Inox is the second largest multiplex chain in India currently running 38 multiplexes in 25 cities. The chain has 144 screens and 40,000+ seats. Before delving deeper into the rationale of whether to invest/not invest, let us have a look at a typical day in an average Inox multiplex.
It is easy to observe that due to three-way distribution of ticket collections, the net share of the multiplex is less than 30%. A heavy share of profits from multiplexes come from food (67% gross margins), and advertisements (90% gross margins). A multiplex takes about Rs 8-12cr to set up depending on the location (assuming that the place is leased, which is an industry trend now-a-days). The operating profit transforms into a RoCE of ~20% - apparently not too bad for a business with stable and predictable cash flows and good growth prospects.
Myth 1 - Stable and Predictable cash flows: Reality could not have been further from the myth. Entertainment tax is a key component in determining the profitability of the multiplex. A small rise in the entertainment tax will cut through a major chunk of the profits of the multiplexes. Most states have entertainment tax in the range of 50%-60%, with rebates during the first few years (5 in Maharashtra where first Inox started operations in 2003). The good profits during the first few years turn out to be a mirage as soon as the honeymoon period is over. To add to it, distributors and producers have lobbied to get a higher share of collections. Earlier, operators used to squeeze smaller film makers and average share of distributors was on the lower side. For Inox, occupancy levels have been on the higher side due to good locations of the initial multiplexes, but with expansion comes the scourge of low occupancies. At industry average occupancy of 35%, at a ticket price of 200, a multiplex is barely operating at breakeven. In tier-2 cities, low occupancies coupled with low ticket prices imply continual losses in the hopes of riches ahead.
Myth 2 - Good Growth Prospects: The table below shows the composition of Indian cinema industry. Multiplexes command 4% of the share of the eyeballs, suggesting that there are enormous growth prospects.
But before coming to any conclusions, let us have a look at another table, which finds average cinema visits per patron in the addressable segment. The average is not far behind US - 4.8, US's is amongst the highest cinema going populace in the world.
For the purpose of finding average visits per patron, we have assumed that 40% of the people (a very high number, if you ask me, but let us keep it at that) residing in these cities visit multiplexes. So, in a country where per capita chicken consumption is 5% of the US average, multiplex operators want us to believe that per capita cinema visits will far surpass corresponding figures in US.
With good reasons, I believe that majority of the addressable locations already have a multiplex, the newly opened ones are in fact, running in losses, with a very small likelihood of turning profitable in the next five years, unless the Government comes up with a radical overhaul of entertainment tax regime. Due a high cost structure, it is not feasible for multiplexes to move beyond Tier-1 and Tier-2 cities. The opportunity of growth through geographical roll-out gone, the only way for multiplexes to increase revenues is through a rise in ticket prices or higher cinema visits per patron. Even here, prospects look bleak. The average cinema visits are on the higher side of the average in developed countries, while ticket prices are at the higher end of affordability level for most patrons - a trend symbolized by almost 15% reduction in food consumption per ticket in Inox as patrons look to bring down their average cost per cinema visit. A reduction in food consumption has been a double whammy for operators, due to the higher contribution to profits from food. That leaves the multiplexes with below average (may be 5-6%) growth prospects in the short to medium term. If they could have looked beyond their immediate greed, they would have cut down the ticket prices and offered food at reasonable prices to improve food sales as well as overall profits.
History of Inox: With the myths about multiplex industry forsaken, let us look at Inox specifically. The promoters of Gujarat Flurorochemical (a very good company with sound fundamentals) decided to make a foray into a sector with a mass appeal for investors. In 2002, promoters transformed a piece of land worth Rs 17cr into a company with a further investment of Rs 8cr. The Company launched its first multiplex in a year in Mumbai, and secured Rs 50cr debt in 2003 to start work on three other multiplexes. As the initial multiplexes slowly took off, the promoters put in an additional Rs 20cr as equity, which did not prove enough for growth (work on four more multiplexes started) and was supplemented by a Rs 40cr subordinated debt from Gujarat Fluorochemicals. In effect, promoters had put in Rs 68cr into the company (Rs 28cr equity, and Rs 40cr debt), leading to a 100-cr turnover Company by 2005-end with eight operational multiplexes (second only to PVR at the time), and Rs10cr+ profits. Armed with these statistics, Inox came out with an IPO in Feb 2006, valuing itself at Rs 576cr (pre-money). The company raised growth capital to the tune of Rs 144cr and the promoting company sold shares worth Rs 54cr (double of its equity investment in less than four years). GFC's shareholding in Inox came down to 72.5% as a result of the IPO.
Inox used Rs 40cr from the proceeds to pay the promoting company back the unsecured debt over next three years. The Company bought an East Indian multiplex chain (1 operational multiplex, 1 about to be started, and 6 in pipeline) from Ambuja Group for Rs 48cr (instead of paying them in cash, Inox awarded them 5% equity worth almost that much at that time, bringing down GFC's shareholding to 69%). By 2009-end, the Company has 30 multiplexes with just Rs 224cr turnover and profits languishing at Rs 20cr. Stuck in a trap, Inox acquired a controlling stake in Fame Cinemas with a view to transform its operations (the stake, worth Rs 83cr was financed through an unsecured debt from GFC). Just about an year back, Fame's promoter was complaining about occupancies as low as 24% during the IPL season and the need to shut down a major chunk of his screens. Yet, at the time of acquisition the total number of screens was trumpeted.
On a consolidated basis, Inox has 50 multiplexes (second only to Reliance Big Cinemas), with an expected turnover of Rs 452cr and PAT of Rs 22cr in FY11. At current market cap of Rs 286cr (about 30% of market cap in 2006 at listing), it is available at 13x FY11 earnings and at just under Rs 6cr per multiplex.The Company's profits have hardly moved up since FY06, as the expiry of tax rebate on the initial multiplexes cut out any new contributions from the other multiplexes. The average revenue per multiplex (ARPM) are just above Rs 9cr per multiplex (down from Rs 13cr+ ARPM at the time of IPO). In short, the Company's fundamentals have gone from poor to poorer. As if being in a bad sector was not enough, the Company is not even best in its category. PVR has surpassed it in terms of average revenue per multiplex by avoiding any needless acquisitions. The Company is better fundamentally than Reliance Big Cinemas (a heap of zero-yield junk bonds, as you would expect from an ADAG group company), and Fame Cinemas (the company which Inox seemed too eager to buy, and Fame promoters seemed too eager to sell).
Transaction and Trade Multiples
IPO Frenzy of 2005-06: Investors who may have observed the IPOs by multiplex chains in 2005-06 period, may think that Inox is a very good pick. After all, a loss-making Shringar (erstwhile Fame Cinemas) commanded a valuation of Rs 41cr per multiplex. Taking cue, PVR valued itself at Rs 45cr per multiplex. Inox came with the IPO at an even better time, and its higher ARPM (Rs 13.6cr) allowed it to command a valuation of Rs 72cr per multiplex. Considering these figures, the current figure of Rs 6cr per multiplex on a consolidated basis seems very cheap. However, if we return back to our multiplex level analysis, it should be noted that Inox is operating at operating profits of just about Rs 1cr per multiplex, where it is in danger of going under with small fluctuation in occupancy levels or a rise in rentals. Hence, a value of Rs 6cr per multiplex after taking into account a debt of Rs 4cr per multiplex seems rather expensive.
The Company has amassed Rs 100cr+ unsecured debt from the promoters, which they would want to get back soon (either directly or through loans extended to other group companies), so I expect a round of QIP or an FPO, once economy brightens up a bit. Needless to say, interests of the minority shareholders can be sacrificed at the altar of relentless expansion.
Environment Management: I do agree that promoters have a good track record in environment management, but we have to keep in mind that Inox was just a value unlocking exercise from a parcel of land for GFC. As such, any promoter expertise is likely to benefit GFC more than Inox. To cite an instance, Inox has commissioned a wind power plant for captive consumption, but the real purpose is to test Wind Power potential, which once tested would likely end up as a separate company with substantial shareholding from GFC.
There is only one recommendation coming out from all this analysis: stay as far as possible from this nervy steel.
