This note is the only analysis that I found on the internet on this special situation. I think the treatment in that note was quite superficial for investing in this opportunity. I intend to be a little more comprehensive than that. Do leave a comment in case you have any questions.
Instead of writing a long paragraph, let me explain the demerger with the help of a picture.
In a nutshell, Cinemax India has decided to split into Cinemax India (CIL) (later to be named as Cinemax Properties) which will manage the asset side of the business while the CEIL side of the business will manage the theatre exhibition business. Here’s the link to the announcement. As usual, when two companies merge, the Board gives an explanation of ‘synergy’ and when a company is demerged into two, they term it as ‘focus’. I would not read too much into the Board’s explanations of ‘focus’ and ‘creating value’.
Our business as investors in such kind of Special situations is to see if we can create low cost shares of either the demerged entity or the main entity. For the sake of further discussions, I will call the asset business as CIL and the theatre exhibition business as CEIL. As per the announcement, Cinemax India has decided to issue 1 share of CEIL for every 1 share held in Cinemax India as on record date. Essentially, the current Cinemax India will become CIL on record date, which will later be renamed as Cinemax Properties. CEIL of which new shares are being issued to existing shareholders will be renamed as Cinemax India at a later point in time. For the sake of this discussion, mention of Cinemax India means ‘Cinemax India before ex-date’.
In case you are wondering, this opportunity is still available. The record date has been announced as 18th May 2012. Ideally, the ex-date should be 17th May 2012 (Record Date – 1) unless there is a holiday/weekend/bank strike. However, in line with this announcement, looks like the ex-date will be 16th May 2012. That is, even if you buy Cinemax India (CMP: Rs. 32.8) on 16th May 2012, you will be eligible for shares in the demerger. However, share trading in the entity will be suspended from 17th May 2012 and the record date (that is, the date on which you can sell the shares and yet be eligible for demerged shares) has not been announced yet. (However, if you want to venture a guess, Provogue India which went through a similar demerger listed in about 10 days from the day of the suspension of trading. But no guarantees).
There are two major questions that we need to answer in such demerger situations –
a) What would be the price of the entity on the record date?
b) How long would my capital be tied up?
I will explain the two questions with an example. The CMP of Cinemax is Rs. 32.8 (90 cr market cap). If on record date, the price corrects to Rs. 30/-, and if I sell the shares, I would have created one share of CEIL for Rs. 2.8/- (which by the way is damn cheap). Also, my capital of Rs. 2.8/- would be tied up till CEIL lists (which going by previous experiences might take anywhere from 3-6 months). If it’s only Rs. 2.8/-, then not much damage done. Let’s say, if the price corrects to Rs. 10/-. In that case, I would have created one share of CEIL for Rs. 22.8/- and this capital would be tied up till CEIL lists. The opportunity costs might be quite large depending on what percentage of portfolio you take this demerger bet on as well as how the market would move in the next 3-6 months.
A comparative comparison of Cinemax with competitors will tell you that it is quite cheap on a relative basis (I would not get into that since the note link on the first line of this post would explain that).
At this point, we arrive at a behavioural crossroad. Am I investing in Cinemax because it is cheap on a relative basis, or am I investing in Cinemax for the special situation (that is, to create cheap shares of one or the other entity)? I have observed, in my short experience in the markets that it is better to clear the intent before investing in the stock rather than later. Once you invest, a lot of stupid behavioural bias get in and meddle with your mind 🙂 .
My intention in evaluating this opportunity is quite clear. It is only to create cheap shares through the demerger than the cheap relative valuation. In fact, I hadn’t even looked at Cinemax till I saw the announcement of the demerger (primarily due to high debt, I think but that’s a story for another day). Now with the intention clear, let’s move on to valuation.
In special situation valuations, I am trying to arrive at the dirt cheap valuations rather than calculation of sharp intrinsic values based on nuanced understanding of the business. So, let’s see the dirt cheap valuations of CIL and CEIL.
Please do go through this Bombay High Court Order note which explains the demerger in detail (this was available on Cinemax website). In this note, there is one paragraph which details what CIL will do in the future –
The Annexure 1 (scroll to the last page of the court order note) lists out the 9 locations spread across Mumbai, Thane, Nashik andNagpur. CIL will own and lease out these 9 locations to CEIL. Out of these 9 locations, 7 locations are pure theatre businesses and 2 locations (Eternity Malls in Thane and Nagpur) comprise of other businesses along with theatres (which will include renting out the mall to other brands/entities).
Let’s look at the Operating Income and Expenses of Cinemax India over the past 3 years under different segments (taken from the ARs) –
(I really don’t know (and they have not made it clear) as to what arm’s length means, but based on logic, the ones colored in yellow will belong to CIL and the non-colored ones to CEIL in the Operating Income table)
Rental expenses for 107 screens (end of 2011) was about Rs. 20.3 cr. Per screen cost works out to around Rs. 19L per year. This obviously doesn’t include the rental cost of Cinemax owned properties that is being transferred to CIL now.
This old report would tell you that the 9 properties that CIL would own would be around 23 screens. Even if I assume CIL would deal fairly with CEIL, and considering all properties are in Mumbai (which is a high cost location), per screen cost would be around Rs. 30L. So, total cost to CEIL and hence income to CIL in 2012 would be around 7 cr.
There is no clarity around how much of debt would be transferred between CIL and CEIL (hence we will assume CIL will borne 50% of interest costs). For CIL, there will no more be major expenses of rental/distributor’s share etc. It’s a pure asset play business. Except for a few administrative, salary and power expenses, there would be not much to deduct from income.
If we take a look at Cinemax’s P&L statement over the past 3 years, the average salary, marketing, administrative expenses comes to around Rs. 40 cr. per year. Since we are living in an inflationary environment, let’s assume it will shoot up to Rs. 55 cr this year. And 25% of this would be borne by CIL (not a people intensive business).
Depreciation would only be on existing assets and not leased assets. Based on the past 3 year data, let’s assume the entire depreciation of Rs. 15 cr would be borne by CIL.
Let’s draw up the income statement now of CIL for 2012 (I have assumed a 10% inflation over 2011’s numbers for operating income).
Based on the numbers, CIL will be a loss making business unless they find some other source of income. Even with very generous assumptions, they’ll just about break-even (unless of course CIL and CEIL have come to an agreement to share ticket/food&beverage revenue depending on footfalls – this info is not forthcoming in any of the documents I have gone through).
Since this is a loss-making business (and at best, a break-even business unless Cinemax sells any of these properties, which I think they will not), the market would assign a very low value to the business (heck, NESCO with all its profits is being valued at 12 P/E). So, fat chance that CIL would get any sort of value. Even at a generous P/S=1, the market would value CIL at no more than 15 crs.
I will not value CEIL. That’s an easy exercise, but there is another reason why I wouldn’t value CEIL. The reason being, my capital is being tied up for too long.
Let me explain.
The CMP of Cinemax India is Rs. 32.8 (mkt cap of 90 cr). On record date (whenever they announce it), the market will value Cinemax India at the valuation of CIL. CEIL will list later (3-6 months later).
With a generous valuation of market cap of 15 cr, the price of CIL (and hence Cinemax India which you would buy today) when it lists on record date would be around Rs. 5/-. That is, a capital of Rs. 28/- would be tied up for 3-6 months till CEIL lists. By the time CEIL lists, we might lose out on many other opportunities that the market may provide in the mean time that we could have used with the capital that is tied up.
In fact, there is another reason why we should not invest right away and wait till the record date when the share price of Cinemax would be around Rs. 5-10. Look at the shareholding pattern.
There is ICICI Prudential holding onto 6.7% of Cinemax shares. Usually mutual funds do not like these asset-rental type of businesses in India. So, in all likelihood, ICICI might dump Cinemax (CIL shares) subsequent to the record date and just wait for CEIL shares and hold on to them (which is considered ‘good’ and ‘high growth’).
We might hence be getting CIL shares at a lower price than Rs. 5/- in case this happens. The time to invest is then, not right now.
And the allure of CEIL? Well, who cares. In these markets, I don’t like my capital being tied around for too long unless it’s a good story (and I think I have much better stories than Cinemax to invest in for the long term). If you get a bear market in the interim, who knows, you might get to pick CEIL at a cheaper rate than Rs. 28/-. If it’s a bull market, well my other holdings would have appreciated as well. Heads I win, Tails I don’t lose much.
Let me know if I have missed any angle.