Indian stock market investors in January 2018 felt like this: 

Source: Iwmbuzz

Then for the whole of 2018 & 2019, the investors kept saying this about the midcap and smallcap basket: 

Source: twitter

Trivedi supposedly was a basket of a few so-called Quality stocks that would survive the carnage of the market. 

And after the recent spread of Coronavirus around the world, the mood of the Indian stock market looks like this: 

Such a swift and drastic turn of events can happen only in movies and stock markets. And you and I watch them with awe. 

Life and business, in general, do not have this knack of exciting us all the time. While there are twists and turns in life and business too, the pace is too slow compared to stock markets. 

Just like any thrilling Bollywood movie, stock markets exaggerate the reality at times.  We know that mean reversion is inevitable, but before the pendulum comes to the balance, it goes so far away on one side that it becomes very difficult to control our behavior. 

And if you analyze closely, it is not the stock markets that make us suffer. It is our behavior during extreme times in the stock market that makes us suffer.  

The Novel Coronavirus situation is indeed evolving and we cannot predict the future.  

As investors, though, it is a good time to take a step back from the screen of stock ticker and have a look at something more fundamental. 

Estimating the near-term earnings would have helped but it is very difficult during the current pandemic. 

In times like these Balance Sheet would give us a much more realistic picture. 

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So let’s explore the position of a listed company, Mahindra Holidays Resorts India Ltd (MHRIL) from this angle. 

MHRIL, a part of the Leisure and Hospitality sector of the Mahindra Group, offers quality family holidays primarily through vacation ownership memberships and brings to the industry values such as reliability, trust, and customer satisfaction. Started in 1996, the company’s flagship brand ‘Club Mahindra Holidays’, today has a fast-growing customer base of over 250,000 members and 100+ resorts at some of the most exotic locations in India and abroad. 

To know more about the company check our notes here

The Balance Sheet of MHRIL looks like this: 

And before we move ahead, here is an imaginary conversation between Mr. Arun Nanda- AN (the chairman of MHRIL) and Mr. Thappar (An entrepreneur who is looking to buy a business to diversify his source of earnings) on MHRIL. 

AN: Hi Mr.X, I thought to share with you an investment opportunity that can yield you a very high return. 

T: Hi Arun, that sounds interesting.  Let me hear more details. 

AN: MHRIL is a leading vacation ownership company in India. We have a unique business model and the following features: 

  • A trusted brand with a choice of 57 domestic resorts & 51 international resorts. 
  • 2.54 Lakh+ member base 
  • Successful track record of over two decades 
  • Consistently High Occupancy rate (in excess of 80% for several years) 
  • Significant recurring income streams/Revenue visibility 
  • A very strong Balance Sheet with no debt 

We are looking at diluting our stake in the company.  

T: But why do you want to reduce your holding if your business is so good? 

AN: Mahindra & Mahindra (M&M) is the promoter group of the company and also the largest shareholder (67%) in the company. We have other businesses that are capital intensive. By paring our stake in MHRIL we can pump in more money to the businesses which are starving for capital. MHRIL, on the other hand, does not need capital for further expansion. In fact, the only equity money put in by M&M was in 1997 when MHRIL was started. M&M only invested Rs 18 Cr in MHRIL in 1997. And since its listing, MHRIL has been valued roughly between 1700 Cr and 5500 Cr. That’s huge wealth creation for its owners. 

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T: Ok. That was good to know. Let me check what’s the current market cap of MHRIL. OK, 1800 Cr!  Why should I pay this much? The Coronavirus uncertainty may impact the business of MHRIL big time. And the panic in the share market across the globe may drive the share price down a lot from even the current levels. I may wait for the price to fall further from here and then buy from the market. 

AN: You are right. Nobody knows when this panic will give way to normalcy. But tell me what would be the value at which you would be interested? 

T: I believe in buying it below liquidating value. 

AN: Fair enough. Let me ask my team to do the calculation and I will get back to you. 

The conversation ended there. 

Liquidating value! 

A timeless concept coined by the father of investing, Mr. Benjamin Graham. 

In the euphoria of a bull run in the stock market, we often forget these concepts. 

Time to have a relook on it. 

An excerpt from the 1940 edition of “Security Analysis” by Benjamin Graham and David Dodd defines Liquidation Value as the following:

He further writes in his book as to how to calculate the realizable value of a business: 

Realizable Value of Assets Varies with Their Character– A company’s balance sheet does not convey exact information as to its value in liquidation, but it does supply clues or hints which may prove useful. The first rule in calculating liquidating value is that the liabilities are real but the value of the assets must be questioned. This means that all true liabilities shown on the books must be deducted at their face amount. The value to be ascribed to the assets, however, will vary according to their character. 

In our assessment of the liquidating value of a company, we are assuming that the business is being sold to a different owner on a going concern basis. 

Now let’s look at the Balance Sheet of MHRIL from the point of view of calculating the liquidating value. 

In the asset side we have the following items:

Property Plant & Equipment  The fixed asset and property which the company has built over the years 
Right of Use Asset (India AS 116)  The property and rooms which are available on lease for MHRIL (Check Note below) 
Trade Receivables  The pending EMI of the members of MHRIL 
Cash and Cash Equivalents  Cash and liquid investments 
Deferred Tax (net)  A deferred tax asset is an asset to the Company that usually arises when either the Company has overpaid taxes or paid advance tax. Such taxes are recorded as an asset on the balance sheet and are eventually paid back to the Company or deducted from future taxes. 
Other Assets  This includes intangibles, deferred acquisition cost, and other current assets 

Note: The Ministry of Corporate Affairs (MCA) notified Ind AS 116, the new leases accounting standard, and certain other amendments to Indian Accounting Standards (Ind AS) on 30 March 2019. Ind AS 116 and other amendments came into force on 1 April 2019. Ind AS 116 defines a lease as a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. … For a finance lease, the lessor recognizes a receivable, and for an operating lease the lessor continues to recognize the underlying asset

Property Plant and Equipment were revalued in 2018 and hence would be trading at around near realizable value. However, for the sake of conservatism let’s take their realizable value at a discount of 25%. Similarly, let’s assume the realizable value of the assets as follows: 

Particulars (INR Cr)  Dec 2019 Amount  Discount  Amount 
Property Plant & Equipment  2063.21  25%  1547.41 
Right of Use Asset (India AS 116)  178.65  25%  133.99 
Trade Receivables  1698.03  20%  1358.42 
Cash and Cash Equivalents  694.17  0%  694.17 
Deferred Tax (net)  438.15  0%  438.15 
Other Assets  1248.11  75%  312.03 
Realizable Value of the Assets      4484.17 

Now let’s move on to the liabilities side 

Other Liabilities  Loans plus Sundry Creditors 
Lease Liability (IND AS 116)  The Liability related to lease rentals 
Deferred Revenue:  VO  The membership fees received to be booked over the lifetime of members 
Deferred Revenue:  ASF  ASF received to be booked over the lifetime of members 

While Graham tells us to take liabilities at actuals, I observed that Deferred Revenue formed the majority part of the liability side in MHRIL. 

If I exclude the equity part, the liability side total is Rs 5976 Cr. 

Out of this, deferred revenue forms Rs 5476 Cr.  

So effectively, more than 90% of the liability in the Balance Sheet is Deferred Revenue. 

Now, let us understand what is deferred revenue. 

Any liability on your Balance Sheet generally means you owe that amount to someone. 

For example, a loan of 100 Cr would mean that you have to pay back that amount to the person from whom you took that loan.  

Similarly, sundry creditors of Rs 50 Cr would mean an outstanding amount of 50 Cr to be paid to your creditors. 

Does that mean a deferred revenue of Rs 5476 Cr in the Balance Sheet of MHRIL would be the amount they have to pay back to their customers? 

Of course not! 

You may be tempted to say that MHRIL may not have to pay that amount to the customers, but they will have to provide service worth that amount. 

Fair enough! 

Let’s understand what happens in the business of MHRIL.  

They sell 25-year membership to their customers, where they receive the membership fees upfront. But the accounting rules of IND AS 116 does not allow them to book all the revenues upfront. They have to spread the revenue over the 25-year period.  

So, hypothetically speaking, if a member is paying a lakh now to gain membership for a period of 25 years, MHRIL has to book Rs. 4000 every year for the next 25 years for that member. 

However, what are the costs involved in serving the members? 

The major ones are as follows: 

  • Promotional cost to acquire customers (offers of iPhone, free cruise holidays, etc) 
  • Marketing and sales activity 
  • Digital promotion 
  • Salaries and perquisites to sales and marketing people to acquire customers 
  • Cost of serving the customers when they are on vacation 

I have included above almost all the major costs involved in serving a customer.  

And if you notice, apart from the last point of serving customers in the resort, all the expenses happen at the time of acquiring customers. And naturally, they also form part of the profit & loss account in that year itself. 

Before the adoption of Ind AS 116, the company used to recognize around 70% of the vacation ownership income of a new member in the first year to match the cost incurred in acquiring him/her. This means over the lifetime, as per management’s estimation, the cost of serving customers is only 30% while the cost of acquiring them is 70%.  

While Ind AS 116 does a good job of using the principle of conservatism for recognizing revenue, we must understand the nature of the term Deferred Revenue. 

Deferred Revenue as it stands in the liability side of the Balance Sheet of MHRIL, is just an accounting entry for the company. It represents the vacation ownership income; the company can generate over the lifetime of all existing members. 

This does not reflect the true liability associated with serving the members. The true liability is about 30% of this figure. 

I read up a little on how to find out the cost of Deferred revenue in terms of liquidating the business to another private owner. The following link helped immensely 

Let me quote an extract from the link which is very relevant for our understanding:

 The important words are: 

“It will be important to separately define what the future obligation will cost the buyer.” 

The buyer would not have to spend on marketing, sales promotion, digital advertising, etc to serve the existing customers. Hence, the cost of the obligation would be restricted to expenses incurred in servicing customers in the resorts. 

The purpose of calculating liquidating value is not to come out with a precise number but to roughly understand what an investor/owner may be willing to pay for it. 

Hence, even if we assume that 40% of the Deferred Revenue Amount signifies the cost of the obligation of serving the existing customers, we are left with the following rough calculations: 

Particulars (INR Cr)  Dec 19 Amt  Discount  Amount 
Other Liabilities  308.34  0%  308.34 
Lease Liability (IND AS 116)  191.78  0%  191.78 
Deferred Revenue       
       VO  5325.15  60%  2130.06 
        ASF  151.07  60%  60.428 
Total cost of Obligation      2690.608 

So, a rough estimate of the liquidating value would be the realizable value of assets minus the Cost of Obligation. 

Particulars (INR Cr)  Amount 
Realizable Value of Assets  4484.17 
Cost of Obligations  2690.61 
Liquidating Value  1794 

The current Market Cap is around Rs 1800 Cr. So the stock is effectively trading at its liquidating value. 

Which means the market is currently suggesting zero value to the business of MHRIL.

And since I have focused only on the liquidating value, I have ignored the following growth drivers: 

  • Growth of Vacation Ownership Income due to net new member additions in the future 
  • Resort Income growth (which is growing at double-digit for several years) 
  • Investment in the biggest timeshare company of Finland which is funded predominantly by low-cost foreign debt where dividend from investment takes care of the interest payment. 
  • Healthy cash on the Balance Sheet gives visibility of the capacity of inventory build-up in the future with internal accruals. 
  • Improving the Member-to-Room ratio leading to better member satisfaction in the future, which in turn enhances the value proposition. 

However, I must admit that the above calculation of liquidating value is based on the assumption that the company continues to be a going concern. Only the ownership changes.  

In the worst-case scenario, if the company becomes bankrupt and has to go into liquidation, all the physical assets will be sold for cash to pay off all the liabilities of the book. Based on the current Balance Sheet figures, MHRIL would have to then return all the realized money to the existing customers. It means the equity owner, in that case, would hardly receive anything. 

But, what probability would you assign to that kind of bankruptcy? 

I would say very little.   

And even if that would have to happen, it won’t happen overnight.  We will get enough clues like: 

  • Net Member addition becomes negative 
  • Occupancy in resorts starts dropping consistently 
  • Resort Income starts going down   
  • Cash levels dry up 
  • Debt starts appearing on the books 

As on date, we do not see any of them happening.  

Now it’s up to you to decide whether the risk and reward are in your favor or not. 

However, due to the beating that the stock has taken over the years, a biased long-term shareholder of MHRIL might be telling this to his/her investor friends: 

And we don’t know yet how the story is going to unfold. 

But the big question is: Are you willing to bet on MHRIL today?  

P.S. This is the first of the series of posts on businesses we are tracking.


Stocks discussed in this post are for educational purposes. Please do not take it as a recommendation. Please read our terms and conditions.

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