Barcelos Private Placement

Introduction

Food Emporium International Limited (FEIL), the owners of the Barcelos franchise in Nigeria and West African Sub-region, recently floated a private placement. The offer held between 22nd September 2008 and 3rd October 2008; it was for 300 million shares of 50K each at N2.50 per share.

FEIL has authorized capital of 2 billion shares out of which 1.42 billion had been issued and fully paid for. The company will have 280 million shares left after the offer, which may be used for bonus issues in the future or to accommodate over-subscription if it happens. There is also room for offer for sale of shares if there is overwhelming demand for the shares.

FEIL intends to use the money raised to open new outlets, acquire up-to-date IT infrastructures, boost working capital and to liquidate outstanding debts.

Minimum subscription was for 1 million units (N2.5million) and additional multiples of 500,000 units (N1.25million). This means that only 300 investors are all they need for the offer to be fully subscribed and they will raise N750million at the end of the exercise.

The offer was not underwritten, which shows the confidence of the directors about it and they intend to list by the end of 2009. As at the time of the offer, no official application had been made to the NSE or SEC for the shares to be listed on the floor of the NSE.

The aim of this analysis is to determine the fair price of the offer looking at it from the buy-side perspective.

Economic Analysis

The chairman’s letter dated 22nd September 2008 noted end 2007 inflation to be 6.6% year on year and the monetary policy rate (MPR) was 10.25%. As at the time of this analysis the current inflation rate is 14.5% and the MPR is 9.75%. This means that there is a likelihood of higher inflation rates by the time the effect of the MPR is fully integrated into the economy. The effect of this potential increase in inflation could have a positive or negative impact on Barcelos depending on how the management handles the situation.

The Quick Service Restaurant (QSR) sector of the economy is in Stage II (rapid accelerating growth rate phase) using the five-stage industry life cycle analysis. This is based on low number of key players servicing a population of 150 million, minimal competition where it exists, and large profits. The QSR industry is worth about N60 billion in Nigeria with an estimated growth rate of 40% per annum for the next 10 years. It is a sector in monopolistic competition with low entry barriers and little product differentiation. The companies need to spend money on strategic location, corporate branding and advertisement to be able to stay ahead of other players.

Barcelos is presently restricted to Lagos, Abuja and Accra but they intend to expand to other parts of Lagos, Enugu, Warri, Porto Novo, Benin City, Banjul, Port Harcourt, Ibadan, Asaba, Abeokuta and Freetown before the end of 2009. It beats me though why they want to open an outlet in Porto Novo instead of Cotonou in Benin Republic.

The chairman also noted that there are only three major chicken suppliers in Nigeria that produce about 30,000 birds per day for consumption and they are presently finding it difficult to cope with the increasing demand. There was a hint about backward integration along the supply chain; this could be a big boost to profitability if Barcelos goes into this.

Keys to success of the company include strategic location, fast rollout of new eateries, quick service delivery, branding, trained manpower, customer service, product quality standardization, innovation, ambience, hygiene, adaptation to local palate and organizational structure.

The industry challenges are pilfering, poor service culture, underdeveloped tourism, high attrition levels and wastage, which the company intends to curb.

Economic/political risk was identified, which the company intends to mitigate by opening outlets in several locations in different countries within the next one year to reduce unnecessary exposure to one region. They will also latch on their brand to be able to ride on identified sector/industry risk, which will be posed by stiff competition. There is also specific/company risk, which they will mitigate by motivating and retaining their employees.

The success of Barcelos will be hinged on brand appeal and rapid expansion.


Financial Analysis

It should be noted that the first in first out (FIFO) accounting basis that was used by the company to prepare their financial statements is not likely to have any material impact on valuation since the maximum shelf life of their inventories is 48 hours as noted by the chairman. The asset depreciation method used is also fair and is likely to be in tandem with economic depreciation. The financial statements for three years from 2005 to 2008 in the memorandum omitted 2006 financial year as 16 months was reported for 2007 when they changed their financial year end from December to April. Appropriate adjustments were made to the profit and loss statements in order to uniformly evaluate performance.

Total assets had a cumulative annual growth rate (CAGR) of 135% for the three financial years. Current ratio dropped from 7.38 to 6.44 indicating a 12.74% drop between 2007 and 2008. Total debt to equity ratio dropped from 1.03 to 0.21 between the two years; a 79.61% reduction. This was largely influenced by the deposit for shares of N600m in 2008. This means that the company is presently highly liquid and has a lot of working capital at its disposal even before embarking on the private placement.

The turnover was noted to be increasing at a decreasing rate; 17.51% increase from 2005 to 2007 and 14.57% increase from 2007 to 2008. The gross profit was also noted to have followed the same pattern, that is, 7.81% and 5.21% respectively. The gross profit margin also decreased over the three years from 50.83% in 2005 to 46.63% in 2007 and then 42.82% in 2008. This reduction in profit margin which is due to rising cost of sales over the three year period is partly accountable for the net profit margin of only 1% in 2008 as against 4.43% in 2007 and 9.02% in 2005. There was also a non-linear increase in interest rates and taxes for 2008.

The return on assets (ROA) dropped from 0.072 to 0.003 between 2007 and 2008. The return on equity (ROE) dropped from 0.14 to 0.003 between the two years. These drops can be explained by the massive reduction in profit after tax (PAT) for 2008 and the increase in net assets from the deposit for shares.

No dividend was paid in 2008 as earning per share (EPS) was negligible (also due to the dilution of shares and poor PAT), therefore price earning multiple (PE) could not be calculated. The sales per share was 17K, price to book value was noted to be 4.95 and price to cashflow is 6.68. These data will be more meaningful when compared with other QSRs.


Forecast/Valuation Analysis

There has been a consistent reduction in the rate of increase in turnover over the past three financial years but the directors are confident that the rollout plans will improve economies of scale which will act as a positive boost to a significant increase in turnover. It is expected to grow at a CAGR of 75.83% over the next three years while the gross profit is also expected to experience a CAGR of 82.6%. This means that the management expects a continued reduction in the cost of sales over the years.

There is a forecasted EPS of 10K per share and 4K dividend per share for the 2009 financial year. They also expect PEs of 25, 11.36 and 5.95 over the next 3 years based on the results. A sustainable growth rate of 14.4% was calculated for the company. The ROE is expected to be 0.24 while the ROA is expected to improve to 0.20. The dividend discount model revealed a cost of equity of 16%.

Based on the forward PE of 25 for 2009, the price of N2.50 is rather expensive for this company. This is also reinforced by the poor performance for 2008.

The only QSR presently trading on the floor of the NSE, Tantalizer Plc, is priced at N2.49K and based on the half year results released for the period ended June 2008, the linearly projected year end EPS comes to 16K per share, while the forward PE is 15.56. This cheap price can be attributed to the present state of the stock market but it should however be noted that Tantalizer was listed at a price of N3.50 with a forward PE of 21.88. Using the listing price as a benchmark, Barcelos should sell for N2.19.

It should also be noted that FEIL has not applied to the NSE and SEC to be listed, which means that there will be a relative illiquidity, which has introduced another dimension of risk as we do not know what new rule may be introduced into the market with new private placements. Applying a liquidity discount of 5 PE multiples for private placements, the Barcelos private placement should be sold at N1.70 per share.