Download - The Maharaja Dilemma Presented by Sanjay Pamnani Heidi Pellerano Dhanusha Sivajee Vidhi Tambiah
Situation OverviewMaharaja
Corporation
July, 1991Exclusive FranchiseOle Spring Bottlers
Joint Venture
January, 1997Road Show & Search for 3rd Party Investor
One Offer ReceivedWhat should Maharaja Do?
May, 1995 Capital injection by Maharaja
$2 Million Capital Injection by Pepsi
Sri Lanka Population: 18 million Ethnic Make Up:
- Singhalese (Buddhist majority)
- Tamils (Hindu minority)
GDP: 13.6 bn ($US) Main Industries
Agriculture Manufacturing Mining
Raging Ethnic Conflict 11.5 % Inflation Rate Inverted Term Structure Exchange Rate: 56 Rupees to $US
The Players The Maharaja Corporation
Largest Privately-owned conglomerate in Sri Lanka International JV Experience Highly Diversified Business Units
PepsiCo International Lagging behind Coca Cola in International Markets Sri Lankan is a Natural Extension of the Indian Market
Olé Joint Venture Exclusive Bottler & Marketer of the Pepsi, Miranda and 7-Up
Brands Bottling Plant in the Outskirts of Capital City, Colombo Extensive Distributor Network
Ole’s Performance to Date
Capital Structure 1992
Capital Structure 1996
Equity Debt1992 61,147,206 15,286,8011996 208,934,371 112,824,561
80%
20%65%
35%
Cumulative Losses of SL Rs. $268,979,408 (US $ 4.7 million) Marginal Free Cash Flows High Debt Burden – Debt Coverage of close to 2x EBITDA
Competition
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1950,s 1960 to 1978 1978 to 1985 1985 to 1987 1987 to 1991 1992-1995 1995-1997
CCS (Elephant House) Pure Beverages (Coke) The Maharaja (Pepsi)
Decision AlternativesStatus Quo
Terminate JV
Inject New Internal Capital
Bring in New 3rd Party Investor
Maharaja SWOT Analysisfrom Outside Investor Perspective
Strengths High brand awareness of Pepsi products Established network of 45 distributors
each supplying 1,100 retailers Strong marketing track record Heavy involvement in infrastructure
ventures - $3 billion worth of projects in the pipeline
Weaknesses Over-reliance on Pepsi and its assumed
marketing savvy Unable to maximize local consumer
knowledge Lack of soft drink “know-how” as a result of
diversified business units and generalist managers
Opportunities High per capita soft drink consumption –
average of 22 servings compared to 5 for India
Opportunity to distribute Pepsi snack foods in the future
Threats Non-carbonated substitutes, such as juices
and tea brands are maintaining a strong foothold in the market
External threat of labor strikes and power outages
Political instability and civil unrest
Risk Analysis from Outside Investor Perspective
High Risk Description Mitigation
Currency Risk
Currency depreciation and high inflation could lead to an increase in input prices for Pepsi Concentrate.
Revenues in Rupees and main in put in dollars
Demand investment and returns in dollar returns
Political Risk
Risk of political unrest in the form regime change and labor strikes.
Bottling plant may be the target of a Tamil separatist attack
Fairly difficult to do as a result of force majeure
Creeping Expropriation
High risk of the government targeting and collecting cash flows in the form of higher taxes from privately-held companies
Employ Maharaja’s political weight to lobby government
Management RiskMaharaja’s immense business diversification leads to uncertainty about management’s competency.
Bring in industry experts as part of
management team.
Cost of Capital Calculation Time varying Harvey ICCRG (May 97) Crisis Factor
Skew
Result - 23%- 26%
Spikes up to 36% - 40%
DCF Valuation DCF
APV approach as leverage changes Cash Flows Forecast 10 years out 1997-2006 PPP used to convert Cash Flows to USD Cost of Capital arrived at using ICCRG
Riskiness addressed in the Cost of Capital Historical Cost of Debt Growth Rate close to Historic Inflation Value per share in SLR And USD terms
DCF Valuation
Par Value
Par Value Rs. 10
X Rate 56.82
US $ Par V $0.176
Sensitivity Analysis
5.0% 0.169
5.5% 0.170
6.0% 0.172
6.5% 0.174
7.0% 0.176
7.5% 0.178
8.0% 0.180
8.5% 0.182
9.0% 0.185
9.5% 0.187
10.0% 0.190
10.5% 0.193
11.0% 0.197
11.5% 0.200
12.0% 0.204
Growth Rates
Share Value
Equity Value SL Rs. US $
Total Firm Value 990,169 $10,818
Less Debt (112,825) ($1,986)
Less Preference Share Capital (944) ($17)
Total Equity Value 876,400 $8,816
# of Equity Shares 47,697 47,697
Value per Equity Share 18.37 $0.185
Firm Value SL Rs. US $ % of value
APV Firm Value 504,792 $6,340 50.98%
Terminal Value 376,151 $3,176 37.99%
Tax Shield Value 109,226 $1,303 11.03%
Total Firm Value 990,169 $10,818 100.00%
Comparables Valuation Comparables
Performance Metric: P/E (Two Year Leading) Two comparables from the beverage industry chosen
2-year leadingMarket Cap/Earnings
Market Capitalization(US$ mn)
Ceylon Cold Stores 5.26
Maskeliya Plantations 2.52
Ole Springs Bottlers
Ceylon Cold Stores (60%) $ 2.379
Maskeliya Plantations (40%) $ 1.140
Enterprise Value for Ole $ 1.884
Proposed Deal Structure New Investor Demands
Guaranteed $ Investment Returns Convertible Preference Shares Put Option that essentially a convertible bond 10% return if option exercised Optional 3 year or 4 year exercise period
Recourse: Pepsi & Maharaja guarantors Should they accept the deal? What risks have they ignored?
Value of Option
Combination valued at $387k
Payoff on the three year option exercise
Payoff on the four year option exercise
0.249
0.22.7
Asset Price
0.227 0.249
Call Option
0
Bonds
Monte Carlo DCF with Skew
Compare with cost of Par value of Rs10. - Looks good
BUT – When consider the dollar value of the share, - below the par value of $17.6
Our ConclusionValue to Maharaja Org. Value to DLJ.
DCF Value
Option Value $387k-$387k
-$104k
$283k-$387kNet
N/A
BUT REAL OPTIONS ?
What Happened Maharaja Accepted the Deal The Put Option was exercised Olé is currently self-sufficient Maharaja is planning to retain due to large
capital investments However, willing to sell if receive a good offer
Key Lessons Exchange rate and skew are key Uncertainty involves time varying risks Option value underpins deal structure
Option Value – Detailed Calc.Bond ValuesAssume "normal" 8% return 3yr zeo 3,1 zero PV Sum 4yr zero
Actual Return (10%) 0.227 0.023 0.25 "Normal" Return 0.214 0.018 0.23
XS Return 0.012 0.005 0.02 PV 0.010 0.003 0.013 0.013
Call Option 3 year call 1 year call PV Sum PV 4 year callSpot Price 0.17 0.17 0.17
Exercise Price 0.23 0.25 0.25 Time 3 1 4
Volatility 30% 30% 30%Risk Free 6.00% 6.00% 6.00%
Option Price 0.028 0.004 0.032 0.031
Value of security 0.045 0.044 Total Value 779,955 775,053 Illiquidity Discount (50%) 389,977 387,526
Volatility risk free0.0447 6% 6.50% 7% 7.50%
10% 0.022 0.022 0.023 0.02415% 0.027 0.028 0.029 0.03020% 0.033 0.034 0.035 0.03625% 0.039 0.040 0.041 0.04230% 0.045 0.046 0.047 0.04735% 0.051 0.051 0.052 0.05340% 0.056 0.057 0.058 0.05945% 0.062 0.063 0.064 0.06550% 0.068 0.069 0.069 0.07055% 0.073 0.074 0.075 0.07660% 0.079 0.079 0.080 0.081