Verdict: This lemon ain’t refreshing! 

IPO Snapshot:

Lemon Tree Hotels is entering the primary market on Monday 26^th March 2018 with an offer for sale (OFS) of up to 18.55 crore equity shares of Rs. 10 each, in the price band of Rs. 54 to Rs. 56 per share, by a host of investors including Warburg Pincus and RJ Corp (of Varun Beverages). Representing 23.59% of the post issue paid-up share capital, total issue size is Rs. 1,039 crore at the upper end of the price band, and no proceeds will flow into the company. Issue is closing on Wednesday 28^th March and listing is likely on 9^th April.

Company Overview:

Lemon Tree Hotels is India’s third largest hotel chain and the largest in the mid-market segment, operating 4,697 keys under 3 brands (Lemon Tree Premier for upper mid-scale, Lemon Tree in mid-scale and Red Fox in economy segment) across 45 hotels in 28 Indian cities, as of 31-1-18, of which, 68% are owned/leased while 32% are managed rooms. With a high average occupancy rate of 76% versus industry average of 65%, company has reported break-even at the net profit level for the first time in 9MFY18, reporting PAT of Rs. 3 crore on a revenue of Rs. 352 crore for 9MFY18, leading to an average daily revenue of about Rs. 4,000 per room. Over the next 3 years, company aims to add 3,038 keys across 28 hotels (of which 875 keys, 142 keys and 199 keys in the premium Lemon Tree Premier segment at Mumbai, Kolkata and Pune respectively, which are likely to yield higher margins). Also, nearly 50% of the incremental rooms will be on managed contracts, preserving capital.

Financial Performance:

During 4 year period between FY13-17, company’s revenues grew at 18% CAGR to Rs. 412 crore, while EBITDA reported 32% growth to Rs. 123 crore, as EBITDA margin expanded to healthy 30%. However, since FY13 till FY17, its bottomline has been in the red. Higher interest outgo of Rs. 78 crore (to fund expansion debt) coupled with huge depreciation burden of Rs. 55 crore (on owned and leased properties) lead to net loss of Rs. 7 crore in FY17, down from FY16’s net loss of Rs. 30 crore. Finally, for 9MFY18, bottomline was in the green (Rs. 3 crore), albeit marginally so, on a revenue of Rs. 352 crore. EBITDA for 9MFY18 stood at Rs. 99 crore, translating into an EBITDA margin of 28%. Cash profit for FY17 and 9MFY18 stood at Rs. 44 crore and Rs. 43 crore respectively, leading to cash EPS of Rs. 0.54 for 9MFY18.  

As of 31-12-17, company’s net worth (excluding minority interest) stood at Rs. 803 crore (BVPS same as face value of Rs. 10), with gross debt quite high at Rs.974 crore, translating into debt equity ratio of 1.2:1. This high leverage will not decline anytime soon, as no primary money is being raised to either augment capital or repay debt. Infact, debt has shown an increasing trend, up from Rs. 625 crore (31-3-16) to Rs. 800 crore (31-3-17) and further up to nearly Rs. 1,000 crore (31-12-17) as company added room inventories. In downturn of the highly cyclical hotel business, servicing such humungous debt has led to doomsdays for many in the past. In contrast, some peers like EIH Associated (Oberoi group) have cash surplus balance sheet, which is favoured by the investors.

Objects of Issue and Shareholding Pattern:

Since the IPO is 100% OFS and no funds are flowing into the company, it is being undertaken merely to provide part exit to investors, one of which, Warburg Pincus, is invested for over 11 years now, exiting at a mere 11% IRR and its stake, through investment arm Maplewood, will halve to 12.51% post listing, from current 24.53%. Ravi Jaipuria’s RJ Corp and RKJ HUF, collectively owning 11.79%, will hold 6.79%, post OFS. These 2 selling shareholders together account for 72% of the OFS, with balance accounted for by 4 private corporate bodies and 2 individuals. Given multiple rounds of fund-raising, current promoter holding is low, at 31.07%, and will remain unchanged post listing.

Valuation:

At Rs. 56 per share, company’s market cap and EV stand at Rs. 4,400 crore and Rs. 5,350 crore respectively. Due to marginal profits, PE based valuation multiple can not be applied here, although few peers are reporting positive bottomlines. Considering cash EPS (PAT + depreciation), valuation multiple are at 78x and 40x, based on FY18E and FY19E numbers respectively, while EV/EBITDA multiples are 38x and 30x respectively, which are very aggressive based on below peer comparison:

Lemon Tree is ruling higher than all established hotel brands in India (bigger or smaller in scale) on both valuation parameters – EBITDA and cash profits. While some of them such as Asian Hotels North is clocking higher EBITDA margins of 36%, they have substantially lower valuation multiples too. Thus, pricing of the issue is steep. Moreover, as company’s new hotels get operational, stress on profitability will remain, as current owned/leased room count will spike by 50% going forward from 3,200 currently to 4,800. Also, managed rooms under development are concentrated in tier 2/3 towns where realisations are lower compared to metros.    

While promoter credentials are excellent with IIT/IIM background, 17 years work experience with Taj Hotels and AT Kearney before starting the company 15 years ago, it is not an investment worthy stock for an Indian investor with a time horizon of even upto 1-2 years, and not just listing gains/ short term perspective. Hotel stocks are anyway unpopular with investors due to their poor rewards on the bourses (which is seconded by poor returns being made by one of the PE investors making a part exit). 

Conclusion:

While the industry opportunity may be large and tempting, highly demanding nature of the service industry, cyclical turns and steep valuation expectations make this IPO unexciting. Weak primary and secondary market conditions provide no respite either.

Hence we recommend one to skip Lemon Tree Hotels IPO!

Disclosure: No interest.