Compact Disc at Rs 87.20…Fantastic Surge past few days…is it sustainable?

last June 2009,Kamal had responded on my blog requesting for a view on Compact Disc (CD)…I had promised to review it before offering a view…never got round to doing so

And Now I find on March 23,2010 CD announcing to the BSE that they have got a huge US $ 82 million Animation Film on ‘Hitler’ outsourcing order from a leading UK Production House…A Hollywood Production House is the co-producer and this Order has to be executed over Three years

Will this be a  Game Changer for CD?

Some in the Market think so…nothwitstanding a huge Bulk deal on March 23,2010 where the Buyer and Seller are the same !,the Share Price has surged to a 20% upper circuit on Tuesday and today is up another 10% upper at Rs 87.20

So I had a good look at CD Fundamentals…and here’s what I found for this Chandigarh based Company

Promoters & Management

• CD is promoted by 59 year old Suresh Kumar and his relative Rashmee Seengal…Kumar heads the Company as Chairman & Managing Director ,while Rashmee Seengal was inducted as Director last year when they merged her company into CD…she is the Creative Director
• Kumar draws a salary of Rs 4 lakhs  a month + perks,while Seengal gets Rs 2 lakhs a month + perks + half a percent commission on profits
• Rs 4.16 crs are shown as Loan to Directors at 31/3/2009…Notes to Accounts reveal that under an Income Tax  Sec 133 Survey this was revealed and is claimed as Imprest with Directors to buy land in the name of the Company….Question arises as to why Company itself could not have made the payment directly
• In an Interview on March 23,2010 with CNBC,Kumar disclosed that current order book is US $ 65.80 Million and a fresh US $ 82 Million order has just been received ,of which 10% will be received as Advance by April 20,2010…the order has to be exceuted over next three years by 2013 and 20% margins are expected to be retained…..If you check the Annual Report of 2008/9 ,you’ll find that Kumar has signed the Annual Report on June 30,2009 and the quantum of orders on hand then stated too is US $ 65.80 Million!…have no other orders been received past nine months!?
• Kumar discloses in the Interview that CD has 400 Animators on it’s rolls….2008/9 Accounts reveal just Rs 78 lakhs as Salaries and Wages under Admin Expenses….maybe the Salaries for the Animators have been directly debited to the Animation Outsourcing Product Development Expenses head of Rs 145 crs against Revenues  of Rs 192 crs in 2008/9…there is no breakup provided for these Expenses
• Kumar reveals that HSBC will be paid of the packing loan and disputed Interest and Bank Charges by March 31,2010 so that the Dividend of 20% or Rs 2 /share or a total of just under Rs 2 crs will be allowed to be released to shareholders

RELEVANT CONSOLIDATED FINANCIAL EXTRACTS AND PROJECTIONS MADE BY PROMOTERS

 Rs Crs

Dilution of Equity

• On December 18,2008,a preferential allotment of 14 lakh Equity Warrants was made with conversion option within 18 months at Rs 100 (10+90) …the allotee was Pariscope Pictures Pvt Ltd…the name is now Pariscope Financial Advisors Pvt Ltd…Part Conversion has been made in FY 2009/2010

Shareholding Pattern at December 31,2009

• Promoters Group hold just 20.01 % or 19.20 lakh shares over 23 shareholders
• Interestingly from the Public,there are 5 shareholders holding individually over 1% stake,aggregating 9.23% and 8.86 lakh shares…..,Ashok Kumar Parmar holds 2.18% and Angel Broking holds 1.44%….On November 19,2008 I had blogged on how Ashok Kumar Parmar is making a hostile bid on Bhilwara Spinners at Rs 15…it remains even now at Rs 17 Bhilwara Spinners under Hostile Bid by Ashok Kumar Parmar…Parmar ? Aha ! Suzlon !

Negative Cash Flows

• In FY 09,despite a strong PAT of Rs 39.5 crs,there was a negative Rs 17 crs cash flow from Operations….as Rs 61 crs was the Incrementals in Trade and Other Receivables…largely the Investments made in Films that were reflected as part of ‘Other Current Assets’…Debtors have not confirmed the balances…..see the above Financials Extracts
• CD had to resort to working capital borrowings of Rs 18.21 crs as at 31/2/2009 from HSBC…this is being planned to be paid off in the next few days 

Significant Capital Committments

A : Investment in Movies

• ‘Eternal Love’ is set for a 2011 release…the Production cost is estimated at US $ 23.55 million and expected Revenues estimated by the Company are US $ 35.75 Million(Rs 173.40 crs)….at 31/3/2009 the Investment as shown above was a mere Rs 9.18 crs (US $ 2 m)…another US $ 21.55 m would be costs to incur in 2009/10 and 2010/11  
• ‘Futebul’ is also set for a 2011 release…It’s a 3D 90 minutes film…the Production cost is estimated at US $ 30.15 million and expected Revenues estimated by the Company are US $ 60.10 Million(Rs 290.50 crs)….at 31/3/2009 the Investment as shown above was a mere Rs 16.11crs ( US $ 3.5 m)…another US $ 26.65 m would be costs to incur in 2009/10 and 2010/11…a Demo reel should be ready to display at the World Cup this July..after which CD plans to tie up distribution for the release in 2011  

B : Studio Projects

• US $ 3 Million pre-production studio in Los Angeles,set up in late 2009
• US $ 14.73 Million(Rs 73.65 crs) is the cost of the fully integrated State of the Art Animation Studio in the SEZ at KINFRA Film and Video park ,Kazhakuttom,Thiruvanthapuram,Kerala…At 31/3/2009 just Rs 13 lakhs was invested in it
• Chandigarh Project to be opened on April 12,2010 as disclosed by Kumar in the recent TV Interview…when asked what would be the Investment in this,he replied “Nothing” !..till 31//3/2009 CD had invested Rs 38 lakhs in it

CURRENT BUSINESS MODEL OF COMPACT DISC AND GLOBAL SCENARIO

• CD operates in two major segments…Animation Outsourcing and International Film Production
• Animation Outsourcing is largely a Fixed Payment Contract Model…there is no IPR and Brand Licensing and no risk of Box Office…ensures regular Cash Flows
• International Film Production is where huge Investments are required to produce or co-produce Films…This is the reason  why CD seems to have suffered Liquidity Problems…it has appointed KPMG to advice it on demerging this segment…the Risk is High,but so would the Gains be if the Films are Box Office Hits…While CD has high hopes on ‘Eternal Love ‘ and ‘Futebul’ when they release in 2011,the risk is that the Films may not be well received and they may not recover Production Costs
• A Full fledged Animation Movie would cost over US $ 75 Million and would take over 3 years to make….most of the Revenue shares would go to the Exhibitors and Distributors…what remains trickles down to Production Houses and Studios  
• CD is the largest Animation Outsourcing Company on South Asia…India continues to enjoy the advantage of Cost Arbitrage and Availability of Skill Sets   
• From 1994,under 20 full fledged Animation Movies have been made…the Success of Shrek 3,Finding Nemo,The Incredibles,Ratatouille,Monsters Inc has inspired incremental investments in this field
• The Advantages are clear…3D effects,Digital Platform Applications on Mobile Phones,Internet,DTH,Video Games
• The Global Animation market is currently US $ 75 billion and expected to cross US $ 100 billion in the next three years
• The Indian Animation Industry is just over half a billion dollars and is expected to double from here in the next few years

NEW AND BIGGEST ANIMATION OUTSOURCING ORDER FOR CD THAT HOLDS GREAT POTENTIAL

• CD has just announced that it has bagged a huge US $ 82 Million Animation Outsourcing Order from a leading UK Production House…This House is co-producing the Movie ‘Hitler’ with a leading Hollywood Studio….CD had to complete this contract in three years…10% of the order value will be received by April 20,2010…That’s over Rs 37 crs
• Clearly this order has boosted the counter on BSE and has caused the surge in the Share Price
• The excitement is clearly the Earnings Per Share of over Rs 50 projected for next year…a 10 multiple gives a share price of Rs 500 !…so then what’s the problem ?

SO THEN WHAT’S THE CAUTION !?

• Even FY 09 EPS was Rs 41,but P/E had remained in a poor 1 to 1.5 range…there was clearly suspiscion and a question mark on the Quality of Earnings and Recoverability of Trade and Other Receivables and the True value of Film Stocks…and how would the Company fund such huge Capital Committments….Liquidity Issues had surfaced….Dividend Declared last year has yet to be paid…and it was under 5% payout of Profits..at Rs 1.91 crs (20% or Rs 2/share)…profits were Rs 41 crs
• Though the Auditors had given a Clean Report,the Groupings and Notes to Accounts had revealed Corporate Governance Issues…Incidentally Auditors Remuneration reads at only Rs 25000 !….too low !…wonder why!
•  CD will get re-rated only if it can clear it’s Liquidity Issues once and for all and prove that the Value of Current Assets it’s showing truly is the Fair Value that can be recovered
• There could be a further Dilution in Equity…the Authorised Capital is Rs 15 crs…so it has leverage for another 50 lakh shares without having to seek to raise the Limits…at Rs 100,that’s another 50 crs

Conclusion

Compact Disc may show great future potential with this huge New Order of US $ 82 Million…as the cash flows will help liquidity and cleaning up it’s Balance Sheet and make it a Zero Debt Company….Yet Investment in Compact Disc may not suit all Investor Risk Profiles…the biggest Risk I see is the huge Capital Committment to Film Production….Both the Movies ,’Eternal Love’ and ‘Futebul’ are going to cost over Rs 250 crs to make….How much of this is CD going to bear?..till 31/3/2009 it had hardly invested a little over Rs 25 crs in them….If these 2011 scheduled Releases flop,so will Compact Disc….ofcourse CD is expecting these films to clock revenues of over Rs 460 crs…but Risk is the Actuals will be Lower than Expectations…perhaps even Lower than Production Costs!

Thus ,to reiterate,Investment in Compact Disc will not suit all Investor Risk Profiles at this cuurent Price of Rs 87.20 upper circuit today…tomorrow it will cross Rs 90….remember that there is yet outstanding some Equity warrants and the Conversion is at Rs 100…CD is taking a risk on International Film Production…not everyone would want to take this risk with the Company…thus this idea of demerging this division…then CD’s Profit and Loss and Balance Sheet will look that much more attractive,with just Animation Outsourcing Revenues which accrue on a Fixed Payment Contract basis….that’s exciting…Low Equity…Certainty and genuineness of High Revenues and High Earnings and therefore a high EPS…Zero Debt…Tata Elixi,a leading listed name in the Animation Segment gets a 15 Multiple 

A last thought…clearly Fixed Assets will go up significantly as Los Angeles,Chandigarh and KINFRA Studios get reflected properly in the Balance Sheet…They’re going to cost much over Rs 100 crs on the aggregate….In 2008/9 CD  has shown Chandigarh and Kinfra as Investments under ‘Other Current Assets’…Higher Fixed Assets will bring about a higher depreciation charge

This New Order has increased the Credibility of CD…now let’s await some strong cash flows…and let them reward shareholders with better dividend payouts rather than direct these funds to Investments

Will keep an eye on CD

Cheers !