Transcript The Maharaja Dilemma Presented by Sanjay Pamnani Heidi Pellerano Dhanusha Sivajee Vidhi Tambiah Situation Overview Maharaja Corporation July, 1991 Exclusive Franchise Ole Spring Bottlers Joint Venture May, 1995 Capital injection by Maharaja $2 Million.

The Maharaja Dilemma
Presented by
Sanjay Pamnani
Heidi Pellerano
Dhanusha Sivajee
Vidhi Tambiah
Situation Overview
Maharaja
Corporation
July, 1991
Exclusive Franchise
Ole Spring Bottlers
Joint Venture
May, 1995
Capital injection by Maharaja
$2 Million Capital Injection by Pepsi
January, 1997
Road Show & Search for 3rd Party Investor
One Offer Received
What should Maharaja Do?
Sri Lanka
 Population: 18 million
 Ethnic Make Up:
- Singhalese (Buddhist majority)
- Tamils (Hindu minority)
 GDP: 13.6 bn ($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
 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
1992
1996
Equity
61,147,206
208,934,371
Capital Structure 1996
Capital Structure 1992
80%
Debt
15,286,801
112,824,561
20%
Debt
Equity
65%
35%
Debt
Equity
Competition
45%
1992 Market Shares
1997 Market Shares
8%
15%
37%
45%
40%
40%
55%
CCS (Elephant House)
CCS (Elephant
House)
The Maharaja (Pepsi)
Pure Beverages (Coke)
Pure Beverages (Coke)
The
Maharaja
(Pepsi)
CCS (Elephant
House) Pure
Beverages (Coke)
The Maharaja (Pepsi)
Profit (+)
EH
Coke
Non-Carbonated
Carbonated
Pepsi
Profit (-)
Competition
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1950,s
1960 to 1978
1978 to 1985
CCS (Elephant House)
1985 to 1987
1987 to 1991
Pure Beverages (Coke)
1992-1995
The Maharaja (Pepsi)
1995-1997
Decision Alternatives
Status Quo
Terminate JV
Inject New Internal
Capital
Bring in New 3rd Party
Investor
Maharaja SWOT Analysis
from Outside Investor Perspective
Strengths
Weaknesses
 High brand awareness of Pepsi products
 Over-reliance on Pepsi and its assumed
 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
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
Threats
 High per capita soft drink consumption –
 Non-carbonated substitutes, such as juices
average of 22 servings compared to 5 for
India
 Opportunity to distribute Pepsi snack foods
in the future
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
Currency Risk
Political Risk
Creeping Expropriation
Management Risk
Description
Mitigation
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
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
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
Maharaja’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
Equity Value
SL Rs.
Total Firm Value
US $
990,169
$10,818
(112,825)
($1,986)
(944)
($17)
Total Equity Value
876,400
$8,816
# of Equity Shares
47,697
47,697
18.37
$0.185
Less Debt
Less Preference Share Capital
Value per Equity Share
Firm Value
APV Firm Value
Par Value Rs.
Terminal Value
X Rate
Tax Shield Value
US $ Par V
Total Firm Value
SL Rs.
Par Value
US $
% of value
Sensitivity Analysis
Growth
Rates
Share
Value
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
504,792
$6,340
50.98%
10.5%
0.193
376,151
$3,176
37.99%
11.0%
0.197
109,226
$1,303
11.03%
11.5%
0.200
990,169
$10,818
100.00%
12.0%
0.204
10
56.82
$0.176
Comparables Valuation
 Comparables


Performance Metric: P/E (Two Year Leading)
Two comparables from the beverage industry chosen
2-year leading
Market Cap/Earnings
Ceylon Cold Stores
5.26
Maskeliya Plantations
2.52
Market Capitalization
(US$ mn)
Ole Springs Bottlers
Ceylon Cold Stores (60%)
$
2.379
Maskeliya Plantations (40%)
$
1.140
$
1.884
Enterprise Value for Ole
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?
Our Recommended Analysis
 Value of the Put Option
 Monte Carlo DCF including skew
 Real Option
Value of Option
Call Option
Combination
valued at
$387k
0.249
0.22.7
Bonds
0
0.227 0.249
Asset Price
Payoff on the three year option exercise
Payoff on the four year option exercise
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 Conclusion
Value to Maharaja Org.
DCF Value
Option Value
Net
BUT REAL
OPTIONS ?
N/A
Value to DLJ.
-$104k
-$387k
$387k
-$387k
$283k
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 Values
Assume "normal" 8% return
Actual Return (10%)
"Normal" Return
XS Return
PV
Call Option
Spot Price
Exercise Price
Time
Volatility
Risk Free
Option Price
3yr zeo
0.227
0.214
0.012
0.010
3,1 zero
0.023
0.018
0.005
0.003
3 year call
0.17
0.23
3
30%
6.00%
0.028
1 year call
0.17
0.25
1
30%
6.00%
0.004
Value of security
Total Value
Illiquidity Discount (50%)
Volatility
PV Sum
0.013
4yr zero
0.25
0.23
0.02
0.013
PV Sum PV 4 year call
0.17
0.25
4
30%
6.00%
0.032
0.031
0.045
779,955
389,977
0.044
775,053
387,526
risk free
0.0447
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
6%
0.022
0.027
0.033
0.039
0.045
0.051
0.056
0.062
0.068
0.073
0.079
6.50%
0.022
0.028
0.034
0.040
0.046
0.051
0.057
0.063
0.069
0.074
0.079
7%
0.023
0.029
0.035
0.041
0.047
0.052
0.058
0.064
0.069
0.075
0.080
7.50%
0.024
0.030
0.036
0.042
0.047
0.053
0.059
0.065
0.070
0.076
0.081