Piramal Enterprises

As I wrote 2 days back, today I perform the detailed analysis of Piramal Industries, earlier known as Piramal Healthcare.

Let me first write my reasons to research this stock, they'll help remove some biases:

1. Its been discussed few times in value investing forums.
2. Prof. Sanjay Bakshi analyzed it an year back and found it attractive, the price has not moved yet and there're more reasons for the business to be more attractive than an year back.
3. Mr. Ajay Piramal is known for his superb capital allocation skills, and I think he can make better use of my money than I can do.
4. PEL now owns 11% stake in Vodafone India. Below I analyze if this stake is undervalued in PEL stock.

Ok, so, first step in valuation of PEL is to find a value for Vodafone India. Vodafone India has about 16.4% market share of Indian telecom (cellular, GSM) market, which currently stands at about 911 million subscribers, according to a report by TRAI. Since Bharti Airtel, the largest subscriber owns 19.62% market share, a reasonable estimate of Vodafone's revenue is 16.4/19.6 * 416038 million = ~Rs 350000 million for year 2011-12. Taking an average Net Profit Margin of 20% for the industry, we can arrive at Earning for Vodafone as Rs 70000 million for year 2011-12. Now, under current distressed industry situation, Bharti trades at 17P/E, and it won't be unreasonable to assume that if Vodafone India were public it'll trade at least at 15 times its earnings. This gives a total market cap of Rs 105000 crores to Vodafone India, of which, PEL owns 11%.

Thus, the market value estimate for the stake in Vodafone India alone is Rs 10500 crores. Taking a margin of safety of 40% on this calculation, we can at least assume Rs 6000, which is what is roughly PEL paid to acquire the stake. So, this gives a good confident that book value of vodafone stake in PEL is at least slightly undervalued, and Mr. Piramal has struck a good deal.

So, net of Vodafone Investments + Cash - Long term Debt is Rs 300 per share (6000 cr + 57 cr - 892 cr = 5150 cr = 46% of book value) = Rs 300 roughly, and there's a lot of margin due to Vodafone valuation with 40% discount.

The question now is, at current price of Rs 470, what else within the business makes it still undervalued compared to rest of Rs 170 per share price. Let's try to analyze:

DRG Acquisition
Referring to Analysts presentation, DRG is a healthy business, with high barrier to entry, negative working capital, consistent 20%+ revenue growth and even high profit growth, debt free, diversified client portfolio, and PEL has acquired it for $635M, when DRG is expected to have a revenue of $160M in FY2012. This is 4X revenue valuation, in line with market valuations for such businesses in US.

Assuming current profit of 20%+, earnings for FY2012 are expected to be about $35M. Assuming 2 stage DCF, with 18% growth in FCFF for next 8 years and 2% thereafter, we arrive at a fair value of $650M, very close to what PEL paid. Thus the value of DRG in each share of PEL is about Rs 180.

Due to bridged acquisition over 18 months, starting May 2012, with 1:1 payment through equity and debt, and debt being at 5.5% cost. They plan to raise debt against DRG asset itself in US. Can we count the value of DRG today? There'll be increase in debt upto an amount of $320M on books of DRG, which can be easily serviced (interest cost will be $17.5M per year). Even if debt is carried on books of PEL, it can be easily serviced from available cash (or potential cash inflow from dividends that might be generated from DRG profits). The equity part will be paid out of cash inflow to come from Abbott over next 3 years ($1.2B) and from sale of Vodafone stake, which they say is a short term investment. Hence, we should NOT add Rs 180 into value for PEL, maybe something between Rs 90 and 180.

Before we move forward, let's stop and revise and tally. Sale to Abbott would generate a total cash inflow of $2.2B as one time, received in 2010, and then, $400M annually from 2011 to 2014. Till now, $2.2B + $400M is received and is on books ending FY2011-12. ll this total amount is sufficient to cover purchase of Vodafone and DRG and still leave surplus cash, so debt arising from DRG should not worry us, but as a conservatism, let's account for only 70% of Rs 180 from DRG, and hence total value accounted is now rs 300 due to Vodafone and Rs 125 due to DRG. This leaves Rs 45 more to be accounted, NOT counting any surplus cash inflow remaining from Abbott by 2014.

Pls note that we've been very conservative in valuing Vodafone and DRG so far, and yet only left behind with Rs 45 to be accounted for remaining businesses that PEL holds.

Financial Subsidaries
Let's start with the INDIAREIT Fund advisors and Investment Management compaty, along with PHL finance pvt ltd. These were acquired for a total consideration of Rs 225 cr, summing to Rs 11.63, net's knock off Rs 10 as the value from remaining Rs 45. Sime reason being a belief in Mr. Piramal's value investing skills, he won't pay more that value, and then we can say Rs 10 per share of PEL is a good value for these INDIAREIT companies.

Let us also not count any further value for other financial subsidaries.

Now remains Rs 35. Sales from all the Pharma and Healthcare related businesses (accounting for over 80% of total consolidated sales) was Rs 1988 cr in FY2011-12. Average profit margin is 16%+, and this means a  total Operating Profit - Depreciation (EBIT) of over Rs 318 - Rs 140 cr or equivalently, Rs 180 cr = Rs 10.5 per share.

This gives a debt capacity of Rs 10.5 / 3 / 0.09 = Rs 39 per share for healthcare related business. This means, that if we leave aside Vodafone and DRG and financial acquisitions at cost (and believe in Mr Piramal's skills to equate purchase price as fair value), the remaining business, in current state is available at Debt Capacity!

Can you buy a pharma business today at debt capacity? Not really, all pharma businesses enjoy high valuations, owing to stability of their business fundamentals. Hence, I believe Piramal Enterprises is still quite undervalued and I can enter below Rs 470 a share quite comfortably. Of course, it'd make sense to stagger the buying, so I'll now start increasing my stake in PEL gradually, buying on dips below Rs 470, upto 10% of my portfolio.

The belief is in excellent skills of capital allocation of Mr. Piramal, and the fact that he's driving the enterprise to be in the right businesses in pharma world, and building a portfolio of right verticals. I still need to read in details the analysis Prof. Bakshi did 17 months back, but now I won't be biased - I have performed my analysis and can make it more pruned by reading what the revered professor has to say.

Another sidecar investment. Its good to analyze sidecar opportunities and invest while you're still learning to do independent research :-)

Here I come Piramal Enterprises...and next post will tell the new action plan.

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Here's a structured calculation of IV to find at what margin of safety is the stock trading right now.

1. Valuation of Vodafone stake is Rs 10500 cr.
2. Valuation of DRG stake is NOT counted, since it is yet to come on books. instead, we count the cash inflow of 3 x $400M = $1.2B = Rs 6000 cr (@ 50$ - INR = 50). Let's be double conservative and consider only upto 70% will go to good use (this also discounts future cash flows), and hence, effective value comes at Rs 4000 cr.

3. We found that debt capacity for all pharma related business is about Rs 667 cr. Taking Graham's minimum value of common stock as 1.75X of debt capacity, we can assume a value for Rs 1160 cr. for pharma business.

4. Finally, we reduce total liabilities of Rs 2600 cr.

Ignoring other businesses, we find the value for Piramal Industries as Rs 10500 + 4000 + 1160 - 2600 = Rs 13000+ cr. This translates to Rs. 680 per share. Since a good part of this is cash, which will be paid to buy DRG, we should still take some decent margin of safety.

At CMP, we're getting this company at 30% margin of safty. I think it's a decent margin of safety for such a well managed enterprise, in hands of an excellent investor. I'll be doubly confident to buy this stock now :-)