233-100
The Maharaja Dilemma
8-233-100
March 1, 2004
The Maharaja Dilemma
Teaching Note
Case Synopsis
In July 1991, the Maharaja Corporation, Sri Lanka’s largest privately-held company, entered into
a joint venture agreement with PepsiCo International. Under the joint venture partnership, the
Maharaja Corporation would commence production at its Olé Springs bottling plant and serve as
the exclusive bottler and marketer of the Pepsi, Miranda and 7-UP brands.
Over the next three years, both Pepsi and the Maharaja Corporation made further equity
investments into the joint venture. However, towards the end of 1996, the project was still highly
undercapitalized and Pepsi’s management made it clear that it was no longer willing to make
further capital investments. Thus, the case is set in January 1997, when Mano Wikramanayake,
Group Director of the Maharaja Corporation ponders the fate of the joint venture. Mano had just
returned from a grueling road-show in New York in search of a new third-party investor. But, at
the time of the case, he had received only one proposal from Donaldson, Lufkin & Jenrette
(DLJ). The proposed DLJ deal structure clearly reflects the concerns of any potential investor
considering this investment decision in Sri Lanka. As such, the case naturally stimulates the
instructor and students to analyze the investment proposal from both sides of the negotiating
table. What should the cash flows and discount rate look like from the third-party investor’s
perspective? Are there other ways for the Maharaja Corporation to mitigate specific risks and
address DLJ’s concerns?
Pedagogical Objectives
The case is designed to take on a multi-disciplinary approach, and to illustrate how in addition to
rigorous financial analysis, emerging market investment decisions encompass much needed
strategic, marketing, socio-political and cultural analysis.
Finance - The case aims to illustrate the appropriateness and accuracy of various valuation
methodologies including Multiples and Discounted Cash Flow (DCF) approaches. In particular,
the case is designed to demonstrate the use of various models that capture project risk in
emerging markets.
Marketing - From a strategic marketing perspective, this case is an excellent example of how a
unique competitive landscape can lead to surprising market share results. In particular, the breakout of carbonated versus non-carbonated segments is a key component of the case analysis and
must not be overlooked.
1
233-100
The Maharaja Dilemma
Socio-Political – Given Sri Lanka’s tumultuous history of civil war, it is imperative that any case
analysis involve a deeper examination of the country’s political environment. In particular, the
case is designed to illustrate how the existence of a peace agreement and promising economic
indicators are highly fragile and unpredictable factors when making investment decisions in Sri
Lanka.
Assignment Questions for Students
 Calculate the cost of capital for this project
 Evaluate the risks involved in this project
 Value the “put option”
Classroom Questions
 What are the principal risks involved?
 What would a foreign investor insist on in order to invest?
 Is the option really a “put”?
 How can we model a crisis?
Define the Issues
SWOT Analysis
Before embarking on a quantitative analysis of the project investment, the instructor should
engage in a detailed analysis of the project from an outside investor’s perspective. The instructor
should employ a SWOT Analysis (Internal Strengths & Weaknesses combined with External
Opportunities & Threats) to highlight the key issues that would immediately jump out at any
third-party investor. See Exhibit TN 1. In particular, the instructor should encourage students to
consider the reasons why Pepsi opted not to make any further capital investments in this joint
venture. Does Pepsi’s management team really believe that Olé is a viable and sustainable
business that can capture significant market share in Sri Lanka? Does Pepsi simply want to check
off another country box in the global expansion war against Coca Cola? These are the types of
questions that students should be discussing and mulling over before determining Pepsi’s exact
role in the venture. Moreover, it is important for students to understand that irrespective of the
joint venture’s free cash flows, the project still remains profitable for Pepsi because of the sale of
Pepsi concentrate to Olé.
Despite Pepsi’s world-renowned marketing savvy it is clear from the case that in many instances,
local knowledge of the market was not applied. The instructor should pick clear holes in the way
Pepsi handled the Sri Lankan launch and the continued marketing of its products. Again, it
appears that Pepsi may not have been truly committed to the project from its initial inception.
Students should be encouraged to take on the role of the outside investor and to seriously analyze
and consider Pepsi’s motivations and actions.
Students should also be encouraged to consider the benefits and drawbacks of the Maharaja
Corporation as the exclusive bottler, marketer and distributor of Pepsi products in Sri Lanka. Is it
2
233-100
The Maharaja Dilemma
the right company for this project? It is true that the Maharaja’s have a great deal of power and
business clout in the country, but the extent of their diversification could be both a current and
future source of weakness and inefficiency.
The instructor should continue to explore the role of the Maharaja Corporation from a strategic
marketing perspective. It would appear that the Maharaja’s have found the perfect blend of a
“pull” versus “push” distribution strategy. The company uses its extensive distribution network
to push Pepsi products in retail stores around the country. At the same time it uses its ownership
of prime broadcast and radio outlets to reach the mass-market, gain brand awareness and
ultimately pull customers into a retail outlet selling Pepsi products.
However, amidst strong Pepsi brand-name recognition, and the distribution prowess of the
Maharaja Corporation, it is important for students not to loose sight of the competitive landscape
in Sri Lanka. Specifically, the instructor should lead students to think about the break-out of
carbonated versus non-carbonated brands in the soft drink market. Although Sri Lanka does
indeed have a high per-capita soft drink consumption as compared to other countries in the
region, it is important to note that much of this consumption involves non-carbonated softdrinks. In fact, Sri Lanka is one of the few countries in the world where Coca Cola and Pepsi are
the number two and three players behind a local bottler. In terms of consumer preferences, Cola
products are not as popular as fruit-based juices and soft-drinks, such as those produced by the
local Elephant House brand. In the end, this insight could prove to be one of the defining factors
in the success or failure of the Olé venture.
Risk Analysis
When analyzing the risks of an emerging market investment, students often double count project
risks in both the discount rate and the cash flows. In this particular analysis, the instructor should
use the opportunity to outline the sovereign, operating and financial risks of the project and
demonstrate how most of these risks can be captured in the adjusted project discount rate. One
recommended method is to Campbell Harvey’s Institutional Investor’s Country Credit Rating
Calculator (IICCRC) to calculate Sri Lanka’s country risk premium.
Once the country risk premium has been determined, the instructor should translate the
qualitative risk analysis into weighted adjustments for the specific project at hand as compared to
an average project in Sri Lanka. To stimulate further analysis, the instructor should engage in
discussion surrounding the evolving nature of project risk and how in the future, it can be more
or less of a factor. This time varying risk component should be folded into the IICCRC and the
cost of equity calculation.
When discussing the cost of equity and cost of debt for the project, the instructor should not only
emphasize the evolving nature of risk factors but also the changing capital structure of the
project. This analysis should lead to the use the Adjusted Present Value (APV) method when
using the discounting the project cash flows and arriving at a Net Present Value (NPV).
3
233-100
The Maharaja Dilemma
Exhibit TN 2 provides a comprehensive guide to Olé Spring Bottlers risks from the perspective
of an outside third-party investor. In particular, the instructor should focus on the four key
project risks.
Currency Risk:
Continued currency depreciation and high inflation rates will have a huge impact on the risk of
the project. The instructor should highlight the fact that there is no natural hedge built into the
project. In short, the project’s main input – Pepsi Concentrate is paid for in U.S. Dollars while
revenue cash flows are received in Sri Lankan Rupees.
Political Risk:
Political instability and turmoil is a clear risk when assessing any project in Sri Lanka. However,
the instructor should encourage students to think specifically about how the presence of a major
international partner in the Olé venture could lead to the bottling plant becoming a prime target
for any Tamil separatist bombing attack.
Creeping Expropriation Risk:
Given that the Maharaja Corporation is the largest privately-held corporation in Sri Lanka, the
instructor should emphasize how the Sri Lankan government is beginning to clamp down and
enforce new measures to collect taxes from those companies that are not listed on the Sri Lankan
stock exchange. As such, any third-party investor should be aware of the creeping expropriation
risks that will face the joint venture moving forward.
Management Risk:
The instructor should reiterate the fact that management risk translates Maharaja’s immense
diversification into a source of weakness and inefficiency. This is certainly a viable concern from
the point-of-view of an outside investor who must gather insights into Maharaja’s management
capabilities. In analyzing this particular risk factor, students should be instructed to weigh the
benefits of Maharaja’s extensive distribution and marketing network against the negative pull of
having too many generalist managers who lack specific experience in the bottling industry.
Case Analysis – Project Valuation
Cost of Equity Calculation:
The cost of equity was calculated using a time-varying discount rate methodology using
Institutional Investor Country Credit Ratings (ICCRG). Exhibit TN-5 shows the entire
calculation. This methodology takes a constant risk-free US return of 6.33% based on the
average yield of a 5 year treasury note. It also assumes a US equity risk premium of 3.5%.
From a regression between the ICCRG ratings and sovereign yields, we determine the country
risk premium of around 17.9%. An adjustment is made for the industry beta in the US.
Risks are categorized between Sovereign, Operating and Financial and allocated weights
according to importance. In this case highest weight values were given to Currency Fluctuation
4
233-100
The Maharaja Dilemma
(~20%), Direct Expropriation (~10%), Political Risk and Uncertainty (~25%), Management Risk
(~6%) and access to capital markets (~15%). Because risks change over time, these weights also
change over time. We assumed that currency and political risks would remain relatively
constant. We assumed expropriation risk would lower over time as would management risk. We
assumed that the importance of gaining access to capital markets would however increase
significantly over time. Our rationale for this is that over time, further expansion may be
necessary especially in response to competitive threats. While the market may conceivably hold
three players, the ability to raise finance to compete effectively would become more important as
the market becomes saturated.
Each risk is given a score between 10 and -10. A positive weight indicates that the risk has not
been mitigated in terms of the current deal structure. A negative weight means that the risk has
been mitigated to the extent indicated by the value of the score. For example, in this case the
risk of currency had not been entirely mitigated since cashflows would be potentially paid in
US$ to DLJ while revenues were being generated in SLR. Consequently a score of -3 was given
to this risk. Note that these scores are arbitrary and students may score risks differently as long
as they have a justification for doing so.
Finally, we introduced some stochastic variables to simulate the probability that certain events
would occur to change the riskiness of the venture. In particular a binary variable to denote
“crisis” was introduced. This variable had a 10% chance of occurring (again the probability may
be different) but when it did, the values of the scores attached to each weight changed
dramatically. For instance, if “crisis” occurred, the currency risk changed from a score of -3 to 10 reflecting the fact that a sharp depreciation of the currency would occur making payments to
the third party in US$ a more likely outcome. This in turn would affect other factors such as risk
of default etc. Without the stochastic variation of the crisis factor, an equity cost of capital of
around 24% was returned.
Cost of Debt:
The cost of debt was calculated by taking the interest expense as a percentage of interest bearing
debt. Although currently the company has a high interest cost and would in the future look to
restructure its debt, given the high interest rate and inflationary environment in Sri Lanka we find
it advisable to continuing using the current interest cost.
Free Cash Flows:
The two major considerations in projecting the free cash flows for Olé are capital expenditure
and depreciation. We know from the industry analysis that bottling operations are highly capital
intensive. However this holds true only in the initial period when manufacturing and distribution
infrastructure is being set up. Once the operations begin, volumes increments would require a
lower marginal investment in capital equipment. Hence gradually the nature of capital
expenditure becomes more like maintenance capital expenditure. It will hold true in the case of
Olé which implies that its capital expenditure as a percentage of revenues would fall. In our pro
forma cash flow statement we assumed that capex as a percentage of revenues falls from 17.8%
in 1997 to 10.6% in 2006. Using similar logic, depreciation as a percentage of revenues would
also decrease. Our pro forma assumes depreciation decreases from 14.4% of revenues in 1997 to
5
233-100
The Maharaja Dilemma
9.9% of revenues in 2006. Further this implies that by 2006 the company achieves a near steady
state and its capital expenditures incurred correspond closely to the depreciation it claims on
assets.
Discounted Cash Flow Valuation:
 APV Approach
The preferred method to discount cash flows for Olé is using the APV approach. (Exhibit TN-4)
The instructor should highlight to students that in Olé’s case the firm’s debt/equity ratio
fluctuates constantly over time and that the APV approach helps to account for those changes in
capital structure by varying the interest tax shields benefits accruing to the firm. The WACC
approach on the other hand assumes a constant debt/equity ratio and is likely to either under- or
over-estimation of the tax benefits.
 Exchange Rate
In discounting Olé’s cash flows which are in the nominal Sri Lankan currency, we also need to
express those cash flows in US dollars terms. This is also necessary since we are evaluating the
Olé investment from the perspective of an overseas investor who invests in US dollars and would
measure his return also in US dollars. The instructor should draw the student’s attention to the
persistently high inflation rate in Sri Lanka vis-à-vis the United States. Using that data, one can
conclude that the Sri Lankan Rupee’s devaluation is primarily a result of the different in inflation
rates between Sri Lanka and United States. Further one can generalize that this trend will likely
continue over our forecast horizon since we are dealing with long-term average inflation rates.
Using PPP, one can arrive at estimates for future currency conversion rates. Sri Lanka’s historic
inflation rate which hovers around 11% and the US inflation rate at 2.3% can be used as inputs to
project how currency rates would play out over our forecast horizon. We estimated the 1997
exchange rate to be SLR 56.82 for each US dollar increasing to SLR 118.45 for each US dollar
by the end of 2006. The instructor should reiterate the importance of exchange rate risk as
crucial for this case as the investment is made in US Dollars and the investor’s returns should
also be looked at in the same currency. A further complication is that Olé is susceptible to
exchange rate risks in its cost structure as the soft drink concentrate purchases from Pepsi are in
US$ while all revenues on cola drinks accrue in SL Rupees.
 Terminal Value & Perpetual Growth Rate
The terminal value calculation is always a difficult task but in emerging markets it becomes
more difficult given the unpredictability associated with making predictions on long-term
political and economic conditions. Instead of using a terminal value multiple for which finding a
proxy is difficult, we would recommend using the final year pro forma free cash flow forecast
with a perpetuity formula to come up with the terminal value. The challenge then is to come up
with a fair assumption for the perpetual growth rate on which the terminal value is highly
sensitive. The instructor should point out to students that an educated assumption can be made
using the context for each circumstance in which the valuation is carried out. In this case, we are
predicting cash flow growth in nominal terms and thus given the inflation rates in Sri Lanka any
growth rate that is close to the expected long-term inflation rate is a fair assumption. However
the end result should be verified using a sensitivity analysis and separately by factoring the
contribution of the terminal value in the overall value arrived at for the firm. Our valuation
exercise uses a perpetual growth rate of 9% which our sensitivity analysis shows as reasonable
6
233-100
The Maharaja Dilemma
estimate since it does not cause large variations in the firm’s valuation. Similarly the percentage
of overall value coming from the terminal value is an acceptable 38%.
 Results
The results of our DCF valuation yield a significantly positive NPV in Sri Lanka Rupee terms
and a slightly positive NPV in US Dollar terms. This difference can be accounted for by the
change in exchange rates over the course of our cash flow projection period. At this stage, the
instructor could position the project as a feasible investment even for an overseas investor.
However the analysis so far has not taken into account drastic events such as terrorist attacks,
political instability etc. which Sri Lanka has been prone to in the past. After such events one can
assume that the required cost of capital is likely to spike up in the near term. How can one
account for this? This could be an interesting question for the instructor to pose to students. Is
there a way to factor this into the DCF analysis? Surely increasing the cost of capital over the
entire DCF period would be unduly unjust for evaluating this project and would result in a
negative NPV. The method we propose, instead, is for the instructor to have students introduce
the Monte Carlo simulation to their cost of capital calculation. If we can arrive at our best
estimate for the probability that such incidents will occur and how they would affect the cost of
capital, we can model this probability using a Binomial distribution for our cost of capital
calculation. Our analysis used a 10% probability of a destabilizing event occurring in any given
year. The result painted a different picture of the firm’s valuation, the firm continues to remain
an attractive investment in SL Rupee terms with a NPV of Rs.16.80 on a par value of Rs.10.
However the return in US Dollar was now negative with a DCF value of $0.17 on a par value
investment of $0.176 per share. Moreover, the probability that the value will be below $0.17
was over 66% indicating that the option was more likely to be exercised than not. The instructor
can use this as an example of how marginally positive valuation should be closely scrutinized
because as in this case these valuation can become negative if addition levels of complexity like
negative random events are modeled into the analysis.
Multiples Valuation Approach:
The instructor is encouraged to lead students into a discussion surrounding the appropriateness of
a multiples approach to value the venture. In conducting this analysis we recommend that
students use outside sources to gain better knowledge and understanding of the soft drink market
and the key players on both a global and local level. Given the lack of competitors listed on the
Sri Lankan stock exchange, we focus our analysis on two comparable companies - Ceylon Cold
Stores and Maskeliya Plantations. Although the latter is a tea-based company, we feel that its
asset base and size provide a reasonable proxy of Olé’s risk.
Given the limited data, we chose to analyze our comparable firms based on the Price/Earnings
metric. The furthest forward looking EPS estimate that was consistently available was for the
Year 1998. As such, we used a 1998 weighted EPS (60% Ceylon Cold Stores & 40% Maskeliya)
to calculate a Price-Earnings multiple for Olé.
Exhibit TN-3 illustrates how purchasing power parity was used to convert Olé‘s revenues in Sri
Lankan Rupees into U.S. Dollars using the forecasted inflation rates for both countries.
Nonetheless, it is extremely important to note that instructors and students alike should remain
7
233-100
The Maharaja Dilemma
deeply critical and cautious of this and other multiples valuation approaches in this emerging
market setting where they is a lack of obvious and appropriate comparable companies.
Further Analysis
 Value of the Put Option
DLJ hold an option to be paid a guaranteed 10% US$ return after 3 years and then again after
4 years if they didn’t exercise the option before. This “put option” can be viewed as a
portfolio of equivalent securities. Exhibit TN-6 describes the option payoff. Essentially, the
option describes the payoff for a convertible bond with two conversion periods. The payoff
diagram is more akin to a “call” option than a “put”. Therefore, we value this instrument
using straight zero bonds with a call option at 3 and 4 years. The first conversion option
occurs at 3 years. The option holder will only elect to convert the bond to equity via the call
option if the equity value delivers more than a 10% annualized dollar value return.
Otherwise the option holder will elect to take the bond return. The option holder again has
the same choice a year later. Hence we value the instrument by replicating a straight 3 year
zero with a call option at strike price $0.227 and a one year zero (three years out) and a call
option at $0.249. The calls are European in nature since they are only exercisable at a point
in time. Although this “point” is one month long, a minimum of one month’s notice has to
be given before exercise and hence no extra value is derived from having a one month
period.
In our calculations we estimate that DLJ are incented to invest in a zeros with a 2% premium
to equivalent US zeros with the same risk. This means there are two components to our
calculation. First the “extra” value over and above the “normal” return expected from an
alternative use of funds and second the value of the call option. We value the call option
using the standard Black-Scholes-Merton model. For this we assumed the volatility of the
underlying stock is 30% and the risk free rate is 6%. In Exhibit TN-7 we also show the
sensitivity of the option price to changes in these parameters. Another way we could have
valued this instrument would be take equity and puts. Students electing to value this way
would arrive at the same answer through put-call parity.
Exhibit TN-7 shows the valuation of the 17,460,000 options held by DLJ. We assume an
initial exchange rate of Rs58.75: $1. The initial value invested is Rs174,600,000 or
$2,971,915.
This exhibit also shows the difference in valuation of a straight 4 year zero with call option at
$0.249 (that is assuming the 3 year option would never be exercised). The difference
between that and the original price is the value of the 3 year optionality. Additionally, we
included a liquidity discount of 50% since a hedge with the underlying security cannot easily
be formed. This is because there is no liquid traded security, nor an exchange traded option.
Based on these assumptions, we value the security at $387k. The bulk of the value derives
from the option valuation. This scenario will change if students elect to increase or decrease
the premium incentive for the zero bond investment.
8
233-100
The Maharaja Dilemma
 Monte Carlo DCF including skew
The DCF analysis using monte carlo simulation showed that “skew” is important to risk
evaluation. In this case, the probability distribution of a “crisis” event occurring was such
that it occurred 10% of the time. When it did occur it caused the discount rate to spike
upwards. This spiking causes skew in the expected distribution of returns used to evaluate
the project. Exhibit TN-8 shows the monte carlo results after including the “crisis” factor.
The breakeven level for the project in SLR terms is Rs10. Exhibit TN-8 shows that even
with skewness included, a positive NPV is likely in SLR terms. The mean is still 16.88 with
a standard deviation of 1.84. This means even at 3 standard deviations, this project would
still be valuable. Now look at the dollar return table in Exhibit TN-8. The breakeven level is
$0.176. The mean here is $0.170 indicating a negative NPV return. Furthermore, the
standard deviation is $0.020, meaning that a large loss will be more likely. Thus the
instructor can use this case to show how skew matters when evaluating projects involving
risk.
 Real Options
Given that the option of taking the funding is negative, why would the Maharaja Group agree
to the funding. A qualitative assessment of real options is relevant. They may include:
 Brand image – being associated with foreign companies allows an improvement
to brand
 Easy to JV with other multi-nationals – with two well-known multinationals,
others might be more inclined to do business.
 Other product launches through Pepsi – once one JV was operating profitably,
Pepsi would naturally choose the Maharajas to distribute future products.
 Inverted Term Structure of interest rates
Students may note that the term structure of interest rates is inverted around the time that this
case is set. Harvey 1988 (?) shows that term structure inversions are good predictors of
impending recession. However, students must be careful since this might equally mean a
prediction of inflation.
What Happened?
 Maharaja Accepted the Deal
 The Put Option was exercised after 3 years.
 Olé is currently self-sufficient
 Maharaja is planning to retain due to large capital investments
 However, willing to sell if receive a good offer
Key Takeaways /Learning Points
 Exchange rate and skew are key
 Important to model factors which skew the distribution of returns.
9
233-100
The Maharaja Dilemma
 Without modeling spikes, you run the risk of evaluating the project too
simplistically – especially if the probabilities of spike events occurring are low
but the cost of consequences high.
 Evaluating projects from only one exchange rate point of view may result in the
wrong decision being taken. All views must be taken since exchange rate risk is
important.
 Uncertainty involves time varying risks
 Recognise that risks vary over time in the same way that interest rates will vary
too.
 Model the pattern of risk variation to give more depth to a model and still retain
an intuitive structure.
 Option value underpins deal structure
 Getting a deal put through often relies on delivering value in the right places.
 In this case, DLJ walked away with $387k for virtually no risk. If the option
value had been computed more precisely, the Maharajas may have been able to
craft a deal that was cheaper and more effective at mitigating the key risks.
10
233-100
The Maharaja Dilemma
Exhibit TN-1 SWOT Analysis
Strengths
Weaknesses
 High brand awareness of Pepsi products
 Over-reliance on Pepsi and its assumed
 Established network of 45 distributors
marketing savvy
each supplying 1,100 retailers
 Unable to maximize local consumer knowledge
 Strong marketing track record
 Lack of soft drink “know-how” as a result of
 Heavy involvement in infrastructure
diversified business units and generalist
ventures - $3 billion worth of projects in
managers
the pipeline
Opportunities
Threats
 High per capita soft drink consumption
 Non-carbonated substitutes, such as juices and
– average of 22 servings compared to 5
tea brands are maintaining a strong foothold in
for India
the market
 Opportunity to distribute Pepsi snack
 External threat of labor strikes and power
foods in the future
outages
 Political instability and civil unrest
11
233-100
The Maharaja Dilemma
Exhibit TN-2
Risk
SOVEREIGN
Currency Risk
Rank
Description
Very High
Expropriation Risk
(Direct &
Diversion)
Expropriation Risk
(Creeping)
Commercial
International
Partners
Political Risk
Med
Currency depreciation and high inflation could lead to an increase in input
prices for Pepsi Concentrate. Revenues in Rupees and Main Input in US
Dollars
Medium risk of direct government seizure of assets. Government has history
of seizing private assets.
Corruption Risk
OPERATING
Technology Risk
Med/High
Management Risk
Med/High
Resource Risk
Low/Med
FINANCIAL
Probability of
Default
Access to Capital
Markets
High
Low
Very High
Low
Low/Med
High
High risk of the government targeting and collecting cash flows in the form
of higher taxes from privately-held companies
Pepsi’s brand name and involvement in the joint venture sends a strong
positive signal to other potential international investors and partners
Risk of political unrest in the form regime change and labor strikes.
Bottling plant may be the target of a Tamil separatist attack
Immense political nepotism, bribery and threat of corruption.
Bottling Technology is unlikely to advance beyond the capabilities of the Olé
Springs Plant.
Given Maharaja’s immense business diversification, there is much
uncertainty about Maharaja’s ability to efficiently focus on the management
of the bottling and distribution of Pepsi products
Aside from the Pepsi concentrate, there is significant reliance on production
and supply-side inputs from within Sri Lanka, including sugar, carbon
dioxide and glass bottles.
The Maharaja organization is well financed. Pepsi also underwrite the
project and so default is unlikely.
As a private company not listed on the Sri Lankan stock exchange, there is
illiquidity risk and a restriction on the ability to raise capital.
12
233-100
The Maharaja Dilemma
Exhibit TN-3
Comparables
Valuation
Earnings 98E
(US$ mn)
Olé Springs Bottlers
0.452
Inflation (Sri Lanka)
11%
Inflation (US)
2%
Exchange Rate using
PPP (R/US$)
59.24
Average of 97 and
98 Exchange Rate
Comparables in
Beverage Industry
Ceylon Cold Stores
(soft drinks)
Maskeliya Plantations
(tea)
Market
Capitalization
(US$ mn)
Earnings
98E
(US$
mn)
EPS 98E
12-mth Price Range
(Rs)
Price/Book
Value (X)
Par Value
(Rs)
Shares
In Issue
(mn)
164.9 - 50.9
0.8
8
10.8
19
3.61
19.8
2.4
10
20
11.5
4.56
13.5
49 - 33.8
1771.2
2-year leading
Market
Cap/Earnings
Ceylon Cold Stores
5.26
Maskeliya Plantations
2.52
Market
Capitalization
(US$ mm)
Olé Springs Bottlers
Ceylon Cold Stores
(60%)
$
2.379
Maskeliya Plantations
(40%)
$
1.140
Intrinsic Enterprise
Value for Olé
$
1.884
13
233-100
The Maharaja Dilemma
Exhibit TN-4
OLE SPRINGS DISCOUNTED FREE CASH FLOW STATEMENT
APV Method
Cash Flow from Operations
Add Cash Interest paid
Less Interest Tax Shield
Capex
1997
146,818
42,000
(12,600)
(67,000)
1998
78,247
49,660
(14,898)
(78,710)
Free Cash Flows
Free Cash Flows (US $)
1
109,218
$1,922
2
34,299
$556
3
65,222
$975
APV Value
Cost of Equity (Time Varying)
Discount factor
Discounted FCF
Discounted FCF (US $)
Discounted FCF
Discounted FCF (US $)
23.7%
0.81
88,274
$1,554
504,792
$6,340
24.1%
0.65
22,341
$362
Tax Shield Value
Cost of Debt
Discount factor
Discounted Tax Shield Value
Discounted Tax Shield Value US $
Tax Shield Value
Tax Shield Value (US $)
22%
0.82
10,334
$182
109,226
$1,303
0.67
10,022
$163
Terminal Value
Terminal year FCF
Terminal Growth Rate
Terminal Value
Discount factor
Present Terminal Value
Present Terminal Value US $
1999
2000
116,087 165,950
58,213
67,670
(17,464) (20,301)
(91,614) (105,664)
figures in 000's SL Rupees
2001
214,421
78,019
(23,406)
(120,764)
2002
270,787
89,220
(26,766)
(136,756)
2003
2004
2005
337,997
405,869
485,005
101,196
113,827
126,945
(30,359) (34,148) (38,084)
(153,412) (170,414) (187,347)
2006
Terminal
576,861
140,323
(42,097)
(203,681)
4
107,655
$1,483
5
148,271
$1,883
6
196,485
$2,299
7
255,422
$2,755
8
315,135
$3,132
9
386,520
$3,541
10
471,406
$3,980
24.2%
0.52
34,213
$511
24.4%
0.42
45,413
$626
25.2%
0.34
49,975
$635
25.3%
0.27
52,838
$618
25.5%
0.21
54,740
$590
25.6%
0.17
53,763
$534
25.8%
0.14
52,417
$480
25.8%
0.11
50,818
$429
0.55
9,635
$144
0.45
9,186
$127
0.37
8,687
$110
0.30
8,148
$95
0.25
7,579
$82
0.20
6,992
$70
0.17
6,396
$59
0.14
5,799
$49
11
26,448
$223
471,406
9.00%
3,489,338
0.11
376,151
$3,176
14
233-100
The Maharaja Dilemma
Exhibit TN-4 cont’d
Firm Value
APV Firm Value
Terminal Value
Tax Shield Value
Total Firm Value
SL Rs.
US $
% of value
504,792
$6,340
50.98%
376,151
$3,176
37.99%
109,226
$1,303
11.03%
990,169
$10,818
100.00%
Equity Value
Total Firm Value
Less Debt
Less Preference Share Capital
Total Equity Value
# of Equity Shares
Value per Equity Share
SL Rs.
US $
990,169
$10,818
(112,825) ($1,986)
(944)
($17)
Par Value
876,400
$8,816 Par Value Rs.
10
47,697
47,697 X Rate
56.82
18.37
$0.185 US $ Par V
$0.176
15
233-100
Key Drivers
FOREIGN EXHANGE RATE USING PPP
SL Rs. : US $
Inflation in SL
Inflation in US
The Maharaja Dilemma
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
56.82
11.0%
2.3%
61.65
11.0%
2.3%
66.90
11.0%
2.3%
72.58
11.0%
2.3%
78.76
11.0%
2.3%
85.46
11.0%
2.3%
92.72
11.0%
2.3%
100.61
11.0%
2.3%
109.16
11.0%
2.3%
118.45
11.0%
2.3%
13.4%
55,000
12.8%
64,900
12.2%
75,911
11.6%
88,029
11.0%
101,220
10.4%
115,407
9.8%
130,461
9.2%
146,195
8.6%
162,349
8.0%
178,584
16.3%
15.5%
14.7%
13.9%
13.1%
12.3%
11.5%
10.7%
9.9%
9.1%
2,427
183
2,610
70%
1,827
7.5
244
350
(106)
430
2,729
278
3,007
70%
2,105
7.5
281
244
37
430
3,046
396
3,442
70%
2,410
7.5
321
281
41
430
3,379
539
3,918
70%
2,743
7.5
366
321
44
430
3,726
710
4,436
70%
3,105
7.5
414
366
48
430
4,084
912
4,996
70%
3,497
7.5
466
414
52
430
4,452
1,148
5,600
70%
3,920
7.5
523
466
56
430
4,826
1,421
6,248
70%
4,373
7.5
583
523
60
430
5,205
1,735
6,940
70%
4,858
7.5
648
583
65
430
5,584
2,092
7,676
70%
5,373
7.5
716
648
69
430
Invetory/Receivable/Payables
PCI - Net Sales
OLE - Net Sales
Total Sales
PCI - Contribution ratio
OLE - Contribution ratio
Cost of Sales - Pepsi flavours
Cost of Sales - OLE flavours
Total Cost of Sales
383,513
26,674
410,188
46.00%
54.00%
221,501
188,686
410,188
463,452
43,245
506,698
47.50%
56.20%
266,016
221,934
487,950
556,233
65,552
621,785
49.00%
58.20%
317,110
259,906
577,017
663,304
95,011
758,316
50.25%
59.70%
377,262
305,601
682,863
786,176
133,297
919,473
51.25%
60.70%
448,243
361,353
809,596
926,397
182,378
1,108,775
52.25%
61.20%
529,440
430,205
959,645
1,085,530
244,552
1,330,083
53.25%
61.20%
621,814
516,072
1,137,886
1,265,129
322,479
1,587,608
53.25%
61.20%
742,207
615,992
1,358,199
1,466,696
419,222
1,885,918
53.25%
61.20%
881,667
731,736
1,613,403
1,691,647
538,281
2,229,928
53.25%
61.20%
1,042,491
865,212
1,907,703
Inventory / DirectCOS - 2 mnths
Receivables / Net Sales - 55 Days
Payables - 90 Days
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
15.00%
15.00%
25.00%
DEPRECIATION & CAPEX
Depreciation as a % of revenues
Depreciation
Capex as a % of revenues
WORKING CAPITAL ASSUMPTIONS
Bottles & Crates
PCI flavours 8 oz cases
OLE flavours 8 oz cases
Total Volume
Glass sales %
Glass sales - raw cases
Turns
Glass required
Glass in hand
New Glass required
Unit cost of Glass & Crates
WORKING CAPITAL
Invetory
Receivables
Payables
1996
108,059
50,255
54,113
Glass Bottle Deposit per Crate
Changes in Working Capital
Glass & Crates
Inventory
Receivables
Payables
Glass Bottle Deposit
INPUT ASSUMPTIONS
Cost of Capital
Terminal Growth Rate
Tax Rate
101,780
45,752
46,531
(11,273)
48,434
(27,664)
1997
61,528
61,528
102,547
1998
73,192
76,005
121,987
1999
86,552
93,268
144,254
2000
102,429
113,747
170,716
2001
121,439
137,921
202,399
2002
143,947
166,316
239,911
2003
170,683
199,512
284,471
2004
203,730
238,141
339,550
2005
242,010
282,888
403,351
260
260
260
260
260
260
260
260
260
(12,995)
(15,922)
(11,664)
(14,476)
19,441
9,627
(15,266)
(17,478)
(13,360)
(17,263)
22,267
10,568
(17,445)
(19,097)
(15,877)
(20,480)
26,462
11,547
(19,712)
(20,769)
(19,010)
(24,174)
31,683
12,558
(22,280)
(22,486)
(22,507)
(28,395)
37,512
13,596
(24,954)
(24,235)
(26,736)
(33,196)
44,560
14,654
(26,879)
(26,005)
(33,047)
(38,629)
55,078
15,724
(30,209)
(27,781)
(38,281)
(44,746)
63,801
16,798
(33,853)
(29,548)
(44,145)
(51,601)
73,575
17,866
2006
286,155
334,489
476,926
260
24%
12%
30%
16
233-100
The Maharaja Dilemma
Exhibit TN-5
17
233-100
The Maharaja Dilemma
Exhibit TN-6 – Option payoff
Call Option
0.249
0.22.7
Bonds
0
0.227 0.249
Asset Price
Payoff on the three year option exercise
Payoff on the four year option exercise
18
233-100
The Maharaja Dilemma
Exhibit TN-7 – Option valuation
Bond Values
Assume "normal" 8% return
Actual Return (10%)
"Normal" Return
XS Return
PV
Call Option
Spot Price
Exercise Price
Time
Volatility
Risk Free
Option Price
3yr zeo
0.227
0.214
0.012
0.010
3,1 zero
0.023
0.018
0.005
0.003
3 year call
0.17
0.23
3
30%
6.00%
0.028
1 year call
0.17
0.25
1
30%
6.00%
0.004
Value of security
Total Value
Illiquidity Discount (50%)
Volatility
PV Sum
0.013
4yr zero
0.25
0.23
0.02
0.013
PV Sum PV 4 year call
0.17
0.25
4
30%
6.00%
0.032
0.031
0.045
779,955
389,977
0.044
775,053
387,526
risk free
0.0447
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
6%
0.022
0.027
0.033
0.039
0.045
0.051
0.056
0.062
0.068
0.073
0.079
6.50%
0.022
0.028
0.034
0.040
0.046
0.051
0.057
0.063
0.069
0.074
0.079
7%
0.023
0.029
0.035
0.041
0.047
0.052
0.058
0.064
0.069
0.075
0.080
7.50%
0.024
0.030
0.036
0.042
0.047
0.053
0.059
0.065
0.070
0.076
0.081
19
233-100
The Maharaja Dilemma
Exhibit TN- 8 – Including Skewness in return distribution
Table 1 – SLR Return
Table 2 – Dollar return
Skewness of distribution - (showing discount rate)
20