Sai Silks (Kalamandir) IPO Review by Naman Sec (Avoid)

Review By Naman Securities and Finance Pvt. Ltd on February 12, 2013

Sai Silk (Kalamandir) Ltd, a retailer of sarees and jewellery operating primarily in southern India, has come out with an IPO to raise Rs 89 crs for meeting long term working capital requirements, expanding its retail footprint, carrying out brand promotion, and pre-paying debt. The issue, which opened yesterday, will close on the 13th February 2013. The price band has been fixed at Rs 70-75 per share. What makes this issue unique is that the promoters have opted for the safety net scheme. In this scheme, the promoters stand ready to buy back shares from retail investor applicants should the price fall below the issue price within a specified time frame.

Safety-net scheme, background and implications

SEBI came up with the idea of the safety net scheme intending to protect retail investors in IPOs. Excerpts from the SEBI document read 'In the analysis of price performance of the scrips listed during 2008 to 2011, it was observed that out of 117 scrips, 72 (around 62% issues) were trading below the Issue price after 6-months of their listing. Out of those 72 scrips which witnessed fall in price, in 55 scrips the fall was more than 20% of the Issue price. In this scenario if the trend continues, the sentiments of the investors would get affected and they may lose confidence in the capital market. Thus, there is a need to provide Safety Net arrangement for RIIs to build their confidence in capital market.'

The safety net scheme - If at any point in time, within 6 months from the credit of shares to your demat account, the stock price falls below the issue price, say Rs 75 in this case, the promoters will buyback maximum of 1000 shares at Rs 75 per share. This definitely sounds like a no-loss situation for a period of 6 months. However, is it worth a try for this IPO? I would say no. It is very likely that the stock will be 'managed' at levels marginally above Rs 75 for next six months to avoid triggering the safety net. I say 'marginally' above because, in my opinion, the stock is already expensively valued given its average fundamentals; this I will elaborate later in the post. Hence, I will be sitting on returns of 0-1% for the six months, post which the stock is likely to fall owing to profit booking and expensive valuations. The other situation is where the stock price falls and I get my money back - without the interest that I could have made for whatever little time my funds were locked in. In contrast, I stand to make much better risk adjusted returns by simply parking funds in a term deposit with a commercial bank.

Usher Agro, which got listed in October 2006, was the first company to offer this scheme. The issue price was fixed at Rs 15 per share. A look at the stock price performance for the first six months of listing reveals that the stock, for a large part of the time, was trading below the issue price of Rs 15. This definitely would have induced investors to tender their shares for buyback in the safety net scheme.The red line depicts the share price at Rs 15 in both the charts.

Nevertheless, the safety net scheme is beneficial for retail investors as it provides some amount of protection from downside risk for a limited period; but that alone may not be reason enough to subscribe to an IPO! Fundamentals and valuations, like always, should remain the drivers for any IPO investment decisions.

Evaluating the fundamentals

Saree business: Sai Silk is a retailer of sarees and jewellery in South India; sales from sarees and other related apparel categories constituted 61% of total revenues as at October 2012. The company retails sarees under the brands, 'Kalamandir', 'Mandir' and 'Varamahalakshmi'. It purchases majority of its inventory i.e. sarees from its group company, M/s Sai Retail India which in turn purchases it from small weavers. M/s Sai Retail is paid a commission of 2% for the saree purchases, which gives comfort that the transactions largely take place at an arms length basis. The company currently has 15 retail outlets in Hyderabad and Bengaluru spread over 129,035 sq. feet; it plans to add 4 more to the count by deploying Rs 13 crs from the issue proceeds. All the stores are on lease. The saree industry is highly unorganised, with a few players having pan India presence. The highest demand for sarees probably stems from south India, leading to intense competition in that region. Sai Silk, akin to other players in the industry, does not enjoy the benefits of brand pull, brand loyalty or large scale of operations through pan India presence.
Jewellery business: The company started retailing jewellery to expand its product offerings. It retails jewellery of its group company, Sai Swarnamandir Jewellers Private Ltd. through a shop in shop arrangement in its own retail stores. Sai Silk earns EBITDA margins of 2% in this trade as compared to ~15% for the saree business. The good thing is that the proportion of jewellery revenues has declined from 41% in FY10 to 39% as of October 2012 and that the EBITDA margin in the saree segment has improved from 9% in FY09 to ~15% as of October 2012. The improvement is largely led by cash purchases with discounts and higher average purchase per customer, as stated in the IPO grading report.
Wind power business: The company has spent Rs 11 crs to set up a 2MW wind power plant in Andhra Pradesh through a tie-up with Shriram EPC. The power produced will be sold to Andhra Pradesh Central Power Distribution Company Ltd. as per the power purchase agreement dated 31st March 2011. The revenue contribution of this segment is insignificant; this segment has reported revenues of Rs 47 lakhs and a loss of Rs 17 lakhs at the EBITDA level as of October 2012.
Management: The promoters, Mr. Chalavadi Prasad and Mrs. Chalavadi Jhansi Rani, have acquired most of their retail experience on the job. While Mr. Prasad serves as the Chairman and Managing Director and oversees the functioning of the company, Mrs. Rani serves as the Head of the Retail department. There are many companies in India which have diversified into wind energy to avail tax benefits. The amount of focus and resources that the management puts into this segment is a key thing to watch out for.
Corporate governance: i) Since the major suppliers of sarees and jewellery are promoter group entities, the quantum of related party transactions is very high. Thus, 65% of the total issue proceeds, i.e. Rs 60 crs meant for meeting long term working capital requirements, is effectively going to service the payments for inventory purchased from its group company. ii) The salary levels appear to be below industry standards; the HR manager, aged 28 years, draws an annual salary of Rs 66,000! iii) The company pays royalty to Mrs. Rani, the promoter, as its trademark is registered in her name. The quantum of royalty, Rs 1,00,000 per retail outlet, is small; nevertheless the management has indicated that it is in the process of registering the trademark in the name of the company. iv) There is a contingent liability of Rs 22 crs arising out of a bank guarantee extended to its promoter group, Sai Swarnamandir Jewellers.

Conclusion / Investment Strategy

Valuations expensive; avoid the IPO

According to my estimates, the company is likely to report an EPS, based on weighted average number of shares, of Rs 6.2 for FY13. At the price band of Rs 70-75, the PE multiples are 11.3x-12.1x. Since there is no directly comparable listed player, I use my fair value estimates for V Mart for comparison. V Mart and Sai Silk have the following similarities - both are regional retail players, V Mart is concentrated in the north, while Sai Silk stores are located in the south, both earn 60% of revenues from apparel, both have grown at healthy pace in terms of revenues and profits in the past and have similar revenues (~ Rs 260-280 crs), margins (EBITDA margins of ~11%) and returns (RoE of ~22%) profile. In my IPO review of V Mart, I applied a PE multiple of 13-13.5x for arriving at the fair value estimate. In my opinion, Sai Silk should trade at a 15% discount to V Mart's PE multiple of 13x owing to: i) V Mart has three times the retail store presence as Sai Silk and a higher brand recall ii) V Mart continues to focus on its core business, while Sai Silk has has diversified into unrelated area of wind power generation iii) V Mart has limited related party transactions and relatively better corporate governance practices.

Applying a PE multiple of 11x, I arrive at a fair value estimate of Rs 68 per share for Sai Silk, which indicates that the issue price has a marginal downside potential. Hence, I recommend avoiding the IPO.

Reviewer recommends Avoid to the issue.