Analysis beyond the P&L and the Balance Sheet is a must if we have to take a long term view of any company. I am not referring to fundamental or technical factors, but to more number work based on the published accounts. I am referring to the cash flow. My approach is different from what most textbooks would prescribe. Statutorily the accounts do carry something called the ‘funds flow’. That is not what I mean when I talk about ‘cash flow’. In the past, during a few of my presentations, I have taken up some analytical work on companies like Sintex, ABG Heavy Industries where a reconstruction of the cash flow showed that the story was vastly different from what the EPS and the PE numbers were telling. A solid cash flow analysis can tell us what the health of the business is and based on what current and likely future trends are, what would be the outcome.
The ultimate test of a good business is that it must throw out enough cash year after year and help the company to become debt free, not raise more equity and use the cash for dividends or for buybacks. Yes, in the early years of growth, a company will need cash to scale up. That should ideally come from debt, which gets paid off as the business grows. Growth can be either organic or inorganic. Inorganic growth can scale very quickly or can sink a company. A large acquisition would call for dilution or for raising of debt.
I have taken up PVR Ltd for a study of the cash flow. It is an interesting business and accounting is also very interesting. And what I discovered is that constructing a cash flow is an extremely challenging task (for this company). I have approached this in two parts. In the first part, I will try to write down the business of the company today and then take the cash flow up to a point. The last leg on the cash flow is complex and I will probably not venture into that zone right now. The task has been more challenging by the adoption of a new accounting standard for the way the company does business. This new accounting standard makes it more difficult to reconstruct the cash flow from the published accounts.
To begin with, let me give you the revenue stream of the company for the year 2019-20. The company operates multiplexes across the country. A multiplex can have three to ten or more screens, with varying seating capacities. They have some shared infrastructure and technology is constantly being upgraded- whether it is in the way tickets are sold or movies are broadcast.
Here is a bird’s eye view of PVR revenues in 2019-20:
As on 31-3-2020, there were 845 screens, 1.8 lakh seats covering 71 cities. Average occupancy for the year was 35 percent, average realization per ticket was Rs.204 and total tickets sold was 10.2 cr during the year. Each viewer spent around Rs.99 outside of the ticket (which contributes to the F&B revenue). PAT margins have varied between four and six percent in the last few years. Company’s growth has been driven by acquisitions. In 2012 it acquired Cinemax, in 2016 it acquired DT Cinemas and in 2018 it acquired Satyam Cinemas. 57% of tickets are sold online and contribute to 62% of revenue. It had nearly 24000 employees (including contract labour). It has one wholly owned subsidiary which produces and distributes movies.
Looking at the fixed assets in the balance sheet, the company does not seem to OWN much of the multiplexes. Most seem to be on lease. And in one place in the annual report it is mentioned that a typical lease is for 7 years, lease rents paid in 28 quarterly and quit is akin to borrowing money at between 11.37 to 13.99 percent per annum. The major costs are in plant and machinery/ furniture/fittings/equipment etc needed to ensure delivery of the movie by the multiplex. You can visualize a multiplex and understand the scale of the fitouts needed. Let us look at some numbers on assets:
Acquisitions at above book value are treated as ‘goodwill’. For instance, the latest acquisition of Satyam Cinemas gives us a glimpse :
Payout for acquisition Rs 883 cr and for that the value of assets transferred as per books was 267 cr (which again included intangible assets of 170 cr). Thus the Goodwill is recorded at 616 cr.
Thus, we get a hint here. The value paid was not for the assets bought but for what it can earn. There is a mention that Satyam entity, in its first six to seven months of the acquisition date, contributed a PAT of Rs.23 crores to PVR.
The ROU assets are more interesting. PVR follows a model of ‘lease’ of its multiplexes. In other words, there is a contract for seven years, with agreed payouts by PVR to the owner. The instalments typically have two components- principal and interest. If the sale value is 1000 and the agreed rate of interest is , say 12 percent over 7 years, we have to work out the EMI payments. The EMI component has principal and interest. Till 2018-19, PVR would debit the EMI payment (lease rentals) as operating expenses. Now, the accounting standards demand that:
- Capitalise the asset in the books at the agreed value;
- Show a liability equal to future rent payable; and
- Split the EMI into principal and interest. The principal will go to reduce the liability and the interest component will be charged to the P&L account. This has an effect of showing higher profits in the early years and lower profits in later years. This makes it difficult to measure the actual cash flow from the published accounts.
As regards the business of film production, the costs are written off based on some milestones. It could vary depending on sale of different rights (broadcast in theaters, OTT viewership etc) and in the first year sixty to eighty percent would be shown as costs and the remainder would be charged over the next four years. Thus, this again makes it difficult to re-write the cash flow. The cash has already been spent. But the P&L has taken only a part of it in year one. In the subsequent years, there is a charge to the P&L , with no cash outflow. The company has to build a cash flow from its movie bank in such a way that it is able to produce films without messing up. A movie can give revenue at the box office plus some in-movie advertising.
For the multiplex owner, advertisements on the screen are a major revenue source. And these are also on credit sales basis. For PVR, the debtors on this revenue were nearly five months of revenue and there are write offs also.
At an early stage of growth, cash flows are always going to be negative. Given that PVR has just 845 screens in 71 cities, there is a long way to go before the company enters a period of stable cash flows. Given that PAT is around four percent now and cash flow is lower than the PAT numbers, fundraising on a regular basis is likely to happen.
CASH FLOW ANALYSIS
When doing a cash flow analysis, I start from the Profit After Tax number. From this, I reduce the dividends paid. This is the cash available. Now I can add the amortisations and depreciation numbers since they are not actual cash flows. From this cash, one has to manage things like normal addition to fixed assets, working capital needs (funding current assets). From this, I reduce the amount needed for normal capital expenditure. Capital expenditure on acquisitions, rapid expansion costs are things that probably need a mix of debt and equity. A company like PVR will have negative cash flows for a long time.
Spreadsheet - Cashflow analysis of PVR
There are two tables. Table A shows the ‘change’ in value of major heads of assets and liabilities from year to year, for ten years. Table B is the cash flow. Table B is NOT accurate, since I did not access details of all fund raising in the last ten years. There have also been write offs from the Reserves, which need to be captured. However, I believe that these two tables will provide a framework for casting a cash flow model for most companies (excluding those in banking and finance).
I must state that I have neither any position nor any view on the stocks of PVR Ltd. I just noticed that during FY 2020-21 ( a lost year for the movie halls, thanks to the pandemic) the company had a loss (before tax) of Rs.939 crores! The company raised fresh money of Rs.300 crores through a rights issue and Rs.800 crores through a private placement (QIP). This has helped them to meet financial obligations. We do not know what FY 2022 holds.