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Is your stock a bad investor? - I

Oct 11, 2012

There have been numerous instances in history when companies have diversified into businesses that are unrelated to their core business, thereby leading to various problems. While there might have been exceptions, their proportion to the overall failures would be small.

While managements may sense opportunities in certain segments (thereby prompting them to diversify), many a times, they tend to face what is called the 'Shoe Button Complex'. In simple terms, this occurs when success in one area can give a person an illusion that he can be successful in other fields as well. It would not be wrong to say that businesses (and their respective managements) often fall prey to this complex.

In this short series of articles, we shall take up a few bizarre examples and see how these 'diworsifications' have impacted companies.

Deccan Chronicle Holdings (Deccan) would be the first company we would be discussing as part of this series.

The cover of the company's FY09 annual report boasts - 'No. 1 team in the IPL' and 'No.1 newspaper in the South'. This pretty much sums up the company's story and its 'then' future.

Deccan is mainly engaged in the business of printing and publishing newspapers. Deccan Chronicle, the company's flagship daily newspaper is the largest circulated English daily in South India and the fourth largest in the country. The company also publishes Financial Chronicle, a business daily. The company's subsidiaries included (all amalgamated in FY11) Asian Age Holdings Ltd, Sieger Solutions Ltd, Odyssey India Ltd and Deccan Chargers Sporting Ventures Ltd.

Making headlines...

Deccan has been 'in the news' of late for all the wrong reasons. These include IFCI seeking Deccan's liquidation, loan (including NCDs) re-payment issues, resignation of MD, downgrade in ratings by credit rating agency and banks writing off Deccan Chronicle Holdings' loans, amongst others.

The chart below articulates the same.

Data Source: ACE Equity

Deccan has been in a tizzy, facing liquidity issues as it is finding it difficult to repay some of the short term debts.

Till not so long ago, the going was good for the company as it grew substantially in a short span. Not only did its reach increase but its advertising revenues also witnessed very good growth. Its core business - the newsprint business - started facing pressures post FY10 as the overall economy growth slowed down leading to lower advertisement revenues. In addition, the company's margins were under pressure on the back of high newsprint costs and the appreciating rupee.

But let's back track a little bit...

What largely led to liquidity issues were the investments in other unrelated businesses and more importantly investments into businesses - retail and sports - with relatively longer gestation periods (as compared to its core business). Not to mention the lack of experience in operating them.

Odyssey (a book store chain) was acquired for about Rs 610 m. The investment projections did not go as planned and the returns on this business were depressed. Investments in the company stood at over Rs 1.1 bn at the end of FY10. Further, Deccan's move into buying the franchise of the Deccan Chargers - which seemed like a good investment initially given the rising team valuations and hype created - came back to haunt the company later. As reported in its FY10 annual report, the capital invested in the special purpose vehicle (SPV) Deccan Chargers Sporting Ventures stood at Rs 500 m, while the total liabilities stood at Rs 4.2 bn. Losses in this venture stood at Rs 418 m, while the turnover stood at about Rs 566 m.

A key factor that led to the problems at the company was the funding (including capex) of these investments. These were done largely with the help of outside funds. And as long as these funds were coming and cheap, all was good.

Deccan has been taking the help of non convertible debentures (NCDs) to meet its funding requirements for a while now. A few years ago, the company paid an interest of 6% to 9% (the cheap funds mentioned earlier) on these NCDs. However, during FY10, the cost of these debentures (which were scheduled for repayment in 2012) increased to the range of 8% to 12%. It seemed though that the availability of cheap funding became a problem before any of the other businesses could turn around, causing the current problems for the company, leading to an eventual default.

A small discussion on the numbers

While the company's operations were barely throwing out any cash during the FY04 to FY05 period, it lost money during the next two years. However, the cash flow from operations jumped up substantially during the FY08 to FY11 period, on the back of a surge in operating margins.

During the four year period FY04 to FY07, the company continued to invest heavily, with its cash outflow from investing activities increasing from Rs 818 m to about Rs 3 bn in FY06 and Rs 2 bn in FY07. Investments continued during the next two years as well, averaging to about Rs 2.7 bn each.

Coming to the cash from financing activities - during FY04 to FY08, the cash from financing activities stood at a positive figure (indicating inflow) of Rs 1 bn (FY04), Rs 2.6 bn (FY05), Rs 3.1 bn (FY06), Rs 3.7 bn (FY07; includes Rs 2.2 bn due FCCB conversion) and Rs 1.7 bn (FY08) before the company began to repay the debts. All this indicates that the company had taken on debt to finance its growth.

Allegations

IFCI - which subscribed to the NCDs to the tune of Rs 250 m - made allegations in its petition (of liquidating the company) setting off alarm bells among investors. It has stated that the Deccan had debt 'running into thousands of crores of rupees' (Rs 40 bn is the figure being reported). It also accused the publisher of defaulting on other liabilities and said it expected winding up petitions would be filed by other creditors.

Key learning

We believe a key learning from this is for investors to ideally stay away from companies which diversify into totally unrelated businesses as the possibility of these impacting financials of a company in the long run are high. Another key takeaway is of focusing on businesses that can fund themselves solely through internal accruals, thereby not really taking the help of debt to fund their growth.

We shall continue this series with some other examples.

Devanshu Sampat

Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.


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1 Responses to "Is your stock a bad investor? - I"

Abrar

Aug 2, 2013

where are the follow up articles?

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