In my last blog on Motus (see here: https://what-the-finance.com/2019/02/22/maybe-motus/ ) I mentioned why I don’t like entities that take on too much debt. And Taste (which went from trading at R5 to R0.1) is a prime example why. So, lets have a closer look at what happened.
Taste has two main divisions, namely luxury goods (NWJ, Arthur Kaplan and World’s Finest Watches) and food (licences Starbucks and Dominos and owns The Fish & Chip Co and Maxis) with the main shareholder being the Riskowitz Value Fund. The rest of this blog is mainly going to cover Starbucks and Dominos as this is where things started going a bit pear shaped.
Starbucks
Being a coffee addict, the news that Starbucks was coming to South Africa got me very excited. But Starbucks hasn’t been doing too well. Why? Well firstly, to set up a store, it requires a considerable capital outlay of approximately R15mil. Starbucks success is also based on the concept of it being a place people will be when they’re not at work or at home. Their cafes have lovely décor, relaxing music and fantastic free Wi-Fi which you can walk into on your way to work. But does this work in South Africa? Starbucks target market are working individuals, most of whom in South Africa drive to work (and don’t walk past a Starbucks on their way to work). Now I don’t know about you, but I’m not going to stop at Mall of Africa on my way to work, pay R10 for parking, spend 20 mins getting lost in the mall to find Starbucks and pay a premium for a coffee which doesn’t taste (no pun intended) any better than a coffee at Seattle or Vida.
Domino’s
One of the main reasons to Domino’s success was the ease of which one could order a pizza off their mobile app. Over the years they’ve built considerable customer loyalty and brand reputation. It also hasn’t been doing too well in South Africa, but why? Well before Domino’s came to South Africa, we already had the likes of Mr. D and Debonairs (and more recently, Uber Eats). So, if Domino’s isn’t competing on ease of delivery and their pizza doesn’t taste any better than the likes of Debonairs, then why would I pay a premium for their pizza?
Going forward…maybe
Now based on the above, Taste took on too much debt to try and fund rolling out Starbucks and Domino’s which they could not afford with their existing cash flows. This ended up with them having to make a rights issue of R398mil to settle their debt (after breaching covenants), restructure their Board of Directors and relook at their strategy. Will this work? Their latest SENS announcement states that they need R700mil over the next 7-8 years before they start generating “positive” free cash flows! They also mention that they’ll need 150-200 Starbucks Cafes and 220-280 Domino’s Restaurants. With a company that can’t generate any positive cash flows from their operations, where are they going to a find a minimum of R1.5 billion just to establish 150 Starbucks Cafes alone? I doubt any bank will want to finance them, another rights issue seems unlikely and just how deep is the Riskowitz Fund’s pockets to keep on financing them? A delisting is becoming to seem inevitable.
Valuation
Valuing Taste is a seemingly impossible task, but I’m going to give it a go. Valuations of entities with negative earnings become a bit more tricky. We have to start making assumptions that the entity will resolve all it’s problems or whether it will go bankrupt. Assuming the Board of Directors will miraculously be able to turn it around, I’ve come up with the following:
I’ve determined a cost of equity using a beta of 1.5 (beta is essentially a measure of relative risk. It tells you how risky a stock is relative to an average risk stock) a risk-free rate of 6.21% (the RSA186 bond rate adjusted for default risk) and applied a country risk premium for South Africa of 3%. Assuming positive free cash flows will be generated, and revenue growth/margins will normalize after 7 years, I’ve come to a value of 3 cents per share. This is a lot less than the current share price of 14 cps.
Conclusion
It’s always easier to see where things went wrong with the benefit of hindsight. Would I buy shares in Taste? No. Perhaps I’ve missed something in the valuation above, but I just don’t see how they’re going to turn this one around.
If you have any ideas, comments, recommendations or any questions on how I did the valuation, let me know!
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