thanks TCX. Your help in digging for info was much required:)
I agree with you much of the facts/arguments on both sides of the table have been put up by members. In our collective wisdom, we have seen strong arguments on purported corporate governance issues, value destruction fears or value creation optimism, all pitted against the reputation and track record of undoubtedly one of Corporate India’s biggest wealth creators (for long term shareholders).
Its time to sit back and weigh the odds - which side is it stacked decisively(?). Its useful to review all 3rd party information - and give an impartial read - may be some more facts/information may emerge or even opinion influencers.
I somehow am not able to buy the corporate governance questions raised - and they are very important ones, strongly indicting (seemingly) the management. The group and the Management’s reputation is so unsullied, its diffcult to paint them in that light. But as we all know BIG Money can have its own effects! All of us are prone to itsinducements! Would like us to dwell more/dig facts on this aspect too.
Some more earlier reports
Exactly, Donald. I have been trying to find some info on 2 aspects - the non compete fee - why was it necessary to be paid to Piramal Enterprsies, and the deal structured the way it was.
This Piramal -Abbot Deal report and dissection by Nishith Desai Associates, seems to point that it was in best commercial interest to structure its as a slump sale or business transfer vs a demerger.
Piramal Abbot Deal Dissected)- Nishith Desai Associates
The advantages -Simple structure and Quick deal, although it meant higher tax outgoes. Compare this with the smaller Ranbaxy deal that took over a year to complete! It should be considered a plus that the Piramals preferred to pay much higher taxes. Some 3800 Cr from the 10000 Cr received. (20% on teh entire transaction of 17500 cr even though as much as 7500 cr will be recieved by the company in next 4 years).
I would certainly give the Piramals the benefit of doubt on the deal structure.
Thanks Arindam. This document was pretty useful for me to understand things better.
Some excerpts from the report on why the business transfer/slump sale was preferred over demerger.
Challenges with a scheme of demerger for Formulations Business
Transfer of Formulation Business by way of a demerger may not have been a commercially viable option due to the following reasons:
(i) Demerger, being a court approved process, takes around 5 â 7 months for completion and is subject to numerous approvals including approval of the High Courts. Time being an essence in such a big ticket deal, a simpler route such as a slump sale would have got commercial preference;
(ii) The consideration for a demerger should be issuance of shares to all the shareholders of the demerged entity28 for availing the tax benefits under the IT Act. Accordingly, for a scheme to be qualified demerger under the IT Act, the shares of AHPL or the New Co. should have to be issued to all the shareholders of Piramal Healthcare. This would involve significant dilution of Abbott Lab in AHPL or the New Co. and commercially it may not be desirable for the shareholders of Piramal Healthcare (including its promoter group viz. the Piramal Group) continuing to hold shares in AHPL or the New Co. post the sales. Further, Abbott Lab would want to have 100% control over AHPL or New Co. which would not be possible if shares are issued to the shareholders of Piramal Healthcare.
(iii) Currently, there are around 84,000 shareholders in Piramal Healthcare. Issuance of equity shares of AHPL or the New Co. to all these shareholders could also result in PiramalHealthcare or the New Co. opting for an automatic listing29, which may not be commercially viable for the acquirers.
Challenges with a scheme of demerger for remaining business of Piramal Healthcare
Similarly, one can also think of an option of demerging the remaining business of Piramal Healthcare (other than Formulation Business) into a separate entity and AHPL acquiring thereafter acquiring the shares of Piramal Healthcare. However, this would require two fold process â one, demerger of remaining business into a separate entity and second, open offer by Abbott Lab and AHPL to acquire the shares of Piramal Healthcare (which would post demerger include only the formulation business). This again may carry the same challenges of a demerger as mentioned. Further, this would also result in an open offer under the Takeover Regulations and Abbott Lab may run the risk of not being able to control 100% of Piramal Healthcare due to presence of public shareholders. Also, under this option Piramal Healthcare may not have received consideration directly to use for future expansion of its remaining business as consideration for demerger will be paid to the shareholders.
-Donald
Thanks Shiv Kumar. Useful article.
Reading this article gives comfort that a person of Mr Ramesh Jogani’s calibre is heading the IndiaREIT venture. At the same time it raises questions like “key person” risk. What kind of management bandwidth does IndiaREIT currently have? It may be heavily dependent on Mr Jogani.
Here is Bear Case market value of PHL:
| Expected Cash Receivables for next 4 years starting September 2011 | |||||
| Recivable (Cr) | Discount Rate % | Time | PV of Cash Flows | ||
| 1750 | 12% | 0.3 | 1,692 | ||
| 1750 | 12% | 1.3 | 1,510 | ||
| 1750 | 12% | 2.3 | 1,348 | ||
| 1750 | 12% | 3.3 | 1,204 | ||
| PV of Above Cash Receivable | 5,754 | ||||
| Cash on Balance Sheet as on 31st March 2011 | 1770 | ||||
| Investments on B.S. as on 31st March 2011 (Should be cash. Check it?) | 1481 | ||||
| Debt on Balance Sheet of PHL as on 31st March 2011 | 756 | ||||
| Estimated Debt on PLS | 450 | ||||
| Net Cash adjusted for above items | 7,799 | ||||
| Cash disbursed for NBFC | 1000 | ||||
| Cash disbursed for acquiring REIT | 225 | ||||
| Capital Expenditure on PLS | 200 | ||||
| Estimated Remaining Cash as on today | 6,374 | ||||
| Number of Shares (In Cr) | 17.43 | ||||
| Estimated Cash per share as on today (Rs) | 366 | ||||
| Sum of the Parts: | |||||
| Residual Pharma Business of PHL: | |||||
| Adjusted PAT for March 2011 quarter (Rs Cr) | 70 | ||||
| Annualized earnings ( At Normalized levels) | 150 | Assumption | |||
| Estimated Market Value at 12 times normalized earnings | 1,800 | ||||
| REIT Business: | |||||
| Value at 30 % discount to buying Price | 158 | ||||
| NBFC Business | |||||
| Valued at 40 % discount to earmarked amount | 600 | ||||
| Piramal Life Sciences | |||||
| Rs 200 Cr capex going into this part in 2011 - 2012 | |||||
| Sales is only 1.2 Cr | |||||
| Loss of -120 Cr last year | |||||
| 24 molecules in pipeline | |||||
| Assuming value to be (Rs Cr) | 100 | ||||
| Cash | |||||
| Valued at 40 % discount to actual value | 3,825 | ||||
| Total Value | 6,482 | ||||
| Value per Share | 372 | ||||
All the above estimations are as on today. As mentioned at the top this is Bear Case. There can be a number of triggers for value creation. Important one of them are:
- Residual Pharma PHL business clocked an Adjusted PAT in excess of Rs 70 Cr in last quarter March 2011(after taking out Investment income). This business was in loss in March 2010. What is the normalized level is difficult to estimate? I am assuming only Rs 37 - 38 Cr (Rs 150 Cr Annualized level)quarterly normalized level for estimating the value of this business. If the normzlied level is higher and sustainable then value of this business can be in excess of Rs 2500 Cr. This is the most important trigger for PHL.
- Estimated Cash of Rs 6374 Cr is valued at 40 % discount. This may not be the case if PHL acquires a pharma business which complements its existing business. It will also depend on the price paid by PHL for acquisition.
- Third biggest value creator is NBFC. But it may not change the valution by a whole lot.
- Nothing else is a big needle mover so focus more on first two points: Residual pharma business andCapital allocationof Rs 6374 Cash
Above analysis is Bear Case for PHL. I dont think value of this company is way lower than the Bear Case price of Rs 372. However if one of the first two trigger do not materialize, stock my languish for a long time. But given the track record of promoter, it is more likely that one of the two trigger works out.
On the other hand questionmark on corporate governance are justified in my opinion.
As the price goes lower risk reward ratio, however, will be higly skewed more towards buy.
Thanks Amit, for your very discerning comment that the Rs.10,000 Cr received upfront is mostly expensed with. We are coming round to that conclusion, but more on that later.
So what we are left with is the $400 Mn to be received every year 4 next 4 years. Each trench of Rs 1750 Cr is not a small sum by the way, and can be very very handy for expanding existing businesses from internal accruals.
Which means we should first concentrate on putting a value to the existing business for the next 3 years, say. If existing business stand strongly on their own, then this additional cash flow can be very healthy. I am now able to appreciate the way the whole deal was structured! The 10,000 Cr upfront payment ensured that they had enough to pay the big taxes (3800 Cr), carry out a buyback (2500 Cr) and still have enough to start off additional businesses (not going into the merits of NBFC, IndiaREIT and Lifecare), and then have a comfortable cushion (1750 Cr) coming in each year for 4 years to sustain and enhance existing businesses.
I differ with you on the applicable discount rate - because this is pure cash coming in - contracted and therefore pretty certain - this is not coming in from a business -and therefore NOT RISKY like Equity investment. A 10% discount rate is being pretty conservative, actually.
I like to think of it this way. If someone was doing a DCF calculation for the Piramal business, assuming they had a very predictable earnings say ( which they don’t btw considering FY11 record of CRAMS), won’t any analyst be happy to add in this near-certain additional cash flow of next 4 years at a 10% discount rate. I reckon, they would.
A 10% discount rate means a PV of 5547 Cr or Rs. 318/share ( #of shares post dilution 17.4 Cr)
To arrive at any conclusions, we must try and put some value to existing businesses.
-Donald
:While theyreceivedas newannouncementis riskappetite,
Thanks Finblog1 for your extensive calculations and inputs.
With your fair value calculation of 372 and a CMP of 366,what you are effectively saying is thatthere isn’t much of a bargain left on this counter.
There are lots of assumptions made on the new businesses, which may materialise or may fall far short, so either way there doesn’t seem to be a big margin of safety!
One last thing left to incorporate
Some folks like Sajan Mathews have raised before is the implication of the accumulated losses of Piramal Life Sciencesand R&D expenseson Piramal healthcare P&L, leading to lower taxes!
Will try to come up with something simple on that! All help welcome.
As on Mar 31,2011, Piralmal Healthcare Consolidated Book:
Cash & Bank Balances : 1770.28 Cr
Investments : 1481.58 Cr
Total Cash & Cash Eqv: 3251.86 Cr
less Debt P healthcare: 756.86 Cr
Net Cash : 2495 Cr
In May 2011 we have seen announcements for IndiaREIT purchase 225 Cr, and NBFC outlay 1000 Cr. So totally 1225 Cr; NCE unit of Piramla Lifescience demerger is a share-swap, but it brought in additional debt of ~500 Cr
So Net Cash as on June 2011 ~=2495 - 1225 - 500 =~770 Cr
net cash/share = 770/17.4 ~= Rs. 44
which for our purposes should be ignored!
If we look at Consolidated earnings of Piramal Healthcare for Q4, we are in for a nice surprise:
|
Net Sales |
559.05 |
|
Exp |
451.96 |
|
PBIT |
107.09 |
|
Interest |
16.95 |
|
PBT |
90.14 |
|
Tax |
16.38 |
|
PAT |
73.76 |
|
QEPS |
4.23 |
|
EPS |
17 |
|
x12x |
203 |
So if we are to say that existing businesses continue to do as well for the next 4 quarters, and we value the business at 12x, we have a fair value at Rs. 203
I agree lets not count in anything on IndiaREIT PAT 22cr last year, so it wont amount to even Rs.2, and lets not factor in anything for NBFC.
But my question is why wouldn't you add the PV of $400 mn every year to this, or Rs 318/share as in Donald's calculation.
if you add that then 203+318= 521
Why isn't fair value Rs. 521?
Accumulated Loss for Piramal Life Sciences:
-142.98, -129.79, -110.85, -91.7 for last 4 years
or -475.32Cr
Can someone knowledgable throw light on how this will be gainfully used by Piramal Healthcare? if we cover that we should be able to finally close this round:)
DCF/Cashflow/PE Multiple based valuations make sense only when there is an element of predictability in the future of the business. The future growth of Piramal Healthcare is completely unpredictable.
The margin of safety for this stock can only come from the degree of confidence we have in the integrity and ability of the promoter.Rather than calculate a mathematical margin of safety, one should think of it as an opportunity to invest in a start-up with a decent businessman at somewhere close to book value.
I guess Rajiv Subramanian has valid point. Piramal used to get majority of its revenues from healthcare. Questions that need to be asked are: what products or services are going to earn majority of revenues in future? Does management/promoter has clarity on products or services that may add to revenues in future? Are they investing to develop new products or services? Piramal’s experience is in healthcare, will it be able to succeed in other fields such as NBFC (personally I think it will not be easy as other established players will fiercely defend their market share)? What is the attractiveness of other businesses that promoters are planning to venture into?
Analysis of cash that has been received or to be received will give an idea about health of Piramal’s balance sheet. For a long term investor, focus must be on sources of future cash flows. Will it be NBFC or residual healthcare or REIT or combination of these? What competitive advantages does Piramal has in these businesses? After considering the nature of business from which Piramal is likely to generate and if Piramal has any strengths or advantages in chosen business, one can apply appropriate discount factor to arrive at approximate value for its stock.
Consolidated BV/Share = (11822.63+33.58)/17.4 =681
You are getting the business at 0.54x BV!
Also its not right to say that the existing business of Piramal healthcare is unpredictable. The CRAMS business, OTC business, and the Critical care business - these are solid residual businesses.
Is everyone getting carried away by the Noise?
