My Investment Thesis on Viad (VVI)

At Coho, we are always looking for informational inefficiencies. One of the areas in which we have found success is analyzing businesses with multiple operating units. On occasion, such businesses possess a high quality enterprise obscured by the dominant business unit. Such is the case with Viad, a company primarily known for its trade show exhibition management business but with a jewel of a travel and recreation business.

Viad Tradeshow Business, Oligopoly with Sticky Customer Relationships

Let’s start with the exhibition management business, Global Experience Specialists, or (GES), which generates 89% of Viad’s revenues. GES focuses on trade show management and exhibitor services including planning, installation, kiosk and exhibit design, audio and video and on-site management. GES is the leading exhibition provider In Canada and the UK and the second largest provider in the US.

There are a number of things we like about the GES business. It operates within a duopolistic market structure. Viad and its primary competitor, Freeman, control 80% of industry profits in the US with Viad maintaining a 30% market share. In Canada, Viad accounts for nearly half of all dollars allocated to exhibition construction and management and in the UK Viad dominates with a 55% market share.

It’s a scale business with leading players having best in class local operations that are hard for new entrants to create from scratch, creating barriers to entry. Viad’s customer base is highly fragmented with no customer accounting for more than 6% of GES’ revenue. Contracts are typically for 3-5 years creating recurring revenue streams.

Last, and probably most important, there is a switching cost for customers wishing to hire new providers. This explains why Viad has a client retention rate of over 90%.

Viad Travel and Recreation, Unique Assets with Few Substitutes

The Viad Travel and Recreation business, known as VTR, sells travel and leisure experiences at four well-known national park destinations in North America, including Glacier and Denali National Parks in the US and Banff and Jasper National Parks in Canada. The parks benefit from perennial demand with current annual visits of over eight million. A rise in global wealth has led to a surge in international tourism, driving strong demand for park facilities.

VTR generates revenue through providing transportation, lodging, package tours, and creating unique attractions.

While VTR only accounts for a tenth of Viad’s revenue it generates 40% of profits due to its lush margins. The VTR business is highly profitable, sporting an EBITDA margin of 30.2% last year compared to 5.7% in GES. Not only is the business highly profitable but growth has been explosive with a CAGR of 15% over the past five years.

VTR’s lodging business is a steady generator of revenue in supply constrained markets but VTR’s crown jewel is its attractions business. VTR’s attractions offer unique experiences you can’t get anywhere else such as a tour of the Athabasca Glacier on vehicles designed specifically for glacier travel or Jasper Park’s Glacier Skywalk, a cliff edged walkway allowing you to step into the void with nothing but a sheet of glass between you and gravity.

The economics of VTR’s attractions business are extremely compelling. The Skywalk cost $20 million to build but generated $5.5 million dollars in its first year of operations and possesses 60% operating margins.

Viad’s VTR business possesses unique assets with few substitutes, limited supply and barriers to entry through government permits. One way to think about this business is similar to the casino business in Macau, though much more wholesome. Similar to Macau, where the government limits the licenses to operate casinos, the Canadian and US Park Services are very restrictive in terms of new builds. It is virtually impossible to build new inventory within the parks and even building outside of the parks is heavily restricted. As a result, Viad is able to earn abnormal economic returns.

Tradeshow Business for Below Market Multiple with Recreation Business for Free

It’s clear that Viad’s business structure obscures the value of its VTR assets. Given the lack of synergies between Viad’s two business units it does not make sense to keep the two businesses attached at the hip. The sensible course of action would be to separate the two businesses into independent operating entities where they would be worth almost double their current market quotation.

Management has guided its exhibitions business to over $1 billion in revenue and $80 million in EBITDA by 2016. Given the stability of Viad’s market position and recurring cash flows, we think 8x EV/EBITDA is appropriate, especially given a growing sales contribution from high margin complementary services. Recent acquisition multiples within the exhibitions space have been in the region of 10x EBITDA so we think our estimates of value are conservative.

Based on Viad’s guidance for its exhibition business in 2016, Viad trades for an EV/EBITDA multiple of 7.6x. This implies you are getting Viad’s travel and recreation business for free.

So what would Viad’s travel business be worth to a buyer? For valuation guidance we can look toward other mountain recreation specialists such as Intrawest Holdings and Vail Resorts which both trade at a 14x EV/EBITDA multiple. Due to their reliance on skiing both Vail and Intrawest have to pray to the snow Gods to earn economic returns, whereas Viad just needs summer to arrive each year, fair weather or not.

If we want to consider attractions as a comp, we can look at amusement park operators Six Flags or Cedar Fun which trade at an average EV/EBITDA multiple of 14.3x. Like Viad, both Six Flags and Cedar Fun have unique assets with limited supply and a captive audience.

The comps I have mentioned have greater scale in their operations so we discount Viad’s multiple by 15% for what we think is an appropriate metric of 12x EV/EBITDA. We have already included debt in our EV/EBITDA calculation for the exhibitions business so we don’t have to count it twice. With a 12x EV/EBITDA multiple, Viad’s travel business is worth $480M. Since we are getting it for free we can add it to Viad’s existing market cap suggesting upside of 95%.

We felt strongly enough about Viad’s prospects to present the idea at Fairfax Financial’s annual meeting in Toronto earlier this year.

The above post has been excerpted from the Coho Capital June 2015 Letter.

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Highlighted by #valueinvestors on Slack

Here’s a message from the #investing channel in the #valueinvestors online community:

Regarding Motors Liquidation Trust: Currently there are 31.85MM units of the trust. Each unit represents $1,000 of general unsecured claims from the GM bankruptcy. There are only $70MM of unresolved claims in the bankruptcy. There is a piece of litigation outstanding with JPMorgan that is actually fascinating for anyone still adhering to efficient market theory. JPM incorrectly released their lien on a $1.5B note bumping it down to the general unsecured class. Humans make expensive mistakes. JPM is in a final appeal but unlikely to prevail. This would dilute the existing trust by approx 5%. However, the cash benefit of a win vs JPM doesn’t accrue to the trust but is paid directly to the claim holders. At the beginning of Aug the trust finished liquidating its holdings of GM shares and warrants. This had represented nearly all of the trust’s assets. It now holds cash and equivalent net of estimated final expenses of $736MM. However, there is a tax liability due for the capital gains on the GM instruments sold. This was last estimated in the 6/30 disclosures at approx $260MM. This results in distributable assets of $476MM or $14.94/unit ($14.19 if JPM’s claims are dropped down to the trust). I would expect the distribution to come in short order even if the JPM case isn’t resolved as this could easily be reserved for later distribution since the claim amount is known. However, the market price of the trust units is not low enough to offer a positive return. I suspect it trades rich because of aggressive mkt assumptions regarding final expenses, JPM litigation prospects and the tax liability. I pointed it out last week because in the case of a market crash this represents a nearly riskless liquidating “cash box” should it be indiscriminately sold off below its distributable assets.

Members: Go to this message on Slack to see its author and the related discussion.

Not yet a member? Here’s how to join: The #valueinvestors community on Slack was founded for the benefit of subscribers to The Manual of Ideas. However, even if you are not a member of The Manual of Ideas, you may join the community on a trial basis. In order to remain in the community, non-members are expected to add value through their active participation. Apply to join (we will email you when approved).

Berkshire Hathaway 50th Anniversary Symposium

Golden anniversaries warrant jubilee celebrations and no milestone in value investing warrants more notice than that of Berkshire Hathaway’s 50 years under Warren Buffett’s leadership. Wall Street’s Museum of American Finance on November 11 will host a symposium commemorating this achievement. Boasting a dozen devotees of Berkshire and its philosophy, discussion will consider Berkshire’s conception of partnership, views from those who have been significant investors, and assessments from those who have been inspired to emulate the Berkshire model. Rounded out with distinguished authors and commentators on these topics, the Museum will contribute not only a day of important dialogue but will create an archive on videotape to become part of its permanent collection.

I’m honored to be giving the keynote address at this event and happy to be able to donate copies of my book, The Essays of Warren Buffett: Lessons for Corporate America, to all who attend the live event. As the Museum explains: “When Warren Buffett took control of Berkshire Hathaway Inc. in 1965, it was a small textile company. Through a combination of value investing, exceptional management and savvy acquisitions, Buffett has transformed the firm into one of the most profitable, successful and highly-emulated corporations in American history. ” The program schedule follows.

8:00-9:00 am: Fireside Chat
Byron D. Trott, chairman and CEO of BDT & Company and source for several of Berkshire’s important acquisitions, will be interviewed by Carol Loomis, long-time editor of Fortune magazine and editor of Buffett’s annual letter to shareholders.

9:15-10:15 am: Panel 1: Investors Inspired by Berkshire Hathaway
Roger Lowenstein (moderator), financial journalist and author of Buffett: The Making of an American Capitalist and America’s Bank: The Epic Struggle to Create the Federal Reserve
Bill Ackman, founder and CEO of Pershing Square Capital Management, L.P.
Seth A. Klarman, president and CEO of The Baupost Group, L.L.C.

10:30-11:30 am Panel 2: Berkshire Hathaway Shareholders
Jason Zweig (moderator), Wall Street Journal columnist and editor of the revised edition of The Intelligent Investor
Paul Lountzis, president of Lountzis Asset Management LLC
Thomas Russo, partner at Gardner Russo & Gardner LLC
Whitney Tilson, founder and managing partner of Kase Capital Management

11:30 am-12:15 pm Lunch Break

12:15-1:15 pm: Panel 3: Value of Partnerships
Jim Grant (moderator), founder and publisher of Grant’s Interest Rate Observer
Thomas Gayner, president and chief investment officer of Markel Corporation
John C. Phelan, managing partner of MSD Capital

1:30-2:30 pm: Afternoon Keynote
Lawrence Cunningham, author of Berkshire Beyond Buffett, co-author of The Essays of Warren Buffett and the Henry St. George Tucker III Research Professor of Law at George Washington University

Register Here: Tickets and Admission

General admission: $325
Current MoAF and NYSSA members: $125

All guests will receive a complimentary copy of The Essays of Warren Buffett: Lessons for Corporate America, courtesy of the editor and publisher, Lawrence Cunningham.

SWFF Guide to Value Investing in Asia

The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.

TSRWhat do you care enough about to risk time, energy, and money to try to make happen?

What if you are operating in an emerging Asian country where the electricity cost is the highest in the region, even ahead of developed Japan and Singapore, due to complex political and regulatory capture reasons, and the high electricity rates have resulted in one of the most under-penetrated markets in household appliances such as air-conditioners and refrigerators as consumers are wary of their energy bills that may comprise as much as one-third of their income? It would be foolhardy and risky to have a business to sell air-conditioners in such a country, isn’t it?

In his thought-provoking book “Taking Smart Risks”, Doug Sundheim explains that at the heart of the capacity to take smart risks is genuine passion, or what is called SWFF (“Something Worth Fighting For”). A SWFF must be simple, stir emotions, lend itself to a narrative or story, and inspire action. The idea is simple and powerful: Can the value investor sense, observe and measure the SWFF in the companies and entrepreneurs they invest in, as opposed to pretenders who take short-cuts, using complex financial engineering schemes and accounting tunneling manipulations to opportunistically generate short-term “wow” results that would eventually unwind in massive impairment losses?

In the month of September, we investigate a listed Asian family business that has persevered for over fifty years since 1962 in this high-electricity-rates emerging country to sell something that seems risky – air-conditioners and refrigerators to consumers and commercial clients. Mr. C, the third generation business leader of this family business, commented:

“I’m very proud of the fact that [Company’s name], at its core, is a homegrown business that is dedicated to helping [our countrymen] live, work and play in cool comfort. I am proud that our products are energy efficient, thus helping them save on electricity expenses. But even as more.. are able to purchase high-end air-conditioners, we are still looking to provide energy-saving cooling solutions that the typical [local] can afford and enjoy. After all, we believe that air-conditioning is a necessity, not a luxury—especially in a tropical country such as ours.”

Led by the capable, down-to-earth third generation leader Mr. C who believe in making available to his countrymen products and services that used to be affordable by only the rich as his family and personal SWFF, [Company’s name] is now the #1 market leader in air-conditioner (36.7% market share) and refrigeration (25.6% market share) which are under-penetrated appliances in the country, with household penetration rates at 6% and 35% respectively, amongst the lowest in Asia where its neighbours have at least twice the penetration rate, representing significant untapped market potential.

Amongst the white good appliances that are disrupted by ecommerce, the sale of aircon and refrigerator remain resilient because they require installation and aftermarket service support. [Company’s name] provides unmatched end-to-end solutions from production to distribution to aftersales services network that spreads across the logistically-challenged country. [Company’s name] has over 90% appliance store coverage nationwide and its unrivalled aftersales service business is supported by over 170 accredited installer companies; over 130 accredited service centers; over 2,000 technicians; rapid sales facilitation and service turnaround from over 1,000 merchandisers deployed at the point of sale; and 8 dedicated parts stores; and a centralized in-house call center, distribution, parts availability/support as well as regional field personnel. Its robust logistics network ensure speedy delivery and fast service response.

The company has an impressive track record of continuous product innovations adapted to local market conditions supported by 8 self-owned labs, complemented by an engineering and design team of more than 30 engineers who focus on designing and developing solutions for the consumer suitable for the local market, including patented energy-saving fan-plug technology and corrosion-resistant coating, adding value to the consumer experience.

In its commercial business, the company is working with architects and building consultants at design stage to provide customized solutions and creates a sticky partnership. [Company’s name] develop solutions for commercial clients that cover the entire lifecycle of the air-conditioning and refrigeration products, beginning with the design stage and moving through equipment scoping and selection, supply, installation and testing and commissioning and aftermarket services. As a result of providing end-to-end solutions from direct sales relationship with its sticky commercial clients, [Company’s name] has created a resilient recurring income stream in an otherwise cyclical project-based business in which players are competing on prices, discounts and bribes.

The company’s manufacturing facilities in aircon and refrigerators are the largest of their kind in the country. Interestingly, it has an innovative lean manufacturing strategy with entrepreneurial local partners who are former employees. due to its effective cost management and resilient business model integrating distribution reach, logistics and aftersales to produce scale advantages in efficiencies, [Company’s name] has amongst the lowest operating expense (OPEX) as % sales in the industry at 16.7% vs 25-30% for local and global peers.

The company’s strong top-of-mind brand equity has also attracted long-term strategic partners to add value to the customer experience. New businesses include acquiring a 51% effective interest in the local affiliate of a leading American MNC elevator-escalator company in Mar 2014 and forming a 40:60 JV with an Asian MNC giant in Nov 2013.

In terms of business nature, margins and profitability, [Company’s name] is comparable to India’s Voltas (NSI: VOLTAS), India’s #1 aircon company who is an affiliate of the Tata Group with a 20% market share. [Company’s name] has a much higher and more stable market share than Voltas and generates higher ROE at 23.1% as compared to Voltas’ 18.1%. Yet, [Company’s name] trades at a 140% valuation discount in terms of EV/EBIT and EV/EBITDA at 9x as compared with 21x for Voltas. We think [Company’s name] deserves to command a higher valuation premium for its market leadership in an under-penetrated domestic market, its strong portfolio of synergistic businesses, and its visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat. The company has a healthy balance sheet with net cash comprising 26% of book equity due to its integrated business model that has enabled the generation of steady, resilient and growing margins, profits and cashflow and the efficient employment of capital with a 23.1% ROE.

[Company’s name] may surprise on the upside with its long-term plans to expand beyond the core into businesses that leverage upon its core competencies and core business infrastructure with potential new strategic partners into kitchen solutions and building management solutions (fire & security, generators, building maintenance, remote monitoring, energy performance contracting). Sales have increased 64% in the past four years and EBIT and EBITDA growth is faster at 85% due to effective cost management. We believe [Company’s name] can build on the momentum to at least double its profits in the next 4-5 years, pointing towards a potential tripling in market cap based on EV/EBITDA 15x.

During the recent volatility in the emerging markets, [Company’s name] is down 20% since August, more than the 10% decline in the local composite stock Index. [Company’s name] interim result is also decent, with 1H15 sales +11.2%, driven by new business revenue which more than doubled yoy, and operating profit +10.1% on effective cost management (OPEX +2.2% yoy). After the fall, [Company’s name] is now trading at an attractive EV/EBIT 9x and EV/EBITDA 8.6x and we think this is an opportunity to accumulate.

We like how Mr. C has forged a unique entrepreneurial culture and strong corporate governance at [Company’s name]. The dedication and passion in finding ways to better serve customers has opened up [Company’s name] to a future of great possibilities and [Company name]’s next 50 years will be about providing innovative value-added cooling, energy-saving and building management solutions.

Finding SWFF (Something Worth Fighting For) is the process of identifying and clarifying why risk taking and sacrifice is important to you in the first place. From the below conversation, we can also understand a little more about the SWFF factor in the company and Mr. C:

Q: “[Company’s name] has an illustrious business history of over 50 years, having celebrated your jubilee year 3 years ago in 2012. Can you share with us how the success journey of the company started, and importantly, how you got started working at the family business? What are the business and personal challenges that you faced as a third-generation business leader and how did you adjust along the way?”

Mr. C: “[Company’s name] was founded by my grandfather… in 1962.., while my father… developed it into a leading appliance manufacturer… We attribute our growth and success to our unique integrated manufacturing-distribution-aftersales services-solutions model focused on customer satisfaction.

At a young tender age of 7, I spent my extra waking hours working hours working for the family business… But the harsh reality of working in a ‘real office’ struck me hard at the age of 11 as I was sent to the company’s factory to finally get my hands dirty, working alongside plant employees in a hot room with no air-conditioning where we assembled parts, even though our business was making air-conditioners. I had to work with two conditions under my father’s explicit orders: one, I cannot work in an air-conditioned room and second, I cannot eat in the executive floor so I can truly mingle with the factory workers. I think that built my character. That’s when I realized the value of hard work and the humility of hard work. It was there I also realized the value in earning the respect of employees, no matter their pay grade. I also learned to see the perspective of other people, that you see things from the ground level – and I think that gives our organization an advantage. In hindsight, the lesson my father wanted us to learn was the dignity and respect for hard work.

The moniker really given to people like myself is we are COO [children of the owner]. But in my father’s case, you have to earn the title, for you to be a CEO. We all had to work hard and know the company from the bottom up. This was why all my free time in the mornings were spent in the office to learn. It was an unforgettable and enriching experience—my father was firmly against special treatment of the COO, so I really learned what it was like being one of the factory workers. I mingled with them, and ate with them in the cafeteria. Actually, I wasn’t allowed inside the executive rooms at all.

I prefer to work in a manufacturing environment. My father was a huge influence. But even on my own, I was attracted to the idea of people designing and building things that help improve lives, and help make the world a comfortable place. Understanding how things work just fascinates me. And in terms of running a business, that is in my genes, so I had a very strong inclination towards running and growing an enterprise.”

Q: “How about the personal pressures that you face in taking over the reins of the family business?”

Mr. C: “When you join a company and you’re the owner, am I there because of my name or am I there because of what I can do? I think that challenge was more to myself than to the employees. Proving that you know we were worth the position that we carry. That, I tell you, is the biggest challenge faced by companies like ourselves where you have a family corporation, where you tend to tangle up family affairs and business affairs—that’s very critical. I have proven my naysayers and detractors dead wrong.

Being heir to my family’s empire has put a lot of weight on my shoulders. My name is on every product we carry. If you criticize our product, you criticize me. This is one challenge we face every day – proving that we are worth the position we carry. We are so passionate in building solutions worth staking our name on. They say that the third generation will destroy the business that the first generation established, but I think I was able to prove that wrong. Of course, I am proud that we… are able to carry on the legacy of my father and grandfather, and that we were able to make the business flourish even more… We are now a local company with international clout, backed by solid infrastructure and research & development ties that attune the firm to the needs of consumers.

The way I look at it is that I have a goal, that goal is clear, achieving those goals. Working every day to achieve those goals and moving to the next goals. I often tell our people in the plant – we have very big plants – and I ask them, ‘How do you eat an elephant? Piece by piece.’ And that’s what we do with our expectations. It’s not about, ‘hey, I want to be this great guy up here,’ it’s about taking that step at a time. I think humility is very important in that as a person, you are thankful with what you have accomplished. I think being humble as possible is good for this business.

Despite the success of the company, I remain hands-on in the business as I believe in the importance of team work in running the company. And I don’t micro manage. I believe in my team, from the factory workers to the corporate employees, and I trust them to do their tasks well. There is a lot of communication, constituting some 80% of my time, bringing groups together, sharing the vision, helping solve problems. You have to know your staff. If I don’t understand what they are doing, how will I motivate this organization? I’m very easy to relate with. That’s the advantage – people can easily come to me, talk to me and we discuss. But I challenge them and bring out the best in them. Every time, I try to raise the bar, motivate and challenge people to do their best and help them develop their potential.”

Q: “Can you share with us what you believe is [Company name] economic moat and unique competitive edge in garnering a market leadership position..?”

Mr. C: “[Company’s name] market leadership has been built through in-depth knowledge of the end-user and the industry as well as a proven track record which enabled us to build a strong reputation and a solid customer base. We have and continue to offer the widest range of products and the best end-to-end customized cooling solutions and backing this with excellent after sales services to meet the needs of local consumers and businesses… These cooling solutions are defined by individual customer needs and are adapted to [the local] weather conditions and use. We understand the [local] consumer by heart. The company has established its track record by introducing automatic timers into air conditioning units and our patented fan-plug technology, knowing that families switch between air conditioning and fans throughout the night to save on electricity. We also launched refrigerators with larger freezer compartments as many families use them for business. Such intimate knowledge of its target consumers has driven [Company’s name] phenomenal growth.”

Q: “Where do you see [Company’s name] in 2020 and in the next 50 years?”

Mr C: “We see a future of great possibilities… Our next 50 years will be about providing solutions – solutions that will enhance our environment – whether at home, at work, in the place of business or in areas of recreation and leisure. We are not a perfect company, but we have always strived and dedicated all our efforts and are very passionate in finding ways to better serve our customers.“

Who is Mr. C and his wide-moat family business innovator?

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published last week:


A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:

Learn more about The Moat Report Asia.

My Investment Thesis on Videocon d2h (VDTH)

Videocon d2h is a satellite television provider in India. The Indian PayTV market is the fastest growing in the world and VDTH is the fastest growing PayTV provider in India with a 20% market share.

Satellite TV is an attractive business model with recurring revenue streams, significant operating leverage and recession resistant economics. It is also a market that naturally lends itself to oligopolistic structures as growing economies of scale provide substantial barriers to entry for new competitors.

Videocon went public as a result of a transaction with Silver Eagle, a Special Purpose Acquisition Company (SPAC), which acquired a 38% stake in VDTH. Remaining shares in VDTH are owned by Videocon Group, a family conglomerate with interests in oil and gas, retail and consumer electronics.

Silver Eagle was started by two highly respected media executives, Harry Sloan and Jeff Saganasky. Between them, Mr. Sloan and Mr. Saganasky have run more than a half dozen entertainment companies and movie studios including TriStar Pictures, MGM, Sony Pictures, and CBS Entertainment. Both Mr. Sloan and Mr. Saganasky have an impressive record for value creation. Mr. Sloan started SBS Broadcasting with an initial investment of $5M and grew it into Europe’s second largest broadcaster, reaching 100 million people in nine countries and helping to pioneer the model for PayTV along the way. SBS was sold to KKR in 2005 for $2.5 billion dollars. Mr. Sloan saw similar success with New World Entertainment, purchasing the company for $2M in 1983, leading the company through multiple acquisitions, including Marvel Entertainment, before selling the business for $260M less than six years after launch. Mr. Sloan’s studio experience also includes stints as CEO of MGM Studios and Chairman of Lionsgate Films.

For his part, Mr. Saganasky lifted CBS’ television ratings from worst to first and grew network cash flow at a 25% annual clip while serving as President of the unit for five years. Apart from CBS, Mr. Saganasky also served as head of programming at NBC where he developed Miami Vice and Cheers. Mr. Saganasky has studio leadership experience as well having served as Co-President for Sony Pictures, where he acquired Telemundo and then sold it three years later for six times Sony’s investment. While at Sony he also presided over the merger of one of the world’s largest movie theater companies in combining Loews with Cineplex Odeon.

Sloan and Saganasky will be serving on the board of directors at Videocon. One could argue that their lack of experience in the Indian market makes their background less relevant, but both executives have a record of producing stellar results. In addition, their familiarity with content providers and media negotiations should yield useful insights as Videocon scales.

India’s TV Market Offers Tantalizing Growth

India is an attractive market with a long runway for growth. With an average age of 26 and a population of 1.3 billion people the potential opportunities are vast. Prime Minister Narenda Modi, elected in May of 2014, has set about reducing bureaucracy and opening up India’s economy to make it more business friendly. The reforms are having their desired effect with India’s economy on pace to grow 7.5% this year and over 8% next year.

At 168 million TV households, India has the second largest TV market in the world behind China. However, household TV penetration is low at 61% compared to other developing markets, such as China at 97%, Vietnam at 86% and the Philippines at 83%.

Historically, the Indian PayTV industry has been highly fragmented with tens of thousands of local operators selling pay TV service to connect to cable company networks. Increased modernization of India’s media infrastructure has flipped this dynamic with the growing scale of larger players resulting in a more orderly marketplace where brand cachet carries more value.

Rising incomes and increased leisure time should spur demand for home-based media and entertainment consumption. According to KPMG, the Indian TV market is expected to grow at a 16% compound annual growth rate between 2015-19.

We think VDTH represents a play on India’s growing middle class and believe the company will pay a key role in the modernization of the country’s media infrastructure. The company is currently the second largest satellite TV provider in India behind Dish India. VDTH’s marketing efforts have focused on localizing programming options as a distinct offering from packages offered by foreign owned DISH. The approach appears to be paying off with VDTH growing its market share from 11% three years ago to 20% today. In contrast, Dish India has seen its share of the market slip from 28% three years ago to 27% today. VDTH continues to narrow the gap capturing 26% of satellite subscriber additions during the first half of 2015.

Well-Positioned to Capture Additional Market Share

VDTH has a compelling program offering with the greatest number of overall channels across every conceivable package option including sports, premium and regional channels. VDTH also offers 37 HD channels as well as a suite of education focused services for children and a multi-channel music offering. Despite more channels, VDTH offers attractive price points with some of the industry’s best pricing. The company has a history of innovation in content curation and delivery with many popular channels debuting on VDTH including National Geographic, Discovery and ESPN.

One of the reasons VDTH has been so successful in capturing market share has been Videocon Group’s network of consumer electronics chain stores. Consumers can enter the store, arrange for new service and schedule installation the same day.

In aggregate, VDTH has 200,000 distributors and is the only PayTV operator with its own service centers. VDTH’s service record would make US cable customers envious with installations taking less than four hours for 97% of VDTH’s customers. VDTH keeps things running smoothly with 6,700 customer support staff, including 2,500 engineers and 24/7 call centers featuring nine regional languages in addition to Hindi and English.

Customers tend to be happy with the service, with monthly churn rates of only 0.46% compared to .70% for Dish TV India. As a point of reference, DirecTV has a churn rate of 1.35% in the US. Lower churn rates are critical as they increase the lifetime value of a customer.

Given the patchwork nature of India’s PayTV infrastructure, VDTH recognized early that a strong reputation for quality customer service would put the company in good stead. And indeed it has with a recent brand audit by KPMG naming Videocon as one of Asia’s most promising brands. India’s The Economic Times, the most widely read business newspaper worldwide after the Wall Street Journal, named Videocon as one of the best brands in 2013 and 2014 and “Asia’s Most Promising DTH (direct to home) Brand.”

Videocon’s premier brand and reputation for quality customer service should enable the company to continue to gain share from competitors.

Built-in Catalyst with Government Mandated Transition to Digital TV

Even absent additional share gains VDTH should still manage to grow its subscriber base rapidly due to the Indian government’s mandated transition to digital cable television under its Digital Access Service (DAS) initiative. Phase I and II of DAS occurred in 2013 and 2014 and phases III and IV are scheduled to be completed by December 2015 and December 2016 respectively. Phases III and IV will feature rural geographies where VDTH is favorably poised due to its vast rural distribution network and greater selection of local content preferences. Speaking to the government’s digitalization drive, CEO Anil Khera noted the growth opportunities for VDTH, “We believe that 90- 100 million homes will be making the switch to digital platforms. We are well positioned to benefit from this and we believe we will take the largest share of this opportunity, as we have in the past.”

Parsing out the numbers for the government mandated digitalization drive opportunity suggests VDTH can double its number of subscribers just from the digitalization initiative alone. The areas of focus for Phase III and IV contain 70 million homes where satellite providers have an 80% market share of the homes that have already switched to digital TV. If satellite providers maintain their share in the transition to digital and VDTH continues to capture 20% of new satellite subscribers then the company should be able to grow its subscriber base by 11 million. This would be a doubling of VDTH’s current subscriber base of 10.6 million and give the company approximately 22 million subscribers, a larger total than DirecTV’s 20 million subscribers in the US. We think these numbers are likely conservative as VDTH’s share of gross satellite subscriber additions continues to grow and averaged 26% for the first half of 2015.

Significant Opportunities for Margin Expansion

The satellite business is characterized by inherent operating leverage with a largely fixed cost base able to serve more subscribers with minimal variable costs. This is reflected in VDTH’s fixed costs as a percentage of operating revenue falling from 22.5% in 2013 to 17.2% in 2015.

An increased subscriber base also results in lower fixed costs if content fees are fixed fees rather than per subscriber. Even on a per subscriber basis, content costs are lower with a larger subscriber base resulting in increased negotiating leverage with content providers. In VDTH’s case, half of its programming fees are fixed costs with the other half assessed fees on a per subscriber basis. VDTH’s content costs have fallen from 40.4% as a percentage of revenue in 2013 to 37.0% today despite expansive growth in its channel line-up and increased carriage of premium and branded channel content. Videocon renewed all key content contracts for an average length of three years in 2015 ensuring that 95% of content costs are locked in through 2018.

As VDTH’s subscriber numbers continue to scale, operating leverage will result in higher margins. Results of recent years have demonstrated this trend with EBITDA margin growing from 7% in 2013 to 28.7% today.

Rising Average Revenue Per User, or ARPU, represents another source of margin expansion. India’s DTH industry’s ARPU lags far behind not only mature markets but other developing markets as well. The average ARPU in India is $4 per month compared to $98 in the U.S. and $12-$14 in developing markets across Asia. One way to think about ARPU is to use movie ticket prices as a benchmark. The ARPU of satellite subscribers in the U.S. is roughly 12x the average movie ticket price. This compares to a 1x ratio for Indian satellite TV subscribers suggesting there is significant leeway to raise pricing. Our interest is piqued when we discover businesses with latent pricing power.

Consolidation within the satellite TV market should be a key source of ARPU growth. At present, there are six satellite TV providers within India, compared to a typical industry structure of two providers in most other markets. The pace of consolidation has quickened in recent years with VDTH rapidly gaining share. The economies of scale enjoyed by VDTH and Dish India will make it increasingly difficult for peripheral players to compete, eventually paving the way for a duopoly or oligopolistic industry structure. Once the market consolidates there will be substantial opportunity to raise prices.

The migration to high definition (HD) programming from standard definition (SD) will also increase ARPU with the average ARPU of HD subscribers 2.5x that of SD subscribers. At present, only 10% of VDTH’s subscribers are HD but 30% of new customers select HD programming.

High Margin Advertising is an Untapped Opportunity

Increased advertising revenue presents another source of upside for VDTH. At present, Indian broadcasters control the entire inventory of TV advertising. As the market for PayTV grows, India should migrate toward the standard in other developed markets in which PayTV operators with scale are able to negotiate ad inventory for themselves in exchange for favorable channel placement. There is also the opportunity to develop original content in which VDTH would own the ad inventory.

VDTH recently launched an initiative to jumpstart ad revenues by commissioning a team of advertising sales professionals to sell ad inventory on proprietary channels. Recent channel additions, including an HD movie channel, a music channel, and a kids learning channel, should further increase potential ad inventory. VDTH has also started selling ads on its channel guide. While management has not yet put numbers to the anticipated growth in advertising revenue they have stated they expect growth to be exponential.

Deceptively Cheap

VDTH is deceptively cheap. The company trades for an EV/EBITDA of 10x based upon our estimates for 2015. This is a fine price to pay for one of the best business models we know of in the early stages of explosive growth. As a point of reference, VDTH’s main competitor in India, Dish TV India, trades for 13x EV/EBITDA. As VDTH continues to take share from Dish TV India we expect the company to fetch a comparable multiple.

Where things really get interesting is looking out two to three years in the future. We expect EBITDA growth of 30-50% a year over the next couple of years using past levels of subscriber additions, increased operating leverage and a 10% annual rise in ARPU. On our 2016 numbers, VDTH trades at an EV/EBITDA of 7x. Using a more appropriate multiple of 14x EV/EBITDA results in a double from current levels.

There is a lot of embedded optionality in VDTH’s growth prospects with the Indian government’s digitalization initiative (DAS) as well as high margin advertising revenue likely to be material to the company’s revenue growth. Looking at the level of potential subscriber additions from DAS, a 2-3x return in the shares is a reasonable outcome over the next two to three years. Even absent higher multiples, shareholders should be well served for years to come due to the compounding of profits.

Why is it Cheap?

VDTH is cheap for a number of reasons, all of which are transitory. Typical SPAC dynamics have held down shares as event focused investors have sold shares post announcement. VDTH only began trading in April and the company has scant Wall Street coverage with only one analyst covering the company. In addition, because VDTH was not brought public through a typical IPO route with its attendant road show, it has had little opportunity to get in front of investors. We trust that as Videocon continues to post impressive growth and investors familiarize themselves with the attractive economics of the satellite business, demand for shares will respond in kind.

The opportunity to own a Dish or DirecTV early in its lifecycle offers significant opportunity for compounding capital. While market operating dynamics are vastly different between India and the US, consider that DirecTV trades for an enterprise value of $62 billion dollars for 35 million subscribers (with 43% of subscribers in Latin America) while VDTH trades at an enterprise value of $1.56 billion dollars with 11 million customers.

The above post has been excerpted from the Coho Capital June 2015 Letter.

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