The following investment case concerns a security which is very thinly traded and where only limited information is available. The author owns the security.
This private equity investor is currently in the process of liquidating its Indian investment portfolio. Despite an improved sentiment in the course of the Indian elections in May, the stock trended downwards, currently offering a 44% discount to NAV. Based on current NAV and assuming that the company will be liquidated until September 2017, an investment offers an 18% IRR and a 1.6x equity multiple over a 40 months holding period.
Eredene Capital is a private equity investor in Indian infrastructure operating companies. Private equity in India has been one of the worst performing asset classes. The aggregate dollars invested in India based on private equity funds from 2000 to 2009 have produced an IRR of less than 4%. The situation is even worse for investors, who piled into the country in 2007 and 2008, when the economy was expanding at 9% to 10%. Since then, growth has fallen, sliding to 5% to 6% mostly due to a slowdown in both public and private sector investment. Many investments made 6 to 7 years ago are now down 30% to 40%.
One of the major reasons is the fall of the Indian rupee, which has lost roughly 51% against the USD dollar since September 2007. This was caused by rising interest rates and inflation coupled with a reduction in foreign direct investments.
Apart from that, corporate governance standards and quality of management for many investments falls well short of the minimum standards required. In some instances, promoters acted fraudulent. At the same time legal proceedings against these promoters are complicated due to an inefficient court system. Moreover, land accumulation (for real estate and infrastructure investments) is very time consuming. A high level of bureaucracy, inefficient taxation policies and corruption complete the picture.
Based on this paper from the beginning of 2014, negative investment sentiment is expected to lead to a continued decline in allocation of funds to India in the near term as a result of slowing growth and increased competition from the next wave of emerging economies like sub-Saharan Africa and Southeast Asia. In addition, high entry valuations and a difficult exit environment are currently major deterrents to investing in India.
However, there are indications that investor sentiment has improved after the recent elections in May and that fund raising for new funds is accelerating. For the first time in 30 years, a single political party won a clear mandate from Indian voters for a five year mandate. The new administration headed by Narendra Modi, stands for a new government approach with streamlined decision making and improvement of accountability. As Chief Minister of Gujarat, Mr. Modi was already quite successful in implementing reforms and generating relatively high levels of growth. The question will be whether the new government can implement their approach for the benefit of the whole country and whether they can continue and improve the former government’s attempt to contain the current account deficit, support the currency, and better regulate the banking sector. On thursday, the new government released its budget plans. They plan to reduce the budget deficit from 4.1% for this year to 3% for 2016/17. In terms of tax reform, the implementation of a goods and service tax was highlighted. They also announced a programme to boost infrastructure investments.
The Indian stock market has reacted very positively with the BSE SESEX increasing by 20% and the BSE Small Cap Index increasing more than 40% since the beginning of 2014:
As a consequence, overall expectations are quite high now. At the same time, Eredene’s stock price has trended downwards since the beginning of the year losing more than 30% of its value and was not positively affected by the improved sentiment. During that time GBP/INR has been more or less flat. Reasons for the underperformance might be Eredene’s listing on the AIM in London and its small market cap leading to less attention from investors.
Description of Eredene Capital
Over the last years infrastructure investments in particular have been negatively affected due to a delay in project approvals and failures to accumulate land combined with increasing interest rates. As a consequence, the number of non-performing assets increased and banks became more reluctant to provide financing. However, this has not reduced the overall need for high quality infrastructure which is one of the most important requirements for the Indian economy to make use of its growth potential on a consistent basis. Based on my information, most of Eredene’s investments provide for relatively high quality infrastructure assets with some of them meeting Western standards.
Between 2006 and 2011 Eredene Capital raised roughly GBP 90 m. After withdrawing from the Ennore Container Terminal project in 2012 and the disposition of the fund’s share in Ocean Sparkle in 2013 the company returned so far GBP 35.4 m to shareholders. The current portfolio consists of investments made in 2007 and 2008. Eredene will release its annual accounts as of March 31, 2014, at the end of July. My estimation of current NAV is GBP 24.4 m leading to a discount to NAV of 44% compared to the current market cap.
Eredene Capital is registered in the UK. Its investments are held through holding companies (SPVs) in Mauritius, which has a double tax agreement with India. Each investment is made through a dedicated pair of SPVs in Mauritius, giving flexible realisation options by allowing the sale of the lower tier Mauritian company rather than selling the investment directly. The company believes that proceeds of such sales held in Mauritius will not be subject to tax and, if remitted to the UK, may not be subject to tax there.
Eredene’s investment portfolio
MJ Logistic Services (MJL) operates a logistics center in Palwal on the Delhi-Agra Highway. The high-tech warehouse at Palwal provides both cold and ambient storage over 200,000 square feet. MJL also operates leased warehouses, and including Palwal it has a total warehouse capacity in North India of 800,000 square feet. The major ambient customer is Tata Motors. Cold chain customers include Domino’sPizza, Subway Du Pont Danisco and Unilever. MJL is dependent on two customers with one customer representing 36% of revenue and the other 33% of revenue. The company owns additional land around its current site to be developed for capacity expansion.
MJL, posted revenue of GBP 4.2m for the financial year ended March 31, 2013, a 23% increase over the previous year in Indian Rupee terms, and generated positive EBITDA.
Eredene is holding an 86% share in the company. The remainder is held by the management. Eredene’s equity injection of GBP 10.9 m in 2008 secured an initial 90% of the company, which can be diluted to 74% due to the conversion of preference shares into ordinary shares by the MJL management team following the achievement of performance milestones.
There is an interesting interview with the promoter Anil Arora available, where he explains why the company is increasing its cold storage capacity and how the company will profit from an implementation of a GST tax and increased infrastructure spending. Based on my research the promoter seems to know what he is doing.
Contrans Logistic CFS services bulk cargo and containers through the Maersk operated port of Pipavav in Gujarat. Major customers include shippers Maersk India, Hapag-Lloyd and J.M. Baxi & Co, global chemical and textile company GHCL and logistics providers Shreenathji Worldwide and Gudwin Logistics. The CFS is currently using 23 acres of its 79-acre site and has an annual throughput capacity of 0.1 m TEUs (twenty foot equivalent units, the length of a standard container). A CFS is an off-dock facility close to a port, helping to de-congest the port by shifting cargo and customs related activities outside the port itself.
The CFS is located 700m from the Pipavav port gates. Pipavav is the first privately owned port in India having begun cargo handling operations in 1996. The port’s operating company is listed on the stock exchange. Based on this press release, France’s CMA CGM Group is going to partner with one of Pipavav’s rivals to build a new container port leading to more competition. Based on this presentation, the Pipavav port grew revenues by 135% from 2009 to 2013 to INR 5.2 bn. In 2013 they generated a profit margin of 37% and a ROCE of 13%. At the same time, debt has been steadily reduced and is 20% of equity as of 2013. It is planned to increase the container handling capacity from 0.85 m TEUs to 1.35 m TEUs. In addition, Maersk took measures to increase traffic at Pipavav port by adding Pipavav to its India-Middle East-East Coast service, thereby connecting its customers in Gujarat and the North India hinterland to the US market.
Based on this document, the Indian rating agency ICRA assigned a BB- rating to Contrans Logistic in 2012. They had debt outstanding of INR 170 m. Based on the current valuation, this translates into a gearing ratio of 0.1x. The business generated revenues of INR 133 m for fiscal year 2012 and a small profit. I could not find any information about 2013, despite Eredene reporting that revenues fell due to a decline in volume. The promoters have several years of experience in the industry and have been operating a CFS at the Port of Mundra in the North of Gujarat State since 2003. In addition, there seems to be limited competition for Contrans Logistic CFS.
Contrans Logistics’ second project is a 128-acre site at Baroda in central Gujarat which has planning permission to develop a road and rail Inland Container Depot on the busy Delhi-Mumbai freight corridor. Based on Eredene’s information, the market value of the site is at a significant premium to the original purchase price. Currently, the company is trying to sell the site.
Eredene invested GBP 5.7 m for a 44% stake in the two projects. The current valuation of Eredene’s share is GBP 6.0 m. Most of the value seems to be attributable to the land held by the company.
Although relatively small, the most successful investment to date has been Sattva Vichoor in Tamil Nadu, which is profitable and dividend paying. Eredene invested GBP 0.7 m and is holding 39% of the operating company. It operates on a 26-acre site and handles containers from Chennai Port and also provides facilities for on-site assembly of imported machinery. Customers include South Korean machinery manufacturer Doosan, NYK Line and Maersk. The container freight station handled 75,300 TEUs in 2012-13, compared to 68,000 TEUs in the previous year, an 11% increase. The business posted annual revenue of GBP 3.7 m, a year-on-year increase of 5% in Indian Rupee terms. A new 10,000 square feet export warehouse is under construction which will take the total warehousing capacity on the 26-acre site to 97,500 square feet.
Sattva Vichoor Container Freight Station is one of two joint investments with the Sattva Business Group. Sattva Business acquired a 10% stake of the investment from Eredene at the beginning of 2012. Hence, chances are good that the remainder will also be sold to Sattva. Based on this analyst report from 2008, the project was financed with debt of INR 282 m. Based on the current valuation the gearing ratio is 0.3x. Eredene’s share in the business is valued at GBP 3.8 m.
After this successful joint venture with with Sattva Business Group, Eredene invested another GBP 3.8 m for an 83% share in Sattwa Conware also located in Tamil Nadu. This Container freight station on a 60-acre site is located within reach of both Ennore and Chennai ports and the newly opened Kattupalli container terminal and has a total warehousing capacity of 74,000 square feet. However, so far the business was unable to launch its export-import container business due to a lack of the necessary Government-allocated customs staff. At the moment, the container freight station is only handling empty container boxes from Wan Hai and NYK shipping lines and domestic cargo for Ford India.
Eredene has two logistic parks in East India with investment partner Apeejay Surrendra Group, a Kolkata-based conglomerate. The two facilities are operated in a 50/50 joint venture.
The Apeejay Infra logistics park in Haldia operates on a 90-acre site close to the port of Haldia, a petrochemical hub at the mouth of the Hooghly River and the major gateway to Kolkata. It has a warehouse capacity of 140,000 square feet and a container yard of 300,000 square feet. Haldia Port has recently seen a reduction in container volumes and Apeejay’s logistics park has been impacted by a restriction on containers being handled by external CFS imposed by Haldia Port Trust. Eredene has written down the value of its investment in Apeejay Infralogistics as a result of the reduced prospects for the Haldia logistics park.
Apeejay Infra-Logistics’ second logistics park at Kalinganagar is the first purpose-built transport and warehouse facility in Orissa State and has been set up to service the local steel and metallurgical industry. The 30-acre facility has a warehouse capacity of 84,000 square feet and a container yard of 185,000 square feet. The domestic warehouse and a substantial area of the open yard are leased to logistics services provider Tata TKM.
Based on Eredene’s notes in the financial report, the SPV for this investment has entered into two deeds of undertaking with the financing bank. Under the terms of those undertakings, the SPV has agreed to provide additional funds to Apeejay Infra-Logistics in the event that there is a shortfall in the Apeejay Infra-Logistics Group’s ability to service its debt. The debt facilities provided by the bank total to INR 778.3m (GBP 7.6 m) and the undertaking is provided on a joint and several basis by the SPV and its joint venture partner. Assuming that the whole facility has been drawn, this would translate into a gearing ratio of 1.65x based on the latest valuation. However, in this article the chairman of Apeejay Surendra states that total investment for the two projects was INR 2.5 bn (GBP 24.7 m). So it is likely, that there is more debt outstanding up to a gearing ratio of 4.4x.
Nevertheless, Eredene’s joint venture partner seems to be pretty solvent. Apeejay Surendra, is a privately held conglomerate. They own a hotel chain, have one of India’s largest privately held shipping lines and are the third largest Indian tea producer. Based on Indian credit agency ICRA, their other businesses are all graded with A grade ratings as can be seen here, here, and here. Apart from that, their hotel chain raised USD 55 m from one of Credit Suisse’s real estate funds in 2007 for a 15% stake in the company.
Eredene invested GBP 2.9 m for a 50% stake in the two logistics parks. Eredene’s share is valued at GBP 2.3 m.
Eredene is also holding a majority stake in a low-cost housing real estate project, Matheran Realty, near Mumbai. Eredene invested GBP 15.3 m. They have been trying to sell the project for quite some time, but have not been successful so far. As of September 2013, the potential sales price was GBP 3 m and Eredene wrote the realisable value down to that price in the accounts. They also reported, that if a sale is not achieved then it would be the company’s intention to work with Matheran to complete the first phase of the affordable housing development prior to any subsequent sale. This may require further funding from the company.
New Investment Manager and liquidation of the company
After withdrawing from the Ennore Project in September 2012, Eredene decided to make no further investments in new projects in India and in 2013 decided to liquidate the company. After an independent financial and legal review of the principal investments the company reported it may take until September 2016 to sell all investments and to return the sales proceeds to shareholders.
In addition to that, Eredene transferred the investment management to Ocean Dial Asset Management in September 2013. The investment management agreement is for a 24 month period and thereafter can be terminated with three months’ notice. The transfer leads to a significant cost reduction. Eredene is saying that holding costs will be reduced from GBP 1.8 m p.a. to GBP 0.85 m p.a. Ocean Dial used to be wholly owned by Caledonia Investments, a 21% shareholder in Eredene. In May 2013, Caledonia disposed of its entire shareholding in Ocean Dial to the Ocean Dial management team. The team on the ground in India is led by Raju Shukla, a former country head of Barclays Capital India. Apart from the Eredene mandate, Ocean Dial is managing to Indian public equity funds with combined AUM of roughly USD 190 m. Ocean Dial receives a capped performance fee on the sale of each investment, of 0.4% to 0.6% of the sales proceeds per investment. Should a sale of Matheran Realty not occur, Ocean Dial will manage the assets and will receive a capped performance fee which varies from 0.67% to a maximum of 5.0% of proceeds depending on the sales value achieved.
Ocean Dial is supported by Ranveer Sharma and his team to identify and execute the sale of the investments. Mr. Sharma has already worked alongside the former investment manager since the setup of Eredene Capital. The above mentioned holding costs of GBP 0.85 m p.a. include his work for the company.
Below you can find my estimations of the current NAVs, gearing and gross values for the single investments and the company:
The investments Sattva Vichoor, Contrans and Apeejay are held in the accounts at fair value and that fair value was determined by Grant Thornton India. The appraisers used a 19% discount factor for Apeejay and 16% discount factors for the other two investments. In addition, they used a terminal growth rate of 4% and a marketability discount of 15%.
I do not believe in a sale of Matheran Realty, as management has already made an announcement in this regard two years ago. So I assume that the current liquidation value of this investment is zero, but that any future injections into the project will flow back to Eredene.
The two direct majority stakes in MJ Logistic and Sattva Conwave are consolidated on the balance sheet. For the NAV computation I have used book value including goodwill arising from the original acquisition of MJ Logistic which is subject to impairment. In the notes of the latest annual report management states regarding the value of goodwill that:
“Sensitivity analysis has determined that no reasonably possible change in the key assumptions used will result in significant impairment and that there is sufficient headroom in all of the key assumptions before the carrying value becomes impaired.”
From my perspective, this is an indication that book value might be a conservative estimate of intrinsic value for MJ Logistic.
Apart from that, I have reduced the cash balance by GBP 0.6 m compared to September 30, 2013 to account for holding costs from October 2013 to June 2014.
Management has set the target to liquidate the company until September 2016. I think it makes sense to be more conservative here. I assume that half of the NAV will be returned to shareholders until September 2016 and the other half until September 2017. For the period from July 2014 to September 2017, I include holding costs of GBP 2.8 m in my calculation and I assume that Ocean Dial will receive a performance fee of 0.6% of sales proceeds in September 2017. Based on these assumptions an investment in Eredene returns an 18% IRR and an equity multiple of 1.6x.
The following sensitivity analysis shows the total returns under different scenarios based on changes in gross values of the investment portfolio and foreign exchange fluctuation (INR/GBP).
First, for the internal rate of return:
Second, for the equity multiple:
The liquidation of Eredene’s portfolio will take time. Further setbacks are likely given the difficulties to conduct business in India and the country’s current economic weakness. Expectations on the new government seem to be very high. At the same time, there is a general view that it can’t get worse after the former government. The announcements made regarding an investment programme and the implementation of a GST tax are a first step into the right direction for India’s infrastructure sector.
From my perspective, the decision to liquidate the company and to change the investment manager shows the strong influence of the two largest shareholders. Both Ruffer and Caledonia are each holding more than 20% of the shares outstanding. The decision to transfer the investment management to Ocean Dial, a former affiliate of Caledonia, is a positive not only from a cost perspective. Ocean Dial is a small owner operated investment boutique and the Eredene mandate gives them the opportunity to prove their abilities in the management of private equity investments. If successful, they should be able to attract further mandates and to grow assets under management. Apart from that, the quality of the promoters seems to be relatively good. In addition, the stock price has not reacted to the improved sentiment in India and the large discount to NAV provides a healthy margin of safety.
Since April 2, 2014 there have been no news and the stock traded in a range between 5.3 pence and 6.0 pence. Due to the stock’s low liquidity I assume that I have traded one third of the volume since then at a VWAP of 5.6 pence. This leads to a current portfolio position of 1.6%. I will add to this position until reaching a 2.5% position with a limit of 5.8 pence.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!