Coffee Day sells shares to Blackrock, Merrill, Jupiter on eve of IPO

Coffee Day Enterprises started off its share sale at its initial public offering, which could give it a valuation of $1bn, by selling some 10.4m shares to institutions such as Blackrock, Jupiter and ICICI Prudential.

Coffee Day, owner of India's largest coffee chain, said it had raised some 3.34bn rupees ($51m) from an initial sale of shares to so-called "anchor" investors, which also included the likes of Merrill Lynch Capital Markets, Reliance Life Insurance and Swiss Finance Corp.

The anchor investors paid 322 rupees per share, in the middle of the range of 316-328 rupees at which the company is launching its IPO, which will be opened to other investors for subscription from Wednesday to Friday, ahead of the listing in Mumbai.

The anchor investors would be obliged to pay extra for the shares if the main subscription process allowed a higher price, Coffee Day said in its statement on Tuesday.

Expanding market

The announcements represents the kick-off in earnest of a flotation which has been keenly awaited being the biggest in the local market in nearly three years.

Besides being the owner of the Café Coffee Day outlets, which number some 1,500, the group also owns a coffee vending business with nearly 29,000 machines and a 590-strong kiosk chain, boasts bean roasting and exporting assets, and technology park, financial services and hospitality operations.

However, it is the coffee chain for which the group is best known, being by far India's largest, well ahead of the 180 outlets owned by Barista, the 100 by Costa Coffee, with Starbucks in fourth place with 40 stores as of last year, according to Technopak.

These companies are attempting to exploit an Indian coffee market which is expected to grow from 77bn rupees this year to 151bn rupees in 2020, according to Technopak data quoted in the Coffee Day prospectus.

Of this, coffee chains will account for 54bn rupees as of 2020, up from 26bn rupees this year.

Tough competition

However, despite the strong growth, the market is proving highly competitive, with Gloria Jeans Coffee quitting last year, and both Barista and Costa Coffee rationalising stores.

Coffee Day itself, while opening 730 stores since 2012, has closed 298 over the same period, besides closing a number of kiosks.

The group has defended its large market share, of 46% in coffee chains last year, largely through competing on prices, with its cappuccinos, for instance, selling at 79 rupees, below the 90 rupees at Barista and 120 rupees at Starbucks, according to Technopak.

The group's intends to invest some 877m rupees of its IPO proceeds – pencilled in at 11.5bn rupees -  in further expanding its café and kiosk networks, plus a further 974m rupees on manufacturing vending machines, 606m rupees on repairs and 419m rupees on a second coffee roasting facility.

However, the bulk of the intended proceeds, more than 6bn rupees, has been earmarked for repaying debt.

Broker reaction

The IPO pricing has attracted a mixed welcome from analysts, with ICICI Securities among more upbeat commentators, recommending investors buy in on grounds that the proposed market value suggests that the enterprise value of coffee business would be the equivalent of about 4.3 times sales.

That would be a discount of some 15% to the multiple at which Starbucks trades, the broker said.

However, Sharekhan has taken a more neutral view, saying the IPO values the coffee business at about 25-26 times earnings before interest, tax, depreciation and amortisation (ebitda), a valuation in line with peers.

Angel Broking also took a "neutral" stance, citing the group's poor record of profitability and complex holding structure, and saying investors wanting to buy might consider waiting for a potential correction in Coffee Day stock.

'Poor returns'

Ambit Insights put an "avoid" recommendation on the flotation, saying that all Coffee Day's divisions "have a history of poor return on capital employed".

"One needs to consider the fact that the company is exposed to not only high competition from global entrants but also to the rising capital/operating costs/needs which will make it difficult for it to post respectable returns on capital employed".