Dhandho investing is a framework created by Mohnish Pabrai. The essential idea is elegantly summarized by “heads I win, tails I don’t lose much”.
I’ve created my interpretation of this idea. While looking at a Dhandho opportunity, there are three questions:
- Can the company sustainably lose money/invest?
- What is the present valuation covering? (i.e. What am I paying for? What is free?)
- What is the opportunity of that new/nascent venture?
If the answers are yes, just the main business, and big, we’ve hit a jackpot.
CESC Ventures is essentially a holding company, which prima facie, appears to be a Too-Good-To-Be-True Dhandho opportunity. CESC Ventures holds 54.1% of Firstsource Solutions Limited (a listed IT company). So a straightforward calculation of CESC Venture’s holdings in FSL with their prices gives us a discount value of 72%.
| Particulars | Value |
|---|---|
| CMP FSL | Rs. 62.9 |
| CMP CESCV | Rs. 244.5 |
| Stock holding Ratio (1 share of CESCV has x Shares of FSL) | 14.10 |
| CMP FS Value of CESCV | Rs. 887.28 |
| Current Discount | 72.4% |
CESC Ventures Discount
But there’s more to CESC Ventures as well.
CESC Ventures is essentially a holding company with 4 more subsidiaries apart from FSL.
| Sl. No. | Subsidiary | Sector | Brand |
|---|---|---|---|
| 1 | Firstsource Solution Limited | IT | Firstsource |
| 2 | Quest Properties | Real Estate | Quest |
| 3 | Bowlopedia Restaurants | Hospitality | Waffle Wallah, Bombay Toastee |
| 4 | Guiltfree Industries | FMCG | Too Yumm, e-Vita (step down) |
| 5 | Herbolab India | Ayurvedic Medicines | Dr. Vaidya’s |
CESC Ventures Subsidiaries
These subsidiaries in turn have step down subsidiaries with businesses or investments.
Below is a graphical representation of the relationship including holding percentage, company profile, and flows.
CESC Ventures holding structure (FY20 figures)
What is happening here?
RP-Sanjiv Goenka Group decided to spin off CESC Venture from CESC (their flagship power company based out of Kolkata). While doing so, they rolled in a few more companies into the mix.
It’s structured beautifully. And this is what caught my attention. What’s essentially happening here is CESC Ventures is primarily using the dividends from their FSL holding the buy other companies and manage/grow their existing companies. They are also using Quest properties in a similar manner for their venture capital investments (visible in the right-hand side in the relationship structure). CESC ventures also has an IT services business that adds to the top line but the impact on the bottom line is limited compared to the dividends from FSL.
The dividends from FSL come up to a sizable number that allows CESC Ventures to explore opportunities. In FY-20, CESC Ventures received around Rs. 168 crores in dividends from FSL (Rs. 2 from FY19 final and Rs. 2.5 from FY20 interim declared in Feb). This is used to back Guiltfree and Bolwopedia. In FY20, CESC Ventures also picked up a 64.6% stake in Herbolabs.
| Date | Entity | No. of Shares | Dividend Per Share | Dividend Income |
|---|---|---|---|---|
| 06-05-2019 | CESC Ventures | 37,39,76,673 | 2 | 74,79,53,346 |
| 17-02-2020 | CESC Ventures | 37,39,76,673 | 2.5 | 93,49,41,683 |
| Total | 1,68,28,95,029 |
CESC Ventures’ dividend from FSL
The below figure shows what happened in FY20 – how cash moved around.
What happened in FY20
Well, you might notice that the sum of CESC Ventures’ investments is greater than the dividend that came in. That’s because of two things. The first is that there is a Rs. 60.23 crores adjustment at Guiltfree against share application money paid in the previous period. The second is that not all the cash actually moved. The cash flow statement calls out a Purchase of non-current investments of Rs. 20.99 crores. This matches the Peel-Works investment. Investment in Subsidiaries including Share Application has a figure of Rs. 108.84 crores against it. This brings the total investment to Rs. 129.84 crores as against an increase in investments in the balance sheet of Rs. 193.7 crores. Adjusting for the Rs. 60.23 crores with Guilt, this makes it Rs. 133.47 crores.
However, just these investments aren’t enough as there are ventures that are losing money. Too Yumm is a gigantic black hole losing money but that’s being taken care of by a mix of equity and (primarily) debt (an additional Rs. 81.63 crores was taken on in long term borrowings taking the total to Rs. 231.62). Similarly, with Apricot Foods (debt) and Herbolabs (equity) at a significantly smaller scale.
Given Guiltfree’s scale and importance, perhaps a closer look is required.
Based on Guiltfree’s P&L, 2 things are clear:
- Marketing & Advertising and Sales promotion are a significant part of their expenses. Together, they made up 166.82%, 87.4%, and 89.6% of revenue from operations for FY18, FY19, and FY20 respectively.
- Scale is important. While revenue from operations grew 387%, total expenses 197.8% between FY18 and FY19. Revenue from operations declines by 22.18% while total expenses declined only by 5%. It’s not going to be easy to only focus on costs here. Revenue growth and scale will be the main factor going forward.
Looking at ratios at this point in its growth stage may not reveal anything important, apart from the way it manages its receivables and payments (which is fine).
What are the shareholders doing?
While the promoters have had a constant holding of 49.92%, the others have been pretty active.
FPI and mutual funds seem to be exiting their position since the listing while individual shareholders (up to 2 lac – that’s the small retail people like me) seem to be acquiring shares. However, what is interesting is that the total number of shareholders has been decreasing across categories, signifying that the existing shareholders are acquiring the shares being offloaded. This could also be interpreted as a sign of conviction.
Shareholding pattern from March 2019 to June 2020
Since these shares were acquired at close to no cost and CESC shares didn’t correct much since the spin-off, entities that got these shares got it for close to free. Any price they sell at is a no-loss proposition. This huge selling pressure by mutual funds and FPIs (with other entities also selling), pushed prices down.
The market has settled down at a discount rate of 70% to the FSIL holdings. If there is another trigger to start selling, prices will again start dropping as the category absorbing the shares are small retail holders.
What’s the verdict?
- Can the company sustainably lose money/invest?
Yes. The company is heavily dependent on Firstsource’s dividends, without which things could get difficult. If the businesses themselves fail, the dividends can manage to smoothen things over time. Firstsource has been stable over the past decade. They have managed to make acquisitions and adapt to industry changes while also managing their debt. So the expectation is things will continue to be fine in the future.
- What is the present valuation covering? (i.e. What am I paying for? What is free?)
At the present valuation, FSL is available at a 70% discount with the other businesses being available for free. HOWEVER, deciding to buy simply based on the discount in these crazy markets may not be the best way. It’s important to consider FSL’s price movement and valuation as well. When you look at the delivery volumes of CESC Ventures, you notice a pattern of price movement linked to actual delivery volumes. This is important to keep in mind.
- What is the opportunity of that new/nascent venture?
There are multiple opportunities with nonlinear payoffs. There are ventures from FMCG (Too Yumm and e-Vita), Hospitality (Waffle Wallah, Bombay Toastee), Ayurvedic medicines, and venture capital investments. While there are natural limits to some of these ventures (Waffle Wallah may not grow to be as big as FSL), the FMCG and Ayurvedic bets combined with the venture capital investments do show some promise.
At this point, it’s important to recognize that the time scales are pretty long on this one. Once I complete my targeted acquisition, I’m prepared to be sitting on this for 10 years (unless there is some issue of fraud (which I think is very low) or some other risk showing up) just tracking developments annually (with the annual reports of its subsidiaries being released on the site).
I’m capping my exposure to this at 3% of my portfolio. In the intervening period, it is possible that the stock will test sub 100 levels. Keeping a small sum aside for that might be a good idea. I’ve completed about 58% of my allocation so far.
It’s also important to recognize another opportunity (that would be a levered opportunity). As FSL dividends are crucial, they will continue to flow to CESC Ventures. Buying into FSL seems to be a good dividend play. It is available at an incredible yield (was actually, now I think it’s a little overvalued but the yield still looks good). This is something I have done. The problem now is that this becomes a levered play (without debt). If FSL goes up, CESC Ventures goes up. If FSL goes down, CESC Ventures also goes down. I take double the hit in the short term (and long term if things go wrong at FSL and ALL the other companies). Both together will make up 6% of my portfolio. I don’t think CESC Ventures will be in a position to pay any dividends in the next 10 years.