High dilution must be backed by high earnings growth

The following article from Economic Times provides some good insights for understanding finance...

18Jan2010

Often overlooked and underestimated aspect of investments is equity dilution. You would have come across advertisements saying a certain company posted a high profit growth or a certain company’s market value was worth a few hundred crore some years ago but now its market capitalization is worth a several thousand crore. But the fact is that these examples don’t tell you the entire story.

It doesn’t tell you the cost of growth. As you would appreciate, growth requires capital and investors need to know the source of the capital. If the growth has been funded through internal accruals then, existing shareholders will fully capture the growth, but if the company is growing by expanding its equity base (i.e. creating new shares) then existing shareholders will have to share the growth with the growing numbers of shareholders. This phenomenon is called equity dilution and it caps the gains for shareholders.

Let’s take a simple example. Consider a company ABC Ltd with Rs 100 as profit and only two shareholders. Each shareholder is entitled to Rs 50 each of profit. Assuming that the profit grew by 50% in a year, ABC Ltd makes Rs 150 as profit and two partners are entitled to Rs 75 each. Contrast this with another company called XYZ Ltd. It also finished the first year with Rs 100 as profit. It also had two shareholders and therefore they too were entitled to Rs 50 each. But this company decided to rope in more shareholders to pump in more capital. As a result, it had three shareholders. XYZ Ltd grew at a faster rate than ABC Ltd. Let’s assume that it grew by 70%. So next year it finished with Rs 170 as profit.

Every shareholder is entitled to Rs 57 as a share in profit. Note that despite XYZ Ltd growing at a faster rate than ABC Ltd, the shareholders of former were worse off than latter. However, there are several permutations and combinations. It might have happened that XYZ Ltd grew at such an astronomical rate that profit per shareholder was higher than ABC Ltd. Taking this as the central idea, ET Intelligence Group decided to look into several sectors and hunt for such cases. In real life the dilutions happen through rights issue, conversion of debt into equity, private placement of shares, QIBs, GDR issues, domestic public issue and issuance of stock options among others.

We don’t treat bonus issue in dilution because the existing shareholders get the shares and company’s networth (or total equity) remains unchanged in a bonus issue. The dilution rate is calculated as compounded annual growth rate of paid up equity capital since the start of FY 2000 or from the year the company was listed, whichever is later. Similarly, earnings growth was calculated. The difference between the earnings growth and dilution rate is referred as real growth (or growth in earnings per share).

Since all the companies under consideration were not listed in FY 2000, the share price growth and market capitalization growth was calculated from FY 03. We found cases wherein a company grew its profit at a higher rate than its rival. However, it had to fund its growth by constantly raising equity capital and it kept on diluting its equity. And therefore, EPS growth was much lesser than the actual growth in the company’s earnings. Let’s take the case of Amtek Auto and Bosch.

Both companies are in auto-ancillary space. At 22% per annum, Bosch’s profit growth was much lesser compared to 37% growth posted by Amtek Auto. But while Amtek Auto diluted its capital at the rate of 14% per year, Bosch didn’t have to expand its capital base. So Bosh’s real earnings growth stood at 24%, which is marginally higher than 23% posted by Amtek Auto. The story gets more interesting in the case of two banking giants – ICICI Bank and HDFC Bank.

Banking is a capital-intensive sector by its very nature. Banks have to maintain a certain minimum percentage of their assets as capital. So dilution is inevitable. But different banks have handled it in different ways. ICICI Bank preferred the strategy of aggressive capital raising leading to high earnings growth and on the other hand HDFC Bank managed to grow at high rates despite being far more conservative on dilution. At 49% per annum earnings growth, ICICI Bank seemed to be the fastest growing bank of the decade. However, it came on the back 21% dilution per annum. So, the real earnings growth was reduced to 28% per annum. With 39% growth in earnings HDFC Bank grew at lesser pace than its rival ICICI Bank. However, with 6% dilution rate, it managed to post EPS growth of 33%, which is much higher than ICICI Bank.

Let’s look at the cement sector. For instance, Ambuja Cements diluted its capital at the rate of 8% per annum, while ACC’s dilution was minimal. Despite this, Ambuja Cements could manage to maintain earnings growth of only 28%, while ACC’s earnings grew at 47%. Similarly, India Cements’ real earnings growth came down due to constant dilution over the years. Similarly, in hospitality industry Indian Hotels diluted its capital at 5% per annum, while EIH didn’t dilute its capital at all. Despite this, EIH grew at 10% per annum higher than 8% earnings growth registered by Indian Hotels. Perhaps the most classic cases of conservatism on dilution are in the FMCG industry. Both ITC and Nestle have not diluted their capital base. Yet they managed to post earnings growth in double digits.

These companies may not be among the highfliers on Dalal Street, but when it comes to stability, it’s tough to find a match to steady companies like ITC and Nestle. On the other hand, in the same industry and growing at almost identical rates, Dabur diluted the capital at 8% per annum, which pulled down its EPS growth. But before you conclude that the performance of companies with high dilution is always below others , which do not, we have examples of companies with high dilution and a very high growth in real earnings. These are typically those cases, wherein the company had to raise capital to scale and reach a higher level. For instance, Shriram Transport Finance. At 26% per annum, it has one of the highest dilution rates. However, the company’s earnings growth stood at 76% per annum implying a real earnings growth of 50%.

Similarly, in construction industry IVRCL Infrastructures & Projects diluted its capital at 18% per annum, one of the highest rates in construction industry. At the same time, it managed to grow its profit at 44% resulting in a high real earnings growth. So what are the key points for investors? In many cases, we have observed that the companies with less dilution give better return to shareholders over a long period of time. For instance, Bosch’s stock has given a return of 42% per annum, while Amtek Auto has given a return of only 12%. With one of highest dilutions in banking space, ICICI has given one of the lowest returns at just 16% per annum.

It is noteworthy that the state-owned banks like State Bank of India and Punjab National Bank have given more return than ICICI Bank. One of the aspects investors should be cautious of is that in companies with high dilution, the growth in market capitalisation is far higher than that of its stock price. This is because more stock gets added to paid up capital. So, next time your advisor boast of high market cap, please run a check. For instance, Amtek Auto’s market cap has grown at a rate of 16% per annum, while stock price has grown at the rate of 12%.

In the end, we don’t want to say that investors should ignore companies with high dilution in capital. The mantra is to make sure that high dilution is backed by high earnings growth.

Source:

http://economictimes.indiatimes.com/features/investors-guide/High-dilution-must-be-backed-by-high-earnings-growth/articleshow/5456409.cms

Google acquires AdMob for $750 mn

12Nov2009

Google has acquired AdMob, a mobile display ad technology provider, for $750 mn (~Rs 3375 cr) in stock. The deal is similar to mobile advertising acquisitions that AOL, Microsoft, and Yahoo have made in the past 2 yrs. Though Google offers many forms of mobile advertising, its focus to date has been on mobile search ads, while AdMob's focus has been on mobile display ads and in-application ads.

It marks Google’s third-largest acquisition after DoubleClick and YouTube and is a very solid exit for AdMob and its investors, which have pumped in $47 mn into the business. But more importantly, the acquisition also lends credibility to the struggling mobile advertising space, which is always being characterized as being around the corner from taking off.

Benefits to Google

• AdMob brings to Google immediate scale in display advertising as well as ads on applications that next-gen phones like the iPhone, Nokia N97 and a number of Android phones have made popular
• Although the mobile ad market remains tiny, with less than $200 mn in total revenues in 2008 and little adoption by large brand advertisers, Google is betting that in the long-term, mobile advertising will become a blockbuster play.
• Owning one of the biggest mobile advertising networks will give Google lots of data helping it understand what works on iPhones. This will help Google better challenge Apple with Google's own Android operating system and its flagship Droid handset. The AdMob deal may not help Google's bottom line for several years, but it could give the company critical insights into how to compete with Apple to entice Droid users to consume more Internet time and use more applications.

Google acquisition history

• The AdMob buyout is the 3^rd by Google this year. First was a $106 mn purchase of video compression company On2, which could help Google more efficiently deliver video (Google owns YouTube through a $1.6 bn buyout in 2006). The second deal Google made this year was for ReCAPTCHA, which brings Google some cool authentication technology that it can use to accelerate its massive effort to scan tens of millions of books and periodicals.
• Google’s 1^st public buyout was in Feb 2001 when it acquired Deja.com’s Usenet Discussion Service, including the domain names déjà.com and dejanews.com, just 3 years after the Google started.
• Among the deals that have expanded the company far beyond search, include 2003’s buyout of Pyra Labs (Blogger’s creator) and 2004’s purchase of Keyhole, whose technology now powers Google Earth. In 2006, Google bought a company called Writely, a word processing software maker whose technology became the basis for Google Docs
• While many of Google’s buyouts have been relatively small, it has hit $1 bn a few times, including for a chunk of AOL and for online advertising company DoubleClick ($3.1 bn).
• Many of Google’s newer products have either emerged from the company’s acquisitions or at least have benefited from them. Google Voice, for instance, is based on technology from Grand Central, which Google gobbled up in 2007 for $45 mn.

How Bonus Shares are Issued?

How Bonus Shares are Issued?

Bonus shares are issued by using on the free reserves of a company. Companies accumulate its reserves by retaining part of its profit over the years (the part that is not paid out as dividend) and it soon gets ‘large enough’. When the company issues Bonus shares, the reserves will converts into the capital (‘capitalization’). Finally, you are also not paying for this and the company's profits are not affected.

Does it impact Stock Price?

Bonus Shares issue adds to the total number of shares in the market. If a company had 10 lakh shares, with a bonus issue of 2:1, there will be 20 lakh additional shares resulting in a total of 30 lakh shares. The earnings of the company will have to be divided by this new number of shares.

Earnings per Share (EPS) = Net Profit/ Number of Shares

As the profit remains the same and the number of shares increases, the value of EPS is expected to go down. In fact, the stock price should also go down proportionately to the number of new shares. But sometimes, in reality, the share prices may not go down, which gives more advantage to the share holder.

Whenever Bonus shares are issued the stock becomes more liquid making it easier to buy and sell.

A bonus issue indicates that the company is booming and it is in a position to service its larger equity. Bonus share issue is considered as a positive sign for the company.

Always follow wise Investors

In each stock, there is a small group of investors who know more than general public. They have an advantage, because they can better envisage than a company will make in the future. To be successful, we must find out of what the investors with best information do, and then we follow the same.

http://www.keralabanking.com/html/guide_for_stock_trading_in_ind.html

HomeShop18 raises $23.5 mn to fund expansion

15Nov2009

·         Investment of $18.5 mn (~Rs 85 cr assuming $1=Rs 46) comes from Korea based GS Home Shopping (GSHS) to acquire 15% equity stake in HomeShop18 valuing Homeshop18 at around Rs 571 cr. GSHS has entered in a strategic agreement with the HomeShop18’s parent firm Network18 to lend its expertise in the areas of Sourcing, Merchandising, Broadcasting and Logistics to scale the HomeShop18 business in India. This will be facilitated by way of seconding key employees to HomeShop18 as well as training HomeShop18 employees in Korea. HomeShop18 also plans to leverage on GSHS' good relationships with suppliers in China and in other parts of the world.

·         Network18 Holdings (a wholly-owned subsidiary of Network18) would infuse the remaining $5 mn (Rs 23 cr)  to hold on to controlling stake of 51% stake in the Company.

·         After the deal, Network18 holds roughly 51% stake in HomeShop18, 15% will be with GSHS, and about 27% with SAIF Partners.

·         HomeShop18 was created in Apr 2007 with SAIF (Softbank Asia Infrastructure Fund) Partners as an anchor investor, which is a pioneer PE investor in Home Shopping in India and China.

·         Currently, HomeShop18 is hitting a run rate of just about Rs 25 cr a month on gross sales and is doing about 2 lakh orders in a month. It reaches out to 1.5 mn consumers across 2700 cities in India and is the largest e-commerce player in India as well.

Govt approves HITS policy guidelines, Allows 74% FDI

13nov09

The cabinet yesterday approved a proposal to issue policy guidelines for HITS (Headend-in-the-Sky) operators allowing the use of 'C' and 'Ku-band' resrved hitherto for DTH. The new policy allows HITS operators to uplink signals only from India. This is expected to speed up digitalization in CAS areas, though it would cost around Rs 100-120 cr for capital expansion to roll this out.

Govt also raised the cap on FDI in the sector to 74% (from existing 49% for cable TV operators) out of which, 49% is through automatic route and the rest is through FIPB. FDI caps for all broadcast sectors would be reviewed soon.

• The policy does not make it mandatory for cable operators to obtain signals only from the HITS network. It is only another delivery platform being provided. Hence, it may not have the complete impact in addressing the cable operator’s monopoly, though consumer dependence on cable operators will reduce further.
• Though the operators are not permitted to provide signals directly to subscribers, the policy suggests that if the HITS operator is also an MSO/cable operator, he can do so through his distribution network.
• In a bid to avoid vertical integration and promote competition, the cross media holding restriction of 20% of total paid up equity has been prescribed for various segment of broadcasting services.
• The digitalisation would help in cutting operational costs for WWIL. WWIL stock responded positively and was locked up at 20% upper circuit at Rs 20.40 on 12nov09 and was trading up another 9-10% 13nov09 morning. WWIL’s services will be operational from today, since it has already set up the infrastructure and made the capital investment. It will get 3 months to restructure and to adhere to the new guidelines.
• Presenly, only WWIL and Noida Software Technology Park Ltd have permission to offer HITS service.

Twitter to be a billion-dollar entity soon

26Sep2009

Micro-blogging site Twitter is close to securing $100 mn funding from about 7 investors (incl T Rowe Price Group, Spark Capital) led by New York-based venture capital firm Insight Venture Partners. This would buy the fast-growing Internet-messaging company more time to chalk out its business model.

The proposed funding companies are valuing Twitter, which is yet to generate more than a trickle of revenue, at about $1 bn. That’s more than triple the valuation Twitter received during its last round of capital raising in Feb’09 when it raised $35 mn from Benchmark Capital and Institutional Venture Partners, valuing the micro-blogging site at $250 mn, underscoring how quickly the company has grown.

The company had 54.7 mn unique visitors worldwide in Aug’09, up from 4.3 mn in Aug’08. Twitter is facing competition from companies such as Facebook that have also rolled out Twitter-like features. Twitter, which rejected a $500 mn takeover proposal from Facebook last year, has preferred to rope in financial rather than strategic investors.

Raghav Bahl's Interview on CNBC after Q1FY10 Results

17July2009
Network 18 Media and Investments has announced its first quarter numbers of FY10. It has reported consolidated net loss of Rs 36.3 crore and net sales of Rs 225.7 crore.

Commenting on the results and when the company would start seeing profits, Raghav Bahl, Editor of Network 18 said the company was almost at break-even point already and should report operating profits by the end of the calendar year 2009.

On the company’s focus for the year, Bahl said the network would see operating margins by the last quarter of calendar year 2009. He added that he would like to focus on current businesses and had no capex plans as of now. “Our main focus is to become cash positive on all businesses,” Bahl said.

The main problem Network 18 was facing was interest costs for the TV18 balance sheet, Bahl said. “When you look at complete bottomline profitability, if you look at the results, the problem is only one. We had Rs 22 crore of standalone loss on TV18 and we had an interest cost of Rs 30-31 crore. Debt is the only issue and we have acknowledged it in the past. We have to get that debt off the balance sheet. Once you take that off, the interest number comes down and we come back to bottomline profitability.”

Here is a verbatim transcript of the exclusive interview with Raghav Bahl on CNBC-TV18.

Q: Q1 numbers too, there are operating losses at TV18. By when do you think you can start reporting profits at an operating and a net level along with your subsidiaries, the operations at net, Infomedia all put together when can you start to get back to profitability again?

A: We should be able to hit operating profitability by the end of the year because the operating profitability of the business news channels, although operating on a 17% margin which is much lower than what they have been operating on, is positive. Web18 is headed towards operating breakeven. Infomedia as well should be operating breakeven and Newswire18 is almost operating breakeven. So I think operating profitability is pretty much a given and we should hit it before the end of year.

When you look at the complete bottomline profitability — if you look at the results, the problem is only one; we had Rs 22 crore of standalone loss on TV18 and we had an interest cost of Rs 30-31 crore. So there is only one problem on the balance sheet and that is the debt and that is something which is not something that we are acknowledging today, we have acknowledged it in the past. So we have to get that debt off the balance sheet. Once you take that debt off the balance sheet, the interest number comes down and we come back to bottomline profitability.

We also have clearly shared with our shareholders the roadmap to taking that debt off the balance sheet. We are doing a rights issue, are hopefully in the final stages of regulatory approval. Once we have that rights issue, we have got Rs 300 crore loan liability which will be extinguished by early next year or thereabouts. Just that one extinguishing of the loan liability takes off Rs 45 crore of interest burden on an annual basis from the balance sheet. So the bottomline profitability depends on when we can take a large amount of that debt off operating profitability. As things stand today, there’s no reason why we should not be healthily there by the last quarter this year.

Q: Just to clarify, operating profitability by the end of calendar year 2009 or by the end of FY10?

A: I think calendar year 2009. We are about Rs 9-10 crore positive on the business news channels, we are about Rs 4 crore negative on Web18, we are about Rs 2 crore negative on Infomedia and we are about Rs 40-50 lakhs negative on Newswire18. So we are pretty much breakeven already. So I think I am being conservative when I say last quarter this calendar year but there is no reason why we won’t hit operating profitability. The problem is the interest number that is coming in which is a colossal Rs 31 crore and for that we have a roadmap laid out to reduce that.

Q: We talked in the past about plans that there are to scale down the net debt for the company but just to understand it better – any target you have set out, by the end of FY10, where would you expect to see net debt at?

A: We have got Rs 3 crore loan liability which we will certainly extinguish. The other loan liabilities are really much longer-term and it doesn’t make sense from a shareholder perspective to extinguish an eight-year loan which can be used much more profitably to leverage shareholder returns. So I think we will knock off the Rs 300 crore of short-term loans that is going to be coming due which as I said will straight away save nearly Rs 45 crore of interest costs on a per annum basis. We will keep the long-term loans because we believe that’s good for generating shareholder returns and once revenues have come back to normal at the business news channels, it is simple arithmetic to say that the balance sheet would be back on strength. Also, the fact that Web18 is also getting out of its investment phase, the fact that Newswire18 is out of its investment phase, the fact that Infomedia has been cleaned up and is out of investment phase is in fact going to be hopefully PAT positive very soon. Once you put all these things together I think the roadmap is clear but I mean these are words – we have got to get them done.

Q: When does business start to pick up – revenues of four news operations have been quite sluggish as well – what is your own estimate of when advertising revenues start to pick up, distribution revenues pick up because ad revenues are the first to get hit in a downturn and often the last to come back? Are you seeing the first signs of recovery and by when can the ad revenues get back to where they were a year or year-and-half back?

A: If you look at TV18 today, our business news channels now are about 50% of our business – 50% of the business is non-business news channels. The non-business news channels are growing fine. That revenue is on a growth path. Unfortunately, we had the curse of the leader in the business news channels because we are the category. The category does about Rs 250 crore of revenues and I think we are Rs 225 crore out of that. So when we gain, we gain big – when we lose, all the losses come to us as well i.e. when the industry itself loses revenues, all those are our losses. It is the curse of the winner.

As far as turnaround is concerned, we are seeing it. We are beginning to see it but to be able to say with complete confidence that we are back to the 2007-08 revenue levels, I think we will have to wait for the October to March six-month period because that’s really where we get roughly 65% of our revenues – the first two quarters we don’t get that much revenue. So even if one does better in the next quarter, one would hold ones horses on proclaiming victory because that is in any case a thin quarter. So October to March – can we come back to 2007-08 levels? It will be wonderful if we can. Are we confident? I think we are going to be cautious about that.

Q: Just to come to Network18 for a second – the perennial problem for investors has been how to value Network18. While they can value IBN and they can value TV18, some of your other properties have consistently struggled to give appropriate valuations to, which is why they can’t arrive at a valuation for assets and then give a holding company discount, which is typically how holding companies are valued in this country. Can you give us some sense of what different properties are valued at in your eyes including likes of Indian Film Company or even Homeshop18?

A: Since you have asked for my eyes, do let me qualify that this is going to be obviously biased since it is my eyes. Let us look at the Indian Film Company. The Indian Film Company’s performance is as good as any in the country and I would wager that you can benchmark it to players like UTV and Eros in the film business. So clearly UTV’s film business is valued by the market and there should be a valuation ascribed to the Indian Film Company. The problem there is that we have a small stake and our stake therefore is not getting consolidated at any level and therefore that’s disappearing into a black hole. It is a problem that we would like to address. But once and hopefully that value gets known to shareholders, I am sure that will get valued, but as I said, if you look at the audited results of the company as of March 31, they’ve done Rs 300 crore of topline and they have done Rs 31 crore of PAT, which speaks for itself. I would wager that was the only film company which was profitable last year in India but is getting zero valuation.       

Homeshop18 has come from zero to gross sales of Rs 200 crore in the last one-year. We did a private placement in that company last round which has had a benchmark valuation, since it is a structured deal you can’t say it is definite valuation, but it is benchmark valuation of a USD 125 million plus. So that is about Rs 600-650 crore. Both these values are not being captured by shareholders at all. In this country holding companies do suffer a peculiar decline or a discount, I don’t know as and when that will get corrected but value has a way of showing up. Just as you cannot keep a good man down, you cannot keep values down for long. Shareholders will see it. If you just see our results yesterday – Homeshop18 has gone up from a commission income of Rs 2.4 crore to Rs 9 crore – that’s commission income. Remember, that’s about 20% of the gross sales. Therefore, the company had done sales of Rs 40 crore in this quarter for it to give a commission income of Rs 9 crore. One cannot miss these values. It is the first home shop company, Homeshop all over the world is an extremely valuable media property. So sooner than later this value will get seen.

Do also remember that Network18 has grown nearly 100% (?) year-on-year (YoY) revenue growth in this environment. The number that you have got is Rs 220 crore topline which has gone up from Rs 136 crore. But at Rs 220 crore is an understatement because that still consolidates only 33% of Viacom18. It should technically from this quarter onwards start consolidating 50% because 17% couldn't be consolidated pure technicality but you have to consolidate it because it is owned by Network 18. That is another Rs 20-25 crore coming straight into the topline. So Network18 is already a Rs 250 crore company which has grown from Rs 130 crore base last year and they still does not consolidate even a penny on the film company. So it is approaching Zee TV size but has a much more diversified revenue base and in valuation terms it is less than a 10th of Zee TV. So as I said, the market will recognize these valuations. These things sometimes take time but you cannot keep good man down for long and the markets will see that.

Q: Over the next one year though, are there any capex plans that you have laid out routed either through TV18 or Network18?

A: We are very clear that all our business segments are growing robustly. So we would like to focus on existing businesses right now and get them to profitability. Our target is to get every business in the group cash positive by the end of this year or Q1 next year and that is the thing we are focused on. We don’t have any capex plans outside of keeping these businesses chugging along and getting them the cash profitability, all of them. Each and every business segment in the group will be cash positive hopefully by the end of this year or early next year. That is our focus.

This is going to be a dull and boring phase to Network18, we won’t be doing headline grabbing things. We will actually be sitting down and getting these businesses to profitability. So it is like one-day cricket match, we are entering the twentieth over with two wickets down and from twentieth to the fortieth over, we will now build an innings. So we will be pretty boring for the whole year.

Q: So no stadium hit with the print foray just yet?

A: That is a stated intent with our shareholders that we would. That is the only missing piece that we believe we should have. We would like to make that investment but we would like to make that investment properly with a good partner, with a pedigreed brand. So, all those things take a bit of time. If everything can come together, we would like to make that investment. But as I said that investment will be calibrated. As of now that is the only capex plan that we have, there is nothing else until we can get all business segments to cash positive and if you look at the lines, the lines are moving fine. We should be cash positive in all businesses by the end of this year.