The Maharaja Dilemma

1
The Maharaja Dilemma

• Presented by
• Sanjay Pamnani
• Heidi Pellerano
• Dhanusha Sivajee
• Vidhi Tambiah

2
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?
3
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

4
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

5
Oles 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

Capital Structure 1996
Capital Structure 1992
20
35
80
65
6
Competition
EH
Profit ()
Coke
Carbonated
Non-Carbonated
Pepsi
Profit (-)
7
Competition
8
Decision Alternatives
Status Quo
Terminate JV
Inject New Internal Capital
Bring in New 3rd Party Investor
9
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
10
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 Maharajas political weight to lobby government
Management Risk Maharajas immense business diversification leads to uncertainty about managements competency. Bring in industry experts as part of management team.
11
Cost of Capital Calculation

• Time varying
• Harvey ICCRG (May 97)
• Crisis Factor

• Skew

Result - 23- 26 Spikes up to 36 - 40
12
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

13
DCF Valuation
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
Sensitivity Analysis 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
Par Value
Par Value Rs. 10
X Rate 56.82
US Par V 0.176
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
14
Comparables Valuation

• Comparables
• Performance Metric P/E (Two Year Leading)
• Two comparables from the beverage industry chosen

2-year leading Market 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
15
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?

16
Our Recommended Analysis

• Value of the Put Option
• Monte Carlo DCF including skew
• Real Option

17
Value of Option
Combination valued at 387k
18
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
19
Our Conclusion
Value to Maharaja Org.
Value to DLJ.
-104k
N/A
DCF Value
Option Value
-387k
387k
283k
-387k
Net
BUT REAL OPTIONS ?
20
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

21
Key Lessons

• Exchange rate and skew are key
• Uncertainty involves time varying risks
• Option value underpins deal structure

22
Option Value Detailed Calc.