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Indian Hotels: Rights issue - Views on News from Equitymaster

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Indian Hotels: Rights issue
Aug 7, 2014

India's largest hotel operator Indian Hotels Company Ltd (IHCL) has announced a rights issue to raise up to Rs 10 bn. The issue will be open from August 04 to Aug 20. If required, the management can extend the issue period by 30 days. Shareholders holding 40 shares will have a right to subscribe to 9 compulsorily convertible debentures (CCDs). The company will be offering nearly 1.82 bn CCDs at an issue price of Rs 55 per CCD. Each CCD will be converted into one equity share (face value Re 1) after 18 months. IHCL plans to use a substantial portion of the funds raised to repay existing debt to the tune of Rs 5.5 bn. The company (as per the FY14 results) had a little over Rs 30.2 bn in long term debt. Nearly Rs 1.3 bn will be used for the company's plans to refurbish its iconic Taj Mahal Palace in Mumbai and Rs 700 m will be used to partly fund the construction of ‘Vivanta by Taj' at Guwahati. The rest of the funds will be towards general corporate purposes.

Our view

The fundamentals of the company are certainly on the mend. The massive write-off regard to its investment made in Orient Express in FY14 took a heavy toll on the bottomline. However, the company has put this behind it and wants to focus on an asset light strategy going forward. To this end, IHCL sold its property, The Blue Hotel, in Sydney Australia. It has 14 Hotels currently under construction but 11 out of them will be under the management contract route which has a lower capex requirement. The company's increasing presence in budget hotels and other non-premium categories will certainly help to de risk the business from an economic slowdown. All these measures along with the improving prospects for the economy will help the company bounce back to profitability. However, it will still be a long hard grind we believe. Its debt burden is still substantial and the shift to the asset light business model will take time. Also, its international operations have been a drag on the financials for some time now.

If we were to exclude the extraordinary expense related to the write-off, the stock currently trades at a P/E ratio of 48.6 times its trailing twelve months (TTM) earnings. The CCDs on offer, if considered at par with equity shares, are being offered at 30 times TTM earnings. There is also the opportunity cost to be kept in mind as the CCDs will be converted into shares only after 18 months. Thus taking in to account all these factors we believe the investors will benefit from the rights issue only if they have a long term holding period in mind. From a 3-5 year perspective, the rights issue is attractively priced and the CCDs are available at a significant discount to the share price. However from a 2-3 year perspective the risks to the stock's valuations are just too high we believe. Thus investors who have an investment horizon below 3 years would do well to avoid subscribing to the rights issue.

We had recommended that investors sell the stock and book profits in our note on 17 April 2014 as the stock had breached our target price of Rs 75. We recommend that investors do not buy the stock at current levels as the near term valuations of the stock are extremely stretched.

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