Why I Bought Thomas Cook

thomas-cook-logo Lecture delivered at MDI yesterday based on work done as of July 2013.


Note: I am long Thomas Cook, and hence you should assume I am biased in its favor.

121 thoughts on “Why I Bought Thomas Cook”

  1. Fantastic piece. Bit coin can be a black swan though. Lol 🙂


    Sent from my iPad


  2. hello sir am following you since long sir i am fascinated by the way you teach value investing i am not fortunate enough to be taught by you. i just given my CA final exams i am very much interested in value investing but am not getting a clue how to start it,like knowledge base requirement and all like stuffs,sir it would immensely helpful if you throw some light on the above issue and please provide your valuable guidance on how to start career in value investing.
    your fan cum follower -devendra pancholi

  3. Thanks for the presentation Prof.

    I have been thinking of travel and its potential in India (both from investment & entrepreneural perspective). There are more Indians travelling than ever before – both domestic & abroad. And still, its only a small figure.

    As a culture, we weren’t much of travellers (holidaying was about visiting relatives / temples). We still largely don’t, but when I see an elderly relative traveling with his family on an East Asia trip, I can see things changing. (He got his passport just 1 month before the trip). These are mostly packaged tours (which I, as a DIY traveller / backpacker, hate so much ).

    Then there’s the younger gen, esp IT crowd thats already exposed to outside India, thanks to office travel. They want more options. In my business, I regularly bump into many who have done an African safari or an expedition to Borneo / Papua New Guinea or saving up for a trip to Pantanal or Kamchatka. The average cost of these trips is a lakh or two at minimum. It’s still a niche though, but increasing. Plus these travellers are to a good extent not bothered about inflation if you look at how the rates have jumped for these trips in 4-5 years.

    Then there’s the bolder crowd – a guy I bumped into recently had quit his job and preparing for his “gap year” – travelling around India and abroad (cheaper countries only since his wallet was not too deep).

    If you look at proxies like DSLR sales, you notice that the Indian market is growing fast (1.5 lakh units in 2011, 2.5 lakhs unit this year and expected to double by 2015 or so – plus there’s the grey market).

    Long story short, though the market is still niche, I see these positive factors
    – low penetration
    – increasing disposable income & willingness of customers to spend
    – not too bothered by price hikes
    – a customer who is opening up to the opportunities around him and wants to explore the world more
    – pressure of social media on having an ‘interesting life’ (sorry to say this, but a good driving factor of few of these things is the pressure to keep-up-with-joneses attitude we have)

    Where I differ is – the driving factor behind this industry is to an extent superficial, at least the way I see it. If you took a hike in the US National parks, there’s a good chance you’d bump into people camping / very enthusiastic and wanting to spend more time with nature and if you strike a conversation with them, you know they’ve been doing it for years almost like a habit and that they really love it. We seem to be travelling more for the social status and bragging rights that it gets us, more like bucket list travellers who do it once and are done with it – I would love to see this change a bit to convince me that its not a superficial interest.

    But yes, travel (and its proxies) sure is an exciting place to be in India.

    I did look at Thomas Cook in the past, but then didn’t see it the way you did and thought it was expensive – plus I didn’t quite understand its forex strengths and was confused about IKYA. Makes me go back to the research table again.

    Sorry for the long comment.
    1. What other opportunities do you see in travel in India?
    2. Since you read a lot, any good reading material on travel industry you know of?

    Thank you Prof. Every time I hit your site, I learn something :).

    – Prem

  4. Dear Sir,

    Since I have covered Indian travel and tourism industry as a sell-side analyst, I had met the ED Finance of Thomas Cook approx 3 years back. The thing that attracts me towards the industry is its ability to generate negative working capital. While all the points mentioned by you about TC are valid, there are points 2 points, that I have to add:
    1. The top layer is very relaxed. It could be because India was never a significant part of the overall plan at the British headquarters.
    2. Heavy cost structure – You have mentioned and discussed this point very well in your PPT, so i can afford to skip.

    The franchise/infrastructure created by the company in last 100+ years is incomparable. I think following 2 points can help them turnaround things faster:
    1. Add India as a travel destination choice across 4000+ distribution shops of Thomas Cook worldwide. ED had shared the plans, but seeing the performance of last few years, it seems that hardly anything has moved on this front.
    2. Need to make top mgmt more accountable. In slide 3 of your PPT, you have covered the changed structure.

    I had issued a 3 pager visit note on the company in July 2010. If required, can send the same.

    Again appreciate your work.


  5. Manav, the transfer of control to Fairfax and the subsequent acquisition of IKYA changed everything.

    Mr. Buffett talks about three types of businesses to invest in: (1) scalable businesses which can take in a lot of capital and re-invest it on incremental rates of return which are enticing; (2) large sized but not very scalable businesses which throw of excess cash which can be paid out or redeployed on rates of return which are enticing; and (3) scalable businesses which earn high returns on capital where growth occurs without requiring much incremental capital.

    As per my understanding, TCIL owns (2) and (3).

    Would love to have your note. Please mail it to me.


  6. Sir, no doubt this is a very good and reliable company. But my main objection is that this company has a 4 year average return on net worth is just 11-12% and an average 4 year profit growth rate is just around 8%. And right now it is available at a monstrous P/E of 40 and a P/B of 4.5. Couldn’t we find better and faster growth stories at a much more reasonable price than this?


    Amit Goyal.

    1. Amit, redo the computations of RONW by focusing on tangible net worth. There is a large goodwill (intangible) on the balance sheet which arose out of an (in my view, expensive) acquisition in the past. If you strip that out, then you get to see the true economic attractiveness of the business.

      Also read excerpt from Mr. Buffett’s 1983 letter in which he advices us that when we are evaluating the economic attractiveness of a business, we should focus on tangible assets.


      We believe managers and investors alike should view intangible assets from two perspectives:
      1. In analysis of operating results – that is, in evaluating the underlying economics of a business unit – amortization charges should be ignored. What a business can be expected to earn on unleveraged net tangible assets, excluding any charges against earnings for amortization of Goodwill, is the best guide to the economic attractiveness of the operation. It is also the best guide to the current value of the operation’s economic Goodwill.


      As for your computation of P/E multiples, I would advice you to focus on operating cash flow, not reported earnings.


      1. sir if we will not consider the good will , then it will have to be written off .. creating negative effect on Profits and balance sheet .

        In this case the good will of amount 145 crs was from take over of a established business, if say that it has to be written off say in next 10 yrs will reduce the profits by 14.5 crores every year .
        That would be a huge draw down on the earnings and other financial ratios .

  7. Hi Prof,

    Some unanswered questions on my mind….

    Since Thomas Cook is now going to be the new investment vehicle for Fairfax in India, is it not fair in your view to value this as an investment holding company, as compared to being a travel and forex business, since the business could look very different in let us say 5 years??

    Are we essentially not betting on Prem Watsa, the man and not Thomas Cook, the business? If he can replicate his past success then of course we should. But can we be certain that he will? There are numerous examples of attempts at replicating the Berkshire model. Very few have tasted success.

    In essence, are we not outsourcing money management to Fairfax? In that sense, is an investment vehicle like Thomas Cook (or for that matter Piramal Enterprises) appropriate or would you be simply better off being in a mutual fund? Should we not compare the costs of this outsourcing with a 2% MF expense structure?

    How would you value such businesses? Would you apply a holding company discount?

    By suggesting that we are getting Thomas Cook at near about the same price as Fairfax bought in, are we not falling for an irrelevant anchor? Does it matter as to what price the promoter bought in?

    Would be great if you could address these confusions.



    1. We can’t be sure about anything relating to the future Abhinav. Mr. Watsa also invested in Blackberry. I read his thesis on that investment and did not agree with it. I agree with his investment in TCIL.

      While there is some empirical evidence that blind replication of whatever other smart investors do works, I feel that the presence of smart investor should be a secondary reason to own a business. The price that Fairfax paid is relevant because Mr. Watsa, in my view, correctly focussed on cash flows and not reported earnings, which materially understate economic earnings of the business. Moreover, once the IKYA acquisition happened (before I looked at the company carefully), the value of the stock went up materially in my view, but the stock market ignored that. So, the idea of buying into a price near about what Mr. Watsa paid (before the accretive effect of IKYA acquisition) made a lot of sense to me. The anchor of Rs 55 should be seen together with another anchor of 10 times operating cash flow (after adjusting for surplus real estate).

      As for holding company discounts, I think they are largely justifiable because most such companies deserve that discount due to misallocation of capital. When you’re not worried about misallocation of capital, then you should also not worry about holding company discounts provided you are thinking in terms of decades and not quarters, months, or even years.

      I am less worried about misallocation of capital at TCIL after it was acquired by Fairfax, than before.


      1. Sir how will you rate the acquisition of sterling resort by thomas cook .
        how this acquisition will effect the financials in the coming years .
        will it negate the positives we are expecting from the ikya .

  8. Thanks a lot sir for another good post. Actually I did detailed study of Thomas cook around the same time and even attended AGM, but I was wrongly focused on more on PE multiple which was more than 20x at that point of time and betting that next two quarters might be weak which might give better entry point, which was a mistake. But leaving aside the valuation part, I was and still not able to understand how to analyse a company which is present into completely unorganized sector.

    I was not bothered much about their travel business, as I felt it’s a very asset light business model and whatever cash is generated will get reinvested in better business [was betting on presence of Prem Watsa]. Again brand does play an important role when choosing a travel house, as person going on vacation needs peace of mind.

    But could not solve the puzzle on their FX business. Not sure if I am right, but I read somewhere that their retail forex business is the major part of their FX business. Now people who go on travel with Thomas cook, it’s not necessary that they take FX from Thomas cook only. They can shop around for best rates before going on travel. I think, it’s more economical to withdraw cash from ATM using debit cards rather than exchanging money with Thomas cook. More over with presence of so many unorganized players in FX market, how to take call on sustainability of margins in retail FX business. Would be great if you help me how to analyse companies which are present in unorganized sector like FX and where brand may not be important [its important in travel but not for FX]. I can understand for travel business, Relaxo and Kewal Kiran where brand plays a role, but FX?

    Any how I took a small bet of around 1% completely betting on Prem Watsa, as I was able to buy at price at which he invested into the company.

    1. While holiday travelers who buy packaged tours from TCIL are not required to buy forex from Thomas Cook, the vast majority of them do. They do that despite Thomas Cook charging higher commissions than competition. Why does that happen? There are multiple reasons some of which are:

      1. The first is availability. You are already in a Thomas Cook outlet and just purchased a holiday. Now you’re being offered a forex deal too. Most people find that hard to resist. They don’t think “um lemme go somewhere and do comparison shopping.” This availability is a direct consequence of Thomas Cook’s vast distribution network. Indeed, you can now buy forex on the company’s site too and you can also buy its multi-currency card with upto 8 currencies loaded on it. Convenience, however, comes at a cost.

      Sometimes people forget to buy forex and realize it only when they are at the airport, where they pay a significantly higher prices for buying forex (partly because of a revenue sharing agreement with the airports.) And you can find Thomas Cook on all major airports in India.

      2. High contrast effect. Why you’ve already committed to spend Rs 300,000 on a foreign holiday, then buying a $1,000 in currency notes (Rs 62,000) doesn’t seem that big. Just as people don’t think too much about the pricing of accessories when they have bought a car.

      3. The brand makes it trustworthy. Its a 132 year old company. People are often worried about buying fake currency notes. They don’t have to worry about that when they buy from Thomas Cook. Paying that little extra buys them peace of mind.

  9. Few interesting points, which I am sure you must have already observed, but just in case:

    • Kuoni records the entire amount recovered from customers as sales and shows direct cost separately. Whereas Thomas cook shows revenue net of direct costs i.e it shows only commission and earnings from travel management and not the gross amount.

    • Unlike Thomas cook India, Thomas Cook plc business model is very capital intensive which was the main reason for their trouble. Company buys up hotel rooms for the year and are then get paid back when customers stay in the rooms. So, if they don’t have full capacity in the hotels they run out of money pretty quick. Apart from this they invested heavily into hotels, aircrafts etc.

    • Globally, different estimates suggest that more than 50% of leisure trips and 40% of business trips are booked online.

    • Cox &Kings distribution strategy is based more on franchisees whereas TCIL has always believed in increasing its own distribution strength and so has a substantially larger number of owned stores. However, in its outbound business, TCIL has permitted franchisees to operate. Not sure though which strategy is better.

    1. Indeed.

      While Thomas Cook accounts for revenue from travel and forex on net basis, IKYA reports revenues on gross basis (Interesting not-so-trivia question: Can you see the similarities between the forex and the HR businesses of the company?). Over time, this will have interesting consequences for the consolidated P&L account of the company (unless the accounting policy was changed). In any case, accounting consequences should have no bearing on capital allocation decisions— for companies as well as investors.

      You’ve mentioned Thomas Cook Plc’s misadventures caused by expansion into hotels and airlines with borrowed money. What were they thinking? But the more interesting story (to me at least) is about how Harriet Green brought the company back on track. One very interesting aspect of this story (which I told my class yesterday) is how Ms. Green got the Chairperson’s job at the British Company. You can read about that from here. Since she took over as Chairperson of that company in July 2012, its stock is up by 1,058% till last week, while FT100 rose by 19%. Ms. Green has been shedding assets (Thomas Cook India was one of them) and going back to a relatively less capital intensive business model that it’s Indian subsidiary always had.

      TCIL is now aggressively expanding its presence in Tier II and III markets (e.g. Thrissur, Erode, Tumkur, Bhilwara and Dhanbad), using the franchise routes. See:

      Click to access PR-TCIL-delivers-on-expansion-plan-Oct-24-2013.pdf

      Done correctly, there is franchise value in franchise based distribution. Just ask KKCL.


  10. Thanks a lot sir for your detailed answer. One thing which I have noticed is, whether its Relaxo, KKCL or Thomas cook, we can understand and interpret things better when we use various mental models [like you mentioned about contrast effect and brand for FX].Though I read about various models but never actively tried using them while analyzing any business] Recently, I tried to use various mentals models to an investment idea and I guess It was easy for me to take call on that….Thanks a lot again….

    1. Mr. Munger’s mental model framework is not just some abstract idea with little practical utility. His models from psychology alone should be applied to every business an investor is contemplating buying into for the long term, by asking critical questions like:

      1. Why would a customer not go to a competitor to buy something seemingly identical but cheaper?

      2. Why would a potential competitor not enter this market and erode its’ superior profitability.

      Some of the answers to those questions come from economics but several will also come from psychology. As Mr. Munger says, you need a checklist. And then you need to relate to what you see out there in with world to that checklist by asking a lot of questions that begin with the words “why?” or “why not?”

      1. Thanks a lot sir

        I seriously feel that I have NOT learnt even 10% from CFA qualification, as I have by going through your various lecture presentation and your posts. Thanks a lot for taking out time from your busy schedule to teach your students outside your class…

  11. Prof. Is the similarity between the forex and the HR business the fact that gross revenues are recognized whereas the actual value addition is only the spread ?

    1. Yes indeed. Another parallel is that while one model deals with buying and selling pieces of paper (currency notes), the other involves buying and selling pieces of people’s time.

      The IKYA business model is also hugely pro-social in my view because it results in upliftment of the living standards of tens of thousands of migrants from rural india who have come to the cities. These low-end jobs (although IKYA also does business in high-end professional staffing) are often the first jobs of these migrants and the money they make in the city is more than what they could hope to make in their villages. There are no jobs in the villages and the cities are a huge attractor for these people. The urbanization wave being experienced by India is a huge tailwind for businesses like IKYA.

      IKYA is a kind of a stepping stone for them for better things in life. IKYA hires these people, often from portals like naukri.com (sometimes after they have been rejected by other potential employers), trains them, and then deploys them all over the country in places like Cafe Coffee Day and Samsung stores, where they learn to interact with educated customers and while on their jobs, pick up English speaking and other social skills. Eventually, they will move up the ladder of their careers, but IKYA is the first rung of their ladder of success in life.

      Contrast that to models like tobacco, alcohol, and gambling which are anti-social on a net basis but where gains are privatized and costs are socialized.

      Somehow, I feel better investing in pro-scocial, scalable, and hugely profitable models instead of anti-social ones.

  12. Dear Sir,

    Thank you for sharing your study, and some very valuable insights.

    I have been studying Thomas Cook for a while, and was extremely convinced of the size of opportunity with the entry of Fairfax.

    As highlighted by you as well, Thomas Cook is a fabulous business with negative working capital with a meaningful float – amplified by the multicurrency prepaid card. The Co. has generated free cash to the tune of ~Rs 240crs over the last 5 year. However, my worry stems from the acquisition of IKYA Human Capital Solutions.

    As observable in the latest quarterly filling (1st quarter post consolidation with IKYA), revenues of IKYA are 3x of other core businesses, its contribution to PBIT is just 0.25 times!! Thus, though acquisition of IKYA Human Capital has been revenue accretive, profitable growth remains a concern. With economics of the business requiring significantly higher capital, coupled with minuscule margins it suppresses the overall business returns.

    It further raises questions with regards to its capital allocation decision, with the clear intent of the management to employ the surplus free cash generated by the core travel business to fund their investments.

    It would be great to receive your feedback on the same. I also have a note, which I could share with you and would love to know your views.

    1. Sahil, look deeper.

      IKYA reports revenues on a gross basis. This point was covered in an earlier comment.

      The margins look low because of this accounting policy. If you look at margin on net revenues (billings for HR clients less payments made to employees), and that’s the correct way to analyze this business, then you will be very impressed by the profitability of this company. See, for instance, slide 46 of my presentation, where EBITDA on net revenue is shown. This was 19% in FY11, 28% in FY12, and estimated 39% in FY13. As the company gets scale economics and because of its presence in professional staffing (a key differentiator with other players in the market) IKYA’s margins will grow.

      If TCIL had reported its revenues from travel and forex businesses too on gross basis, the P&L would look very unimpressive.

      While I don’t know why the company chose to report IKYA revenues on gross basis, we should focus on net revenues and margins calculated based on those net revenues.

  13. Thanks a lot for taking out time from your busy schedule, and sharing your feedback.

    I shall try and look into it further in the suggested manner.

    1. Sure, and while you do that, think of the value proposition to a typical client of IKYA (i.e. what problem does IKYA solves for its customers). Think about customer switching costs. Think about economies of scale. Think about pricing power over a period of time. And think about how scalable can this business become over the next decade or so…

      1. Sir – pardon my ignorance but can you explain how IKYA (or other temp staffing firms) work..

        Firstly – Do they hire for particular assignments and place the employees for that assignment? What happens after the assignment ends. Does IKYA continue paying them till they are placed somewhere else? Do these employees keep coming to IKYA office in the interim period or do they sit at home? Or in addition to hiring for particular assignments they have a ready pool of employees waiting for the right opportunity to get deployed?

        Secondly i would assume that their clients would have relationship with many temp staffing firms in addition to IKYA. What differentiates IKYA from others such as Adecco, Teamlease etc. What prevents their clients from changing to another firm. Or what prevents the employees from moving to a different firm which is paying higher.

        1. Kashif, watch this:

          To my knowledge, IKYA does not hire anyone without first placing him/her with a client. Moreover, these are long-term contracts. For example, about 6,000 people working in Samsung stores around the country are employed by IKYA. The company also has a very interesting subsidiary called Magna Infotech with does high-end professional staffing for IT clients. The EBITDA/employee is high primarily because of Magna. The correct way to look at IKYA is on a net revenue basis. The company charges clients every month for the people placed with them. That’s gross revenues. Then it pays the employees who work on the premises of the clients but are IKYA employees. The correct way to look at IKYA is to think of money received less money paid, as net revenues just as you’d record net revenues in a travel agency (money received from clients for tickets less money paid to airlines). IKYA appears to be a low margin business because it reports revenues on gross basis. But on a net revenues basis, it’s very profitable. EBIT Margins on net revenues for Sept 2013 quarter were about 64%. No, that is not a typo. This is a business which earns 64% margins on net revenues.

          It is also a business, if it scales up, can have even higher margins on net revenues, and that’s exactly what IKYA seems to be doing.

          The business has significant switching costs. Once a Samsung has hired IKYA’s services, it becomes difficult to switch to other HR companies. Just think about how difficult it would be for Samsung to move out 6,000 people from its various stores around the country and replace them with 6,000 different people supplied by a competitor of IKYA.

          So, the two key sources of moat are scale advantage (if you become large, you get scale advantages) and high customer switching costs.

          The fact that IKYA does not have any debt means that it’s working capital requirements are not significant. This means that the lag between payment of salaries to employees and the receipt of funds from clients is not large. Investment in net fixed assets are also low. All of this— a cash generating high margin-on-net-revenue business combined with low capital requirements means that IKYA is a very high ROIC business. And it’s growing at a rapid pace. As of now it has only 64,000 employees. I know 64k sounds like a lot but its a small fraction of what it could become if Indian labor markets became more flexible as western world’s HR markets are.

          The key value proposition for a client is that it can focus on its core competencies instead of worrying about hiring, training, firing people and also dealing with HR compliance issues. In India every state has different labor laws and MNCs like Samsung don’t want to be bothered with all of that. So long as companies like IKYA can take away this headache, they are very happy to retain them for a long time.

          And once you’re in the HR departments (or rather BECOME the HR department) of a large MNC which does not believe in cutting corners (like many smaller HR companies are willing to do by skipping the payments of Provident Funds for employees etc), the relationship with the HR solutions provider becomes quite sticky.

          Another huge value proposition is that, in effect, IKYA allows its customers to convert a fixed cost into a variable cost which makes their business model more robust and flexible. If business expands it can get IKYA to send more people to work for it and if it shrinks it can send them back. This helps the clients compete better in their markets. Of course, this flexibility comes at cost, paid to IKYA. Moreover, from IKYA’s perspective, it is acquiring a fixed cost and selling a variable cost to its clients which makes its own business vulnerable to economic contractions so it has to be very careful about planning its operations, its working capital cycle, and its capital structure, which I believe its doing well.

          The interesting puzzle is how much can IKYA be potentially worth?

  14. Sir don’t you think this pricing power wil eventually be an oblivion as the hay days of forex monopoly are over?

    1. Eventually yes, Jatin. The forex business will decline over time. Until that happens, it will throw off excess cash. The rate of decline will be a function of how quickly India becomes a non-cash economy (in my view that will take a long long time) so that when foreign tourists come to India, they can spend by swiping their cards in hotels, shops, taxis, autos etc not just in the big cities but all over India, and how quickly will most Indians going abroad obtain international credit cards to make the idea of carrying cash forex obsolete. To counter this latter risk, TCIL launched a multi-currency card with Mastercard which has multiple earnings streams for TCIL, and which has gained a huge traction since it was launched.

    1. Vinayak, there is a lot of synergy between my professional and academic work so it’s difficult to estimate the amount of time taken to prepare for a lecture like this one. if one enjoys the process however, and I do, one should not worry too much about the time. In a wonderful book titled “The Little Book of Talent: 52 Tips for Improving Your Skills,” the author writes:

      Take off Your Watch

      Deep practice is not measured in minutes or hours, but in the number of high-quality reaches and repetitions you make—basically, how many new connections you form in your brain. Instead of counting minutes or hours, count reaches and reps. Instead of saying, “I’m going to practice piano for twenty minutes,” tell yourself, “I’m going to do five intensive reps of that new song.” Instead of planning to hit golf balls for an hour, plan to make twenty-five quality swings with each club. Instead of reading over that textbook for an hour, make flash cards and grade yourself on your efforts. Ignore the clock and get to the sweet spot, even if it’s only for a few minutes, and measure your progress by what counts: reaches and reps.


      Working on a stock idea or a lecture, is not much different, in my view!


  15. Sir

    Can you please share what all the books / annual reports / others stuff you read while doing the analysis of thomas cook.

    Manish Yadav

  16. Dear Sir

    A very good article again.

    Sir can you share some of your lecture which will help in understanding the amount of capital which should be allocated to a specific security. What should be the factors one should look at before making capital allocation decisions?


  17. Hi Prof,

    Superb analysis.

    Can you share with us on what prompted you to take a detailed look into Thomas Cook? Was the trigger the news of Fairfax purchase? Or was it the outcome of any other filter? Appreciate if you could give your thought process on selecting Thomas Cook for a detailed investigation.


    1. Sridhar, I got curious when Fairfax bought the company. Then I looked deeper and found that operating cash flows exceed reported earnings and business quality is excellent. The real estate angle was interesting but not critical. Interesting because only a control investor can view the company from that angle and now the control has shifted to one who was looking at it. IKYA acquisition was very very interesting. It’s a business model worth learning a lot about. So I did…

      When owned by a distressed parent, Thomas Cook India was constrained by the parent company’s debt covenants. So, it made sense to investigate how this company’s travel business will evolve once those constraints went away. Similarly, IKYA was bought from private equity owners who just had to sell by a deadline and I was astonished to see how cheap that acquisition looked, so I got very very curious to look deeper.

  18. Dear Sir,

    Can you also pls share the valuation part of the lecture. It will also help us to understand how to value a company apart from understanding the business.

    1. Chetan, one aspect of that is covered on slide 48. I have yet to cover valuation the companies I have covered in my course. For now focus on the choice between investing in: (A) a bond that will pay you a pretax return of 10%; or (B) a business that earns about the same 10% on the price paid but has the potential to grow its earnings in a good way where incremental ROCE is high.

      Which one will you choose, keeping in mind that option (A) cannot earn you more than 10% a year on price paid and inflation alone exceeds 10%?

      1. Sir, Pretax op cashflow was 135*1/10%=1350 so you have paid up for quality wīth no provisions for margin of safety. Is it because of your coc and franchise TCIL has?
        Also why you chose bond component here and not DCF like in case of Asian Paints or EPV for valuations purposes?

        1. Jatin those numbers pertain to a period before the IKYA deal took place. Also, your computations do not factor in any growth at all.

          The implied growth rate in the market value of the firm when the stock price was Rs 55 was negligible.

      2. Definitely option B in this case as there is a potential to increase its earnings over a period of time compared to option A where the real returns will be negligible.

  19. Prof., the stock has run up to ~Rs 80 now. Do you still think this can generate 20-25% per year over next 5 years given that its trading at 14.3 times EBITDA (reasonable estimate of cashflow). Last 2 years trading average is 13-13.5 times EBITDA? Its no doubt a great quality business but stock price was almost flat for 4-5 years before this acquisition. Now that this catalyst is out of the way at 80/share, how compelling is this?

    1. Rishit, In my view, the fact that a stock is selling at 14.3 times EBITDA tells very little, if anything, about it’s current intrinsic value and future potential.

      For a moment let’s ignore travel and forex and just focus on IKYA. Take a look at IKYA’s past performance from https://db.tt/4xr7sPiw.

      Then, monitor IKYA’s progress in TCIL’s quarterly disclosures to the stock exchanges.

      How big can this business become? How profitable is it and what will happen to profitability as the company grows? Can its growth be financed without requiring substantial incremental capital (fixed or working)? Once you’ve a very good idea about the likely value of this company will be, say, a decade from now, discount that value back to the present, using a discount factor which reflects your confidence in that future value. Then, compare that estimated present value of IKYA with the company’s current market value to figure out what are you paying, if anything, for the travel and the forex businesses.

      For many reasons (one of which being that I don’t want to bias you), I am reluctant to provide my estimates here, but this is how I have looked at this company.

      In order to answer the above questions intelligently, I looked at the other successful HR solutions business models outside and inside India including Adecco, Manpower, and PeopleStrong. I also found these two books very useful to gain insights about the evolution of this industry and its role in western civilization as well as its potential in India.

  20. Sir, absolutely new to this world, not only value investing but investing as such.
    like many others here, I am deeply influenced and want to learn more.

    Following could be the most obvious questions, u cn answer at ur will if at all but pls bear..

    silde 48..You have used free cash flow for 2012..why or why dont we take the average of free cash flow for the past 5 or 10 years. isn’t the long term average supposed to give clearer and comforting picture.

    why or why don’t we deduct the interest and financial charges out from the free cash flows.. isn’t this a clear hit on available cash flows..

    You have commented that economic earnings are much higher than reported earnings.. what does this mean..when would this gap narrow down then if at all.


    1. Dear Prof,

      Is the business model of the company sustainable given the fact that more and more people book their vacations online (a trend that is likely to continue)?


      1. The threat from online travel agencies should be evaluated by asking a few questions:

        1. Does Thomas Cook’s business model commits it to distribute it’s holiday packages only through bricks and mortar store? The answer is no. Thomas Cook has a strong online presence.

        2. How well have online competitors done? The biggest online travel company in India is makemytrip.com. This company is listed on Nasdaq. Take a look at the company’s performance from http://investors.makemytrip.com/phoenix.zhtml?c=238356&p=irol-irhome. It will be an eye-opener. I did provide some clues on this in my lecture slides. See slide 55. Makemytrip is hemorrhaging cash whir Thomas Cook is generating cash. At it’s current run rate of cash burn, makemytrip will run out of cash in less than 2 years. Of course, equity and debt markets may continue to finance the operations of makemytrip, but the company’s expected performance, in my view, does not translate into a serious threat to Thomas Cook’s travel business. Indeed, the boundaries between an online and offline travel businesses is blurring as makemytrip has found it necessary to offer offline services (bus tours, guides etc), while Thomas Cook has without much of an effort moved into the online space. Check out its site for its offerings of holiday packages for destinations in India and around the world.

        As Indians increasingly start using the net to book holidays, Thomas Cook is unlikely, in my view, to suffer. Indeed, the shift to the net, over time, will simply give Thomas Cook an additional distribution channel. People want to go on a Thomas Cook holiday, not just because of its current, vast bricks-and-mortar distribution network, but also because of the pull of its brand.

        1. Going forward what would you say are the competitive advantages of its travel business?

          If asked 10 years back I would have said – a) difficulty to shop for deals (informational asymmetry) b) distribution network c) brand. It doesn’t seem like they have any special advantages that TCIL has on the cost side.

          It also seems to me the scale required to be a viable player is not that high. That is, there can be very good local players without a national presence and they will not suffer any dis-economies of lack of scale.

          In the next 10 years, given the internet and the changing consumer behavior with respect to it, one could argue that all 3 moats will likely face strong headwinds. And there should be increased competition.

          I agree that TC will also likely benefit from the additional distribution channel(l’internet). But, the point is that the competitive landscape will likely become flatter. Which usually goes with lower margins and other bad things.

          Would you agree with this argument? Is it just that you attribute a low probability to this scenario? I would love to hear more about your thoughts of the competitive advantages going forward.

          1. TCIL’s fully integrated travel and forex businesses provides the company with a competitive advantage over its competitors. To measure that, compare the profitability of TCIL with its competitors who are mostly into travel but have little or no forex business or competitors who are into forex business but have little, if any, travel business in their portfolio.

            You can also directly visualize the edge TCIL gets by having an integrated travel and forex operation. For example: (1) the company can cross sell products. 70% of travel customers also buy forex and are relatively price insensitive; (2) When the company ships out surplus forex every day and deposits in foreign bank accounts, the balances in those accounts can be used to sell travel related liabilities (payments for room nights, air tickets etc); (3) a weak rupee creates incentives to hoard currency which is good for forex business but not good for outbound travel, while a strong currency has the opposite effects, which has resulted in remarkable stability of earnings over the last 30 years.

            There are huge economies of scale enjoyed by TCIL. The company’s is India’s largest buyer of international travel components. That size provides the company with two key advantages: (1) it pays lower prices for travel components than its competitors; and (2) it pays travel component suppliers later and collects money from customers earlier, making this a negative working capital business. The scale economics are also delivered by the company’s pan-India distribution network which produces “availability”. People recognize the brand of Thomas Cook and when they see it prominently displayed in their small towns and cities, they get attracted to it.

            Just compare the cost structure of makemytrip with that of TCIL to get an idea of how much of an edge does TCIL have over that company. Then, consider that TCIL has also moved into the online space which has opened up another distribution channel for the company. Visit it’s website to see how easily it is for people to book holidays, get visas, buy forex online.

            Keep in mind that TCIL’S competitor is not companies like expedia and makemytrip alone. The company also competes with tens of thousands of small mom-and-pop travel and tour operators and those guys are losing market share to organized travel and tour operators like TCIL who have a pan-India presence.

            IKYA too has significant competitive advantages but since you only referred to travel, I will not describe them here…

  21. I am a hardcore believer of EPS growth Sir. My mental models are very simple. Look for sales growth. Then margin growth or an improvement in asset turnover which improves the ROE. At least for the stocks I go long i use the same steps. For Thomas cook I dont see a strong incentive or strong support which will bubble up sales growth. It looks like a cyclical to me. Margins are already high. I have some questions anyway:
    1. What is their management strategy for next five years
    2. I s the management convinced that they can deliver 20-25% sales growth
    3. What is the meaning in iKYA for travel and holiday company.

  22. Mr. Bakshi , I’m digressing here a bit to try an understand whether a business matters when you’ve got a great capital allocator at the helm.. for eg. how would differentiate between a revathi equip and a PEL? Apart from having float’s is there anything else one needs to consider before you make a bet on either?

    1. Wayne, if you have a great capital allocator (backed by a solid track record), then you’d also expect him/her to be allocating capital to good businesses.

  23. Thanks a lot Prof for another fascinating piece. I had just one doubt about the use of the Thomas Cook brand: I read in the presentation that TCIL has a license to use the ‘Thomas Cook’ brand for 13 years. What happens after that? Will absence of such a solid brand not impact areas concerning ‘in bound’ travel (where an established name will make a huge difference for a foreign national), their ability to buy stuff wholesale using the global network and finally, can the international company not access such a large and attractive market on their own post the mandatory period. Thanks again.

    1. That’s a very good question, Sonik, and I should have addressed this in my original post on this. TCIL has about 12 years to build its own brand. Alternatively, it can license the Thomas Cook brand again once the existing license expires. The only logical reason why Thomas Cook UK will decline this is if it has its own plans to enter India (unlikely given the cost required to re-create the distribution network). The only logical reason for TCIL to not agree to a renewal is that the license fee is too high. I asked the management and they effectively said: (1) they will build their own brand; and (2) when the time comes, they will likely request a renewal.

  24. Dear Sir , one of fan of yours and learned a lot from you in last 2-3 years , have two queries not related to Thomas Cook -as above your detailed ppt and later comments Input details a lot

    My question is related to -how much an investor (with a time horizon for may years ,as not need capital for consumption ) should put in this and similar other position which are long term play ( like Piramal , shriram and other growth companies) -in align that market may or may not identify the potential or overlooked same -or not in fancy of this because of holding company structure,.. ) for a long period of time which leads to opportunity loss as other missed investments are growing in market value

    so should we put 3-5% for these types of plays so we don’t get disturb even if the market is not realizing the value in short term and other investments are quenching the thirst of short term gains and others( not looking bad compare to market returns) or we should overcome this human weakness for comparing results and put alteast 10-15% individually
    -what works for you ,your insights will be very helpful

    second question -very specific related to accounting as being from a engineering background , even after few years of learning -can only understand the broad details of Balance sheet , cash flow and income statement but not able to grasp the finer details of how to correlate nos and check like how good are numbers , do they hold good , how to catch accounting tricks and others -so any pointer for improving in this aspect will be great


    1. Hitesh, the basic principle for diversification is that you want to protect yourself from ignorance. If you don’t feel ignorant about the future potential of a business you want to buy into (and most people don’t), and if subsequently your investment thesis turns out to be right, then you should have had a highly concentrated position in that stock. Unfortunately, you’ll never know where your confidence was justified or not until several years have gone by.

      So, you should size your positions based on your convictions, keeping in mind that the average person is over-confident, and convictions more often than not turn out to be wrong. Practically this means that if you are just starting out, then your investment philosophy should lean towards wide diversification. As you get experience, and hopefully gain well-deserved confidence, you should move towards lesser diversification (unless of course your investment strategy requires wide diversification e.g. in venture cap or risk arb type of operations).

      I can’t turn this into a mathematical formula, however, but those are the main principles which I think apply here. First, size your positions based on conviction. Second, factor in possibility of overconfidence in your conviction.

      In the past, and even now, people talk about the Kelly Formula to think about position sizing in equity portfolios. In my view, that’s a flawed idea taken from one domain (the casino where all outcomes are known and follow a bell curve distribution) and applied in another domain (the stock market where all outcomes are not known and often there are huge outlier effects). But the basic idea behind Kelly Formula of sizing positions based on conviction is roughly right in my view.

      1. Ignorance is known unknowns. Another reason for diversification is to cater for unknown unknowns (aka black swan).

        On Kelly: Ed Thorp has written a few articles about adapting Kelly to investing. IIRC, one key factor in the modification is opportunity cost.


        But I don’t have the time/skills to understand the math in his articles. So, I stick to the “spirit” of Kelly instead of the precise calculation. I like Pabrai’s 10/5/2 allocation approach.

        What do you think, professor?

  25. Thanks Professor for another interesting pick. I had followed your piramal healthcare pick & I still am invested & believe in it’s long term potential. 
    For TCIL you mentioned that operating cash flows exceeds reported earnings. When does that happen? Does it mean that management is not selecting appropriate accounting practises for income statement due to which their earnings are not correctly projected ? Earnings per share is a basic indicator for existing shareholder to know how their company is doing & for investor to know if a stock is expensive or not. So my question is when does opoperating cash flow exceed earning ?

    1. Compare earnings (before interest and depreciation) in the P&L account with cash flow from operations after working capital changes in the cash flow statement to see how operating cash flow exceeds reported earnings.

  26. Professor Bakshi, I went through the 1983 annual letter by Buffer to understand more about goodwill( both accounting & economic) & amortization which will affect earnings as referred by you. In the TCIL annual report 2012 in the consolidated Income statement, the amortization due to intangibles are Rs 3,564,411,575. If we remove it to calculate consolidates EPS, there is only small changes from Rs 2.37 to Rs 2.58, which will give a P/E ratio of 31 at current price of about Rs 80.
    Is this correct or am I missing any bigger goodwill charges? Or is P/E of 31 good for this stock & it is a Nestle kind of stock which will always command high P/E as you wrote in your Article ?

    1. When a company acquires another company’s business at a price which is higher than the target company’s per-share book value, the difference between the price paid and book value of assets acquired is recorded as goodwill. If the acquisition was overpriced, then the presence of goodwill on books, which is fictitious, would depress core ROE. That’s because the earnings acquired in the numerator, when compared with assets acquired at full price paid in the denominator will depress the ROE. Something like that happened to TCIL.

      In order to figure out the quality of the underlying assets, one should, as Mr. Buffett advises, ignore accounting goodwill. THIS is what I was referring to earlier. What you’ve done is to focus on the P&L. Instead, I would like you to figure out the core ROE of the business without counting accounting goodwill in the computation of ROE which requires focus on P&L AND the balance sheet.

      Once you’ve done that, you’d would know just how productive the operating assets are.

      A P/E of 31 doesn’t tell us much about how valuable the asset is. That’s particularly true in the case of TCIL which owns a business (IKYA) which is growing very rapidly. In my view, trying to visualize what the earnings of this company’s various businesses would look like a decade or so from now and then comparing those earnings with today’s stock price would be a better indicator of value than to compare current market value with recent earnings.

  27. Amadeus – Frost & Sullivan Report indicating a 6 fold increase in the number of Indian tourists travelling abroad over the next 20 years and UNWTO ‘s projection of a staggering 50 million Indian outbound tourists by 2020

    Sir, how much of such projections weigh in estimation of pv of future cashflows. They talk abt 50 fold jump from current 1m.

    1. Jatin, while I largely agree that there will be a significant jump in outbound travel business (including package holidays), I prefer to think about this growth potential by asking asking three questions: (1) How much am I paying for this future growth?; (2) Will the company be able to finance this growth without requiring a lot of incremental capital; and (3) Will the incremental capital required to fund this growth result in either higher debt/net worth or a larger number of shares outstanding?

      It’s very easy to become overconfident by reading these types of reports. So, while in my view, it’s a very good bet that outbound travel including packaged holidays will increase, I try to control my enthusiasm by focusing on those three questions…

      Btw, Mr. Watsa also focused on the long-term growth potential of the outbound travel business of TCIL just after he acquired control over the company. Here’s what he wrote in his letter to Fairfax stockholders in FY12 annual report of the company:

      In 2012, we purchased 77% of the publicly-listed Indian operations of Thomas Cook UK. Thomas Cook India has a storied past, beginning 132 years ago transporting the personnel and cargo of the British East India Company to and from England. It also transported the Rajahs and Nawabs (Kings of India) to Europe and thus was born a travel and foreign exchange business. Thomas Cook India is the largest foreign exchange company in India with 154 foreign exchange bureaus in all the major airports and cities and the leading bank note remittance company in India, handling in excess of $1.7 billion annually. It is also the premier travel company for tourists to India and Indians touring outside India, with 289 offices across the country. You will understand the great growth potential of this company when you realize that currently only one million Indians annually travel outside India for holidays. This compares to some 40 million outbound tourists in China and hundreds of millions of outbound tourists in the western world. Enormous opportunity indeed!

      And that was BEFORE IKYA acquisition happened…

      Also, you’ve mentioned that total outbound travel visits from India to be 1 million. The actual number in 2011 was 14 million. The number of people who go abroad on holidays was estimated to be 1 million by Mr. Watsa. We have very reliable figures about number of outbound travelers (because of passport control) but for getting estimates of outbound tourists, we have to rely on industry estimates…

  28. Prof,
    Been looking at the company for a while now. I have one question – why would Fairfax keep it listed on Indian bourses? Don’t you think they would want to delist it in future. Won’t that change things a bit – and make it hard to think in terms of decades with this company? With delisting a definite possibility, how do you approach this, esp if your main interest is in coat-tailing Mr Watsa?

  29. Sir do we find TCIL’s value primarily to the new shareholders (Prem Watsa and his interest in making TCIL an investment vehicle) or to TCIL’s travel and forex business?
    I am asking because of two reasons; Thomas Cook’s 13 years license to TCIL and Thomas Cook’s (UK) ownership status..earlier also they sold stake to DFG and bought it back from them
    Prior to Thomas Cook and Prem Watsa’s acquisition was TCIL getting license from Thomas Cook to use its brand for certain period of time? With the change of shareholding structure wouldn’t there be chances that Thomas Cook might open new subsidiary post 13 years…in that case work done by TCIL can be capitalized by new subsidiary?
    Thomas Cook’s exit and re-entry…would Thomas Cook be interested to come out from developing market like India?

    Secondly in a staffing business, how can we jusge quality of business? or we rely mostly on growth potential?

  30. Thanks sir for another pick which makes us to think.
    Request to clarify the following

    1) During Last fiscal year the Travel business has grown 14% only.Tried to find out how many Inbound and outbound travellers are there Thomas cook.
    whether the same is in increasing trend .But could not able to get the data.

    Is it because the rates/traveller/trip got increased because of which revenue is getting increased.

    2) What will be the strategy for IKYA during recession time?.If the manpower are idling Even 1 or 2 months the same will create impact in EBITDA

  31. Sir, I would like to thank you for the effort you are taking to post these lectures on this forum. I have learnt a lot and the lectures have really helped me in my quest of becoming a better investor.
    Sir, I have two questions regarding Thomas Cook
    1. What are your views on the enormous jump in contingent liabilities of the company. How have you factored them in your valuation estimates
    2. What adjustments have you made for the leases given operating lease constitutes a significant amount of the company’s expense ??

  32. Mr Bakshi, this is my first post on your blog though I have been lurking around for many years. Thank you once again for the knowledge sharing over the years.

    I went through your thought-provoking presentation and the subsequent Q&A, which gave many good insights and answered many of the questions I had. The following questions remain unanswered though… maybe you already know the answers:

    (a) If TCIL is planning to build its own brand, what would distinguish it from (say) a Cox & Kings which would be (probably) more recognizable than a newer brand?

    (b) Why would an outbound traveller prefer brand x to brand y … wouldn’t it finally be a commoditised service? If the only distinguishing factor is branch network, how difficult would it be for a competitor (or several localised competitors) to build a network over time … TCIL would have the lead, but why can it not lose this advantage over time?

    (c) We may get an idea if info is available on the leisure travel industry in China with market share/profitability of key players. This may also help in understanding whether the industry’s future direction in India may be domination by a few large players or may be fragmentation.

    1. The brand problem is an important one. Management feels that they will be able to build one before the rights to this one expires. Alternatively they will renegotiate with Thomas Cook when the time comes, to extend it. From Thomas Cook UK’s perspective it will make sense to do that, in my view. This does not appear to me, as of now, to be an insurmountable problem.

      Building a distribution network takes a lot of time and money. Take a look at the finances of makemytrip. They are in tatters. A holiday is not a commodity. It’s not just a combination of airlines tickets, hotel rooms, sightseeing and shopping. It’s an emotional, memorable experience. Companies that can help people create those memorable experiences through excellent service quality at an affordable prices will enjoy brand loyalty. This is a “making-people-happy” business and averaged-out experience of a TCIL client is very very good. If it wasn’t then the company would have gone out of business long ago. But small mom-and-pop travel agents are going out of business slowly. Why? Because they don’t help in creating memorable experiences. They help in getting people cheap tickets, hotel rooms etc. Companies which can deliver good memorable experiences on a scalable, repeatable, consistent basis will do well. Indians have only just started travelling out. Over the next decade or so the number of people who will go abroad on packaged holidays will grow many times over. There is huge growth potential for players who can offer consistently good quality offerings at affordable prices. Just take a look at the prices at which TCIL offers holidays. As I write this, you can spend 4 nights and 5 days in Dubai for Rs 47,000 (starting price). The number of people who have never been to Dubai, and who can now afford to pay that price, is large. That segment of the population is going to explode over the next few decades…

  33. Article in China Daily (dated Jan 9, 2014):
    At 97m and growing, China has most outbound tourists


    Ninety-seven million Chinese traveled abroad in 2013, beating the 2012 mark by roughly 14 million, according to the China National Tourism Administration. The number is expected to surpass 100 million this year.

    The report released on Wednesday by the Tourist Research Center of the Chinese Academy of Social Sciences said that China’s tourists have had the world’s strongest purchasing power since 2012. They overtook German and US tourists as the world’s biggest-spending travelers in 2012, spending $102 billion overseas, a 40-percent increase from 2011.

    Most Chinese tourists traveled to Asian and European countries, the report said, accounting for 75 percent of overseas tourists in those countries.

    “Chinese tourists spend so much abroad that some foreigners are calling us the ‘walking wallets’, ” Song said, who added that Chinese travelers who purchased luxury products during the 2012 London Olympics led Britons to coin the term “Peking Pound” for Chinese spending power.

    The report said Chinese tourists spent on average $7,107 per person during their trips in the US in 2011. The average amount of spending by a tourist in the US that year, according to the US Commerce Department, was $2,440.

    With increased spending and traveling by Chinese travelers, more travel service providers in foreign countries are adjusting their business models. Hotel groups, including Hilton Worldwide and Starwood Hotels & Resorts Worldwide, have designed new services specifically for Chinese customers.

  34. Using my contacts in China, I have some information and insights that may be relevant for the discussion here.

    (a) My search for top Chinese tourism companies led me to this:
    most of outbound travel companies are government owned or ex-government departments or joint ventures with government agencies. Local laws play an important role for this phenomenon.

    (b) The outbound tourism market is highly fragmented (read this with comment 1c below). Personal contacts, relationships and network play the most important part in winning an outbound tourist (individual) as a client. This is due to local laws that restrict who can become an outbound travel company and that require a high capital adequacy.

    (c) When the outbound tourist books through a travel company, his “real” travel agent may be different. There are several informal and formal channels in the Chinese tourism market. The decision maker on who the travel company would be is not the tourist, but his travel agent, who may be (a well-connected) individual or a local company.

    (a) One of the key data points used by Mr Prem Watsa is the 40 million outbound tourists from China (an emerging market that is looked at as a precursor to what will happen in India 15-20 years hence).

    I updated this with a recent news article which took this number to 97 million (see my earlier comment above).

    (b) This information on number of outbound tourists for China needs to be seen in light of the following:
    > this includes travel for business and government purposes, which is a significant part in China. This means that non-tourists are also counted as tourists.
    > travel to Hong Kong, Taiwan and other Chinese regions is counted as outbound travel. Hong Kong is the No. 1 travel destination for outbound Chinese.

    (3) Two other matters that pertain to China but which are not relevant for India are:
    > Chinese outbound travel (including tourism) was highly restricted and Chinese were not allowed to travel outside China. Even today, travel outside China requires government approval and involves many restrictions. This is due to the political system there (eg, consideration of whether the person traveling abroad would return to China or not). There were/ are no such restrictions in India. This could have created a pent-up demand in China.
    > over the past many years, the Chinese currency Renminbi (RMB) has been continuously appreciating against foreign currencies which makes foreign travel cheaper every year.

    Considering the above, when considering the potential for Indian outbound tourism, does it seem:
    (i) that the China outbound tourist numbers are comparable?
    (ii) that a comparison with the China outbound tourism industry is relevant ?

    I think not on both the counts. Or, am I making a mistake?

  35. Today’s ET says that Thomas Cook is likely to make an offer of Rs. 125/share to acquire Sterling Holiday Resorts, a premium of 32% above market value.

    Looks like Thomas Cook is on way to become a great value holding company as well.

    Two questions: In the US, whenever A makes an offer to buy B at a premium, B’s share price quote, within minutes, reaches the offered price even for market transactions, even if actual M&A is yet to happen.

    In India, despite news of the above likely premium offer, Sterling is still quoting below Rs. 95. Any idea why? Aren’t markets supposed to be efficient and all available information ( at least such publicly available and important info) to be reflected in price?

    Secondly, Is Rs. 125 a good deal for Sterling shareholders? Like Relaxo and Thomas Cook themselves, Sterling has a great growth path ahead of itself. Should the shareholders give up the company at this price at all?

  36. “I prefer to think about this growth potential by asking asking three questions: (1) How much am I paying for this future growth?; (2) Will the company be able to finance this growth without requiring a lot of incremental capital; and (3) Will the incremental capital required to fund this growth result in either higher debt/net worth or a larger number of shares outstanding?” – Superb.

    Sir, will the above three rules change in case of a company which by nature of business itself is leveraged, say an NBFC for example. First two rules I am sure will remain same. Not sure about third, because in case of an NBFC leverage will increase if growth picks up.

  37. Thomas cook announced merger with sterling resorts at much more cheaper price than the street’s expectations. 120 shares of Thomas for every 100 shares of sterling. Deal is valued at 870 crores. Seems a good move. But there are few concerns that needs to be addressed. Sterling is a loss making company and it will effect Thomas cook EBIDTA margins significantly until the synergies pickup. Also might increase company’s interest expense to fund this deal. Please share your views on this move.

  38. Discovered your blog because someone mentioned about it on moneycontrol on the comment page for Thomas Cook. I am sold on this investment idea. If real estate can reap such huge benefits for two decades because of Indian demography, then tourism should too.

    1. With acquisition of Sterling by Thomas Cook, it looks like Club Mahindra would become the main competitor. It’s good because the customers of Mahindra are highly unsatisfied and there is no strong number 2 in the industry. Infact, a look at the notes to accounts in annual report of club mahindra for gains from securitiaation (note 27 or 29 I think) tells you that they have been reversing 30 to 40% of gains from securitisation done every year. I am not sure, but this could mean that 30 to 40% of new customers are cancelling their contract every year.

      As a potential customer I always believed that they highly overcharge their customers. Rs. 60,000 per year for a week of holidays. You would get a room at Taj in Colaba for a week in that much money. Is there a bloodbath in timeshare industry coming?

      Infact, even now Club Mahindra looks like a value investment. Their balancesheet looks more like that of an NBFC 🙂 . Looks like they have 1300 crores of cash advances from customers, which would be free money. Market Cap equal to that of Thomas Cook, but much higher revenues, profits, cashflows and advances from customers too.

  39. Dear Prof,

    Wanted to understand your thought process on the deal of TCIL and SHRL. Without getting into the question of whether INR 870 crs is a good price for SHRL, I have few questions:
    1. There seems to be a large dilution in the equity of TCIL. Is that comforting?
    2. Having tracked MHRIL and hotel industry for almost 4 years as a sell-side analyst, world-wide large hotel industry players have moved away from asset heavy model to franchise model. Future BS of TCIL will continue to become more heavy if they keep on adding locations. Again is that comforting?

    Thanks and regards,

    1. Dear manav
      As now it have become prem watsa’s investment vehicle chances are there he have taken a call on the underlying real estate ..as the real estate prices are set to further move multi-fold and i feel he have got the properties very cheap .
      what could be the effect on the book value of the merged entitiy remains to be seen
      please share your views


      1. Vijay,
        Using the real estate value along with the business value to justify a price remembers me of 2007. A very prominent brokerage house was justifying a BUY on Infosys by adding the value of real estate on which the offices are located. If Sterling Holidays (SH) has been bought because the value of its real estate is very high compared to its price paid, then to me it is a bad business decision. For the simple reason, SH should be bought because of its brand, membership base and a unique concept. All the SH resorts are located fairly away from the street. So there can’t be any alternative use of that asset (either commercial space or residential space).

        What could be the value of merged entity, I don’t have an answer for this question as of now.


  40. Dear Prof.,

    Eager to understand your thoughts on TCIL’s equity dilution and getting into an asset heavy model.

    I’ve seen Sterling resorts properties in Kodai, Ooty and Swamimalai. I feel that underlying real estate would be much more valuable than the deal amount.

    TCIL has said that the new entity would be roughly valued at Rs.3000 crore. Would there be an increase in book value though there is dilution in equity?

  41. Some thoughts on the Thomas Cook-Sterling Holidays deal:

    1. The target company (Sterling Holidays) owns 19 resorts. As of 30 Sept 2013, the target had Rs 419 cr of assets. Of these, assets amounting to only 24 cr were funded with interest bearing debt. Deferred revenue (float represented by money taken in advance from members) was Rs 255 cr. So, while the business model is asset heavy, it’s “equity light” without utilizing significant and onerous interest bearing debt.

    2. The target company has been operating at a low utilization rate of less than 50%. This is a business with high operating leverage and additional revenue should largely translate into additional earnings. Thomas Cook can divert business away from hotels (to whom it will have to pay a part of the total package holiday price charged from its customers) to resorts. While I don’t know how big this number would be, I believe it could be significant.

    3. As of 31 March 2013, the target had accumulated losses of Rs 331 cr. Upon merger with Thomas Cook, these losses will help Thomas Cook save taxes. If all of these losses are available for tax set off, Thomas Cook (the standalone entity) will not be paying any taxes for at least the next few years.

    4. The deal structure is very creative. First, by doing market purchase of shares of the target and a preferential allotment of shares by the target followed by a tender offer, it has been assured that even of the deal fails at the merger stage (as happened in the case of Grindwell-Saint Gobain deal), Thomas Cook will still have control over the target. Very creative. Second, the acquirer is not Thomas Cook but it’s subsidiary. The tender offer has been made by the subsidiary and not Thomas Cook (although Thomas Cook is a person acting in concert). Why? That’s because once the acquisition is over, the merger process will begin and under the terms of the merger, the target will demerge its operating business into the acquirer (Thomas Cook subsidiary) but Thomas Cook will issue 116 shares to the target company’s shareholders for every 100 shares they own. Then, the remaining target company (which I presume will have nothing but tax losses) will be merged with Thomas Cook, for which it will issue 4 shares in itself for every 100 shares in the target. This will ensure two things. One, the tax losses will come to Thomas Cook where they are most needed as discussed above. Two, of the total shares Thomas Cook will issue in itself to the shareholders of the target, a large number of shares will be issued to it’s own subsidiary, which I presume will be cancelled (but I am not sure about that as the merger document is not available).

    5. Thomas Cook will issue additional shares for this deal for two reasons: (1) to convert the fully convertible preference shares being allotted by it to Fairfax group; and (2) shares issued to outside shareholders pursuant to the merger. Of these, the number of shares issued under (2) is uncertain because one does not know the response to the open offer. However, every Target Company share that is tendered under the open offer to Thomas Cook subsidiary or acquired by that subsidiary in open market purchases (it has been buying target company shares in the market), will be a share which will not be converted into 1.2 Thomas Cook shares. Seems like Thomas Cook wants to minimize dilution.

    6. Why was the deal financed partly with cash and partly with shares? I think the reason has to do with aversion to debt. If the deal was structured as a plan-vanilla cash acquisition, then either the target company and/or Thomas Cook would have to resort to debt to finance it. Does that mean that financing with undervalued stock makes it a good idea? Not necessarily. However, we should keep in mind two facts. Fairfax bought into Thomas Cook at about Rs 53 and is now buying at 80. And the stock price is below 80. So, people who are worried about getting diluted can easily cancel that dilution by buying shares at below 80. Here is the key point: Without the preferential allotment of convertible preferred to Fairfax group by Thomas Cook, the merger would have diluted Fairfax stake in Thomas Cook. Fairfax cancelled that dilution by buying new shares at 80 and since the stock is below 80, any stockholder who is concerned about dilution can also do the same by buying in the market – on better terms than Fairfax. So, as long as the price is below 80, current stockholders should not grumble too much about dilution! But see point 7 below.

    7. Is this a good deal? Time will tell. The answer will largely depend upon the realization of synergy that can potentially come from the deal and also how the target company can grow its float- a concept that someone like Mr. Prem Watsa understands quite well.

    8. Oh, one more point. The real estate assets of the target company were last revalued in 1999 i.e. 14 years ago.

    1. Mr Bakshi,

      (1) Since TCIL is the investment vehicle for Fairfax, they would make all acquisitions through TCIL. Does this mean that every time an acquisition is made and TCIL cannot finance it itself, Fairfax will keep pushing money into it and keep diluting the equity?

      (2) Mr Watsa of course realises that equity dilution is far costlier than a cash purchase, specially when your company’s stock is not far over-valued. However, because in this case, the dilution would be costlier only for minority shareholders it should be okay for Fairfax. My view is that Fairfax made this decision only to protect itself from shareholding dilution, not because TCIL needed the money.

      (3) Diluting equity through preferential allotment seems unfair to minority shareholders. Minority shareholders buying additional shares from the market is not a solution… if all of them were to do so, the market price can increase beyond the preferential allotment price. Also, it means a forced additional allocation of capital for the minority shareholder.

      Although not the best solution, a better way could have been to have a rights issue, where all shareholders have an equal right. If the minority shareholder does not want to allocate additional capital, s/he can sell the rights and realise part value.

      The best solution for Fairfax to increase stake would have been to make an open offer for TCIL. It is beyond me why they would not just delist the company earlier (than later) if they see such a high scope for growth for TCIL in future.

      1. Making an open offer would have triggered SEBI’s delisting norms. My understanding as of now is that TCIL wishes to remain a listed company for multiple reasons one of which would presumably be that it provides it with a currency other than cash for inorganic growth.

        TCIL did need the money for the acquisition. Just replace the amount of cash infused as equity into TCIL by Fairfax with equivalent debt and then think if that would have been a good idea for TCIL to borrow or not. I think you’d conclude that it would not have been a good idea. The business model of time shares should not be financed with interest-bering debt. (It doesn’t matter if that debt resides on the target’s or the acquirers’s balance sheet).

        However, your thoughts about the need to use equity sparingly, if at all, are correct as well.

        1. The business model of time shares should not be financed with interest-bering debt. (It doesn’t matter if that debt resides on the target’s or the acquirers’s balance sheet).

          Mr Bakshi, I am struggling to understand why a distinction should be made for debt raised at the TCIL level between one business and another. Can you help me?

          (1) In general,
          (a) I have seen that capital structuring decisions are made at the consolidated level for continuing businesses.
          (b) Most segment analysis ignores interest costs for continuing businesses.
          (c) When we look at Enterprise Value (EV), we look at Earnings before Interest and Tax (EBIT) so as to neutralise the capital structuring decisions.
          (d) In my Corporate Finance experience as well, capital structuring decisions were not made at the operating business level, and specially when the operations were integrated.

          (2) In specific,
          (a) the logic for making TCIL as an investment vehicle was to utilise it’s stable and increasing cash flows for acquisitions. This is a decision at the consolidated TCIL level, not at a operating business level.
          (b) by adding equity at the TCIL level for an acquisition at the operating business level, they have effectively made a capital structuring decision at the TCIL level. Sterling business does not receive any fund infusion, neither debt nor equity.
          (c) the logic for Sterling buy out is to obtain synergy benefits at the operating business level. The benefits of the takeover will be combined at the operating level, but the capital costs of the takeover should be separated?
          (d) If debt is costly at the Sterling level, equity is even costlier at the TCIL level. I don’t understand why it makes sense to bifurcate the capital structuring cost at the operating level, when the capital structuring risk is actually at the consolidated level, specially when the businesses will integrate at the operating level.

          Request to help me understand. Would be grateful if you can suggest any place I can read up more on instances where the capital structuring decision is made at the operating business level for continuing businesses where the operations are integrated.

  42. Sir, what you think about the price being paid. To get 8% post tax return on investment the company has to consistently generate 70crs of post tax cashflows.

    1. Jatin, I don’t have firm views on that yet. As mentioned in my note, the potential synergies have to be quantified. In my view they could potentially be significant but I haven’t got a handle on that yet. For TCIL, the returns on this investment, if any, would depend primarily upon: (1) How quickly the un-utilized capacity at Sterling can be filled up with the help of TCIL?; (2) How much of the past accumulated tax losses in Sterling will be available for shielding TCIL’s pre-earnings from taxes and how quickly can they be utilized?; (3) How much and how quickly could Sterling grow its business by building its float (on favorable terms) under a new owner; and (4) How much of the acquisition cost could be reduced through sale of Sterling’s assets having higher resale value than earning power value?

      Those are the variables I would focus on over the next couple of years to determine the success or failure of this deal.

    1. Dear Prof, Its been great reading Mr.Prem Watsa letters..he really does have a lot of confidence and respect for all his managers and arguably the key criteria along with valuations of course speaking of which could you shed some light on why he prefers ’10 times’ free cash flow existing or expected for TCIL and Sterling?

  43. dear prof., i have been reading your blogs recently and i have learned a lot. i have 1000 shares of sterling holiday and i am long on this. how many shares i will be assured after the merger. is open offer compulsory for retail investor. please guide

    1. You’ll get 1,200 shares of Thomas Cook if the merger goes through and you have not tendered in the open offer. Even if you tender, some shares may not be accepted, which would then get converted into Thomas Cook shares if the merger goes through.

      1. sir thanks, 2 points to clarify
        1) i think that thomas cook would prefer to reduce the dilution of shares then they might accept all the shares which are tendered.
        2) also, want to know about the other big shareholder strategy of sterling holiday i.e. rakesh jhunjhunwala, damani & other genuine long term investors of sterling

  44. Dear Sir,

    I’ve bought and continue to buy ‘Thomas Cook’. No doubt that your detailed analysis was the reason for the same. Being ’greedy’ to be a long term investor, I’ve a doubt. What are the chances that TCIL may choose to de-list in future? Or will they give chance for minority shareholders like us to have a continued side car journey along with Mr.Prem Watsa?

    1. Please don’t buy the stock because I bought it. I could be wrong. In the past, I have been wrong.

      Use the cases I put up to learn the principles I have used to evaluate businesses and not as a tip sheet.

      1. I’m definitely learning from your writings. I’ve been reading your old blogs written many years ago as well. When you use a live case and if I find the reason convincing / compelling, I would like to buy the scrip as well. The intention is not to use your writings as tips. At the same time I don’t want to close myself to opportunities that look compelling to me.

        I read your blog on Piramal after buying the same. Whereas I bought Thomas Cook after reading your blog. As on date, I don’t own any other stocks you’ve written so far other than the above two. But I may buy something you write / have written if I feel so in future. I cannot guarantee:-) Your piece on buying quality (what happens when you buy quality..) was intensely discussed among a group of us in Chennai who follow your writings regularly.

        A fundamental question: Why shouldn’t I buy something I like from your writings provided I’m willing to take responsibility for my decision and accept the risk associated with the same (and reward too:-), don’t intend to share profits with you:-))

    1. Good questions. It would have been nice if TCIL has mentioned the answers as well in the exchange release. Any opinion from you on my yesterday’s query whether TCIL may be delisted in future?

  45. Hi Prof et al,

    I am a full time investor based out of Singapore. I have been following the excellent discussion here and would like to add a few thoughts:

    1. Sunset industry- In my view the role of an intermediary whether physical or online will be greatly diminished over the years as travellers start booking directly. For example I usually take around 3 family vacations per year and have never stepped inside a travel agents office or logged into an online agent for quite some time. I directly book flights through the very user friendly interface of budget airlines or an aggregator such as Zuji and book hotels through booking.com or directly with the hotels if there are special deals. This method works fine unless one is going on customised tours such as visiting craft breweries in California or wine tours in Romania in which case one would visit specialised operators. I recognise India is not there yet but will head in that direction ( at-least tier 1 cities) over time likely faster than we think.

    2. Cash flows- TCIL generates high operating cash flows and FCF largely due to the nature of its business where it receives advance payment from customers and does not need much capex. This is common among people based service firms and nothing unique to TCIL. It will ultimately be higher sales and EPS growth that will drive long term valuations. Many service firms stumble there as it is difficult to carve out a moat and keep competitors out given low barriers to entry.

    3. IKYA- I haven’t done a deep dive on this business but stock prices of global HR firms such as Manpower, Robert Half, Adecco and Michael Page shows that there hasn’t been much long term value creation for investors although they all boast zero net debt and good cash flow generation.. I suspect it is because of the competitiveness, cyclicality and the commodity nature of the business. Companies have no qualms on changing HR firms as switching costs are minimal to none. I am also not convinced that national scale offers much of a competitive advantage as this is inherently a local business. A company say in Lucknow simply needs a good pool of local staff which local firms should be able to provide.

    My intention is not to be negative on TCIL. I actually like the business but am just challenging my own initial thesis.

    Views welcome. Thanks.

    1. Thanks Bobby. Those are good points. My response:

      1. Before the sun sets on this industry, it will be rising for a long long time. It important to form views based on actual data rather then perceptions formed from one’s own opinions. I haven’t used a travel agent for a holiday for more than a decade. I don’t wear Relaxo flip flops. I don’t wear Killer Jeans either. Nor do I use Bajaj almond oil or any hair oil for that matter. I don’t use products made by Page Industries either. But the business volume growth experienced by companies who manufacture these products tell a different story. We should create our opinions based on actual, verifiable facts and not personal impressions because personal impressions are very often not representative of underlying reality. Coming to holidays’s take a look at what’s happening in China. Every year tens of millions of Chinese go abroad on packaged holidays. Most of these are people who don’t want to spend too much time planning a holiday. The same thing is happening in India. The big driver of this trend is urbanization. Drawing inferences from a population which is largely urbanized, and highly educated and applying them to a developing economy where hundreds of millions of people haven’t even seen a city let alone a foreign country would be wrong. In the very long run, I agree this would be sunset industry, but as of now outbound travel volumes are growing at more than 25% a year.

      2. You’re right, the packaged holiday business has favorable working capital cycle as customers pay in advance. Nothing unique about that for TCIL. But TCIL doesn’t just do holidays. It also does forex, which by the way would be a sunset industry much earlier than the holiday business. Over time, as the proportion of outbound holidays grows, TCIL’s balance sheet will reflect that change. Forex is working capital intensive. Travel is not. As travel grows, the balance sheet improves… Secondly, the advantage TCIL has in holidays comes from scale of two types. One is distribution network spread all over the country. Second is the cost advantage in buying travel components. Small travel agents cannot compete with TCIL on that. While anyone can enter the Travel business, it will be very difficult to be profitable without having the scale advantages TCIL has. TCIL also has a brand (at least for another decade or so) which helps…

      3. Let’s just compare IKYA with one of the companies you mentioned— Manpower. IKYA has 70,000 employees placed with its customers. Manpower has 600,000. IKYA had revenues of about $$200 million (annualized revenues for 2013) while Manpower had revenues of $20 billion in 2013. Revenues are flat for Manpower because it largely operates in saturated markets with low population. That kind of of a scenario is a long way off for IKYA. When it was acquired by TCIL last year, it had 45,000 employees. Now, it has 70,000. Even though the growth has been great, IKYA’s current size in relation to the size of India’s workforce, is a rounding error. Watch the profitability too. IKYA is more profitable than any of its global peers.

      1. Thanks for your enlightening comments, prof. I can’t say I really disagree with anything you have said. Few more thoughts from my side from a different angle:

        1. I would tend to agree with you that based on India’s stage of development travel agencies won’t die a quick death. That is what conventional thinking would dictate however I am reminded of an example where such thinking didn’t quite work. Let me elaborate. In 2004/ 2005 investors were clamouring to get into China to tap the coming retail boom and why not? 1.2bn people, super fast GDP growth, rising incomes, urbanization etc. One of the golden areas was developing malls where the masses could shop, Singapore and HKG real estate players used to buzzing and extremely profitable malls in their home countries were the first ones to dive in and start a mall building frenzy all the way to tier 3 cities. Fast forward 8 years, I recently was on an investment trip to several cities in China ( shanghai, Foshan, Shenyang, Chengdu etc.) guess what? The malls are all empty… the Chinese – especially the young- have taken to the internet shopping in a way that no one could have even imagined possible a few years back. The thinking at that time was that even in advanced countries such as the US, UK and Australia internet sales was a mere 5% of total sales, a developing country like China would take quite some time to get to even those levels. Chinese today are the world’s savviest internet shoppers and many do 100% of their shopping over Taobao their popular marketplace. Over the past 5 years they have leap frogged all the developed countries in internet shopping.

        2. In terms of competitive advantage, I can think of three sources- price, variety of packages, customer service/efficiency. Out of these three I think only price can give a true edge as the other 2 are replicable. You mention that scale allows them cost advantages, are they passing it on to customers or using the advantage to increase their own margins? If they position themselves as the lowest cost package provider and deliver that promise, then yes it is a true edge they have over competitors. However if they think their Thomas Cook brand can afford them to not compete on price or worse price at a premium that would be a big mistake. I haven’t come across any global examples of travel agencies with a durable moat though so not sure how this will pan out.

        3. IKYA- I take your point that IKYA and the western HR companies are in different stages of their life cycle and hence cannot be compared.




  46. Hi Prof

    What do you think of current arbitrage opportunity between Thomas Cook and Sterling holidays Shares as the merger ratio is 1.2 shares of Thomas Cook for every share of Sterling. If one buys shares of Sterling @ 93 (CMP) his acquisition cost of Thomas Cook will be @ 78.4 and CMP of Thomas Cook is Rs 88.
    I think as a long term Investor I can additionally earn a risk free profit of almost 12% ?

  47. sir,
    i would like to know when will the merger happen and i see in the future sterling will generate huge positive cash flow in the future for thomas cook and also sterling may start giving positive result.

  48. Sir,
    I am a long term follower of your blog, I am very thankful to you, thank you very much.
    Sir, I am writing this as the links are not working, please help.
    Also is it possible to attend one of your lectures.

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