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Unlimited Deal: Impetus to expansion in new regions

VMART announced the acquisition of Arvind Fashions’ Value Retail format ‘Unlimited’.

* The deal will give VMART a strong headway in Southern and Western Indian, where it has no presence yet.

* At the acquisition cost of INR1.5b (or INR1,923/sq ft including capex and inventory cost), VMART would have found it difficult to set up the same organically.

* This could potentially add about 9% incremental equity value, i.e. INR309/share.

* However, Unlimited has been loss making, despite all efforts by its existing management. Thus, the turnaround could be a complicated and a longdrawn affair.

* We see VMART’s value and cost conscious approach as a silver lining in driving this turnaround.

Deal contours

* VMART announced the acquisition of Arvind Fashions’ Value Apparel Retail format ‘Unlimited’ for a cash consideration of INR1.5b. The latter operates a chain of 74 Value Fashion Retail stores across Southern and Western India and retails fashion apparel and accessories for men, women, and children.

* As part of the transaction, VMART will acquire all stores, warehouses, inventory, as well as the store brand ‘Unlimited’ for INR1.5b. It has agreed to pay an additional ~INR300m, subject to certain milestones in terms of revenue/sq ft for the next three years.

* With an average store size of 10.5k sq ft, the 74 stores generate revenue of INR5.3b at a throughput of INR6.7k/sq ft, i.e. an 18% discount to VMART.

Value creation for VMART

* Historically, Unlimited has achieved a revenue of INR7b from 75 stores, or INR90-100m/store (annual revenue/sq ft of INR10k). Unlimited posted an operating loss prior to the acquisition.

* Despite the ongoing challenges in Unlimited’s operations, it currently operates at a revenue of INR5.3b.

* VMART could leverage its cost optimization measures. After it rationalizes around five stores, it could garner an EBITDA of INR346m from 69 stores at an estimated EBITDA margin of 7%.

* VMART could leverage its expertise in creating a scalable and profitable Value Fashion Retail business model and also gain customer insights and consumption preference in Southern and Western India.

Valuation is compelling if the business can be turned around Valuation based on EBITDA VMART’s INR1.5b consideration looks compelling due to:

* Earnings approach: Assuming a revenue/EBITDA potential of INR5.3b/INR346m, the deal may be valued at 0.3x/4x its revenue/EBITDA potential. Given that the format may be loss making at present, this could seem a bit farfetched.

* Build v/s a buy approach

* Scenario 1: Consideration of INR1.5b: Estimating an average store size of ~10,500 sq ft (0.79m sq ft for 74 stores), the value works out to a mere INR1,923/sq ft. Factoring in: a) inventory cost of INR646m (INR828/sq ft) on the basis of three months of inventory and 25% potential write down (the management said Unlimited has cleaned out its old inventory before the acquisition), b) lease deposits of INR133m (INR170/sq ft,) assuming six months of deposit, the capex works out to be a mere INR722m (INR925/sq ft). This is in lesser than the cost of setting up a store for VMART.

* Scenario 2: Consideration of INR1.5b + INR0.3b: The terms of the agreement involve a contingent payment, subject to the meeting of certain milestones. Assuming a further payment of INR0.3b, the total consideration could be INR1.8b. Taking this as the base, the amount paid per sq ft would work out to INR2,308/sq ft. After reduction of inventory cost of INR646m, (INR828/sq ft calculated as per Scenario 1) and lease deposits of INR133m (six months deposit at INR170/sq ft), the capex/sq ft works out to INR1,022m (INR1,310/sq ft).

Strategic advantage for VMART

* This acquisition would enable VMART to establish a quick and wide footprint in Southern and Western India, thus marking its presence in these untapped markets.

* The move is expected to fit well with VMART’s cluster-based expansion strategy and dramatically shorten the time span required for geographical expansion of this scale in a new big market.

* With this transaction, VMART’s footprint could grow by 27% to 353 stores.

Key risk

* VMART has predominantly relied on organic growth. The valuation for inorganic growth seems compelling, provided it can turn around the format quickly.

* Key risk here is its inability to turnaround the stores, given the cultural change in the organization, which may require rampant restructuring. This could pose a big threat to further capital destruction and RoCE.

Key takeaways from the management call

* The acquisition of Unlimited will provide VMART an entry into Southern and Western India, which are huge markets. The acquisition work out cheaper than the cost of building organically. VMART has got a big headway with 74 stores at one go.

* It plans to change the brand name from Unlimited to VMART gradually, and also the private labels to products under its portfolio. The idea is to focus on the VMart store brand instead of individual product brands.

* VMART has not acquired any legacy issues or liabilities. The cleanup is complete in the form of closure of loss-making stores and getting rid of old inventory, so there is limited risk of asset restructuring.

* Additional contingent payout of ~INR300m has been agreed up to: a) 2% of revenue for the first two years, and b) 1% of revenue in the third year, if the sales/sq ft inches up to specific milestones.

* VMART expects the turnaround in Unlimited to be gradual. It would take oneyear to settle down and five years to show results. In the near term, it expects it to grow up to FY19 levels.

Valuation

* With a potential EBITDA of INR346m, at VMART’s current valuation of 22x, the acquisition has the potential to add INR7.4b to its equity value. Adjusting for the acquisition cost (INR1.8b), the deal could add INR5.6b (INR309/share) to its equity value, i.e. a 9% incremental value.

* VMART is strongly positioned to compete with regional and national players in the Value Retail segment, given its better performance v/s national peers, strong liquidity (INR3.5b cash as of Mar’21, post the INR3.8b fundraise in 4QFY21), and prudent inventory management during the COVID-19 pandemic. This acquisition will provide further impetus to earnings growth.

* We assign a 25x FY23E EV/EBITDA multiple to arrive at our TP of INR3,880 per share. Given the huge growth opportunity in the Value Fashion segment and VMART’s strong execution capability, it has the potential to sustainably garner 25-30% EBITDA/PAT growth for a prolonged period, backed by over 20% revenue growth (SSSG + new store additions). We retain our Buy recommendation.

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